C. F. Mueller Co. v. Commissioner

C. F. MUELLER COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. C. F. Mueller Co. v. Commissioner Docket Nos. 85964, 96331. United States Board of Tax Appeals 40 B.T.A. 195; 1939 BTA LEXIS 883; June 30, 1939, Promulgated *883 1. The difference between payments on subscriptions to building and loan association shares and the amount received upon maturity of the shares, is not taxable in its entirety to the shareholder in the year of maturity, where the shareholder has consistently for all years accrued annually on his books and included in his income the net annual increase in the withdrawal value of the shares resulting from dividends declared and credited annually to his account on the books of the association, but only so much of the gain as has not been accrued in prior years is taxable as a dividend in the year of maturity. 2. Where losses are sustained by the association during any year and charged on its books to the account of the shareholder at the end of the year, and the shares have not matured or have not been disposed of during the year, the losses may not be deducted in such year by a shareholder who has consistently accrued net annual increases in the withdrawal value in prior years but who fails to show how he accounted for the losses on his books or that his accounting method is one under which the deduction would have to be allowed in order to clearly reflect income. 3. An accrual*884 method of accounting does not permit a loss to be anticipated while the transaction is still open. W. C. Magathan, Esq., for the petitioner. F. S. Gettle, Esq., for the respondent. MURDOCK *196 The Commissioner determined deficiencies in income taxes for 1932 and 1935 in the amounts of $3,111.97 and $1,907.72. The only issue for decision as to 1932 is whether the petitioner is entitled to deduct a loss of $22,632.50, being the difference between the excess of withdrawal value of building and loan shares over the amount paid in on those shares as of December 31, 1931, and a similar excess as of December 31, 1932. The only issue for decision as to 1935 is whether the Commissioner erred in including in taxable income the excess of the amount received by the petitioner upon fully paid building and loan shares over and above the amount paid in on such shares, instead of the excess of the amount received over and above the amount accrued by the petitioner in prior years representing the withdrawal value of those shares. FINDINGS OF FACT. The petitioner, a corporation, filed its income tax returns for the taxable years with the collector of*885 internal revenue at Newark, New Jersey. It kept its books and made its income tax returns on an accrual method of accounting during each of the years 1922 to 1935, inclusive. The petitioner subscribed for a number of shares of stock in various building and loan associations during 1922, 1923, 1924, and 1928. Those associations were organized and operated under the laws of the State of New Jersey. The provisions of their constitutions and bylaws, in so far as they have any effect upon this proceeding, were practically identical and were as follows: Art. III. Sec. 1. The capital stock shall consist of shares of the par value of $200 each, to be issued in such series and such number as the board of directors shall determine. Sec. 2. The stock shall be of two kinds, viz: installment stock issued in series on which installment dues shall be paid as hereinafter provided; and fully paid stock not issued in series, on which the maturity or par value shall be paid when issued * * * Sec. 3. The board of directors shall at each annual meeting and semi-annually thereafter put an approximate value upon the shares of each series, which value shall be taken and accepted as a standard*886 until the next semi-annual meeting. Art. VIII. Sec. 1. For every share of stock of this association a shareholder shall pay the sum of one dollar a month to this association * * * Sec. 2. A new series of stock shall be issued [at stated times] and the shareholders shall pay their dues and be entitled to a share in the profits of this association only from the commencement of their particular series of stock. Sec. 3. When the board of directors shall have ascertained that the actual value of any share amounts to two hundred dollars, the owner of such share shall receive the sum of two hundred dollars therefor, or such owner's security to the amount of such share and such owner shall thereupon cease to be a member of this association in respect of such share of stock; * * * Art. *197 X. Sec. 1. Any shareholder who has not become a borrower, desiring to withdraw from this association, shall, on giving one-month's written notice to the board of directors be entitled to receive from this association the amount of dues actually paid in, first deducting therefrom such shareholder's proportion of all losses and expenses incurred by the association, together with all*887 fines and forfeitures charged against such