Sala v. Commissioner

COUNTESS LAURA SALA, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Sala v. Commissioner Docket No. 103863. United States Board of Tax Appeals 47 B.T.A. 850; 1942 BTA LEXIS 637; October 8, 1942, Promulgated *637 The withdrawal of corporate funds by sole stockholder, carried on the corporation's books as "accounts receivable" and written down in a subsequent year pursuant to action of the corporation's board of directors, appropriately reflected on its books, constituted a taxable dividend to the stockholder in the year the accounts were written down. Richard J. Cronan, Esq., and M. Robert Gallop, Esq., for the petitioner. Z. N. Diamond, Esq., and Richard C. Flesch, Esq., for the respondent. VAN FOSSAN *850 The respondent determined a deficiency of $329,878.42 in the petitioner's income tax for the year 1935. The sole issue is whether or not the reduction of the petitioner's indebtedness to two corporations of which she was the sole stockholder, by action duly taken by the corporations, constituted a taxable dividend. FINDINGS OF FACT. The petitioner is an individual and a citizen of the United States, who resided in Paris, France, from 1932 to 1940. Her income tax return for the year 1935 was filed with the collector of internal revenue for the second district of New York. The petitioner is the daughter of Julius Kayser, from whose*638 estate she received all of the outstanding shares of the capital stock of the Broadex Realty Corporation, a New York corporation, hereinafter *851 called Broadex, and of Ideal Investing, Inc., also a New York corporation, hereinafter called Indeal. Broadex owned a building at 50 Broad Street, New York City, and Ideal owned a large building at 19 West 40th Street and a building on Greenwich Street in the same city. From 1920 to 1932 (except in the year 1924) Broadex yielded substantial profits, while Ideal produced large profits from 1923 to 1931 and a small profit in 1932. In 1933, 1934, and 1935 the aggregate loss of Broadex was over $260,000 and of Ideal about $135,000. The basis of the Broadex stock in the hands of the petitioner was $250,000. The petitioner was the wife of Edwin S. Bayer, who died December 31, 1928. In 1932 the petitioner remarried and went abroad to live. Bayer was president of Broadex and Ideal from 1920 to the date of his death in 1928 and managed the business of both corporations. The petitioner did not interfere with his management. In 1929 and 1930 the petitioner received a salary of $25,000 from each corporation as its president, although*639 she rendered no services to the corporations at any time. Bayer's will provided for certain legacies, but his estate was insolvent. The petitioner in 1930 went to her uncle, Jules S. Bache, who agreed to secure a loan for her from the Guaranty Trust Co. if she would give him complete control of her fiscal affairs. The loan was made, with the stock of Julius Kayser & Co. as collateral therefor. Bache also induced his own company, J. S. Bache & Co., to make her a loan and became guarantor thereof. Bache received the stock of Broadex and Ideal from the petitioner and agreed to try to extricate her from her financial entanglement, provided he was given a free rein. Petitioner was the owner of all outstanding stock of Broadex and Ideal during 1935. Bache also stipulated that the details of the operation of all of the petitioner's affairs, including Broadex and Ideal, be entrusted to Harold Nathan, who had been Bache's personal attorney for many years, was a cousin of the petitioner's mother, acted as attorney for the petitioner, Broadex, and Ideal from 1930 to 1941, the year of his death, and was also counsel for J. S. Bache & Co. The petitioner and Bache trusted Nathan implicitly*640 and followed his advice and instructions. Nathan attended the directors' meetings of Broadex and Ideal and prepared all resolutions of those companies relating to the petitioner's accounts with them. He completely dominated the policies and procedure of all corporate action of both companies. Bache had charge of their actual operation. The officers of both companies were Bache's and Nathan's employees or were selected by Bache or Nathan and elected by their direction. From 1927 to 1932 the petitioner withdrew in the form of loans from Broadex sums totaling $760,422.62, and from 1927 to 1931 similarly *852 withdrew from Ideal sums aggregating $1,243,087.18. In 1930 she withdrew an aggregate of $760,860.60 from both companies. No notes or other acknowledgment of indebtednes were executed by the petitioner, but the corporations carried on their books as accounts receivable the amounts due from her. The petitioner's income tax returns for the years 1930 to 1935, inclusive, reported no net income and no tax due. Her income tax return for 1930 showed the receipt of $50,000 from Broadex and Ideal, over $116,000 as stock dividends, with an unitemized and unexplained deduction*641 of over $119,000 as "interest paid." In 1935 she owned valuable jewelry and furniture. Her various stocks had been pledged or lodged to secure the