Piggly Wiggly Corp. v. Commissioner

PIGGLY WIGGLY CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Piggly Wiggly Corp. v. Commissioner Docket Nos. 25126, 43860. United States Board of Tax Appeals 28 B.T.A. 412; 1933 BTA LEXIS 1119; June 20, 1933, Promulgated *1119 1. Held, the money which petitioner's president invested in stock of a licensee corporation in 1922 and, which, while so invested, was lost through embezzlement and conversion by said president, was a loss sustained in the prosecution of its regular business in 1922. 2, Held, under the facts shown, the several items which entered into a judgment balance which a Federal court found was due the taxpayer from its president, on account of overdrafts and unlawful withdrawals of its funds made by him in conducting its business, were lost to it respectively, as and when the various withdrawals and overdrafts to which they related were made. Homer K. Jones, C.P.A., and Frank J. Albus, Esq., for the petitioner. De Witt Evans, Esq., for the respondent. LANSDON *412 At Docket No. 25126 the respondent has determined a deficiency in income tax for 1923 in the amount of $32,062.44. At Docket No. 43860 he has determined deficiencies for the year 1924 and the periods ending December 9, 1926, and December 31, 1926, in the respective amounts of $41,307.28, $76,799.68, and $3,524.86. The two proceedings were consolidated for hearing. The issues*1120 submitted are based upon certain conceded losses of the petitioner, and for determination depend upon (1) the year or years in which they were, in fact, sustained; and (2) whether or not they resulted from its operation of a regular trade or business within the meaning of the taxing statutes. FINDINGS OF FACT. The parties, by stipulation, have made the records of certain proceedings in equity in the Federal court of the Western District of Tennessee, between the petitioner and its president, Clarance Saunders, a part of an agreed statement of facts in these proceedings. Such records contain findings and legal conclusions of the court that tried the issues presented, which are pertinent to the issues here considered and to the extent that they apply will be made a part of our findings of fact by reference. The parties have agreed that *413 in so far as the matters between Saunders and the petitioner are concerned, such findings and conclusions may be taken as true. The petitioner is a Delaware corporation, and during the periods under review maintained its principal office at Memphis, Tennessee. It was organized in 1918 by its president, Clarence Saunders, the inventor*1121 of the "Piggly Wiggly" system of retail marketing, as a holding and leasing company for his patents and trade marks. The petitioner's charter gives it general powers to buy and sell groceries, food and table products and to grow, manufacture, refine and prepare such commodities for the market. Certain other grants of power are given in its charter enumerated as follows: (e) * * * to buy and sell notes, accounts and other evidences of debt, loan money and take notes, accounts and other evidences of debt as security; to appoint officers and agents, to make by-laws; to wind up and dissolve; to carry on business; to purchase shares of its own capital stock and hold, reissue or cancel them, provided, however, that it shall not impair its capital by purchasing its own stock and that shares of stock belonging to it shall not be voted upon. At or about the time of its organization the petitioner acquired from Saunders all of his patents, trade marks, etc., relating to the Piggly Wiggly system of selling merchandise and thereafter, during all times material, consistently confined its business to the leasing of such patents and copyrights to individual or chain store agencies known as*1122 Piggly Wiggly stores, upon a royalty basis, and to the manufacture and sale of Piggly Wiggly equipment. Such business was its only recognized and established source of income. Some time in 1919 the petitioner's president, Saunders, and others organized a corporation known as the Piggly Wiggly Stores, Inc., hereinafter sometimes referred to as the Stores Co. This corporation was authorized to issue capital stock of 250,000 shares without par value; 200,000 to be known as class A and 50,000 as class B common stock. The only difference in these two classes of stock was that the former had a preference over the latter in dividends. Saunders was made president of the Stores Co., and, at all times material, dominated the affairs of it and the petitioner. On November 18, 1919, the Stores Co. entered into a contract with the petitioner under which it became a licensee to operate Piggly Wiggly stores under the Saunders patents upon a royalty basis of one percent payable upon the gross sales of all stores it might operate. Among other things this contract obligated the Stores Co. to have available not less than $1,000,000 in cash with which to begin operations on or before January 1, 1920; *1123 and to have stocked and equipped and ready for business 500 stores on or before March 1, 1922, not including such other stores already in *414 operation as it might acquire in that time. All apparatus and fixtures used in such stores were to be purchased from the petitioner. This contract underwent certain modifications later which are unnecessary to note in these proceedings. During 1920 and 1921 the petitioner's business was highly successful and at the close of the latter year its general balance sheet showed assets listed at $2,267,844.09, which included 27,000 shares of class A common stock in the Stores Co. valued at $1,082,821. On February 14, 1922, the petitioner's executive committee, by resolution, authorized its president, Saunders, to