Opinion
Docket No. 24599.
1953-03-26
ADAM, MELDRUM & ANDERSON CO., INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Fred R. Tansill, Esq., Eugene Meacham, Esq., and John F. Connelly, Esq., for the petitioner. Michael Waris, Jr., Esq., for the respondent.
Fred R. Tansill, Esq., Eugene Meacham, Esq., and John F. Connelly, Esq., for the petitioner. Michael Waris, Jr., Esq., for the respondent.
1. The sum petitioner was obligated to pay because of its statutory liability as a stockholder in a New York state bank held deductible as an ordinary loss under section 23(f) where petitioner's obligation accrued at a time when the bank stock was worthless.
2. The basis to petitioner of bank stock found to be worthless held deductible as a capital loss and not deductible as an ordinary loss under section 23(g)(4) where more than 90 per cent of the aggregate of the bank's gross income for all taxable years has not been from sources other than interest.
3. Deductibility of legal fees determined.
The respondent has determined a deficiency of $207,927.52 in the excess profits tax liability of the petitioner for the taxable year ended January 31, 1944, and the petitioner has filed a claim for refund of part of the excess profits taxes paid for that taxable year.
The petitioner assigns error to the respondent's determination that the sum of $139,952.84, which the petitioner seeks to deduct as an ordinary and necessary business expense or business loss incurred in the taxable year 1944, represents an assessment and should be capitalized and, in addition, the petitioner assigns error to the determination that the expenditure of $16,534.78 in the taxable year 1944 for legal services which the petitioner seeks to deduct as an ordinary and necessary business expense or business loss should be capitalized.
Finally, the petitioner assigns as error the respondent's disallowance of a loss deduction for the cost of stock in the bank which the petitioner contends became worthless during the taxable year 1944.
This proceeding, together with the proceedings in Docket Nos. 25824 and 29141, were consolidated for hearing and opinion. The proceedings in Docket Nos. 25824 and 29141 have been disposed of by stipulations incorporated in decisions and orders entered on February 7, 1952.
FINDINGS OF FACT.
The petitioner is a New York corporation organized in 1923 to engage in the department store business with its principal office and place of business in Buffalo, New York. It carried on a business formerly conducted by Adam, Meldrum & Anderson Company, a joint stock association, and other predecessors since 1867 at the same location.
The petitioner maintained its books and records and filed its Federal tax returns upon the accrual basis, and used a fiscal year ending January 31. The returns for the taxable year in question were filed with the collector of internal revenue for the twenty-eighth district of New York.
Adam, Meldrum & Anderson State Bank, hereinafter sometimes referred to as the bank, was organized under the laws of the State of New York on May 8, 1923. On May 15, 1923, it acquired the assets of a banking company which had conducted a banking business at the same location since 1906. After May 15, 1923, the bank conducted a general banking business under its charter.
On April 27, 1929, and thereafter, the authorized capital stock of the bank consisted of 1,750 shares of common stock with a par value of $100 per share. The petitioner held 1,700 shares which had a cost basis to the petitioner of $205,700.
The remaining 50 shares were qualifying shares issued to directors of the bank. Robert B. Adam, hereinafter referred to as Adam, held 10 of the qualifying shares.
The bank has always been located on the mezzanine floor of petitioner's store. It was accessible only by means of the store stairways or a store elevator. There were no outside entrances to the bank and customers of the bank had to pass through the store in order to reach the bank. During the taxable year in question, the bank's hour of business exactly coincided with the store's hours of business. The bank's telephone is an extension off the petitioner's switchboard.
During the taxable year, many of the depositors of the bank were also customers of petitioner. Likewise, many of petitioner's customers were also depositors of the bank. Petitioner had many more customers than the bank had depositors. The bank was organized by the store to accommodate the store's customers and to increase its business. Petitioner at all times has been interested in the well- being and continuance in business of the bank. Petitioner was benefited by reason of bank customers passing through the store.