payment of certain portions of her indebtedness. At a meeting of the board of directors of Broadex held January 15, 1935, a resolution was adopted reading in part as follows: RESOLVED, that the account receivable of this corporation against Countess Sala be carried in the balance sheet at not exceeding $260,422.62, and that the residue shall be presently written off as uncollectible, but no claim of a deductible loss for income or other tax purpose shall be made by reason thereof. At a meeting of the board of directors of Ideal held December 24, 1935, a resolution was adopted reading in part as follows: RESOLVED, that the account receivable of this corporation against Countess Sala be carried in the balance sheet at not exceeding $543,087.18, and that the residue shall be presently written off as uncollectible but that no claim of a deductible loss for income tax purposes shall be made by reason thereof. Pursuant to these resolutions appropriate entiries were made on the books of Broadex and Ideal to reflect the write-down*642 of $500,000 and $700,000 in the respective accounts receivable from the petitioner. Her accounts were credited with the amounts of the reductions and corresponding charges were made to the surplus accounts. During 1935, at various times subsequent to March 5, Ideal made further advances to the petitioner, totaling $7,952.40. On April 26, 1938, the boards of directors of both Broadex and Ideal adopted the following resolution, in identical language: RESOLVED, that the claim of this corporation against Countess Sala be written off as of December 31, 1937, as presently uncollectible and be eliminated from the balance sheet; RESOLVED, that the writing off of said claim shall in no wise constitute the forgiveness of any indebtedness of Countess Sala to this corporation and shall in no wise affect or impair any rights of this corporation against Countess Sala. At a meeting of the board of directors of Broadex held October 13, 1938, Nathan stated that some questions were raised by the Federal and state tax authorities relating to the write-down of the indebtedness of the petitioner and he advised its restoration to the balance sheet and the cancelation and revocation of the resolution*643 of January *853 15, 1935. Thereupon the said board of directors adopted the following resolution: RESOLVED, that the resolution adopted April 26, 1938, directing that said claim be written off as presently uncollectible, be and the same hereby is in all respects revoked, rescinded and held for naught. FURTHER RESOLVED, that the claim of this company against Laura Sala be restored to the balance sheet in the full amount of $760,422.62, and until further order of this board be carried as an asset regardless of the judgment of this board with respect to its collectibility. On the same day the board of directors of Ideal adopted an identical resolution, with the exception of the date of the prior resolution (December 24, 1935, instead of January 15, 1935) and the amount ($1,243,087.18 instead of $760,422.62). Corresponding entries restoring the claims or accounts of both companies against the petitioner were made on their respective corporate books. The petitioner did not discuss her financial affairs with Bache after 1931. She had not been informed of either the partial or complete write-off of her accounts by Broadex and Ideal and disclaimed all knowledge and information*644 concerning it until 1938. She entrusted her business affairs entirely to her uncle, J. S. Bache, and to her attorney, Harold Nathan. She also disavowed all knowledge of the condition or operation of Broadex and Ideal, of which she was president in 1929 and 1930 and from each of which she received a salary of $25,000. The respondent determined that the write-down in 1935 of the petitioner's account receivable due to Broadex by $500,000, together with the charge of that sum to surplus on its books, constitutes a taxable dividend to the extent of its earnings of $198,547.05 available for dividends and also that the remainder of $301,452.95 was a return of capital, taxable to the extent of 51,452.95, the difference between the basis of the Broadex stock to the petitioner and the said sum of $301,452.95. The respondent likewise determined that the write-down of the petitioner's account receivable due to Ideal by $705,802.90, together with the charge of that sum to surplus on its books, constitutes a taxable dividend to the extent of its earnings of $399,263.98 available for dividends. OPINION. VAN FOSSAN: The issue before us is whether or not the write-down of accounts receivable*645 due from the petitioner to the corporations of which she was the sole stockholder was, in effect, a dividend to her. There is no controversy between the petitioner and the respondent that under certain circumstances the write-down of an account receivable by a corporation from the stockholder may constitute a dividend. The question here is: Do the facts in the case at bar warrant such a conclusion? We find that they do. *854 There is one fundamental fact that stands out with