shareholder; provided, that after the first year a shareholder shall be entitled to receive the actual amount paid in as dues by such shareholder, plus fifty per cent of the profits accrued to such shareholder's share or shares; after the second year, fifty-five per cent; * * * [The percentage increases 5 per cent per year until it reaches ninety-five per cent after the tenth year, and after the eleventh year the rate is such higher rate as the directors may determine.] All of the shares subscribed for by the petitioner were installment shares, upon which, with one exception not here material, the petitioner regularly made payments of $1 per month for each share. The payments were credited on pass books issued to the petitioner by each association. The petitioner did not borrow on or pledge any of its shares as collateral for loans, and no charges were entered on its pass books for fines, penalties, or interest, or for sums withdrawn during the years 1922 to 1935. Each association semiannually declared dividends from its earnings, credited the amount thereof on its books to the accounts of the shareholders, and notified them of the*888 credits. The dividends were declared at a percentage stated in the resolution, and the amount credited to the shareholder was computed by applying that percentage to the book value of the shares. The accounts of the shareholders were charged with a pro rata share of losses when losses were sustained. The pass book credits, plus dividends actually credited on the books of the association, less losses charged to the shareholder, constituted the book value of the shares. The directors, in accordance with article III, section 3, semiannually placed a value on the shares, designated as the "withdrawal value" under article X. It is the amount which a shareholder is entitled to receive upon withdrawal prior to maturity of his shares. The withdrawal value of any share was equal to the amounts paid on the share plus a percentage of the dividends credited. The percentage increased from year to year as provided in article X. The withdrawal value of shares which had not matured was always less than the book values, due to the fact that the book values included the full value of semiannual dividends credited, whereas the withdrawal values determined under article X included only a percentage*889 of the value of the semiannual dividends credited. Each association furnished the petitioner, not less than annually during the years 1922 to 1935, with a notice showing both the book value and the withdrawal value of its shares. *198 It was the uniform practice of these and other associations in New Jersey, from 1922 to 1935, to permit shareholders to withdraw at any time, and to pay to them the withdrawal value upon presentation of their certificates for cancellation, without requiring notice of one month in writing as provided in article X. The petitioner regularly made the required monthly payments on all of its shares. Dividends were credited on all of those shares in each of the years 1922 to 1931, inclusive. All of the associations sustained losses in 1932 and those losses were charged against the shares by the associations in accordance with article X. The total amount of losses charged to the petitioner's shares for 1932 was $22,632.50. The following table shows the total monthly payments made by the petitioner on its shares up to December 31, 1931, and up to December 31, 1932, together with the percentage of dividend credits applicable on each date in*890 order to arrive at the total withdrawal value of the shares on each date: Dec. 31, 1931 Dec. 31, 1932 Total monthly payments $317,375.00 $350,375.00 Percentage of dividends 109,038.75 86,406.25 Total withdrawal value 426,413.75 436,781.25 The petitioner regularly accrued on its books for each of the years 1921 to 1931, inclusive, the increase in the withdrawal value of its shares for that year. It reported as income for each year the excess of the increase in withdrawal value for the year over the amount of subscriptions on the shares paid during the year. The effect of this system was to report each year the net increase in the percentage of dividend credits which could be withdrawn as a part of the withdrawal value. The same system was followed in later years. The amount reported in the earlier years was reported as interest. Later it was reported as dividends. The record does not show how the petitioner accounted on its books for the losses of $22,632.50 charged to its shares on the books of the building and loan associations. The petitioner claimed a loss of $22,632.50 on its income tax return for 1932, which it computed as follows: *891 Total withdrawal value at December 31, 1931 $426,413.75 Payments made in 1932 33,000.00 Total $459,413.75 Less total withdrawal value at Dec. 31, 1932 436,781.25 Loss $22,632.50 *199 The Commissioner in determining the deficiency disallowed the deduction in its entirety. The petitioner did not sustain a loss in 1932 of $22,632.50 upon its investment in the building