Robert B. Adam, hereinafter referred to as Adam, was at all times material hereto and until his death on April 11, 1940, president of the bank, president of petitioner, and a director of each. Until May 23, 1933, he was the owner of 5,001 shares of the common stock of petitioner, which constituted voting control. His wife was Lena S. Adam who died on August 1, 1940.
During the years 1930 and 1931, the Superintendent of the Banking Department of the State of New York, hereinafter referred to as the superintendent, determined that the affairs of the bank were in an infirm condition and that its capital was impaired. On December 31, 1930, he directed an assessment of $15 per share on the stockholders of the bank, and the petitioner paid $25,599 as its share of the assessment. On June 30, 1931, he directed a second assessment of $6 per share and the petitioner paid $10,200 as its share. These two assessments totaling $35,700 constituted additional costs of the shares of bank stock held by the petitioner.
As a further consequence of the financial condition of the bank and at the instigation of the superintendent, the petitioner transferred to the bank, in November 1931, a group of securities having a cost basis of $63,850 to the petitioner. In October and December 1931, the directors of the bank executed promissory notes payable to the bank on demand in the total sum of $190,000. These notes were given as additional security for the depositors of the bank and are sometimes referred to herein as ‘directors' guarantee notes.‘ Adam's share of the $190,000 was $75,000 and his promise was binding on his representatives and assigns.
On February 13, 1932, Adam and his wife, for the further security of the bank's depositors, pledged to the bank a collection of books, hereinafter referred to as the library, which had a value of approximately $400,000, and agreed that in case of a possible liquidation of the bank the library should be sold, if necessary, and the proceeds applied to the payment of the depositors with any balance remaining thereafter returned to them.
On March 5, 1932, an agreement was entered into whereby the petitioner transferred to Adam title to all of its 1,700 shares of common stock in the bank and Adam assumed the petitioner's statutory liability as a shareholder of the bank. To effect the transfer, the old certificates were surrendered and canceled and in place thereof new certificates were issued to Adam.
Adam held these shares as nominee for the petitioner. The petitioner retained the beneficial interest and at all times until the consummation of the plan referred to subsequently, the petitioner remained the real owner of the shares. It was agreed that upon demand of the petitioner, Adam would retransfer the shares to the petitioner if the superintendent indicated that the capital stock of the bank had attained its par value. Adam never reconveyed the bank stock to petitioner as provided for in the agreement.
On March 5, 1932, Adam and his wife also entered into an agreement pursuant to which Adam guaranteed to make good to the bank's depositors any loss which might result to them from the impairment of the bank's capital to the amount of $500,000 which included Adam's assumed liability on the 1,700 shares. As security for the guarantee, Adam, together with his wife, pledged the library. The previous guaranty agreement, pursuant to which the library had been pledged, was expressly canceled.
The agreements of March 5, 1932, arose from the following circumstances: The investments of the bank had shrunk in value and the capital stock owned by the petitioner had become a potential liability. To preserve its integrity and to permit it to continue in business, the bank was required by the superintendent to secure or replace the amount of depletion in the value of its capital stock. The petitioner, as owner of 1,700 shares, was subject to the double liability imposed by the statutes of New York State upon the owners of stock of banking corporations. It would have been liable for assessments to pay depositors up to $170,000 ($100 per share) in the event of a forced liquidation of the bank. However, the petitioner was unable to pay to the bank an amount necessary to make the bank's capital stock whole or to secure the deficiencies in its capital. Therefore, the petitioner entered into the agreement of March 5, 1932, with Adam, its president and controlling stockholder. The superintendent was aware of and participated in these transactions and no attempt was made to deceive him.
From March 4 until March 15, 1933, all New York banks were closed by proclamation of the Governor.
On May 29, 1933, the superintendent took possession of the bank and on the same day, upon application of the bank, he surrendered the assets and authorized it to resume business. The surrender and authorization were on the condition that, in lieu of an assessment by the superintendent upon the shareholders would execute promissory notes payable to the bank's order on demand in the aggregate sum of $175,000 ($100 per share), the then aggregate amount of their liability. The notes were executed and included a note in the sum of $171,000 executed by Adam. One hundred and seventy thousand dollars of the $171,000 note executed by Adam related to the 1,700 shares transferred by the petitioner to Adam as nominee and $1,000 related to the 10 shares owned by Adam. The notes were renewed in 1939.
