Wellington Fund, Inc. v. Commissioner

Wellington Fund, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent Wellington Fund, Inc. v. Commissioner Docket No. 112046 United States Tax Court 4 T.C. 185; 1944 U.S. Tax Ct. LEXIS 43; October 11, 1944, Promulgated *43 Decision will be entered under Rule 50. 1. Where approximately 98 percent of the business of petitioner, organized for the purpose of holding, investing, or reinvesting in stocks and securities, was of that character throughout the taxable periods involved, it is held that such percentage constitutes "substantially all" of its business within the purview of section 361 (a) (1) of Supplement Q of the Revenue Act of 1938, and the Internal Revenue Code. 2. On the facts it is held that a note for $ 75,000 held by petitioner during the two taxable periods involved and evidencing a loan in that amount made by petitioner for a 12-month period to meet current expenses of the borrower did not constitute a "security" of the borrower within the meaning of section 361 (b) (2) of Supplement Q of the Revenue Act of 1938, and the Internal Revenue Code. Lewis M. Stevens, Esq., for the petitioner. William D. Harris, Esq., for the respondent. Leech, Judge. LEECH *186 Respondent has determined deficiencies in income taxes of $ 21,946.29 for the fiscal year ended June 30, 1939, and $ 15,625.40 for the period July 1 to December 31, 1939. The issue presented is whether petitioner*44 in the two taxable periods involved was a mutual investment company within the defining provision of section 361 (a) (1) and the limiting provision of section 361 (b) (2) and entitled to have its taxes computed under section 362 (a) and (b) of the Revenue Act of 1938 and the Internal Revenue Code. The parties have stipulated certain of the facts and others were established by testimony upon hearing. FINDINGS OF FACT. Petitioner is a Delaware corporation, organized December 28, 1928, with principal office and place of business at Camden, New Jersey. For the periods here involved it duly filed its returns as a mutual investment company as defined by section 361 of Supplement Q of the Revenue Act of 1938, and the Internal Revenue Code, with the collector of internal revenue for the first district of New Jersey at Camden, New Jersey. The Pantepec Oil Co. of Venezuela, C. A., (hereinafter referred to as "Pantepec") is a Venezuelan corporation engaged in the business of exploring and exploiting oil bearing lands. On August 19, 1938, Pantepec was indebted for delinquent taxes in the amount of approximately $ 291,000. At that time it had an authorized capital of 3,000,000 shares of common*45 stock of a par value of one bolivar each, of which there were issued and outstanding 2,701,872 shares which, based upon the current market price, were valued at $ 12,496,158, or $ 4.625 per share. On that same date Pantepec held 298,128 shares of its common stock in its treasury. No other securities of Pantepec were outstanding at that time and it had no funded debt. Although the properties owned by Pantepec were of great value, they were as yet undeveloped. It was without sufficient funds to meet the tax indebtedness above mentioned and was desirous of obtaining a short term loan of $ 175,000, having negotiated a sale of certain of its treasury stock to English interests, from the proceeds of which the loan would be repaid. *187 On August 16, the board of directors of Pantepec adopted a resolution authorizing its president to obtain a loan of $ 175,000, bearing interest at 4 percent, to be unsecured and evidenced by a note or notes containing an agreement that the borrower (1) would not borrow any additional funds which, together with any unpaid balance of the $ 175,000 in question, would exceed $ 300,000 in the aggregate, (2) would not grant any security taking precedence*46 in payment over the loan of $ 175,000, and (3) would furnish to each noteholder, after the close of each calendar month, a statement of all additional obligations assumed or indebtedness incurred by it or any of its subsidiaries. This resolution also authorized the issuance of 5,000 shares of the treasury stock then held by Pantepec to the lenders of the $ 175,000. Petitioner, together with others, was approached by one Allen, an independent financial promoter, to advance the necessary funds as a loan to Pantepec. On August 19 the petitioner advanced $ 75,000 to Pantepec, receiving a note in the form authorized by the board of directors of Pantepec, as above set out. Petitioner then received, for furnishing this sum of $ 75,000, 2,143 shares of capital stock of Pantepec of the 5,000 shares authorized to be given for the furnishing of the needed funds. These shares were received and held by petitioner as its absolute property. Their fair market value on August 19, 1938, to wit, $ 4.625 per share, was included by petitioner in income on its return for the fiscal year ended June 30, 1939, in the aggregate amount of $ 9,911.38. In addition to