National Tile Co. v. Commissioner

THE NATIONAL TILE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. National Tile Co. v. Commissioner Docket No. 64013. United States Board of Tax Appeals 30 B.T.A. 32; 1934 BTA LEXIS 1381; March 8, 1934, Promulgated *1381 Upon retirement of petitioner's debentures at a premium with funds realized from the sale of additional stock, petitioner is entitled to deduct the premium paid and also the unamortized discount and expenses incurred in connection with the issue and sale of the debentures. William S. Hammers, Esq., for the petitioner. Harold Allen, Esq., for the respondent. ARUNDELL *32 A deficiency in the sum of $11,449.87 was determined by the respondent for the calendar year 1929. In this proceeding the petitioner attacks the correctness of the determination, which is essentially based on the disallowance as a deduction of the unamortized balance of the discount and expenses incident to a bond issue retired in the taxable year, and the disallowance of premiums paid in connection with the retirement of the bonds. FINDINGS OF FACT. Petitioner, the National Tile Co., is a corporation organized in January 1927 under the laws of the State of Ohio, with an authorized capital stock of 90,000 common shares of no par value, which were sold shortly after its organization for $29.70 per share in cash, or a total of $2,673,000. Petitioner's principal business*1382 office is located at Anderson, Indiana, and its books of account were kept at that office at all times herein referred to. Petitioner adopted the calendar year as its fiscal year, and its income tax returns for the calendar years 1927, 1928, and 1929 were filed with the collector of internal revenue at Indianapolis, Indiana. Shortly after its organization in the month of January 1927, petitioner disposed of an issue of ten-year 6 1/2 percent debentures dated February 1, 1927, all maturing February 1, 1937, in the face amount of $1,000,000, for $900,000, involving a discount of $100,000. This item was set up on its books under the name "Bond Discount", to be written off over the life of the debentures on the basis of one tenth of the full amount each year. In connection with the authorization and disposal of the $1,000,000 debenture issue, petitioner incurred expenses in the amount of $3,053.43, which it deducted on its own books and on its orginal income tax return for the year 1927 as expense of the year 1927, *33 but which upon audit of the return was disallowed as such expense and required to be set up on petitioner's books as "Bond Expense", to be written off over*1383 the same period and in the same manner as the item of bond discount above referred to. On November 16, 1928, petitioner entered into an agreement with Otis & Co., an investment banking firm of Cleveland, Ohio, providing for the underwriting by that firm of an additional issue of 30,000 shares of the capital stock of petitioner at a price of $31 per share, for an underwriting fee of $30,000. The agreement provided that out of the proceeds of the sale of the shares petitioner should retire all of its outstanding debentures on the next interest payment date, which was February 1, 1929. The additional 30,000 shares of capital stock of petitioner referred to in the agreement of November 16, 1928, were sold between November 16 and December 31, 1928, to the shareholders of the corporation and to Otis & Co., pursuant to the underwriting agreement, and $900,000 in cash was thus added to the capital of petitioner over and above the underwriting fee of $30,000 provided for in the agreement. There were outstanding at the close of business December 31, 1928, $929,500 of the ten-year 6 1/2 percent debentures, all of which were thereafter retired on or before February 1, 1929. The deferred*1384 debenture discount and expense referable to the debentures standing on the books of petitioner at the close of business December 31, 1928, was $82,682.60. In connection with retiring the debentures from January 1 to February 1, 1929, petitioner was required to pay, and did pay, premiums amounting to $20,634. In petitioner's income tax return for the year 1929 it claimed as a deduction the amount of $82,682.60 representing the unamortized balance of discount and expenses in connection with the issuance of its retired debentures, which amount stood on its books on January 1, 1929, and was written off in connection with the retirement of the debentures, and a further deduction in the amount of $20,634 representing the premiums paid in connection with the retirement of the debentures. The respondent disallowed both of the claimed deductions. OPINION. ARUNDELL: The pleadings raise an issue concerning a deduction for patent rights allegedly worthless, but no evidence was offered on this question, except the stipulated amount of expenditures in connection with the acquisition and development of the patent rights, and on brief counsel for petitioner abandoned this issue. *34 *1385 On the other issues, in addition to the facts that we have found, the parties have stipulated that there is no dispute as to the correctness of the amounts claimed by petitioner as deductions for the year 1929. We take it as established law that the discount and expenses incurred in connection with the disposal of bonds or other obligations of indebtedness are a part of the cost of the funds secured, and should normally be amortized over the time the obligations are to be outstanding. ; ; affirmed on rehearing, . We think it is equally well established that a deduction is allowable when the obligations so sold at a discount are retired before maturity, the measure of the deductible amount being the unamortized discount and expense in connection with the issuance of the security which has not theretofore been charged off. . The respondent undoubtedly does not dispute the general principles here announced, for they are in accordance with his regulations, articles 68 and 176 of Regulations*1386 74, but he advances an exception to the general rule in this case by reason of the fact that the money used to retire the bonds was obtained from the sale of petitioner's stock, under the terms of which sale it was understood that the bonds would be retired. By reason of these circumstances respondent takes the position that the cost of retiring the bonds was an expense incurred in connection with the issuance of the stock, and, as the expense of securing additional capital by way of a stock issue may not be deducted as an ordinary and necessary business expense, the deduction sought should be disallowed. . Where the bonds are retired by payment of the indebtedness in cash, it does not seem to us important how the obligor secured the money to discharge the obligations. The fact that the money was obtained by the issuance of stock rather than out of earnings is not here controlling. It is the discharge of the obligation that creates the occasion for writing off the unamortized portion of the discount and expense and any premiums paid in connection with the retirement of the bonds. The case is ruled by *1387 , and the petitioner must prevail. See also ;. In the last cited case we specifically held that the payment of a premium on the retirement of bonds gives rise to a deductible loss. Decision will be entered under Rule 50.