Another condition was that title be obtained to the library. On May 29, 1933, the bank received a ‘bill of sale‘ that had been executed by Adam and his wife on May 20, 1933, conveying the library to the bank. In the conveyance, it was provided that upon sale of the library by the bank, the proceeds were to be applied: (1) to reimburse the bank for the discharge of a prior lien on the library; (2) to pay the liability of Adam as stockholder of the bank; (3) to pay depositors and creditors of the bank; (4) to restore the bank's capital in full; (5) to pay the balance to Adam. In consideration of this transfer, the bank canceled the guarantee in the sum of $75,000 given in 1931.
In fulfillment of another condition, the bank, upon reopening on May 29, 1933, withheld 40 per cent ($783,927.71) of its depositors' funds and issued to them certificates of withheld deposits aggregating that amount. The superintendent required the withholding of 49 per cent of bank depositors' funds which he had determined were represented by ‘unsound assets.‘ In accordance with certain administrative principles enunciated by the New York State Banking Board, the bank was required to segregate sound from unsound assets, and write down the values of the unsound assets to a reduced figure, based on probable present, collectible values which, in the opinion of the bank examiner, were sound values.
At the close of business on May 27, 1933 (a Saturday), the balance sheet of the bank showed liabilities in excess of assets in the amount of $10,226.54. On that date the superintendent directed that the value of the assets be reduced to what he determined to be their sound values. After this reduction on May 27, 1933, liabilities exceeded assets by $620,740.71 and resulted in a deficit of $445,740.71 after taking into account the capital stock in the sum of $175,000.
At the opening of business on May 29, 1933, the balance sheet showed surplus and undivided profits totaling $108,196.75. The elimination of the deficit and the creation of the surplus and undivided profits were accomplished by the superintendent's direction to reduce deposits by 40 per cent and issue therefor certificates of withheld deposits. These certificates of withheld deposits were not shown as a liability on the balance sheet referred to above and there was segregated for their benefit that portion of the book value of the assets eliminated by direction of the superintendent, plus the library, the $175,000 in notes (referred to as ‘stock assessment notes‘), and the directors' guarantee notes in the amount of $115,000.
It was known and understood by the petitioner and Adam that when Adam took nominal title to the 1,700 shares of bank stock owned by the petitioner he was subjecting himself, as record holder, to statutory liability for an assessment that might thereafter be imposed and, further, that he was willing to do so to benefit the petitioner. At a meeting on December 1, 1936, the petitioner's board of directors adopted a resolution in which the petitioner acknowledged its agreement and obligation to reimburse and indemnify Adam for expenditures or losses he might sustain by reason of the assumption of the statutory liability imposed on the petitioner as a bank stockholder, the sale of the library to the bank, and the execution of the promissory note by Adam upon reopening of the bank in 1933.
The New York State Banking Department had been continuously urging the directors of the bank to take steps, on behalf of the holders of certificates of withheld deposits, to realize on the directors' ‘guarantee notes‘ and on the stockholders' notes. Notwithstanding such urging, no payments had been made at any time on the notes and no actions had been brought to enforce them. The directors had been unable to effect a sale of the library. The death of Adam on April 11, 1940, brought matters to a head.
On June 18, 1940, the bank as plaintiff filed an action in the Supreme Court of New York. The bank was represented by special counsel appointed in May 1940. The bank asserted four causes of action and named several defendants, including petitioner and the estates of Adam and his wife in the person of their administrators. Only the third cause of action is material to this proceeding.
In the third cause of action, the bank named as defendants the petitioner and the estates of Adam and his wife. The bank sought to recover from Adam's estate the sum of $171,000 (plus interest) which was the amount of the demand note executed by Adam at a time when he and other shareholders of the bank were liable to an assessment in the sum of $100 per share. The bank explained in its allegations forming the basis of the cause of action that the superintendent, after having taken possession of the bank, surrendered possession and permitted the bank to resume business relying upon the $171,000 promissory note and other security.
