Best v. Commissioner

FRANK E. BEST, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Best v. Commissioner Docket No. 36746. United States Board of Tax Appeals 26 B.T.A. 1070; 1932 BTA LEXIS 1195; September 30, 1932, Promulgated *1195 W. M. Whitney, Esq., for the petitioner. T. M. Mather, Esq., for the respondent. MATTHEWS *1070 This is a proceeding for the redetermination of a deficiency in income tax for the year 1923 in the amount of $8,588.24. *1071 The only error alleged is that respondent erred in holding that proceeds from the sale of stock in the amount of $86,067.18 constituted taxable income to the petitioner in the year 1923. This case was originally heard on June 4, 1930, and in a decision promulgated January 20, 1931, and reported at , judgment was entered for the respondent. Upon motion the decision, dated January 26, 1931, was vacated and the proceeding set down for rehearing, at which time evidence was introduced, upon which we base the following findings of fact. FINDINGS OF FACT. The petitioner is an individual, a resident of Seattle, Washington. The petitioner was the owner on January 1, 1923, of over 400,000 shares of the capital stock of Frank E. Best, Inc., hereinafter referred to as the company, a corporation organized on October 15, 1921, with a total authorized and issued stock of 600,000 shares of a par*1196 value of $1 each, and engaged in the manufacture of locks. Most of these 400,000 shares owned by petitioner had been issued to him in exchange for foreign and domestic patents on various locking devices. The petitioner had owned other shares of the stock, but in order to enable the company to do business had had from time to time donated some of the shares to the company, which it had sold for cash, and made loans to it. In 1922 the stock of the company was selling for 16 to 20 cents. On July 1 of that year the petitioner made an offer to the trustees of the company under the terms of which he agreed to pay all of the dividends on his personal stock pro rata to the holders of company stock originally purchased at par, either from him or from the company between October 15, 1922, and a date to be named later, and notice of which was to be given ten days in advance. This offer was accepted and the petitioner deposited a certificate for 100,000 shares in escrow as security for the performance of his offer. This had the effect of raising the selling price of the stock offered for sale by the petitioner or by the corporation. The company in the latter part of 1922 had only enough*1197 funds to pay ordinary running expenses for a few months. Plans were being made to erect machines for manufacturing locks which required approximately $80,000 cash. The petitioner was unwilling to make an outright donation of any more stock to the company. Practically all of this stock owned by the company itself had been sold and the trustees were informed by their attorney that it would be illegal for the corporation to purchase stock from the petitioner or from anyone else out of its capital assets. After various consultations between the petitioner, who was president of the company, Joseph L. *1072 Bradfield, vice president, and L. M. Riches, secretary-treasurer, the three of them constituting the board of trustees, a meeting was held on January 2, 1923, the minutes of which are as follows: A special meeting of the Trustees of Frank E. Best, Inc. was held at the office of the company at 5:30 p.m., January 2, 1923, there being present Frank E. Best, Joseph L. Bradfield, and Lawrence M. Riches. The following agreement between Frank E. Best, and Frank E. Best, Inc. was read by Mr. Best and subsequently approved by Mr. Best personally and the Trustees of the Company. *1198 WHEREAS, Frank E. Best, Inc. has heretofore been engaged in selling its capital stock, from the proceeds of which development work of the company is being carried, on, and WHEREAS, Additional funds are needed for the purpose of completing the development work and Frank E. Best, Inc. is obliged to secure money for the purpose of carrying on its present operations and WHEREAS, Frank E. Best, individually, is the owner of certain capital stock of Frank E. Best, Inc. and is willing to advance the company certain sums of money provided the company will obtain the funds from the sale of the stock now owned by said Frank E. Best, NOW, THEREFORE, IT IS HEREBY AGREED, as follows: 1. That Frank E. Best, Inc. is hereby authorized to sell during the month of January, 1923 not to exceed $100,000.00 par value, of the stock owned by said Frank E. Best individually, and to retain 20% commission on such sales. 80% of the proceeds from the sale of said stock to be loaned to Frank E. Best, Inc. for the uses and needs of said corporation. 2. That upon the receipt of proceeds from the sale of said stock by Frank E. Best, Inc., said Frank E. Best, Inc., shall execute and deliver to Frank*1199 E. Best, individually, demand promissory notes at 7% after demand which said notes shall equal 80% of the proceeds from the sale of all stock belonging to said Frank E. Best, sold by said company under this agreement. It is understood however that said notes shall be paid from profits received by Frank E. Best, Inc. And that the holder of said notes shall not make demand in excess of 25% of said profits. 