United States Playing Card Co. v. Commissioner

UNITED STATES PLAYING CARD CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. United States Playing Card Co. v. Commissioner Docket No. 19305. United States Board of Tax Appeals 15 B.T.A. 975; 1929 BTA LEXIS 2758; March 20, 1929, Promulgated *2758 1. In 1921 the petitioner issued $800,000 of "Serial Debenture Gold Notes," which, it alleged, were sold through a bank at par, less a commission of 5 per cent. The petitioner paid to the bank so-called commissions of $40,000, plus $400 representing the cost of documentary stamps, and claimed the entire amount of $40,400 as a deduction from income for 1921. The respondent prorated the amount over the life of the notes, and allowed $8,206.25 as a deduction from 1921 income. The petitioner kept its books upon an accrual basis. Held, that the $400 stamp tax constitutes an allowable deduction from gross income for 1921; and held, further, that the $40,000 of so-called commissions represents in effect bond discount, and should be prorated over the life of the notes. 2. During 1922 and 1923 the petitioner paid certain New York State franchise taxes and license fees, applicable to the years 1919 and 1920. Held, that in computing invested capital for 1921, surplus should be reduced by the amount of said taxes and fees. R. Kemp Slaughter, Esq., and Hugh Co. Bickford, Esq., for the petitioner. Stanley Suydam, Esq., and O. J. Tall, Esq., for the*2759 respondent. TRAMMELL *975 This is proceeding for the redetermination of a deficiency in income and profits taxes for the year 1921 in the amount of $9,006.75. The issues raised by the pleadings are: (1) Whether the respondent erred in refusing to allow as a deduction from gross income for 1921 the entire amount of $40,400 paid in that year as so-called commissions and selling expense on three issues of gold notes, the whole amount having been prorated by the respondent over the life of the *976 notes and only the amount of $8,206.25 allowed as a deduction from income for 1921; and (2) whether the petitioner's invested capital for 1921 should be reduced by the amount of $16,599.34, representing New York State franchise taxes and license fees paid in the years 1922 and 1923, for the years 1919 and 1920. FINDINGS OF FACT. The petitioner is an Ohio corporation, with its principal office at Norwood, Cincinnati. On March 19, 1921, the petitioner, the United States Playing Card Co., entered into a contract with the First National Bank of Cincinnati, Ohio, under the terms of which petitioner was to issue gold notes in the total amount of $1,500,000. This*2760 contract provided in part as follows: 1. Note. - The company is to issue and deliver its notes in the total sum of one million five hundred thousand ($1,500,000) dollars, in denominations of five hundrd ( $500) dollars and one thousand ($1,000) dollars each, bearing interest at eight (8%) per cent per annum, said interest to be represented by coupons. Said notes are to be dated April 1, 1921, and are to mature quarterly at the rate of sixty thousand ($60,000) dollars each quarter, beginning April 1, 1922, until January 1, 1927. The balance of the issue outstanding after January 1, 1927, to mature on April 1, 1927. Said notes are to be payable in gold coin of the United States of America of the present standard of weight and fineness. 2. Terms of Sale. - The Bankers undertake to sell said Notes of the par value of One Million Five Hundred Thousand ($1,500,000) Dollars for the Company, at a price which shall net the Company par, less a commission of five per cent (5%) which the Company agrees to pay the Bankers for their services. In the event that the Company gives notice to the Bankers on or before January, 1, 1922, that it desires to withdraw Five hundred thousand*2761 ($500,000) Dollars of said notes in whole or in part, from sale, such right and privilege is hereby reserved by and given to the Company upon payment to the Bankers of two and one-half per cent. (2 1/2%) of said Five Hundred Thousand Dollars ($500,000) or such part thereof as may be so withdrawn from sale, the notes so withdrawn from sale to be held in the Treasury of the Company. In the event that the Company shall at any time thereafter desire to sell said Five Hundred Thousand ($500,000) Dollars of notes or the part thereof withdrawn and held in its Treasury as aforesaid, the Bankers shall have and are hereby given the prior right to purchase or negotiate the sale thereof on terms as favorable as may be obtained by the Company from any other responsible banker. The Bankers agree to make payments against delivery of notes, of maturities designated by them, as follows: $300,000 on April 1, 1921. $250,000 on July 1, 1921. 1 $250,000 on October 1, 1921. 2 The balance on January 2, 1922. 