Farr v. Commissioner

FRANCIS SHELTON FARR AND LOUISE ARNOLD FARR, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Farr v. Commissioner Docket No. 101144. United States Board of Tax Appeals 44 B.T.A. 683; 1941 BTA LEXIS 1292; June 6, 1941, Promulgated *1292 Loss incurred by partnership in trade or business of buying and selling securities for its won account, held, capital loss subject to limitations of Revenue Act of 1936, section 117, O, L. Burnett,40 B.T.A. 605; affirmed on this issue (C.C.A., 5th Cir.), 118 Fed.(2d) 659, followed; that section so applied, held, further, not to be unconstitutional. W. Montague Geer, Jr., Esq., and Walter C. Elliott, Esq., for the petitioners. F. S. Gettle, Esq., for the respondent. OPPER *683 Respondent determined a deficiency of $3,601.78 in petitioners' income tax for the year 1937, which is contested only in so far as it results from the disallowance of $11,287,33 claimed as an ordinary loss representing petitioners' distributive share of a loss sustained by a partnership from the purchase and sale of securities for its own account. The only issue is whether the loss is deductible in full under section 23(e)(1) of the Revenue Act of 1936 or is a capital loss subject to the limitations of section 117(d). FINDINGS OF FACT. The facts are largely stipulated and as so stipulated are hereby found. Facts appearing*1293 hereinafter which are not from the stipulation have been otherwise found from the record. Petitioners (hereinafter for convenience sometimes referred to as petitioner) are husband and wife. During the taxable year petitioner Francis Shelton Farr was one of eight general partners in the firm of Farr & Co., having its principal office at 90 Wall Street, New York. The firm was organized and commenced to do business in February 1920; and by all the partnership agreements, a new one *684 being made nearly every year, including the partnership agreement dated January 1, 1937, the partners agreed with each other in part as follows: The purposes of the partnership agreement are: (1) To engage in buying and selling raw and refined sugars, both on commission and for their own account. (2) To engage in buying and selling crude rubber, cocoa and other commodities, both on commission and for their own account. (3) To conduct a general investment business in securities of all kinds, and all business incidental thereto, including buying and selling stocks, bonds and securities, both on commission and for their own account. From the year 1921 and through the taxable year 1937, *1294 the firm was gegaged in the business of buying and selling securities, both listed and unlisted, for its own account and as broker for others; and from 1932 through 1937, the firm was engaged in the business of buying and selling commodities, spot and futures, for its own account and as broker for others. Throughout 1937 members of the firm held memberships in the New York Stock Exchange, the New York Coffee & Sugar Exchange, Inc., the New York Curb Exchange, the New York Cocoa Exchange, Inc., and the Commodity Exchange, Inc., for the purpose of enabling the firm to buy and sell for others and for its own account the securities and commodities listed on the various exchanges and to receive the advantages accorded members of such exchanges. Pursuant to the partnership agreements the firm bought and sold upon the various exchanges and over the counter for its own account, and as broker for others, listed and unlisted securities and commodities, spot and futures, in each of the six years 1932 to 1937, inclusive. The total profit from buying and selling such property for its own account was $18,243.24 in 1932: $71,866.13 in 1933; $177,949.68 in 1934; $84,033.89 in 1935; and $64,925.15*1295 in 1936. During the four years 1933 to 1936, inclusive, the firm for its own account bought and sold stocks listed on the New York Stock Exchange and the New York Curb Exchange, which were carried in accounts entitled "Trading Accounts." Completed transactions (a purchase and resale of the same shares constituting one transaction) numbered 179, 185, 104, and 108 in the respective years; the number of shares bought and sold in each year was 30,750, 20,375, 14,690, and 13,485, respectively; and different stocks traded in numbered 56, 68, 41, and 39, respectively. Profits from this activity consisted of the difference between the cost of the securities and the prices at which they were resold, and income taxes were paid by the partners on income which included such profits. *685 During the taxable year three partners of the firm bought and sold listed stocks for the firm's account, devoting about one-fourth of their time to this part of the firm's activities. They continuously studied economic conditions and other factors affecting the trends of the stock market to enable them to determine which stocks to buy and the proper times to buy and sell. The firm maintained throughout*1296 the year three trading accounts for the purpose of carrying and recording all such pruchases and sales of listed stocks for its own account. The securities involved in this proceeding were all bought and sold in the year 1937 in the course of the firm's business of buying and selling securities for its own account. All the sales and purchases were made through the New York Stock Exchange, and all the purchased securities were fully paid for. Securities of 48 different corporations were bought and sold; the total amount involved in the purchases was $453,129.25; the total amount received from the sale of the stocks was $414,204.86; and the number of transactions on the buy and sell sides was 136 and 122, respectively. The number of securities bought and sold was 14,281 shares of stock and 10 bonds. Stocks were either bought or sold on 115 different days, and a purchase or sale was made in nearly every week of the year. Seventy-six purchases were closed at a loss and 39 at a profit. The stocks on 14 of the 136 purchases were sold on the day they were purchased and certificates therefor were never delivered to or received by the firm. The stocks acquired on 22 other purchases*1297 were sold within two weeks after their purchase; on 19 other purchases, within three weeks; on 14 other purchases, within one month; on 32 other purchases, within two months; on 12 other purchases, within four months; and the balance were sold during the year but more than four months after their purchase. Of the 48 different stocks purchased, 15 were not paying dividends when purchased and had paid none in 1936, and 14 of the 15 paid none in 1937. The others paid dividends not more often than once every three months in 1937 and in prior years. All of the securities were bought without intent or limitation in mind as to what individual buyers or classification of buyers they would be sold to, although the firm knew there was a market for the securities upon the New York Stock Exchange. As a result of the firm's buying and selling of listed securities for its own account through the New York Stock Exchange throughout the year 1937, the firm sustained a loss of $37,505.93, composed of the difference between the purchase and selling prices. The loss was reported by the firm's auditors on the partnership return as a capital *686 loss, by reason of which a deduction of $2,000*1298 was taken. The return disclosed gorss prifit from business in the sum of $472,120.15, which according to the schedule attached, consisted of the following items: Commissions $280,435.23 Brokerage 111,697.63 Sampling 29,843.36 Chartering 40,375.12 Profit on sale of commodities as dealers $17,085.05 Less: Loss on sales of securities as dealers 7,316.24 9,768.81 472,120.15 The profit reported on the sale of commodities as dealers was made on sales of commodities which were bought and sold for the firm's account. Of the commissions of $280,435.23, the sum of $60,434.53 was received as gross commissions from persons who bought and sold securities, and of the latter amount approximately $8,000 was received from persons from whom the firm as broker purchased and sold securities over the counter. In all cases before, during, and after 1937, except some of simultaneous resale, when Farr & Co. bought securities for its own account, whether they were purchased from sellers at private sale or over the counter, or from sellers upon the Exchange, to whatever class of buyers they were sold or intended for sale, the securities were bought and*1299 held for the purpose and with the intent of profiting from the difference between the prices which it paid for the securities and those at which it might sell them, and with the expection and intent of profiting in part from price appreciation as established by the prices of transactions upon the exchanges or other markets where the securities were traded in, and generally the firm's profits were in part the result of such price appreciation. The firm actually did business in securities with more than 625 persons in each of the years 1936 and 1937, and in each of the years it sold to some of them common stocks which had previously been purchased and held for its own account. The firm did not solicit sales to private persons of the securities here involved, but would have been willing to sell any of the listed securities held for its own account to any of its old customers or other private persons if acceptable offers had been made. It was the firm's practice from 1933 through the taxable year to have its auditors prepare an inventory of all the securities, both listed and unlisted, and commodities, spot and futures, held for its own account at the end of the year, in its business*1300 of buying and selling for its won account. These inventories were used by the firm as a record of its holdings, and for the purpose of computing *687 profit and loss as among the partners and in the preparation of partnership income tax returns. As a general rule the inventories carried each item at a stated value, at or near the market value at the end of the year, which values entered into the computation of the year's profits distributable to the partners and into the amount of firm income reported for income tax purposes. At the end of 1934 nine of the firm's security accounts contained unsold securities, and those in five of the accounts were marked to their market values at the end of the year for profit and loss accounting and computation of partnership income for tax purposes. Securities in three other accounts were so marked at one time or another during the taxable year but not at the end of the year, and the securities in the other account were not marked. At the end of 1934 all the securities listed on the New York Stock Exchange and still held by the firm, having been purchased in its business activities for that year, were written up or down to prices representing*1301 or approximating market prices on the Exchange, resulting in a net write-down of $364.63, which was deducted from reported partnership income, upon their distributive shares of which the partners paid income taxes. At the end of 1935, 13 of the firm's security accounts contained unsold