startling significance, one which the petitioner relies upon to absolve her from the proposed tax liability but which has precisely the opposite effect. That fact is that she delegated to her uncle, J. S. Bache, the complete and absolute management and control of her financial affairs. She thus conclusively constituted him her agent and representative. It is well to review the salient events that occurred in the year 1930. The petitioner's husband, Edwin S. Bayer, had died in 1928. He left a will establishing certain legacies but not sufficient estate to pay them. The petitioner's own personal financial situation had become very much involved. She then, in 1930, went to her uncle to seek*646 his advice in solving her fianancial problems. He agreed to help her on the condition, in which she acquiesced, that he be given carte blanche to conduct her affairs as he saw fit, with no interference whatever from her. Thereafter he took over her stock in Broadex and Ideal, secured loans for her, and made all arrangements for the future conduct of all of her business matters. Bache, with the petitioner's complete compliance, delegated to Nathan, his own personal attorney and the attorney of all persons and corporations materially involved in the situation, questions of law and policy thought necessary to the successful consummation of Bache's endeavors. All officers and directors of the corporations, other than Bache and Nathan, were mere figureheads. During 1930 the petitioner withdrew as loans over $760,000 from both corporations. The record is silent whether she did so on the advice of Nathan, under the direction of Bache, or upon her own initiative. She received $50,000 as the president of Broadex and Ideal, although she denied all knowledge of the operation of the companies and of business affairs in general. She rendered no services whatever to the corporations. *647 She also amassed over $116,000 in stock dividends. The total is over $926,000. She paid no income tax that year. Her return showed an item of over $119,000 as "interest paid" but no explanatory or itemized notation thereon. The condition of the petitioner's affairs remained practically the same until 1935, with the exception of the withdrawals which had mounted to over $2,000,000. The withdrawals were entered and carried on the books of Broadex and Ideal as accounts receivable. On January 15 and December 24, 1935, by the authority of their boards of directors, Broadex and Ideal "wrote down" the petitioner's accounts receivable by $500,000 and $700,000, respectively. Those amounts were deemed uncollectible. Proper entries were made on the corporate books to evidence such action and the surplus accounts were reduced correspondingly. However, during 1935 and after January 15 of that year Ideal advanced an additional sum of $7,952.40 to the petitioner. The picture is not complete without reference to the events occurring *855 in 1938. On April 26 of that year, by formal action, the directors of Broadex and Ideal wrote off the entire amounts of their claims against*648 the petitioner "as presently uncollectible" and eliminated those items from their balance sheets. On October 13, 1938, they restored to their books and balance sheets the entire original amounts of their several accounts receivable from the petitioner as they appeared thereon prior to January 15, 1935. The petitioner submits a many-sided defense the principal points of which are that the write-downs did not constitute a cancellation, forgiveness, or release; that there was no intent to forgive or release any part of the indebtedness; that she had no knowledge of and expressed no acquiescence in or consent to such write-downs; that her financial condition was not improved; that she had no control or voice in the management of Broadex and Ideal; and that the restoration resolutions in 1938 show that the write-downs in 1935 were mere bookkeeping entries. We are impressed with none of these arguments. They might have some bearing if a different relationship had existed between the petitioner and Bache, Nathan, Broadex, and Ideal. See *649 ; certiorari denied, ; . The vital element in the situation here is that the petitioner voluntarily and deliberately turned over all of her affairs, including all moneys and transactions which might affect her income tax, to her uncle and Nathan, who thereupon acted in her place and stead. The petitioner now seeks to be exculpated from the normal and logical tax consequences of her act. Having established Bache and Nathan as the managers of her property and income, the responsibility of their maneuvers rests upon her and no disclaimer of hers can be effective. To allow a taxpayer to avoid or evade the natural and inevitable results of actions taken by his representatives in his behalf, by the simple expedient of turning over his property and its management to them, would afford an invitation to collusion and fraud. We can not countenance such a scheme. The petitioner's attorneys argue that Bache, Nathan, Broadex, and Ideal were motivated only by their own personal