3 *2762 *977 The commission of five per cent (5%) herein before provided for shall be paid to the Bankers on the date or dates when payments are made to the Company. If at any time during the life of said notes the Company desires to sell any other notes or bonds for the purpose of refunding said issue of One Million Five Hundred Thousand ($1,500,000) Dollars Eight Per Cent. Debenture Gold Notes or any part thereof or for any other purpose, the Bankers shall have and are hereby given the prior right to purchase or negotiate the sale of said new notes or bonds on terms as favorable as may be obtained by the Company from any other responsible banker. On April 1, 1921, the petitioner entered into a debenture trust agreement with the said First National Bank of Cincinnati, Ohio, which contained the terms of the trust under which the said gold notes were issued and payment thereof secured by certain of the assets of the petitioner. Under the terms of this agreement the notes were to mature as follows: Series Amount Maturity Date A $60,000 Apr. 1, 1922 B 60,000 July 1, 1922 C 60,000 .oct. 1, 1922 D 60,000 Jan. 1, 1923 E 60,000 Apr. 1, 1923 F 60,000 July 1, 1923 G 60,000 Oct. 1, 1923 H 60,000 Jan. 1, 1924 I 60,000 Apr. 1, 1924 J 60,000 July 1, 1924 K 60,000 Oct. 1, 1924 L $60,000 Jan. 1, 1925 M 60,000 Apr. 1, 1925 N 60,000 July 1, 1925 O 60,000 Oct. 1, 1925 P 60,000 Jan. 1, 1926 Q 60,000 Apr. 1, 1926 R 60,000 July 1, 1926 S 60,000 Oct. 1, 1926 T 60,000 Jan. 1, 1927 U 300,000 Apr. 1, 1927 *2763 The notes were designated "8 per cent Serial Debenture Gold Notes," and under the terms of the trust agreement the notes were redeemable at the option of the company at any time at the par value thereof and accrued interest, plus a premium of 1 per cent of the face of the note for each year, or any part of a year, by which the maturity thereof is anticipated. Under the terms of the foregoing contract the petitioner issued notes in the total amount of $800,000 on the following dates, and received from the Bank cash equal to the par value thereof: Series A, B, C, D, and E, Apr. 1, 1921 $300,000 Series F, G, H, M, and $10,000 of J, July 1, 1921 250,000 Series I, K, L, $20,000 of N, and $50,000 of J, Oct. 1, 1921 250,000 In accordance with the provision of the first paragraph of subdivision 2 of the contract of March 19, 1921, the petitioner paid to the First National Bank of Cincinnati, Ohio, a so-called commission of 5 per cent on each issue of such notes as shown above. The checks in payment of such commission (and documentary stamps, $400) were as follows: Apr. 1, 1921 $15,150 July 1, 1821 12,625 Sept. 29, 1921 12,625 Total 40,400 *2764 *978 In December, 1921, the petitioner formally withdrew from issue $500,000 of the total notes authorized by the foregoing contracts, and on December 23, 1921, paid to the First National Bank of Cincinnati $12,500, being a commission of 2 1/2% on the notes so withdrawn in accordance with the second paragraph of subdivision 2 of the contract of March 19, 1921, as above quoted. The petitioner charged the total amount of the so-called commissions thus paid during the year 1921, amounting to $52,900, to an account designated "Special Selling Expenses." This expense account was charged into its profit and loss account for the calendar year 1921, and the total amount thereof was reflected as a deduction in its tax return for that year. The principal amount of $800,000 of notes issued in 1921 was retired by the petitioner before the maturity thereof, as follows: Apr. 1, 1922, Series A $60,000 May 3, 1922, Series K 10,000 July 1, 1922, Series B, E, F, I, J, M, N 380,000 Oct. 1, 1922, Series C, G, K 170,000 Jan. 2, 1923, Series D, H, L 180,000 The respondent in the notice of deficiency, held that the so-called commissions (including documentary stamps) *2765 paid upon the three issues of notes as above stated, in the total amount of $40,400, should be amortized over the life of the notes in question, and has computed the deduction for 1921, as follows: First issue - Apr. 1, 1921, $300,000 maturities to Apr. 1, 1923-24 months - commission paid $15,150 Second issue - July 1, 1921, $250,000 maturities to Apr. 1, 1925 - 45 months - commission paid 12,625 Third issue - Oct. 1, 1921, $250,000 maturities to July 1, 1925 - 45 months - commission paid 12,625 Total commission 40,400 Deduction allowed in 1921 is computed on the basis of the number of months in 1921 to total life of bonds, as follows: 9/24 by $15,150 $5,681.25 6/45 by $12,625 1,683.33 3/45 by $12,625 841.67 Total allowed in 1921 8,206.25 The amount of $8,206.25 thus computed was allowed as a deduction by the respondent, as was the payment made on December 23, *979 1921, of $12,500. The balance of $32,193.75 of the three payments, aggregating $40,400, was disallowed as a deduction from gross income. In the year 1923 the petitioner paid New York State franchise tax amounting to $13,114.77, applicable to the fiscal year*2766 ended October 31, 1919, and a New York State license fee of $1,404.98, which fee was based on the total capital stock employed in the State of New York during the first year of its doing business in the State. The fee was payable in the thirteenth month after commencing business, which in the