Berwind v. Commissioner

Charles G. Berwind, Petitioner, v. Commissioner of Internal Revenue, Respondent Berwind v. Commissioner Docket No. 8599 United States Tax Court 8 T.C. 1112; 1947 U.S. Tax Ct. LEXIS 194; May 26, 1947, Promulgated *194 Decision will be entered under Rule 50. Payment by cash-basis petitioner pursuant to agreement that he would make good deficit, consisting of difference between proceeds of sales of securities and amounts advanced by another, held deductible as a loss in year when sales were completed and final amount due computed and paid; notwithstanding that petitioner was entitled under the agreement to any profit on the sales and has been held in a prior proceeding liable for the tax thereon. Kenneth W. Gemmill, Esq., for the petitioner. Robert H. Kinderman, Esq., for the respondent. Opper, Judge. OPPER *1112 Respondent determined a deficiency of $ 11,446.68 in petitioner's income tax for 1940 in part by disallowing the deduction of an amount paid under a contract to a corporation which had advanced funds to a trust company of which petitioner was a director and *1113 shareholder. Petitioner assails the disallowance and also claims a deduction of the profits of a trust fund created to repay the advance, which profits had been taxed to him in prior years, and of the losses of the trust fund in 1940. Facts hereinafter appearing are from a stipulation of the parties, *195 or from evidence adduced at the hearing. FINDINGS OF FACT. The stipulated facts are hereby found accordingly. Petitioner, a resident of Paoli, Pennsylvania, filed his income tax return for 1940 on a cash basis with the collector of internal revenue for the first district of Pennsylvania. Since 1920 he has been an active officer or employee of the Berwind-White Coal Mining Co. (hereinafter called Berwind-White), of which his father, Harry A. Berwind, was vice president. For many years he has also been an officer, director, and shareholder of numerous other mining, industrial, and financial enterprises, particularly Berwind-White, its subsidiaries and affiliates. In 1931 he was a shareholder in 62 companies, a director of 23, and president or vice president of 18. In November 1926 Edward B. Creighton and Thomas Fisher, officers of Berwind-White and business associates of petitioner's father, with others, organized the Penn Colony Trust Co. (hereinafter called the Trust Co.) as a Pennsylvania banking and trust corporation. At his father's instigation petitioner acquired 100 of its 2,000 shares of stock issued, and was elected a director. Since January 1929 he has held 70 shares *196 and has remained a director. On July 15, 1931, the Secretary of Banking of Pennsylvania notified the Trust Co. that its capital was impaired to the extent of $ 136,568.58 as of May 29, and ordered restoration within 15 days. At that time deposits with the Trust Co. totaled $ 1,388,958, the principal depositors being Berwind-White and persons and corporations closely connected with it. The capital impairment was caused by a sharp decline in the market value of securities held by the Trust Co., and to meet the emergency Creighton formulated and eventually carried out a plan whereby parties interested in the Trust Co. purchased from it 2 lots of securities at a price equal to what the Trust Co. had paid for them, which price was greatly in excess of the securities' market value. Under the plan Creighton himself agreed to take one of the lots at a price of $ 125,416.14. Payment therefor was made by a check in that amount drawn by Creighton's wife to the order of the Trust Co. on August 26, 1931, and on the same date the shares in both lots were transferred to Creighton's name (with exception of a small number of shares of a corporation in liquidation), and the certificates were placed*197 in a safe deposit box under the joint names of Walter J. Fallows and D. V. *1114 Johnston, as custodians for Creighton, acting for himself and/or others, with powers of attorney attached. The sale of the first lot was approved and ratified on September 22, 1931, by resolution of the Trust Co.'s directors, which recited that the Trust Co. "has sold, at cost, to Edward B. Creighton, stock of various companies, as listed." Petitioner attended the meeting as a director. On October 26, 1931, a second resolution was adopted to the effect that Creighton's offer to purchase was accepted. On September 10, 1931, the Trust Co. transferred $ 125,525.15 from Berwind-White's savings account with it as a credit to its security account, and on September 17 following Berwind-White's treasurer informed the directors that: * * * $ 125,525.15 from the funds