securities, and those in all 13 accounts were marked to their market values at the end of the year for profit and loss accounting and computation of partnership income for tax purposes. At the end of 1935 all the securities listed on the New York Stock Exchange, which were still held by the firm, were written up or down to prices representing or approximating market prices on the Exchange, resulting in a net write-up of $1,136.75, which was added to reported partnership income, upon their distributive shares of which the partners paid income taxes. At the end of 1936 seven of the firm's security accounts contained unsold securities, and those in six of the accounts were marked to their market values at the end of the year for profit and loss accounting and computation of partnership income for tax purposes. All the listed securities bought or held by the firm during 1936 were sold in that year*1302 and no listed securities were held or carried over at the end of the year 1936. Respondent's agents audited the books of the partnership in connection with the partnership returns but raised no question as to the inventory method. None of the listed securities in question were on hand at the end of the taxable year 1937. Reports rendered to the New York Stock Exchange by member firms show that many member firms, in the course and as part of their regular business, sold many thousands of shares of listed stocks, *688 bought for their own account at private sale or on the Exchange, by means of direct sales off the floor of the Exchange and directly to buyers at private sales. It was the practice of many member firms to do this throughout the years 1932 to 1937, inclusive. When stocks are sold on the Stock Exchange the purchaser is the principal in the transaction and the Exchange member acts only as his agent or broker, unless the member buys or sells for himself or for a member firm, in which case he or the firm is the principal. In the case of unlisted stocks which are sold at private sale, there is a fluctuating market which determines the prices at which sales*1303 will be made. Every unlisted security, except a few which are inactive or closely held, has a definite market and bid and asked quotations maintained by dealers who hold themselves out to the public as ready to buy and sell unlisted stocks at specified asked prices, and it is the prices maintained by these dealers at or near which unlisted stocks are sold. The market prices of unlisted securities as established by the dealers' quotations move up and down just as the market prices of securities listed on the Exchanges do, and their trend generally follows that of prices on the listed markets. When the bid and asked quotations of an unlisted security advance in the unlisted or over the counter market, the market value of that security and the price at which it can be sold correspondingly advance. That is because when the bid and asked quotations of a particular unlisted security advance, it can be sold at private sale, at a higher price, matching or corresponding to the bid and asked quotations. OPINION. OPPER: We are of the opinion that this case is controlled by *1304 O. L. Burnett,40 B.T.A. 605; affirmed on this issue (C.C.A., 5th Cir.), 118 Fed.(2d) 659. Petitioner's contrary contentions are susceptible of division into three parts: First, that the Burnett case is wrong and "we think should be overruled by this Board"; second, that the case is distinguishable; and, third, that if the rule there followed is applied to petitioner, it places an unwarrantable construction upon section 117 of the Revenue Act of 1936, 1 from the standpoint of constitutionality. *1305 *689 We think the Burnett case was properly decided and should be followed. And we do not think that it is distinguishable. The differences in the present facts petitioner asserts to be that here petitioner's firm was a stock exchange member, and always paid fully for the property bought, and sold the listed stocks by its own firm members to purchasers there, whereas in the Burnett case petitioner bought and sold through brokers and on margin; that here the partnership agreement authorized buying and selling securities for profit as a business; that there was a large business investment and continuing overhead and the devotion to the business of a large amount of time, attention, and experience by firm members; and that petitioner's firm had over 600 customers, to some of whom it at times sold stocks purchased for its own account. To the extent that these facts from the basis for petitioner's contention that the firm was carrying on a trade or business of buying and selling securities for profit on its own account they are persuasive, and we have made a finding of fact to this effect. That, however, does not constitute a distinction from the Burnett case, *1306 for similar facts and the same finding may be found there. They do not demonstrate that the Burnett case is inapplicable. The Board there said that, under the corresponding section of the 1934 Act, "any property is a 'capital asset' unless it may properly be included in an inventory or is held for sale to customers." If petitioner was a trader and not a dealer, it was not entitled to use inventories. O. L. Burnett, supra.The mere fact that it was a stock exchange firm and had customers as a broker neither entitled it to do that nor to claim that securities traded in for its own account were intended for sale to customers. In Vaughan v. Commissioner, 85 Fed.