buy and sell stock in Piggly Wiggly Stores, Inc., in its name, in such amounts and upon such terms as he might see fit, with further power to use freely the corporation's credit in such deals. In the early months of 1922 the Stores Co. decided to place upon the market an issue of 50,000 shares of its class A stock then listed at $43 per share on the Chicago exchange. In order to support the market for this stock and to sustain*1124 it at or near the level listed, Saunders began in April 1922, to buy and sell it through brokers on margin, at and around $44 per share; buying when it could be had for less than that price and selling when the market rose above it. In these transactions Saunders drew upon the petitioner's funds, as well as his own, and from time to time made ratable accounting to it of the profits by appropriate debits and credits in their respective accounts with the brokers, which he caused to be kept separate. Prior to April 21, 1922, Saunders refrained from advising the petitioner's officials of his marginal stock deals, but on or about that he made known to its executive committee that he had been buying "some stock" on margin and requested that it ratify his acts which it did by adopting a resolution reading as follows: Resolved, That the acts of the President of the Company in buying stock of Piggly Wiggly Stores, Inc., on margins, be and the same is hereby ratified and confirmed. Further resolved, That the President be, and he is hereby authorized in his own name, or in the name of such person or persons as he may designate to act as agents or brokers for Piggly Wiggly Corporation, *1125 to purchase further and other certificates of stock of Piggly Wiggly Stores, Inc., common stock, Class A, as he may, in his discretion, determine, and in making such purchases he is to act for and on behalf of Piggly Wiggly Corporation. On May 10, 1922, the Stores Co. successfully completed the sale of its 50,000-share new issue of class A stock, for which it received in excess of $1,000,000. On June 6, 1922, Saunders balanced his personal account with the petitioner and settled for the withdrawals and overdrafts charged to him upon its books with credits for personal advances to the brokers in marginal stock dealings for it. On June *415 20, 1922, petitioner's board of directors formally approved Saunder's marginal stock deals for it in the Stores Co. stock. On the last mentioned date the petitioner's aggregate balances, in the form of marginal deposits with brokers, amounted to $166,000. These deposits were increased during the subsequent summer months by some $735,650 and additional marginal purchases of stock made through brokers until by November 21, 1922, it had to its credit cash and equities in some 59,380 shares of class A Stores Co. stock amounting to more than*1126 $900,000. During his regime as petitioner's president Saunders was, by common consent of its stockholders, directors and executive committee, allowed to exercise a free hand in withdrawing and investing the corporation's funds which they knew, or should have known he was commingling with his own for investment purposes. No comprehensive record was kept in petitioner's books of these investments or withdrawals, and no accounting made of them, except at such times as Saunders saw fit to report them to its stockholders, board of directors or executive committee. During September 1922, Saunders caused standing credits belonging to the petitioner on books of brokers, aggregating $57,572.48, to be transferred to his own accounts with such brokers. In October and November 1922, checks for $76,285.80 and $67,575.09, respectively, representing marginal deposits returned to the petitioner by brokers were received by Saunders and converted to his own use by depositing them to his own personal account. On November 22, 1922, credits aggregating $700,216.52, representing marginal payments made by petitioner on the purchase of 59,380 shares of the Stores Co. class A stock, stood to its account*1127 on the books of brokers. These equities Saunders converted to his own use by settling with the brokers for the unpaid balance of their purchase price and taking title to the stock in his own name. These shares of the Stores Co. stock Saunders caused to be turned over to an investors' pool which he and others, to the exclusion of petitioner, formed to embark in a new series of stock dealings and investments. These pool ventures proved disastrous to Saunders and his associates and late in the spring of 1923, after a series of attempts to corner Stores Co. stock, a crash in the market wiped out all of their investments in them. Independent of the transactions hereinbefore mentioned, at the close of 1922 Saunders stood indebted to the petitioner in the sum of $426,385 on account of overdrafts made by him of the petitioner's funds. This indebtedness was increased through additional abstractions made during 1923 to a total of $1,235,505.84. On August 17, 1923, Saunders filed in the United States courts a suit in equity against the petitioner, the object of which was to *416 compel an accounting by it to him for money expended for it in the stock transactions hereinabove*1128 referred to, alleging as grounds, among other things, that the disastrous pool deals were carried on under authority granted to him by the petitioner's board of directors and in its behalf. Five days later the petitioner filed its suit in the same court against Saunders to recover from him money and property unlawfully abstracted and converted to his own use, under circumstances hereinbefore set out. A consolidated trial of these cases resulted in a money verdict of $2,137,155.84 in favor of the petitioner against Saunders, rendered