3. That any portion of the said $100,000 shares unsubscribed or cancelled is to be considered as unencumbered by this agreement and reverts back to Frank E. Best, personally. 4. That nothing in this agreement contained shall be construed to authorize the company to purchase the stock of said Frank E. Best and the only rights granted hereunder is the right to act as agents and to sell said stock not exceeding $100,000.00 par value to third persons, the proceeds of which shall be used by the said company as hereinabove provided. The officers and salesmen of the petitioner carried on an extensive campaign in order to sell the stock mentioned in the above minutes. Meetings of the stockholders and others were held at which the petitioner gave demonstrations of the lock and*1200 he and the other officers, in urging those attending the meetings to purchase stock, emphasized the bonus agreement and the fact that the money from the sale of the stock was going to the company to be used by it for further development projects. They also emphasized these facts when soliciting stock subscriptions at other times. As a result of *1073 their efforts and in accordance with the agreement of January 2, during the month of January subscriptions were received for 27,300 shares at $1 per share. This stock was sold on a small initial payment, the remainder being payable monthly, and was not issued to the subscribers until fully paid for. In the latter part of January, as a result of the company not selling as much stock as it had hoped to, and after various conferences among the officers, it was decided that after January the company would continue to sell stock belonging to the petitioner at an increased price; that the bonus would be removed; that the money from the sale of the stock would go into the company's treasury; and that the company would give the petitioner promissory notes for the stock payable out of 25 per cent of the net earnings of the company. *1201 On January 20, 1923, the board of trustees voted to raise the price of the common stock of the company from par $1 to $1.50 per share to take effect February 1. On February 3, 1923, the petitioner made an announcement in writing to the trustees that 10 days from that date would be the latest date upon which the purchasers of stock from him or from the company could purchase stock under the provisions of his offer of July 1, 1922. This notice had the effect of stimulating sales and between February 3 and 13 approximately 90,000 shares of stock were subscribed for. No stock was sold by the company in March, April or May because the 100,000 shares had been oversubscribed. All these subscriptions were not paid for and on June 1, 1923, there was a meeting of the board of trustees, the minutes of which are as follows: A special meeting of the Trustees of Frank E. Best, Inc. was held at the office of the company at 2:30 P.M. June 1, 1923, there being present Frank E. Best, L. M. R. Riches and Jos. L. Bradfield. The following agreement between Frank E. Best and Frank E. Best, Inc. was read by Mr. Best and subsequently approved by Mr. Best personally and the Trustees of the*1202 Company. Whereas Frank E. Best, Inc., was on January 2, 1923 authorized to sell not to exceed one hundred thousand shares of the capital stock of the Company owned by Frank E. Best individually and Whereas the amount sold was considerably less than one hundred thousand shares, being in fact less than ninety-four thousand shares, and Whereas Frank E. Best individually is willing to advance certain sums of money to Frank E. Best, Inc. for the purpose of carrying on the Company's future and present operations, provided the Company will obtain the funds from the sale of the stock now owned by Frank E. Best, NOW THEREFORE, IT IS HEREBY AGREED AS FOLLOWS: That Frank E. Best, Inc. is authorized to sell at a price not less than five dollars ($5.00) per share, Ten Thousand shares of the capital stock owned by Frank E. Best individually and to retain twenty per cent (20%) commission or such sales, eighty per cent (80%) of the proceeds from the sale of said *1074 stock to be loaned to Frank E. Best, Inc. for the uses and needs of the Company. That nothing in this agreement contained shall be construed to authorize the Company to purchase the stock of said Frank E. Best and*1203 the only rights granted hereunder is the right to act as agent and to sell said stock to third persons the proceeds of which shall be used by said company as hereinabove provided. Only a small number of shares were sold at this $5 price after June 1. After September the company did not sell any of the petitioner's stock under this or former agreements. The petitioner did not transfer certificates for 100,000 shares to the company in January, as provided for in the agreement, but from time to time as stock subscriptions were paid he transferred stock to the company, sufficient to enable the company to issue as many as were subscribed for. The certificates so transferred, covering a total of 99,958 shares, were endorsed by the petitioner in blank and canceled by the company and new certificates were issued to the subscribers. The certificate numbers, total number of shares transferred and the dates are as follows: Certificate No. Date Shares transferred [824] Jan. 5, 1923 26,000 [201] May 8, 1923 55,000 [3249] Sept. 13, 1923 