(2d) 497, 499; certiorari denied, 299 U.S. 606, the Second Circuit Court of Appeals came to the conclusion that the stock brokerage firm there involved was to be considered a dealer with respect to stocks in which they were "specialists", adding: * * * But we can not see that they were "dealers" within the meaning of the regulations in the other securities, which were held and traded in in relatively small quantities and had no necessary connection with their business*1307 except for speculation. We do not think it possible that they purchased or carried such stocks as a supply for customers. To the same effect is Schafer v. Helvering,299 U.S. 171. There is no claim here that petitioners were specialists or that for any other *690 reason the stocks bought for their own account were "a purchase to create a stock of securities to take care of future buying orders in excess of selling orders." Schafer v. Helvering, supra. We think, therefore, that there is no ground for the assertion that the present facts distinguish this proceeding from O. L. Burnett, supra. On the constitutional point, petitioners contend, in effect, first that the respondent's position prevents them from deducting the cost of goods sold in arriving at their gross income, and, second, that the emphasis placed upon sales to customers creates a "whimsical", arbitrary and unreasonable classification. The first contention was disposed of unfavorably to petitioner's position in *1308 Edward J. White,37 B.T.A. 1106, dealing with the provisions of section 23(r) of the Revenue Act of 1932. As to the second, we can not be unmindful that we are dealing here with a matter of deductions which "may be allowed or not in the sound discretion of Congress; the only restriction being that it does not act arbitrarily so as to set up in effect a classification for taxation so unreasonable as to be a violation of the fifth amendment." Davis v. United States (C.C.A., 2d Cir.), 87 Fed.(2d) 323, 325; certiorari denied, 301 U.S. 704. We think it apparent that, in describing the excepted class by reference to the term "customers", Congress was characterizing not the vendee but the type of business. This was entirely in accordance with precedent. As has been suggested, the use of inventories was restricted by regulation and decision to dealers, who in turn were to be distinguished from traders by reference to whether their sales were made to customers in the ordinary course of their business. That Congress had this analogy in mind in enacting 117(b) is evident from the reference to inventories in the same sentence. Again, in*1309 the 1928 Act (sec. 118), the "wash sales" provision is declared not to be aimed at a corporation which is "a dealer in stocks or securities, and with respect to a transaction made in the ordinary course of its business." This required a definition of dealer, which, as accepted, contained reference to "resale to customers." Donander Co.,29 B.T.A. 312, 314. In the 1932 Act there was a limitation upon losses from sales or exchanges of stocks and bonds even though not capital assets as there defined, meaning those held for two years or more, which, however, was inapplicable "to a dealer in securities (as to stocks and bonds acquired for resale to customers) in respect of transactions in the ordinary course of his business." Sec. 23(r). In 1934, as petitioner points out, the change consisted of a "slightly revised" treatment. Capital assets were defined to include property even though connected with a trade or business, and without regard to any holding period, and the reference to "customer" was moved from section 23(r) to section 117(b). The effect, however, seems *691 to us to have been, first, to create a classification intended, as theretofore, to apply*1310 only to a dealer in securities, "i.e., a merchant of securities * * * with an established place of business regularly engaged in the purchase of securities at wholesale and their resale to customers"; 2 and, second, to make it clear that the classification separating a dealer, on the one hand, from a trader, on the other, is not only sanctioned by repeated precedent, but based upon a real distinction between such a merchant and "traders or other taxpayers who buy and sell securities for investment or speculation, whether or not on their own account, and irrespective of whether such buying and selling constitutes the carrying on of a trade or business." 3 We do not think it possible to say that such a classification is whimsical or arbitrary. Decision will be entered for the respondent. 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. * * * (d) LIMITATION ON CAPITAL LOSSES. - Losses from sales or exchanges of capital assets shall be allowed only to the extent of $2,000 plus the gains from such sales or exchanges. If a bank or trust company incorporated under the laws of the United States or of any State or Territory, a substantial part of whose business is the receipt of deposits, sells any bond, debenture, note or certificate or other evidence of indebtedness issued by any corporation (including one issued by a government or political subdivision thereof), with interest coupons or in registered form, any loss resulting from such sale (except such portion of the loss as does not exceed the amount, if any, by which the adjusted basis of such instrument exceeds the par or face value thereof) shall not be subject to the foregoing limitation and shall not be included in determining the applicability of such limitation to other losses. ↩ 2. H.R. 708, 72d Cong., 1st sess., p. 13, referring to Revenue Act of 1932, section 23(r). ↩ 3. Ibid.↩