receiving the shares of stock of Pantepec, *47 as above detailed, petitioner received from the aforesaid Allen, as consideration for its making the advance of $ 75,000, the sum of $ 1,700 representing one-half of Allen's net commission from Pantepec for negotiating the transaction. This sum petitioner also reported in income for the fiscal year ended June 30, 1939. Pantepec, on its books, charged the value of the stock thus issued as expense incurred and paid on the date the loan was made and entered the note given to petitioner in its "notes payable" as a current account. The note of Pantepec received by petitioner was reflected on the books and accounts of petitioner as a "note receivable." On December 28, 1938, petitioner sold the aforesaid capital stock of Pantepec received in this transaction for a net sale price of $ 13,929.02, which exceeded by the sum of $ 4,017.64 the amount included by it in income on account of the original receipt of the stock. This amount of $ 4,017.64 petitioner included in income on its return for the fiscal year ended June 30, 1939. On August 17, 1939, the note of Pantepec held by petitioner was repaid in full in the amount of $ 75,000, plus interest then due thereon. Petitioner in its income*48 tax return for that period included no sum as representing income from the receipt of the aforesaid $ 75,000. *188 The making of the aforesaid loan of $ 75,000 to Pantepec was not one of the accustomed transactions of petitioner's business. Transactions by petitioner other than purchases and sales of stocks and securities were rare and only in nominal amounts. In 1929 it made some purchases of call loans and in 1933, some commodity futures. The balance sheet of the petitioner, as of the close of the fiscal year ended June 30, 1939, shows its investments in stocks and bonds in the sum of $ 4,452,383.34 and its balance sheet as of December 31, 1939, shows such investments in the aggregate amount of $ 5,021,521.96. During the two tax periods here involved petitioner was a mutual investment company within the purview of section 361 and entitled to have its tax computed under section 362 of the Revenue Act of 1938 and the Internal Revenue Code. OPINION. The purpose of those provisions, it is clear, was to extend relief to genuine mutual investment companies which diversified widely their security investments and thus did not occupy the status of holding companies, but merely permitted*49 their shareholders to obtain the benefit of such diversified holding even with a small investment. 1 The defining and limiting provisions are all framed to eliminate companies which are not strictly of that character. They must be organized and operated for that purpose and may not hold more than 10 percent of the stock or securities of any one corporation. Substantially all of their business must be of an investment and reinvestment character. They are required to distribute their earnings currently and their shareholders must be permitted to withdraw their investments. Respondent does not contend that petitioner is not a company of this character. He argues only that because of a single, isolated transaction originating in the first taxable period and culminating in the second, and which was not of the usual and customary character of petitioner's investment operations, it has, for those periods, forfeited its rights to the benefits extended by those provisions. *50 Thus respondent first contends that the note for $ 75,000 of Pantepec to petitioner, maturing in 12 months, was a "security" within the purview of section 361 (b) (2) of the Revenue Act of 1938 and the Internal Revenue Code. 2 Upon this premise it is argued that, since *189 Pantepec had no outstanding bonds or funded debt, petitioner owned $ 75,000, more than 10 percent, of the total of $ 175,000 in outstanding securities in Pantepec. Consequently, it is then said, petitioner is barred by the limitation of the quoted statutory provision from the advantages of being taxed under section 362 (a) and (b) of the Revenue Act of 1938 and the Internal Revenue Code, as a mutual investment company. Respondent*51 contends that the transaction must be treated as a purchase by petitioner for $ 75,000 of a note in that amount, together with 2,143 shares of Pantepec stock; that on such purchase petitioner received a rebate of $ 1,700, leaving a net cost to it of $ 73,300 for its "investment"; that this cost is to be prorated between the note and the stock received; and that, on the cost basis so allocated to each, petitioner's profit on the payment of the note by the borrower and the sale of the stock by petitioner is to be separately computed. The pertinent statutory provisions do not include any definition of the term "securities." We see no reason to assume, therefore, that such term was used with any other than its ordinary meaning. The question of the meaning of the term "securities," as used in various revenue statutes, has been considered by the courts in a