11,425 [4643] Dec. 21, 1923 5,703 [4644] Dec. 21, 1923 1,830 Certificate No. 824 had been issued by the company to the petitioner*1204 on March 18, 1922, in payment of notes and other indebtedness owing to him by the company in the amount of $19,500. Certificate No. 201 was part of the stock originally issued to the petitioner for patents. Certificate No. 3249 was issued to the petitioner in exchange for other certificates and then endorsed back to the company on the same day. Of the 11,425 shares covered by this certificate, 400 had been purchased by the petitioner for cash and the remaining 11,025 had been issued in exchange for patents. Certificate No. 4643 for 5,703 shares included 2,336 shares which had been purchased by the petitioner for cash and 3,367 shares issued for patent rights. The 1,830 shares covered by Certificate No. 4644 had all been acquired by the petitioner for cash from various individuals. Of the 99,958 shares of stock so transferred 1,494 were not sold by the company and were later returned to the petitioner. The remaining shares were sold and the company received during the year 1923 the sum of $107,583.90 from such sales. As the stock was sold the money received therefor was deposited in the company's bank account and was used by it in carrying on its business. It could be withdrawn*1205 only upon the signature of two *1075 trustees. The company paid its agents a commission of 20 per cent for selling the stock. The amounts subscribed for stock were credited on the books to an account entitled "Frank E. Best, subscriptions," and the cancellations debited to this account, the credit balance at December 31, 1923, being $107,383.50, which is stipulated to be the proceeds from the sale of the stock in 1923. No notes were ever issued to the petitioner by the company as provided for in the minutes of January 2, 1923, or in later agreements. The petitioner's personal account was not credited with 80 per cent of this $107,583.90 and he did not receive any part of this amount in cash. The respondent included the amount of $86,067.18 in the petitioner's gross income for 1923, being the difference between the above amount of $107,583.90 and the 20 per cent commission. The company did not make any profits during the year 1923. OPINION. MATTHEWS: The only question for our determination is whether the petitioner is taxable on the amount of $86,067.18 received by the company in the year 1923, this being the difference between the total amount which the company*1206 received from the sale of the stock and the 20 per cent commission. It is clear that the petitioner did not receive any of this amount in cash in 1923, or at any later date, and also that it was not available to him in that year. The respondent determined that under the agreement the company was acting as agent for the petitioner in selling the stock and was to retain 80 per cent of the proceeds as a loan, and that the substance of the transaction was that the proceeds from the sale became income to the petitioner when received by the company. Counsel for the petitioner enters into a rather lengthy argument in his brief as to the nature of the transaction and makes a great many contentions, some of which are inconsistent. His argument resolves itself, however, into two main contentions - first, that the acts of the parties show that the agreement between them provided for an exchange of stock for the promise of the company to issue promissory notes, which promise had no readily realizable market value, and not a sale by the company as agent for petitioner, and, second, which is really an alternative contention, that even if the agreement of January is one of agency, the oral*1207 agreement under which the stock was sold in February is a different agreement providing for an exchange of stock for the promise of the company to issue notes. With regard to the petitioner's first contention he argues that the corporate minutes in which the company is referred to as the "Agent" are a mere word screen; that the intention of the parties and their acts show that the transaction was an exchange; and that *1076 this is borne out by the fact that the stock was endorsed over to the company; that it was represented to purchasers that the money from the sale of the stock was going into the company's treasury; and that the petitioner did not have any control over the money after it was received by the company. The petitioner and the other two officers of the company testified that the transaction was intended to be an "exchange," but was called one of agency in the minutes on account of the fact that they were told by their attorney that the company could not purchase its own stock out of capital assets. Counsel cites a number of Washington cases to show that the company could have made such a purchase as was here contemplated, but we think this immaterial. It*1208 does not matter why they carried out the transaction in the manner they did. The minutes clearly state that the company was to act as agent and the acts of the parties show that this was their intention. In this regard it should be noted that the parties had been informed that the corporation could not sell its own stock; that the petitioner was not to exchange the stock for a definite sum, but he agreed in advance that 80 per cent of the total proceeds