interests and had no thought of the petitioner when the various resolutions were*650 adopted and the concomitant book entries made. We can not ignore the multiple capacities in which both Bache and Nathan acted, nor can we believe that when the actions of record were taken they suddenly forgot the petitioner and proceeded solely in the interests of others. The petitioner is charged with the knowledge which her agents possessed - they were acting in matters of vital importance to her welfare and pecuniary benefit. She can not successfully plead ignorance and innocence. *856 We must remember also that the petitioner was the sole owner of the stock of Broadex and Ideal. For the sake of convenient handling, the stock of these corporations had been deposited with Bache and he apparently was able to vote it whenever a vote was required. However, she still remained its owner. We deem it unnecessary to comment at length on the recorded inconsistencies relating to the petitioner's alleged financial difficulties in 1935 or 1938 resulting in the various book entries. We note that potential or actual tax difficulties arose. That fact is no justification for playing fast and loose with corporate books and records. *651 We observe that following the resolution of January 15, 1935, adopted by the Boadex directors (the majority of whom were also Ideal's directors), Ideal advanced to the petitioner almost $8,000. However, we will take the resolutions of January 15, 1935, at their face value, consider the petitioner's accounts receivable partially uncollectible, and agree that Broadex and Ideal were warranted in writing the uncollectible portions thereof off their books. In these circumstances the principles announced in , affirming ; certiorari denied, ; rehearing denied, ; , apply. In those cases it was held that cash withdrawals of corporate funds made by stockholders and treated as accounts receivable, constitute taxable income to the stockholders in the year in which the charge to the stockholders is canceled on the corporation's books. In the Wiese case the court held: But if the stockholder borrows money from the company, and subsequently the company cancels the debt, income accrues to the stockholder*652 at the time when the character of the withdrawal changes from a loan to a distribution of profits. ; cf. . Petitioner in his brief attempts to distinguish the Cohen case on the ground that the debt there was charged off by formal resolution of the board of directors, while in the instant case the same thing was accomplished by book entries. The distinction is not important. The result is the same whichever method be applied. We are of the opinion, and therefore find and hold, that the writedown of the accounts receivable by the two corporations resulted in a cancellation or release of the accounts in the amounts written down. We reach this conclusion with full appreciation of the declarations of the witnesses, consistent with petitioner's theory of the case, that no such result was intended. The explanation of the witness, also urged by counsel, that these "were mere bookkeeping entries" is pregnant with the suggestion of possible fraud. We are impressed more by what was done than by what the witnesses say was intended. We are unable to find any legitimate*653 business reason prompting the 1938 *857 resolutions, by which the corporations first wrote off and then restored the accounts in full. If it were necessary to consider the petitioner's contentions not heretofore discussed, on the assumption that her status in the factual situation is other than it is, she still can not prevail. Her argument that there was no intention to forgive the indebtedness is answered by the decision in ; certiorari denied, , under facts very similar to those in the case at bar. There, as here, the book entries confirmed and clarified the resolution to write off a portion of the petitioner's abligation as uncollectible and thus they effectively overcome petitioner's theory that no cancellation thereof was made or intended. The petitioner's argument that her financial condition was not improved by the cancelations is valueless because of her own failure of establish that condition. The record shows that she possessed property in 1935, but its extent, character, and value are not shown. The mere opinion of her uncle, or of any other person, unsupported by other*654 proper evidence, is not a sufficient basis for the conclusion that she was insolvent or that her financial condition was not improved by the partial write-downs, Counsel for petitioner boldly pleads the equities of his case. No purpose is served by discussing this phase. But even a casual reading of the facts leads one to conclude that the equities are all with the Government. The petitioner has not shown that the respondent erred in his allocation of the amounts of the write-downs to earnings available for dividends and the return of capital. Therefore, the determinations of the respondent as they appear in his notice of deficiency are approved. Decision will be entered for the respondent.