of this Company on deposit in the Penn Colony Trust Company were withdrawn to create a loan, to be secured by a note and executed agreement, whereby certain individuals could purchase certain securities of the Penn Colony Trust Company, which securities will be held as collateral in a Trustee Account. No action was taken by the Berwind-White*198 directors at that time, but on October 26, 1931, they adopted a resolution which recited that Berwind-White had paid the Trust Co. $ 125,525.15 for the second lot of securities and ratified the "sale" and transfer of the securities to Creighton, "pending instructions from the purchaser." The second lot of securities had a fair market value of $ 50,717.15 on August 31, 1931. After protracted negotiations petitioner, Creighton, and D. V. Johnston, as trustees, petitioner, Creighton, and Thomas Fisher, as individuals, and Berwind-White on November 23, 1931, made an agreement wherein it was recited that the trustees had purchased from the Trust Co. the second lot of securities, paying therefor $ 125,525.15 advanced by Berwind-White; that petitioner, Creighton, and Fisher were financially interested in the Trust Co.; that they made the purchase to aid and strengthen the Trust Co.'s financial position and desired "to assist in minimizing any loss that Berwind Company may incur by reason of the aforesaid advance of $ 125,525.15." They then agreed: (1) To liquidate the securities in such a way as to result in a minimum loss, having full power to purchase, hold, and sell stocks, and to*199 complete liquidation by August 26, 1934, unless Berwind-White should consent to a later date; (2) to apply income and liquidation proceeds "to the repayment to Berwind-White, on or before the obligatory date for the completion of the liquidation, of the said sum of $ 125,525.15, as aforesaid advanced by it, together with interest thereon, or the unpaid balances thereof, from and after August 31, 1931," semiannually at the rediscount rate in the Philadelphia Federal Reserve District (but in no event at less than 3 per cent nor more than 5 per cent), and to make in their discretion from time to time "part *1115 payments of said principal"; (3) to render to Berwind-White a monthly statement of their acts and accounts; (4) upon repayment to Berwind-White of the principal and interest, to deliver any surplus securities or cash to petitioner, Creighton, and Fisher in the proportions which they agree as individuals to contribute to any deficiency in repayment. In case proceeds of the liquidation should not be sufficient to pay the full amount of principal and interest, the three agreed to contribute the following percentages of the deficiency: Charles G. Berwind, 27.78 per cent; Thomas*200 Fisher, 27.78 per cent; Edward B. Creighton, 16.66 per cent. It was understood that the trustees were subject to no liability for any action taken by them in good faith and that their judgment in matters connected with the liquidation should be final and conclusive. Petitioner's purpose in signing his contract was the protection of his business and investments. He was a member of Berwind-White. Its good name was affected. The Trust Co. was known as the Berwind Bank. At a directors' meeting of December 17, 1931, Berwind-White's president stated that Berwind-White and its subsidiaries and affiliates had about $ 875,000 on deposit with the Trust Co.; that demand had been made on the company to make good the impairment of its capital; that Creighton had purchased one lot of its securities at a price equal to cost to the Trust Co.; and that at the request of the Trust Co.'s board of directors and of petitioner, Creighton, and Johnston, who were unable to obtain additional funds, Berwind-White's officers: * * * had authorized a special deposit of this Company with the Trust Company to be utilized to the extent of $ 125,525.15 for the purchase of the other half of such stocks * * * in*201 order to protect the large deposits of this Company and its subsidiary and affiliated companies in the Trust Company, as well as the public whose confidence in the Trust Company was largely due to the thought that the Trust Company was controlled by this Company; that the acquisition of the stocks by this Company was on the understanding that they would be held by Charles G. Berwind, Edward B. Creighton and D. V. Johnston, as Trustees, under an agreement to hold and liquidate the stocks for the account of this Company and on the understanding that some or all of the Directors of the Trust Company would stand certain percentages of any loss which this Company might ultimately sustain as a result of such liquidation