should be retained by the company as a loan; and that the petitioner did not transfer a certificate for 100,000 shares, but as subscriptions were paid he transferred approximately enough shares to the company to fill the subscriptions and any shares subscribed but not paid for were later returned to him. It seems to us that all these circumstances are indicative of the fact that the corporation was to act as agent for the petitioner and that they bear out the corporate minutes, rather than show an intention different from that expressed in the minutes as contended for by the petitioner. It has been held by the courts and by this Board that receipt by an agent is receipt by the principal and that when the agent receives money*1209 or other property belonging to the principal it becomes income to the principal at that time. ; ; ; ; and . The fact that by the terms creating the agency the principal agrees to allow the agent to retain the proceeds does not change the rule of law that receipt by the agent is receipt by the principal. It has been held many times that the assignment of future income does not relieve the assignor of tax liability. See ; ; , affirming in part ; ; certiorari denied, ; *1077 ; and *1210 . In the case of , where the taxpayer had ordered that his lessee pay part of rents and royalties owing to him directly to his wife and daughter, we held that the amount so paid to the wife and daughter constituted taxable income to the taxpayer, saying: * * * Such a voluntary act in anticipation of actual receipt and before the income exists can only affect the income when it actually arises, and in our opinion it may properly be treated as coming to him and immediately disposed of. See . The case of , relied upon by the petitioner, is not determinative of the issue herein. In the Voyer case an attorney collected money owing to the taxpayer and refused to pay a part of it which he retained as security for his fee, the amount of which was in controversy. We held in that case that both parties had a claim to the amount retained by the agent and that the taxpayer had no right to receive the full amount, and since it was not known exactly how much he would receive, he was taxable on only the amount*1211 actually received from the agent in the taxable year. In the instant case the instrument creating the agency provides that the agent shall retain the proceeds as a loan. It was a voluntary act on the part of the petitioner, and the agent retained the proceeds with the consent of the principal. We do not think that the Voyer case is similar to the instant proceeding. See As to the petitioner's second contention, counsel argues that there were three agreements - one, that set forth in the minutes of January 2; the second, an oral agreement entered into in the latter part of January which covered sales made in February; and, third, the agreement set forth in the minutes of June 1 - and that the oral agreement of February was clearly an exchange. Counsel does not devote any argument to the agreement of June. We are, however, of the opinion that the stock was sold under one agreement. As we view the testimony, towards the end of January the officers found that they had sold only 23,600 shares of the 100,000 they had hoped to sell and they therefore agreed to continue selling the stock, but at an increased price, and they agreed that the*1212 bonus would be removed. They continued to sell it on the same subscription forms as they had in January, to make the same representations to purchasers and to treat the proceeds thereof on the company's books in the same manner. The minutes of June 1 refer to the minutes of January 2 and indicate that the agreement of January was still in force and that the minutes of June were meant to continue that agreement. This seems to corroborate our position that the agreement under which the stock was sold in February was a continuation of the agreement *1078 set forth in the minutes of January 2. But, whether we consider this as one agreement or as three separate agreements, the terms are the same. The corporation was to sell stock belonging to the petitioner and to retain 80 per cent of the proceeds as a loan. The evidence does not sustain the petitioner's contention that this was an exchange of stock for the promise to issue notes. The respondent has taxed the entire net proceeds of the sales to the petitioner and there was no question raised at the first hearing as to the amount of profit taxable. A part of the stock was issued for patents and, in the absence of evidence*1213 as to the value of the patents, it is clear that the proceeds from the sale of this stock constitute taxable income in their entirety. However, the testimony in this case shows that a part of the stock was issued to the petitioner in payment of advances which he had made to the company and a part was purchased for cash. The amount which he had advanced to the company was $19,500, for which 26,000 shares of stock were issued to him. There is no evidence as to the amount of cash which he paid for the other shares, and the petitioner himself testified that he could not remember how much he paid for them. The amount of $86,067.18 should accordingly be reduced by $19,500 and the remaining amount of $66,567.18 is taxable to the petitioner. Judgment will be entered under Rule 50.