number of cases. The rule appears to be settled that, where such an act does not define the term, it denotes an obligation of a character giving the creditor some assured participation in the business of the debtor, or, in other words, an investment in the business, and that the term does not include evidences of indebtedness for short*52 term loans representing temporary advances for current corporate needs. ; ; certiorari denied, ; ; . In our recent decision in , we held that a creditor holding three, four, and five-year notes of a corporation, evidencing advances made to meet current liabilities, was not, because of that fact, a holder of securities of the corporation, since such notes could not be considered investments in the business and thus did not constitute securities within the purview of section 112 (b) (3) of the Revenue Act of 1936. Here the note in question matured in only 12 months. It was unsecured. The funds were obtained by the borrower to meet a temporary need for cash to meet current expenses. There is not the slightest*53 indication that the contract contemplated an investment by petitioner in the borrowing corporation. It was purely a short term loan, and it was treated by both the borrower and the lender as such, being recorded by the former as a current liability and by the latter *190 as a current asset. As a loan to be repaid in 12 months, this appears to be strictly in accord with accepted accounting practices. We hold that the note received by petitioner, evidencing its 12-month loan of $ 75,000 to Pantepec, was not a security within the purview of section 361 (b) (2), supra. It follows that petitioner has not, under that section, forfeited its rights here as a mutual investment company. We do not agree, moreover, with respondent's contention that the contested transaction constituted a purchase by petitioner for $ 75,000 of a note in that amount together with certain stock of Pantepec and the receipt of a rebate of $ 1,700 on the purchase price. We think that both the stock received by petitioner and the share of the commission of the loan broker were consideration paid to petitioner for making this loan to Pantepec. As such consideration, they constituted income to petitioner*54 when received and its action in so reporting them was correct. ; affd., ; ; . It is respondent's second contention that if the note for $ 75,000 received by petitioner in its transaction with Pantepec be held not to be a security for present purposes, it is then not an investment in stock or securities by petitioner. It is then argued that petitioner is barred from being taxed as a mutual investment company, since it fails to meet the requirements of section 361 (a) (1) 3 that "substantially all of its business consists of, holding, investing, or reinvesting in stock or securities." (Italics supplied.) It is urged that in determining whether "substantially all * * * [petitioner's] business" consisted of the approved activities, it is only necessary to ascertain whether the precluded activities -- the loan of petitioner to Pantepec -- involved a "substantial amount." We do not agree. The wording *55 of the provision is not ambiguous and, we think, concludes respondent in that argument. The amount of the Pantepec loan is not the controlling factor. It is the percentage or proportion of all of petitioner's business, including that loan, reflected by its investments. The words "substantially all" make that clear. They have been so construed. ; ; ; ;. *56 The evidence shows that in the two periods in question petitioner's security investment business constituted more than 98 percent of its *191 total business. This, in our opinion, is "substantially all" within the meaning of section 361 (a), supra. Respondent does not contend that the petitioner has not complied with any of the other provisions and conditions of section 361 (a) and (b), supra. It follows that petitioner was a mutual investment company, within the purview of that section, throughout the taxable periods and, as such, is entitled to the advantage of being taxed under section 362 (a) and (b), supra. Decision will be entered under Rule 50. Footnotes 1. See Hearings Senate Finance Committee (1936 Act), pp. 776-789.↩ 2. SEC. 361. DEFINITION. * * * * (b) Limitations. -- Despite the provisions of paragraph (1) a corporation shall not be considered as a mutual investment company if at any time during the taxable year -- * * * * (2) It owned more than 10 per centum of the outstanding stock or securities, or both, of any one corporation.↩ 3. SEC. 361. DEFINITION. (a) In General. -- For the purposes of this title the term "mutual investment company" means any domestic corporation (whether chartered or created as an investment trust, or otherwise), other than a personal holding company as defined in Title IA, if -- (1) It is organized for the purpose of, and substantially all its business consists of, holding, investing, or reinvesting in stock or securities.↩