producing less than the principal amount of the advance of $ 125,525.15 and interest thereon; * * * The president then submitted the agreement of November 23, 1931, to the directors, who adopted a resolution ratifying it and approving the officers' action "in extending aid to" the Trust Co. and "in arranging for the acquisition of the above mentioned stocks," and directed the treasurer to credit the Trust Co.'s special account with the $ 125,525.15 and "to debit the investment*202 in securities account with the same amount as the cost of said stocks," pursuant to the agreement of November 23, 1931. Entries were made in Berwind-White's journal and ledger in *1116 accordance with these directions. In answer to an inquiry about the transaction, Berwind-White's attorneys, by letter of December 31, 1931, referred to the ratification of the officers' action in purchasing certain shares of stock from the Trust Co. under the agreement, and added: * * * Originally it was suggested that the Trustees would borrow on their notes. In view of the terms of the agreement of November 23, 1931, it is unnecessary that the indebtedness therein specified should be expressed in the form of a note. After ascertaining on December 7, 1931, that the Trust Co.'s capital was again impaired, to the extent of $ 200,000, its directors and stockholders resolved to liquidate it, and entered into an agreement whereby its principal shareholders were to advance funds to remove the capital impairment, and they and Berwind-White and its affiliates were to subordinate their claims as depositors to those of depositors wholly unconnected with the Trust Co. and Berwind-White was to lend $ 200,000*203 for paying off the unconnected creditors within three months and for financing an orderly liquidation. As a shareholder, petitioner contributed $ 24,250 towards removal of the capital impairment. After the preferred creditors had been paid off in full and some distributions had been made to the others, the parties on August 10, 1937, agreed to continue the Trust Co. under an amended charter which limited its purposes to acquiring, holding, and disposing of real estate and securities. It eventually paid 99 1/2 per cent of their deposits to those depositors who had agreed to subordinate their claims, and petitioner thus received $ 20,669.34. The last sale of assets and last payments were made in 1946. The capital stock of the Trust Co. became worthless in a year prior to 1940. On December 23, 1931, the custodians, Fallows and Johnston, delivered the first lot of the Trust Co.'s securities to the Fidelity-Philadelphia Trust Co. for the transfer of a stated portion thereof to Mrs. Creighton, and delivered the second lot to the same company for transfer to Fisher's secretary for petitioner, Creighton, and Johnston, trustees under the agreement of November 23, 1931. The trustees took*204 possession of the second lot, and thereafter sold, exchanged, and purchased securities as they were authorized to do. At the termination of the period of the agreement on August 26, 1934, the parties to it amended and extended it with Berwind-White's consent. The amended agreement provided, inter alia: Charles G. Berwind, Edward B. Creighton, and Thomas Fisher herewith sell, assign and deliver to the Berwind Company all moneys, stocks and securities to which they may be entitled on any distribution in the liquidation of the Penn Colony Trust Company, on account of their individual claims against that institution as depositors, or otherwise, whether for principal or for interest, or both, and further agree promptly to pay or deliver over to the Berwind Company any such cash, stocks or securities so received, immediately upon receipt thereof. *1117 The Berwind Company agrees that any such cash, stocks or securities so delivered * * * shall be held by it as additional security for the repayment of the said advance of $ 125,525.15, plus unpaid accrued interest thereon, the Berwind Company being entitled, upon the completion of the liquidation above referred to, to apply such*205 cash, stocks and securities, or the proceeds thereof, to the repayment of any deficit then existing in the Advance * * *. The trustees continued to hold possession and to make sales, exchanges, and purchases until Berwind-White demanded a final liquidation and accounting on July 2, 1940. The net cash realized and paid to Berwind-White was $ 78,130.37 less than the $ 125,525.15 due, and petitioner paid $ 21,704.62, or 27.78 per cent, of the deficiency. Under the agreement, however, as amended on August 26, 1934, petitioner had assigned to Berwind-White as security for his