in December 1925. From most of the items covered in that judgment Saunders was discharged in a voluntary bankruptcy proceedings begun in February 1924, but not determined until some time in 1925. From other items, representing embezzled funds, he was not discharged in that proceeding. The petitioner charged off all of its losses as above set out from its books in the year 1923, and these charge-offs have been disallowed by the respondent. During the years 1922 to 1925, inclusive, the royalties and commissions paid to the petitioner by the Stores Co. greatly exceeded like payments from any other single licensee of its patents or system. OPINION. *1129 LANSDON: In their stipulation of facts the parties to this dispute have agreed that the petitioner suffered losses of various characters in the aggregate of $2,137,155.84 and that this sum is composed of items which they have classified in three groups, as follows: (a) $201,433.48 represents the so-called misappropriated or embezzled funds not discharged in bankruptcy. (b) $700,216.52 represents the amount that the court held was legally expended by Saunders on marginal accounts for the petitioner, which subsequently became lost. (c) $1,235,505.84 represents the amounts expended by Saunders beyond the scope of his authority but not considered misappropriated or embezzled within the purview of the Bankruptcy Act. Although the stipulation shows that the conversions referred to in groups (a) and (b) above set forth, and all except $809,120.84 of group (c), took place in 1922, the petitioner contends that its losses resulting from them should be attributed to 1923 for the reason, as it further claims, that it did not learn of such losses until the latter year. It also contends that all of such losses were sustained by it in the conduct of a trade or business regularly carried*1130 on by it under circumstances which produced a net loss in its income within the meaning of the taxing statutes. *417 Considering these groups in their order, the first (a) consisted of embezzled funds which the petitioner's president, Saunders, because of his having charge of its investment business with the brokers, was able to collect and convert to his own use. Three acts of Saunders committed in the fall months of 1922 accomplished this conversion, viz.; his causing, at different dates in September, of funds in the hands of brokers belonging to petitioner in the aggregate of $57,572.48 to be transferred to his own account with said brokers, and his receipt from brokers on October 2 and November 14, 1922, of checks payable to the petitioner for $76,285.80 and $67,575.09 which he deposited to his own private account. From the proof in the record we are unable to determine whether or not the petitioner knew of its loss prior to 1925; however, in the view we take of the character of the losses, it is immaterial when that knowledge first became manifest. All resulted from the direct appropriation or squandering by Saunders of the petitioner's credits and funds. The bankruptcy*1131 court found that those assembled in group (a) above, were appropriated by Saunders under circumstances which amounted to embezzlement; but, that the funds represented in group (b) were subsequently lost, after having been legally invested by Saunders in marginal accounts for the petitioner. The record shows that the marginal accounts referred to in this item were illegally converted by Saunders to his own use in September 1922, when he founded the investors' pool, and that they became as effectually lost to the petitioner at that time as did the funds embezzled in group (a). The same may be said of the $1,235,505.84 in expenditures set out in group (c), $426,385 of which was withdrawn from petitioner's treasury in 1922 and the balance in 1923. All of these were direct losses which resulted at the instant the funds and credits involved were improperly diverted or converted. ; ; ; *1132 ; ; ; . We therefore hold that all of the losses here in issue, excepting $809,120.84, were sustained by the petitioner in 1922; and that losses equal to the latter amount (included in group (c)) occurred in 1923. We think from the record made that the petitioner's contention that the losses here considered were sustained by it in the prosecution of its regular business must likewise be sustained. The respondent insists that the petitioner's marginal stock dealings in 1922 were not a part of its regular business and for this reason the funds of petitioner embarked in these ventures should not be regarded as *418 having been employed in such business in 1922. To this suggestion we might reply that none of the petitioner's money was lost in the stock transactions. Whether these were properly a part of petitioner's business or not, the record shows that it derived some profit from all of them where purchases and sales were made. The petitioner*1133 sustained no losses from these dealings, but from Saunders' misappropriation of its equities in stocks purchased and of its funds deposited on marginal balances and in its treasury. All of these were assets of the petitioner which Saunders controlled by virtue of his official position as its president and business manager. In these circumstances it is clear that these assets were at risk in the petitioner's regular business and their loss under these circumstances must be regarded as having been sustained in its conduct. ; ; ; . The parties have stipulated that the petitioner is entitled to additional deductions for patent exhaustion of $5,000 for each of the years 1922 and 1923 and additional deductions on like account of $92.01 for each of the years 1924, 1925, and 1926. Reviewed by the Board. Decision will be entered under Rule 50.