Of the $171,000, $170,000 represented notes executed by Adam as record holder of the 1,700 shares owned by the petitioner, title to which had been taken by Adam as a convenience to the petitioner. The additional $1,000 related to 10 shares of stock owned by Adam. The bank explained in the allegations forming the basis of the third cause of action that the petitioner agreed to reimburse Adam to the extent of all payments which he might make as a result of the transfer of title to the 1,700 shares.
The bank also alleged in this cause of action that after applying the estimated, realizable value of the library and the assets (other than Adam's promissory note) that were to be liquidated only for the benefit of holders of certificates of withheld deposits, approximately $299,132.42 would be left owing to depositors and would remain unpaid unless the bank had the benefit of the ‘counter-bond or security‘ which Adam received from the petitioner. Accordingly, the bank sought recovery of $170,000 from the petitioner.
The proceeding was referred to an official referee of the Supreme Court of New York who submitted a memorandum on February 6, 1942. After reciting facts relevant to the third cause of action, the referee continued as follows:
I find that the store (the petitioner) is also liable to the bank. It organized the bank and always owned substantially all its stock. Stockholders' liability and enforcement thereof became impending. Enforcement of such liability in such a large amount would greatly injure the business and the business prospects of the store. Mr. Adam owned the controlling voting stock of the store corporation. He consented to become the record owner of the store's 1700 shares of Bank stock, property then of little if any value and to take the bitter medicine which was about to be prescribed for the store. Of course, while Mr. Adam became of record a stockholder of the bank (Sec. 113-1, par. 2, Banking Law) and liable as such, the store— not only by statute (id.cit.) but in truth and fact was the real owner of the stock and could not escape liability as a stockholder merely by going through the procedure adopted.
Richards v. Robin, 178 A.D. 535;
Broderick v. Aaron, 264 N.Y. 368.
The store has adequately agreed— at least by implication— to indemnify the Adam Estate and in all fairness it should do so. The store is the principal debtor, to an action to enforce a stockholder's liability. The store stands here as one having given counter-security to its president and I find the old case of Vail v. Foster, 4 N.Y. 312 (Comstock) adequate authority for the statement that the instant action lies in favor of this plaintiff directly against the store as well as against the Adam Estate. I should note that the repeal of Article 8, Sec. 7 of our State Constitution does not affect any liability which had accrued in the instant situation (Broderick v. Weinsier, 278 N.Y. 419).
On April 9, 1942, the Supreme Court of New York entered judgments in accordance with the findings of the official referee. The judgment in the third cause of action provided that: (1) the bank recover from the petitioner the sum of $188,373.58 ($170,000, plus interest); (2) the bank recover from the estate of Adam the sum of $189,481.65 ($171,000 plus interest); (3) that any moneys collected on the $188,373.58 judgment against petitioner be credited on the $189,481.65 judgment against Adam's estate. In addition, the court awarded a judgment for $114, costs of the action, against all defendants, both jointly and severally. The defendants, including the petitioner, appealed from the judgment to the Appellate Division of the Supreme Court of the State of New York.
The petitioner wished to compromise the pending appeal. It was influenced by the fact that additional expenses, such as attorneys' fees and interest, would have to be paid if an appeal was prosecuted, and it also believed that a prompt settlement would overcome the feeling of some of its customers that petitioner had not thoroughly protected the bank's depositors.
During the pendency of the appeal and before any hearing thereon, counsel for the various defendants entered into negotiations with special counsel for the bank looking to a plan for the retirement of the certificates of withheld deposits and for the settlement and termination of all pending litigation.
The superintendent, as representative of the New York State Banking Department, required such a plan to include the payment in cash of a sum equivalent to 25 per cent of the unpaid balances of certificates of withheld deposits. This sum was $195,981.93. A portion of this cash was to be obtained from Adam's estate and from certain individual stockholders or their estates. An additional sum of $18,794.28 was to be obtained from the bank's undivided profits. The balance in the amount of $137,187.35 was to be obtained from the bank's undivided profits. The balance in the amount of $137,187.35 was to be paid by the petitioner.