and loan shares. The petitioner received $50,000 in 1935 for 250 shares which became fully paid in that year. The petitioner subscribed for those shares in 1922 and paid $39,250 in monthly payments up to the date of maturity. Losses in the total amount of $1,317.50 were charged against those shares by the association during the years 1932 to 1934, inclusive. Dividends were credited to those shares on the books of the association in all other years during the period 1922 to 1935. The total amount of dividends credited during that period was $12,067.50. The Commissioner, in determining the deficiency, held that the petitioner had realized a profit of $10,750 for 1935 upon the disposition of those shares. The petitioner received $50,235.50 in 1935 for another block of 250 shares*892 which became fully paid in that year. The petitioner subscribed for those shares in 1932 and paid $38,250 in monthly payments up to the date of maturity. Losses in the total amount of $3,467.50 were charged against those shares by the association during the years 1932 and 1934. Dividends were credited to those shares on the books of the association in all other years during the period 1922 to 1935. The total amount of dividends credited during that period was $15,455. The Commissioner, in determining the deficiency, held that the petitioner had realized a profit of $11,985.50 for 1935 upon the disposition of these shares. The petitioner reported a profit of $4,200 on the disposition of the 500 shares which matured in 1935. The petitioner also reported on that return income of $4,673.75 representing the net increase in withdrawal value of its unmatured shares in accordance with its regular bookkeeping methods heretofore described. The Commissioner, in determining the deficiency, credited the $8,873.75, thus represented on the return, against the total profit of $22,735.50, as determined by him, and increased the petitioner's income by the difference of $13,861.75. All of*893 the stipulations of fact and exhibits attached thereto are incorporated in these findings by this reference. OPINION. MURDOCK: Amounts received by a taxpayer upon fully paid building and loan shares in excess of the subscription payments on those shares are dividends. Aaron Ward & Sons,23 B.T.A. 1279; affd., 65 Fed.(2d) 758. The building and loan associations were domestic corporations. A corporation receiving dividends from another domestic *200 corporation was entitled to deduct them in computing taxable net income under section 23(p) of the Revenue Act of 1928 and similar provisions in prior acts. This was changed by the Revenue Act of 1932, which provided that a corporation could deduct dividends received from a domestic corporation "which is subject to taxation under this title." It is conceded that the building and loan associations in which this petitioner owned stock were not subject to taxation under the various revenue acts. See section 101(4) of the Revenue Act of 1932. Therefore, beginning in 1932 and continuing through 1935, the dividends were no longer deductible by this petitioner. It reported its net annual earned accruals*894 as interest in the earlier years, and paid tax accordingly, but obtained refunds for two of those years. It reported the accruals for later years as dividends. There were no earnings for 1932, but the amounts reported thereafter were subject to tax. The building and loan associations annually notified the petitioner and other stockholders of the amount of dividends declared on the stock for the year, of the book value of the stock for the year, and of the withdrawal value of the stock for the year. The petitioner kept its books upon an accrual method of accounting. Although the details of that accounting method are not disclosed in this record, the petitioner regularly, and at least annually, accrued on its books the net annual increase in the withdrawal value of all shares. The petitioner reported on its returns for each year the excess of that annual accrual over the subscription payments made on the shares during the year and strenuously argues that such a method of accounting for and reporting income upon building and loan shares clearly reflects its income and may not be changed by the Commissioner. The Commissioner, on the other hand, argues that the petitioner had no*895 right under the law to accrue either the net increase as income or any decrease as a loss. He further argues that even if the accrual of the increase were permissible, nevertheless, there is no justification for the accrual of any loss for 1932. The Commissioner has presented no persuasive argument in support of his contention that the accounting method of the petitioned must be rejected in its entirety in favor of a method whereby all of the income is reported at the time the shares become fully paid. He argues that the requirement of notice before withdrawal prevents an accrual of the annual increase in withdrawal value. The evidence shows that actually the requirement of notice was not enforced, but even if it had been enforced, that circumstance alone would certainly not prevent an accrual within the year of the increase in withdrawal value. When the right to an amount becomes fixed, the amount may be accrued despite the fact that it may not be payable until somewhat later. Cf. Herbert v. United States, 81 Fed.