Blaise v. Commissioner

E. F. BLAISE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Blaise v. Commissioner Docket No. 98294. United States Board of Tax Appeals 42 B.T.A. 1232; 1940 BTA LEXIS 883; November 15, 1940, Promulgated *883 STATE RULE OF PROPERTY DETERMINES PERIOD OF OWNERSHIP OF CAPITAL ASSET. - In 1925 petitioner subscribed and paid for 50 shares of capital stock of a California corporation in violation of the terms of a permit of the commissioner of corporations authorizing the issuance of stock only to incorporators. The issuance of stock to petitioner was void under California law. In 1934 a new or amended permit was obtained under which a new certificate for 50 shares of stock was lawfully issued to petitioner. He sustained a loss upon liquidation of the stock in the taxable year 1935. Held, the Board is bound by the state rule of property in determining the period of ownership, and petitioner is entitled to deduct 80 percent of his loss under section 117(a), Revenue Act of 1934. Clark G. Clinton, Esq., for the petitioner. J. E. Marshall, Esq., for the respondent. HILL *1232 In this proceeding petitioner requests redetermination of a proposed deficiency of $702.98 in income tax for the year 1935. The sole issue is whether a loss sustained by petitioner on 50 shares of capital stock of a California corporation, liquidated in the taxable year, is*884 an allowable deduction to the extent of 30 percent or 80 percent thereof under section 117(a) of the Revenue Act of 1934. The facts were stipulated by the parties. *1233 FINDINGS OF FACT. Petitioner is an individual, residing in Tulsa, Oklahoma. He filed his individual income tax return for the calendar year 1935 with the collector of internal revenue at Oklahoma City, Oklahoma. H. T. Lockwood, Inc., was organized under the laws of the State of California on June 22, 1925, with an authorized capital stock of 1,000 shares of the par value of $100 per share, to engage in the interior decorating business. The corporation obtained a permit from the department of investments of the Division of Corporations of the State of California, bearing date of July 20, 1925, authorizing it to sell 500 shares of its capital stock to its incorporators for cash at par. Although petitioner was not one of the incorporators of H. T. Lockwood, Inc., he did subscribe and pay for at par 50 shares of the corporation's stock, of which 25 shares were issued to him on July 31, 1925, and 25 shares on September 12, 1925. In 1929 petitioner received a 75 percent cash dividend on the stock. *885 Petitioner remained in physical possession of the 50 shares of stock until August 31, 1934. Prior thereto, and on July 3, 1934, he was informed by an attorney for the corporation that the stock held by him and certain others had been illegally issued, it being pointed out that under the corporation's permit, under California law, the corporation had no legal right to issue stock to any one other than the incorporators. On this latter date, July 3, 1934, petitioner was asked to sign an agreement and waiver, between H. T. Lockwood, Inc., as first party, certain others as second parties, and petitioner and others as third parties, which recited, among other things, that the corporation obtained a permit from the Commissioner of Corporations dated July 20, 1925, to sell 500 shares of its capital stock to its incorporators for cash at par; that the corporation caused to be issued, legally and in accordance with the permit mentioned, 176 shares of its capital stock to those referred to as the second parties, and thereafter illegally caused to be issued to the third parties (including petitioner herein) 436 1/2 shares of its capital stock; and that it was the desire of the parties to*886 the agreement, in order to correct the error and mistake of such illegal and overissuance of stock, to have a complete adjustment and understanding between all parties thereto. The agreement further set forth the following: * * * Said First Party does hereby recognize an indebtedness to E. F. BLAISE in the sum of Five Thousand ($5,000.00) Dollars for cash heretofore advanced by said E. F. BLAISE to First Party and does hereby agree to cancel said indebtedness by the issuance of 50 shares of its authorized capital stock if, as, and when the same shall be permitted by order of the Corporation Commissioner of the State of California. * * * This was the first knowledge petitioner had that the legality of the issuance of the stock to him had been questioned. He at first did *1234 not understand the situation and carried on correspondence with the attorney for the corporation between July 3 and August 31, 1934. In the course of this correspondence petitioner offered to surrender whatever rights he had upon the payment to him of a cash consideration based upon the original investment plus 6 percent interest less the dividend he had received in 1929. In response to his offer*887 petitioner was informed that the corporation was not in position to handle the matter in that manner, and petitioner was finally prevailed upon in 1934 to sign the agreement and waiver (referred to hereinabove), surrender the original stock certificates, and accept new stock certificates purporting to correct the technical legal question that had been raised in connection with the original issue. On August 27, 1934, counsel for the corporation addressed the following letter to petitioner: I am pleased to advise you that I have obtained from the Commissioner of Corporations of