compliance with the agreement the following amounts which the Trust Co. had paid to him in liquidation of his deposit with it: Sept. 18, 1936 $ 2,219.64 Dec. 17, 1938 1,109.82 Dec. 20, 1939 1,109.82 Oct. 30, 1940 1,109.82 Total 5,549.10 In effecting settlement, Berwind-White credited petitioner with the $ 5,549.10, transferring it on its books to its own account, and made demand for the remaining $ 16,155.52, which petitioner paid in 1940. For this payment petitioner had no claim for reimbursement against anyone. Berwind-White charged off $ 21,704.61 on its books and claimed this as a bad*206 debt deduction on its income tax return for 1940. For the years 1933-1940 the three trustees filed fiduciary income tax returns, reporting gains and losses on the sale or exchange of securities held under the agreement. As bases for securities received from the Trust Co., a figure equal to cost to the Trust Co. was used; as bases for securities purchased by the trustees, the price paid was used. Petitioner, Creighton, Johnston, and Berwind-White never reported these gains or losses on their separate income tax returns. Respondent accepted the fiduciary returns for 1933-1935, but, after the statute of limitations barred changes for those years, he determined as to 1936-1940 that the gains and losses from transactions involving the securities held by the trust should be reported by petitioner, Creighton, and Fisher individually in the same proportions as their percentages of liability and benefit under the agreement, and on this basis he reflected in petitioner's taxable income the following gains: 1936, $ 3,234.05; 1937, $ 1,718.26; 1938, $ 807.26; 1939, $ 724.22; 1940, loss of $ 4,375.46. This action, as it related to 1936 and 1937, was the subject of litigation resulting favorably*207 to respondent. The opinion of the Third Circuit Court of Appeals, affirming a Board of *1118 Tax Appeals memorandum opinion of May 15, 1942, is reported at . On his income tax return for 1940 petitioner deducted as a loss the $ 21,704.62 which he paid to Berwind-White under the terms of the agreement of November 23, 1931, as amended, explaining that this figure included the amounts aggregating $ 5,549.10 which had been previously assigned to Berwind-White and by it applied to his liability. Respondent disallowed the deduction "for the reason that no loss was sustained during the taxable year 1940 and that no basis for determining an alleged loss has been substantiated." He added to income reported a short term capital gain of $ 34.21 and deducted a long term capital loss of $ 4,409.67 from the sale of securities held under the agreement. As bases for computation he used the fair market value on August 31, 1931, for securities previously held by the Trust Co. and the cost of securities purchased by the trustees. OPINION. This proceeding is argued by the parties as though such words as "guarantor," "equitable owner," and "loan" were*208 magic phrases calculated to resolve all difficulties. No doubt their use as shorthand expressions of traditional legal relationships is ordinarily helpful, and the conclusion that a situation fits into one or another of a recognized series of categories may frequently have the effect of supplying the answer to a legal problem. But trite as it may be, it is an inescapable aspect of tax law that taxation is an intensely practical matter and that the actual transaction, rather than the legal label, is the key which we must use to unlock the barrier to a correct conclusion. When petitioner and his associates entered into the agreement which dealt with the funds advanced by Berwind-White to the insolvent trust company, and provided that the securities being purchased at a cost greatly in excess of their market value were to be liquidated, that the proceeds were to go to Berwind-White to be applied against its advance, that profits from the sale were to belong to petitioner and his associates, and that loss on the whole transaction was to be made good by them to Berwind-White, they were embarking on a financial transaction, the terms of which were designed to meet the requirements of a*209 business situation and not to fall neatly into the terms of an accepted legal definition. And when for prior years the liability of petitioner and his associates to taxation upon current profits on the disposition of the securities involved was considered by the Board of Tax Appeals, and upon review in the Circuit Court, 1 it is not strange that they were for purposes of that proceeding referred to as "equitable owners." It *1119 was sufficient in the circumstances to decide there that, since they were entitled