petitioner's case would be between April 25, 1919, and May 25, 1919, and hence this fee is also applicable to the fiscal year ended October 31, 1919. In the year 1922 the petitioner paid New York State franchise tax amounting to $2,079.59, applicable to the fiscal year ended October 31, 1920. The petitioner kept its books of account on the accrual basis, and had an earned surplus at the end of the fiscal year 1919 in an amount in excess of the amount of the liability for the New York State license fee and franchise tax, and a surplus at the end of the fiscal year 1920 in an amount in excess of such liabilities for that period, and also in excess of such liabilities for both of the said fiscal years. The Commissioner did not reduce invested capital by the amounts of such license fees and franchise taxes. OPINION. TRAMMELL: The first issue for consideration here is whether the respondent*2767 erred in amortizing or prorating so-called commissions and selling expenses over the life of certain gold notes issued by the petitioner in 1921. In that year the petitioner issued three series of "8 per cent Serial Debenture Gold Notes" in the total amount of $800,000 pursuant to the terms of the contract set out in our findings of fact above. The petitioner claimed as a deduction from income for 1921 the amount of $40,400, consisting of $40,000 alleged to have been paid to the bankers as commissions for selling the notes, and $400 representing the cost of documentary stamps. The respondent disallowed the deduction, prorated the amount over the life of the notes, and allowed a deduction from 1921 income of $8,206.25 as properly pertaining to said year. The petitioner kept its books of account upon an accrual basis. It may be noted that there is no controversy raised regarding the correctness of the respondent's method of computation in prorating the amount of the claimed deduction. The issue relates solely to whether the petitioner is entitled to deduct the whole amount from *980 its gross income for 1921, or whether the amount should be amortized over the life of*2768 the notes. We will consider first the item of $400, representing cost of documentary stamps. The Revenue Act of 1921, provides as follows: SEC. 234. (a) That in computing the net income of a corporation * * * there shall be allowed as deductions: * * * (3) Taxes paid or accrued within the taxable year (with certain exceptions not material in this proceeding). Thus, in the case of a corporation, all taxes either paid or accrued within the taxable year, save only those which are specifically excepted by the statute, are deductible from the gross income for such year, and the exceptions do not embrace stamp taxes. There is no other condition or limitation placed upon such deductions, and it is our opinion, therefore, that the $400 stamp tax, which was both accrued and paid by the petitioner in 1921, is deductible from the gross income of that year. The respondent erred in prorating this amount. The petitioner also contends that it is entitled to a deduction from 1921 income of the whole amount of the $40,000, which it asserts was paid to the bankers as a commission for selling its notes. This contention is predicated on the theory that the said amount was paid to the*2769 bankers by the petitioner as compensation for personal services rendered, and represents an ordinary and necessary expense of carrying on its business in 1921. This position, we think, is untenable. Under the contract, the material provisions of which are set out in our findings of fact, the bankers agreed to "undertake to sell said notes * * * for the Company, at a price which shall net the Company par, less a commission of five per cent (5%) which the Company agrees to pay the Bankers for their services." But the bankers also agreed "to make payments against deliveries of notes, of maturities designated by them, as follows: $300,000 on April 1, 1921, $250,000 on July 1, 1921, $250,000 on October 1, 1921." The petitioner issued its notes in the total amount of $800,000 on the dates and in the amounts specified, and on the respective dates received from the bank cash equal to the par value thereof, and on the same dates paid to the bank by check a so-called commission of 5 per cent on each issue of notes. The record before us does not disclose that the bankers ever at any time sold the notes for the petitioner; in fact, we are not informed what disposition was made of the*2770 notes after the petitioner delivered them to the bank, received from the bank the par value thereof in cash, and at the same time paid to the bank the so-called commission of 5 per cent. *981 Under the terms of the contract, the rights of the petitioner were confined to receiving from the bankers the par value of the notes, less the so-called commission of 5 per cent. If the bankers thereafter retained the notes instead of selling them, there is nothing in the quoted provisions of the contract which would give the petitioner a right to complain. If the bankers had