this State both an Amended Permit and a Supplemental Permit authorizing and permitting H. T. LOCKWOOD, INC. to carry out the terms of the agreement heretofore signed by your good self and others. If you will send me your stock certificates I will see that new certificates are issued in lieu thereof and forwarded to you by return mail. We are trying to avoid any expense of having an escrow holder or a bank act in these exchanges of certificates and I trust it will be satisfactory to you to comply with this request. On August 31, 1934, petitioner mailed the 2 stock certificates for the 50 shares issued*888 to him in 1925 to the attorney for the corporation. On September 15, 1934, a new stock certificate for 50 shares was issued in the name of petitioner, and this certificate was mailed to him by the secretary of the corporation on November 21, 1934, and it was received by petitioner in due course of the mails. During the depression years the corporation suffered adversely and finally, in 1935, found that it could not continue in business. The corporation liquidated before the end of 1935. Petitioner received $244.90 in liquidation in 1935. The cash dividend paid in 1929 was the only dividend ever paid prior to distributions in liquidation in 1935 and subsequently. In his return for 1935 petitioner set up and claimed as a deduction against his gross income for that year a loss of $4,755.10, described in schedule A of his return as follows: "Loss on stock by liquidation - $4,755.10." Upon audit of the return, respondent limited the loss to 30 percent under the provisions of section 117 of the Revenue Act of 1934. OPINION. HILL: The question in this case is whether petitioner is entitled to deduct from gross income for the taxable year 1935 only 30 percent of the loss*889 sustained by him upon liquidation of 50 shares of the *1235 capital stock of H. T. Lockwood, Inc., a California corporation, as contended by respondent, or whether 80 percent of such loss is an allowable deduction under section 117(a) of the Revenue Act of 1934, 1 as contended by petitioner. There is no controversy as to the amount of the loss sustained by petitioner, nor that the shares of stock constituted a capital asset within the meaning of the statute. The sole issue relates to the period or length of time the stock was "held" by petitioner prior to its liquidation in 1935. If it was held by petitioner for more than 1 year but not more than 2 years, he is admittedly entitled to deduct 80 percent of*890 his loss. If the stock was held by petitioner for more than 10 years, he is concededly entitled to deduct only 30 percent of his loss. The word "held" as used in the statute is synonymous with "owned." In , the Court said: In common understanding to hold property is to own it. In order to own or hold one must acquire. The date of acquisition, then, is that from which to compute the duration of ownership or the length of holding. See also ; ; . In order, therefore, to determine how long the stock in controversy here was held by petitioner prior to 1935, we must ascertain the date of acquisition, or that on which he became the legal owner and holder of the stock. Clearly this question involves a state rule of property, and by such rule, as established under the statutes and decisions of the courts of California, we are bound. *891 ; ; . "State law determines the ownership of property subject to its jurisdiction." , citing , and . Petitioner subscribed and paid for at par 50 shares of the California corporation in 1925, shortly prior to which date the corporation had obtained a permit from the State Commissioner of Corporations authorizing it to sell 500 shares of capital stock to its incorporators. Petitioner was not an incorporator. Section 12 of the Corporate Securities Act of California, in effect, during the year 1925 (Deering's *1236 General Laws of California, 1923, part I, p. 1414) provided as follows: Securities Void. - Every security issued by any company, without a permit of the commissioner, authorizing the same then in effect, shall be void, and every security issued by any company, with the authorization of the*892 commissioner but not conforming in its provisions to the provisions, if any, which it is required by the permit of the commissioner to contain, shall be void. The Supreme Court of California, in , referring to the above statute, said: The rule that a security issued without a permit or in violation of the terms of a permit, is void under former section 12 of the Corporate Securities Act, has been frequently declared, and must now be taken as well settled in this state. * * * In 1931 (St. 1931, p. 949) a provision making such a security voidable was substituted for the old section * * * but this has no application in the instant case. The corporation involved in the present case not only was without authority under the corporation commissioner's permit to issue stock to petitioner in 1925, but the stock was issued in direct violation of the terms of the permit, and was therefore void. The fact that both the corporation and petitioner treated the stock as valid, as evidenced by the payment to petitioner of a 75 percent cash dividend in 1929, did not validate the void stock. In *893 , it was said: The doctrines of estoppel by contract and ratification have no application to a contract which is void because it violates an express mandate of the law or the dictates of public policy. Such a contract has no legal existence for any purpose and neither action nor