(2d) 912; article 42-3 of Regulations *201 86, and similar articles of prior regulations, which hold that interest credited to savings*896 accounts is income when credited even to one on a cash basis, despite an unenforced ruling of the bank requiring notice of 30 days for withdrawals. Another argument presented by the Commissioner is that the withdrawal value was not unqualifiedly subject to the demand of the petitioner. He thus confuses constructive receipt by one on the cash basis with an accrual method of accounting. Regulations and cases cited, dealing with constructive receipt, are not in point as to accruals. He relies very strongly upon a memorandum opinion of the Board in which there was no annual declaration of dividends, no annual fixing of withdrawal value, and no regular method of accounting, so far as is shown by the report. The amount which the petitioner accrued in each year was an amount which became fixed and available to it for the first time within that year. The right of the petitioner to receive the amount came into being in that year. Thus it was properly accrued in that year. Cf. Spring City Co. v. Commissioner,292 U.S. 182; *897 Commissioner v. Darnell, Inc., 60 Fed.(2d) 82; H. H. Brown Co.,8 B.T.A. 112; Owen-Ames-Kimball Co.,5 B.T.A. 921. It may be interesting to note in this connection that G.C.M. 15875, reported in C.B. XIV-2, p. 100, approves of a somewhat similar method of accounting for the annual increase in the value of United States Savings bonds which may be purchased at the beginning of their term for an amount less than that which is payable when they become due. Section 42 of the Revenue Act of 1932 requires that income be reported in the year received except where the accounting method permitted under section 41 requires that it be reported for a different period. Section 41 provides a general rule in regard to accounting periods and methods of accounting. The rule is that the net income shall be computed in accordance with the method of accounting regularly employed in keeping the books of the taxpayer. The only exceptions are that if no such method has been employed, or if the method employed does not clearly reflect the income, the computation is to be made in accordance with a method which, in the opinion of the Commissioner, *898 does clearly reflect the income. Cf. Bradstreet Co. of Maine,23 B.T.A. 1093; affirmed on this point, 65 Fed.(2d) 943; International Cigar Machinery Co.,36 B.T.A. 124. The excess of the amount ultimately receivable over the subscription payments made on building and loan shares is income. The petitioner adopted and regularly followed a system of accounting whereby all of that income would be reported. That system of reporting income was one which clearly reflected the income over a period of years. The law is somewhat elastic in regard to accounting *202 methods provided that they clearly reflect income. Where one taxpayer has consistently followed one method and another taxpayer has consistently followed a somewhat different method of accruing and reporting income from similar transactions, each may be permitted under the law to adhere to its own method. We need not decide whether other taxpayers could be required by the Commissioner to adopt the method of this taxpayer, since that is a wholly different question. The method of this taxpayer fairly apportions the total income to the various annual periods in which it was*899 earned. Cf. Burnet v. Sanford & Brooks,282 U.S. 359. It follows that the Commissioner erred in disregarding the accounting method regularly used by the taxpayer and in determining that the petitioner realized a profit of $22,735.50 in 1935 when the 500 shares became fully paid and were retired. The petitioner, in accordance with its method of accounting, had already accrued all but $4,200 of the total gain on the shares, and only the latter amount was taxable as a dividend on those particular shares for 1935. The discussion so far has been confined to the propriety of the method used by the petitioner in reporting its income from the building and loan shares. The issue for 1932, however, is whether the petitioner is entitled to deduct a loss on those building and loan shares. Section 43 provides that deductions shall be taken for the taxable year in which "'paid or accrued' or 'paid or incurred' dependent upon the method of accounting upon the basis of which the net income is computed", unless a different period must be used in order to reflect income clearly. This is a general provision and must be read in the light of any specific provision allowing*900 a deduction. The petitioner may deduct for a loss only in accordance with the provisions of section 23(d) and (f), which allow the deduction of losses "sustained during the taxable year." The petitioner does not claim the right to inventory its stock nor does it claim that the stock became worthless. Such an owner of corporate stock sustains a loss and is entitled to a deduction through a final disposition of his stock whereby he receives less than he paid for it. No authority has been cited to indicate that such a taxpayer may deduct a loss under any other circumstances. Mere fluctuation in the value of corporate stock is not deductible as a loss by one not entitled to use inventories. Harry C. Howard,20 B.T.A. 207; affd., 56 Fed.