thereafter sold the notes for more than par, there is no provision requiring payment of the surplus to the petitioner, or if the notes had been sold at less than par, the bankers had no contract right to require the petitioner to bear the loss. These considerations, in our opinion, fairly justify the construction that the contract in question was in fact a contract of purchase and sale, whereby the petitioner agreed to issue and sell to the bankers, and the bankers agreed to purchase, certain notes at 95 per cent of par. The so-called commission, then, was substantially and in effect discount, and must be*2771 treated essentially in the same manner as bond discount. In our findings of fact, above, we have referred to the item of $40,000 as "so-called commission" for the reason that the contract provided for the payment of a "commission," and in the stipulated facts, which we have substantially adopted in our findings of fact, the parties referred to said item as "commission." However, it is a well established principle of law that the name by which an instrument or transaction is denominated is not controlling in determining its true character. Thus, interest is not changed into a dividend by calling it a dividend, or vice versa, and a mortgage creditor although denominated a "preferred stockholder" is a mortgage creditor nevertheless. . And the discount at which bonds or notes are sold can not be changed into a commission for personal services merely by calling it such. Where a corporation keeps its books upon an accrual basis, as did the petitioner in this case, and sells its own bonds at a discount, we have held that the discount is in the nature of deferred interest, and, in order to reflect the true net income, *2772 the discount must be amortized over the life of the bonds and the portion allocable to each year deducted from the gross income for such year. In , we said: The true income of the company can be reflected only when the discount is spread over the life of the bonds. The most material element in determining the contract rate of interest, that is, whether the bonds shall be sold at par or at a premium or discount, is time. Thus no one would consider the proposition that he pay a premium for bonds payable at once nor would one issue bonds at a discount which are due and collectible the day they are issued. Since time is such a vital element in determining premium and discount, it is difficult to perceive why this element should not be taken into consideration *982 in determining taxable income - why time should not be used as a divisor in order to allocate to each period of time that part of the discount which is greater or less by reason of time. Since the item of $40,000 in controversy in this proceeding represents discount, it follows that the action of the respondent in amortizing*2773 or prorating said amount over the life of the notes must be approved. This case is distinguishable from , in that in this case we have held that the amount paid, which was called commission, was not in fact commission, while in that case, the question was the deductibility of commissions paid. The second issue presented here is whether petitioner's invested capital for 1921 should be reduced by the amount of certain New York State franchise taxes and license fees paid in 1922 and 1923 for the years 1919 and 1920. The facts show that during the year 1923 the petitioner paid a franchise tax amounting to $13,114.77, applicable to its fiscal year ended October 31, 1919, and a license fee of $1,404.98, applicable also to its fiscal year ended in 1919. In the year 1922 the petitioner paid a New York State franchise tax amounting to $2,079.59, applicable to the fiscal year ended October 31, 1920. Since the petitioner kept its books by the accrual method, these liabilities of the years 1919 and 1920 should have been accrued thereon prior to the beginning of the taxable year 1921. The respondent conceded that the petitioner's invested*2774 capital for 1921 should be reduced by the said amounts paid in 1922 and 1923 for taxes which accrued during the years 1919 and 1920, if the record disclosed that the petitioner's invested capital for 1919 and 1920 as computed by the respondent, included earned surplus equal at least to the amounts involved. Thereafter this fact was stipulated. Accordingly, in computing the invested capital for 1921, surplus should be reduced by the said amount of $16,599.34. . Reviewed by the Board. Judgment will be entered under Rule 50. MURDOCK MURDOCK: I dissent from a part of the prevailing opinion in this case. In my opinion the $40,000 did not represent bond discount, and the question pertaining to this item was therefore not adequately disposed of by the prevailing opinion. GREEN agrees with the dissent. Footnotes 1. Notes delivered to have July 1, 1921, coupon detached. ↩ 2. Notes delivered to have July 1, 1921, and Oct. 1, 1921, coupons detached. ↩ 3. Notes delivered to have July 1, 1921, Oct. 1, 1921, and Jan. 1, 1922, coupons detached. ↩