to the profits on the sales, they were subject to taxation in that capacity and to that extent were and should be treated as the owners of the securities. We can and do accept that determination as conclusive here, without further examination, and would be bound to do so even if it were less correct than it seems. ; affd. (C. C. A., 2d Cir.), *210 ; certiorari denied, ; . But the question here is not who secures the benefit and hence owes the tax resulting from profits on the sales of specific securities. When the last sale was completed, and regardless of gain or loss on the individual items, there remained to be undertaken a final settlement between petitioner and his associates on the one hand and Berwind-White on the other. Only, of course, if the securities failed to bring the amount of the Berwind-White advance would there be any liability whatever upon the petitioner to make good his share of the difference. Only when the securities had all been sold could the exact amount of that difference be determined. To say, therefore, that petitioner was in the position of an equitable owner for purposes of reporting gain on the sales does not seem inconsistent with the view that the securities themselves were the primary source of payment and that petitioner was at the same time a guarantor against ultimate loss on the transaction as a whole in the practical, *211 if not in the legal, sense of that concept. Respondent, it is true, meets the difficulty of depriving petitioner of a loss deduction in the only year when the loss was definitely ascertained and actually paid by evolving the theory that the original transaction constituted a contribution by petitioner to the capital of the insolvent Trust Co. and that accordingly his loss was deductible, not when the entire transaction was brought to a conclusion, but when in some prior year the stock of the Trust Co. was determined to have become worthless. But that theory assumes that petitioner acted in his capacity as a stockholder of the Trust Co., and that the purpose and effect of the agreement was to protect his investment in the stock. See ; affd. (C. C. A., 2d Cir.), ; certiorari denied, . This seems so wide of the realities of the situation and so strained an interpretation of the facts and, indeed, of the applicable tax principles, that we are unwilling to accept it. The arrangement between petitioner and Berwind-White Co. became *212 closed and completed for the first time in the tax year before us. In that year he not only ascertained his liability, but paid it in cash. The net result was a loss. This deduction should be allowed. . *1120 The amount of the deduction is also in dispute. In addition to the $ 16,155.52 paid by petitioner in cash, there was credited against his indebtedness in the instant year for the first time an item of $ 5,549.10 which petitioner had pursuant to the 1934 agreement turned over to Berwind-White as an additional source of payment. This sum represented the distribution to petitioner as a depositor in the Trust Co. and was not finally applied to the debt until the year now before us. A deduction for these amounts was disallowed in the earlier proceeding on the very ground that application to the indebtedness was not made until 1940. See , footnote 8. We think it follows that it must be allowed here. Petitioner also contends that an additional amount of some $ 2,000 should be added to his loss on the ground that the gains on the sales of specific*213 securities taxed to him in prior years exceed the loss similarly allowed to him for the instant year by that amount. Even if his theory were less difficult to grasp and could be approved -- which we find it unnecessary to decide -- it seems evident that the facts to support his contention are absent. The concession that deductible losses are first to be set off against taxable gains renders appropriate an inquiry as to the detail of the transactions from 1931 to 1935, concerning which no evidence appears in the record. If in those years losses occurred of which petitioner could have availed himself, they might well have offset the net gain which petitioner now computes. And certainly his failure to take the deductions at the proper time can not entitle him now to attempt so belatedly to correct his earlier error. We conclude that the amount of loss to which petitioner is entitled is to be computed by adding to the losses determined by respondent to be allowable, the cash paid by petitioner and the amounts of dividends from the liquidation of the Trust Co. which were applied against his obligation. Decision will be entered under Rule 50. Footnotes 1. .↩