inaction of a party to it can validate it and no conduct of a party to it can be invoked as an estoppel against its invalidity. See also , where the Supreme Court of California held that stockholders were not estopped from claiming invalidity of stock issued in violation of the terms of the permit because they received dividends. Petitioner did not become a legal owner and holder of the stock of the corporation in 1925 because the stock issued to him in that year was void, and the corporation at all times held the money paid in therefor for the use and benefit of petitioner. ; In the latter case the court held that the defendants, to whom stock had been issued in violation of the terms of the*894 permit, were not liable as stockholders for debts of the corporation. In , the court declared that an act or contract prior to 1931 violating the California Corporate Securities Act was void, not voidable, and a party not in pari delicto, if entitled to any relief, might have restitution only. It is respondent's contention that the period of petitioner's holding of the stock here in controversy should be computed from the date *1237 of issuance in 1925, and that, since petitioner had held the stock for more than ten years prior to the close of the taxable year, he is entitled to deduct only 30 percent of the stipulated loss. In support of his argument, respondent cites , affirming ; certiorari denied, . The cited decision, we think, does not rule the present proceeding. There, the controversy was whether or not amounts paid to the holders of "preferred" stock issued in violation of the California statute constituted interest deductible*895 by the corporation which had illegally issued such stock without a permit. The question of legal ownership of the stock was not directly involved, and, since it appeared from the facts that payments were made by the corporation out of profits to all of the stockholders in proportion to shares, it was held, for the purposes of that case, that the amounts claimed as deductions did not constitute interest, but dividends. What was said in the cited case must be viewed in the light of the facts under consideration. The taxpayer there could not be said to be "a party not in pari delicto", an essential condition to the application of the rules and doctrines hereinabove referred to. On the contrary, the Angelus Building & Investment Co., in connection with the determination of its tax liability, was seeking to benefit by its own wrongdoing. This point was stressed in the opinions of both the Board and court, the latter saying: The government in the collection of its revenues takes no notice of any situation of accountability to a state that the taxpayer may have caused to exist through his own wrongdoing. The principle stated is not applicable in the instant case. Petitioner*896 was not a party in pari delicto in causing the stock to be illegally issued in 1925, and hence is not here seeking to benefit from his own wrongdoing. Petitioner was a member of the investing public for whose protection the Corporate Securities Act of California was primarily enacted. We hold, therefore, that petitioner became the legal owner and holder of the stock here involved on September 15, 1934, and, in accordance with the provisions of section 117(a), supra, is entitled to deduct from gross income for the taxable year 80 percent of the loss sustained by him. Reviewed by the Board. Decision will be entered under Rule 50. MURDOCK MURDOCK, dissenting: The petitioner is claiming a deduction for loss which occurred when a corporation in which he had invested was liquidated. Section 115(c) provides that amounts distributed in *1238 complete liquidation of a corporation shall be treated as in full payment in exchange for the stock. The Commissioner has determined that the loss was a capital loss under section 117 and limited to 30 per centum, since the asset had been held for more than ten years. A capital asset is defined as property*897 held by the taxpayer. The petitioner made an investment of $5,000 in the corporation on or before July 20, 1925. He retained that investment until the latter part of 1935, a period of more than ten years. He received during that time a 75 percent cash dividend on the investment, which was taxable to him as a dividend. Angelus Building & Investment Co. v. Commissioner, 57 Fed.(2d) 130, affirming 20 B.T.A. 667; certiorari denied, 286 U.S. 562. Although the original certificates evidencing his investment were illegally issued, nevertheless the group of investors recognized that all were upon the same basis and permission was obtained whereby valid certificates were issued. I think it was the intent of Congress to limit the deduction under such circumstances to 30 percent of the loss. Cf. Lyeth v. Hoey,305 U.S. 188. The view taken by the majority seems too narrow. It permits no satisfactory answer to the questions of how the dividend of $3,750 was taxable and of how the petitioner would have been taxed had he sold his investment prior to 1934. ARUNDELL, STERNHAGEN, MELLOTT, and DISNEY agree with this dissent. *898 Footnotes 1. SEC. 117. CAPITAL GAINS AND LOSSES. (a) GENERAL RULE. - In the case of a taxpayer, other than a corporation, only the following percentages of gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net income: * * * 80 per centum if the capital asset has been held for more than 1 year but not for more than 2 years; * * * 30 per centum if the capital asset has been held for more than 10 years. ↩