(2d) 781; certiorari denied, 287 U.S. 619. Even an assessment paid by a stockholder may be additional cost of his stock rather than a loss where occasioned by losses of the corporation. John G. Paxton,7 B.T.A. 92; B. Estes Vaughan,17 B.T.A. 620; *901 Estate of G. A. E. Kohler,37 B.T.A. 1019, 1026; W. R. Ranney,16 B.T.A. 1399. It is a loss only if the stock is worthless. Cf. Jamieson Associates, Inc.,37 B.T.A. 92, 118; George H. Stanton,36 B.T.A. 112. Additions to a reserve for *203 anticipated losses are not deductible since the statute "is concerned only with realized losses." Lucas v. American Code Co.,280 U.S. 445, 449; Weiss v. Wiener,279 U.S. 333; William J. Ostheimer,1 B.T.A. 18; Yost Auto Co.,26 B.T.A. 685. Cf. Brown v. Helvering,291 U.S. 193. The amount which the petitioner seeks to deduct for 1932 was not a loss actually sustained in a closed transaction. The petitioner continued to own the shares after 1932 and there was no reason to believe in 1932 that there would be a loss rather than a gain when the shares were finally disposed of and the transactions were complete. This record shows that some of the shares were paid off at a profit to the petitioner. Perhaps the principal difference between the accrual method and the cash method of*902 deducting for losses sustained is that under the cash basis there must be payment of the loss before it can be deducted, while the taxpayer using an accrual method may take the deduction immediately when the events occur which cause the loss even though he has not paid it. An accrual method of accounting, however, does not permit a loss to be anticipated while the transaction is still open. This is clearly true in the present case, where, although there was a reduction in the earnings subject to withdrawal, the transaction remained open with prospects of ultimate gain. The argument that a taxpayer should be permitted to continue with its regular method of accounting can not be used to justify a deduction for a loss where no loss has been sustained in a closed transaction. Although the year in which a loss is sustained is to be determined by a practical test, rather than a legal test, Lucas v. American Code Co., supra, nevertheless a practical test here shows that the petitioner sustained no loss at all. Its shares for the moment became less valuable than they had been, but the question of ultimate gain or loss was still open. Furthermore, the facts do not*903 support any argument that this taxpayer had a regular method of treating transactions such as the ones here in question. The record shows that the petitioner's shares were never charged with losses prior to 1932. This is the first time that the petitioner was called upon to establish any accounting practice to cover such a situation. The petitioner has not shown how it accounted on its books for the losses charged to its shares on the books of the associations. Although the method now urged might be a reasonable one from an accounting standpoint, income can be clearly reflected without allowing the deductions claimed for 1932. No problem is presented of offsetting the income of a period with the expenses of earning that income. Cf. Bradstreet Co. of Maine, supra, and cases there cited. The value of the shares increased as the result of declarations of dividends from earnings of the associations prior *204 to 1932. The petitioner accrued and reported that part of the increase which it could withdraw. There was no increase in 1932. Either there would be additional earnings in later years or there would not. If additional earnings were later assigned*904 to the shares, the petitioner could delay reporting any additional income until those earnings had offset the losses charged to the shares in 1932. In case there should be no future earnings, the petitioner would be entitled to deduct a loss at the time it disposed of the shares, if the amount realized was less than the total subscription paid upon the shares plus the total amount previously reported as income on the shares. The record does not show an accounting method regularly used by this petitioner under which the deductions would have to be allowed in 1932 in order to clearly reflect income. It follows that the petitioner is not entitled to deduct any loss upon these shares until they become worthless or are finally disposed of at a loss. Decision will be entered under Rule 50.