Hercules Motors Corp. v. Commissioner

HERCULES MOTORS CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Hercules Motors Corp. v. Commissioner Docket No. 92225. United States Board of Tax Appeals 40 B.T.A. 999; 1939 BTA LEXIS 768; November 30, 1939, Promulgated *768 Trade acceptances, received by petitioner in payment of goods sold and disposed of at less than their face value, constitute property held primarily for sale to customers in the ordinary course of trade or business. (Sec. 117(b), Revenue Act of 1934.) H. A. Mihills, C.P.A., and F. E. Gleach, Esq., for the petitioner. T. F. Callahan, Esq., for the respondent. VAN FOSSAN *999 This proceeding was brought to redetermine a deficiency in the income tax of the petitioner for the year 1934 in the sum of $1,436.29. The petitioner also claims an overpayment of $482.64. The single issue is whether the difference between the selling price of merchandise and the fair market value of trade acceptances received in partial payment thereof is an ordinary loss or is limited by section 117(d) of the Revenue Act of 1934, relating to capital losses. FINDINGS OF FACT. The petitioner is a corporation, organized under the laws of the State of Ohio, with its principal office and place of business in Canton, Ohio. It is engaged in the manufacture of internal combustion engines, both Diesel and gasoline. In 1934 and several years prior thereto the petitioner*769 had been selling motors, manufactured by it, and parts and accessories therefor to the Amtorg Trading Corporation of New York, New York (hereinafter called Amtorg), a purchasing agency in the United States for the Soviet Russian Government. The petitioner sold its goods to Amtorg in exchange for trade acceptances, negotiable acknowledgments of indebtedness in the amount of the invoice, maturing at a later date, with interest from date. Late in 1934 several minor sales were made for cash. The credit of Amtorg was considered doubtful. Therefore, the petitioner increased the selling price of its merchandise to compensate for the estimated loss on the trade acceptances received in payment. In August 1934 the petitioner sold to J. H. Leader, Inc., all of the trade acceptances it had received during that year. Petitioner offered the trade acceptances to several brokers and banks in New York but that company was the only purchaser the petitioner could find for them. The trade acceptances were taken by the petitioner in the regular course of its business with Amtorg and as a condition *1000 essential to its sales to that company. Petitioner had sold other trade acceptances*770 to other purchasers in prior years. In 1934 the petitioner received from Amtorg trade acceptances of the face value of $72,458.81. The interest thereon to the date of their sale amounted to $6,459.23, or a total of $78,918.04. The acceptances bore dates between January 12 to July 13, 1934, inclusive, and matured from January 12, 1935, to December 29, 1936. They were sold for $63,712.82, their fair market value at that time, the sale resulting in a loss of $15,205.22 to the petitioner. The petitioner kept its books of account and records on the accrual basis. The full amount of the selling price was charged to Amtorg's account as an account receivable and a corresponding entry was made in the petitioner's ledger under its sales account. When cash was received on Amtorg's account, either in part payment of the invoice or in payment of the trade acceptance, it was posted in the cash receipts journal and credited to Amtorg's account. OPINION. VAN FOSSAN: The issue is whether or not, under the circumstances here presented, trade acceptances constituted capital assets within the meaning of section 117(b) of the Revenue Act of 1934. 1 In each instance the determination of*771 the question must rest on the facts of the case. The character of the taxpayer's business, the methods of its operation, the measures required to carry it on, and all acts and transactions incidental to such business must be considered. Here the petitioner's primary business was the manufacture and sale of motors and motor parts and accessories. In order to sell to Amtorg it became necessary to receive its payment in Amtorg's trade acceptances. Because of the uncertain credit status of both Amtorg and the Russian Government, the price of the articles sold was increased to equalize the difference between the possible proceeds from the sale of the acceptances*772 and their face value. This increased price was reflected in petitioner's income account. The trade acceptances came into the petitioner's possession as a necessary incident to the sale of its merchandise and were not received, or were intended to be held, as a capital asset. The respondent does not suggest that the petitioner acquired the trade acceptances as an *1001 investment. In support of his position that they were capital assets, respondent contends they do not come within the precise language of the statute. Here the trade acceptances related directly to the sale of the petitioner's products to Amtorg. They had become a usual and regular factor in the petitioner's transactions with that customer and the sales were accomplished largely through the means of such obligations. Their receipt was thus necessary to the normal conduct of the petitioner's business. Their disposition likewise became essential. Petitioner offered them to several potential buyers, finding a customer in J. H. Leader, Inc. Petitioner had sold acceptances to other buyers in other years. Such activities, in our opinion, come within the purview of the statutory phrase "held by the taxpayer*773 primarily for sale to customers in the ordinary course of his trade or business." The respondent has recently published the opinion of the Chief Counsel, Bureau of Internal Revenue (G.C.M. 21497, C.B. 1939-35-9981) in which he holds: A bank, mortgage finance company, or a building and loan association which is offering for sale parcels of real estate on which it has been compelled to foreclose is holding property "primarily for sale to customers in the ordinary course of * * * trade or business" within the provisions of section 117(b) of the Revenue Acts of 1934 and 1936, and the gains or losses incurred in such sales are to be treated as ordinary gains or losses and not as capital gains or losses. Respondent's position in the present case is entirely inconsistent with the above opinion, which we believe to be sound in law. In our judgment, the sale of negotiable evidences of indebtedness by the petitioner, which had been forced to accept them in order to make its sales of motors, is no more foreign to its business than the sale by a bank of real estate on which it has been obliged to foreclose. The respondent argues that the foregoing conclusion does violence to the petitioner's*774 accrual basis of accounting. We are unable to follow respondent's line of reasoning. The petitioner included in its income account the full face amount of the invoices and seeks to deduct therefrom appropriate amounts representing losses from the sales of trade acceptances taken as part or full payment for the goods invoiced. The petitioner sustained a loss of $15,205.22 on property held by it primarily for sale to customers in the ordinary course of its trade or business. Such loss is deductible as an ordinary loss. Decision will be entered under Rule 50. Footnotes 1. SEC. 117. CAPITAL GAINS AND LOSSES. * * * (b) DEFINITION OF CAPITAL ASSETS. - For the purposes of this title, "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business. ↩