A statutory plan (pursuant to section 609 of the Banking Law of New York), dated December 28, 1942, was finally agreed to and approved by the board of directors of the bank and the Banking Department of New York State. Section 609, 8(a) of the Banking Law of New York provides:
A plan for the retirement of certificates (of withheld deposits) issued or made available by a bank * * * pursuant to the provisions of this section may be promulgated in accordance with this subdivision eight in any case where the value of all the assets of such bank * * * as determined by the superintendent is less than the aggregate of the amounts owing to depositors and other creditors plus the unpaid amount of all such certificates so issued or made available by such bank * * *
As of December 15, 1942, which date is a few weeks before the plan was promulgated and approved by the superintendent, the assets of the bank totaled $2,016,584.24 and its liabilities, including the certificates of withheld deposits, totaled $2,278,362.91. The certificates of withheld deposits totaled $548,749.40 and its other liabilities, to which the certificates of withheld deposits were subordinate, totaled $1,729,613.51.
On March 10, 1943, the plan was approved by the Supreme Court of New York and was ordered to become effective upon filing by the superintendent of the necessary certificate. The certificate was filed on April 19, 1943, and the plan became effective as of that date.
The provisions of the plan for the retirement of the certificates of withheld deposits were drafted in accordance with section 609 of the Banking Law of New York. Pursuant to subparagraph (i) of section 609, within 10 days after the entering of the supreme court's order, the superintendent issued an order directing the bank to make good the impairment of its capital, and upon receipt of the order the bank notified the stockholders that they were assessed $100 per share (the par value) on their stock in the bank. Also, in accordance with section 609, 8(i), by April 17, 1943, which was 30 days after the notice of assessment, the shares of bank stock were canceled and thereupon became null and void for all purposes and the rights of the holders ceased. It was provided, however, in accordance with section 609, 8(i) that each stockholder who paid the full amount of the assessment was paid new stock in the amount to which he would be entitled if he held certificates issued by the bank pursuant to section 609 in an aggregate, unpaid principal and interest amount equal to the assessment so paid. There was no personal liability for these assessments. None of the assessments was paid in whole or in part.
The events that occurred pursuant to the plan included the following:
1. Some time after April 17, 1943, and during the taxable year ended January 31, 1944, the petitioner paid $137,187.35 to the bank and the bank discharged and satisfied its judgment against the petitioner in the amount of $188,373.58, and its judgment against the petitioner and the estates of Adam and his wife for $114, costs of the action. There was set forth in the plan the explanation that ‘the judgment awards the Bank a recovery against the Department Store of $188,373.58, in effect representing the statutory liability, including interest from June 18, 1940, of said Store as the beneficial owner of 1700 shares of stock of the Bank * * *.‘ The bank used this cash, plus cash received from other sources, to pay $195,981.93 to holders of certificates of withheld deposits.
2. The petitioner surrendered to the bank certificates of withheld deposits aggregating $2,767.47 which it had acquired by purchase. The certificates were surrendered in further compromise of the $188,373.58 judgment. This left outstanding certificates with principal balances then unpaid aggregating $350,000. The petitioner's basis for the certificates was $2,767.47.
3. In exchange for the certificates with an unpaid balance of $350,000, the bank issued in the name of the registered holders of the certificates 1,750 shares of its capital stock with a par value of $100 each on the basis of one share of stock for each $200 of unpaid principal. As required by the plan, the holders of the certificates upon receipt of the shares immediately assigned them to the petitioner in exchange for merchandise certificates on the basis of $2 worth of merchandise for each $1 of par value of capital stock. Hence, the certificate holders received merchandise certificates on the basis of dollar for dollar of the unpaid amounts of their certificates of withheld deposits aggregating $350,000. As required by the plan, these acts were done simultaneously. The plan was binding on each depositor and he had no option but had to let the bank stock go over to the petitioner in this manner.
The petitioner transferred 10 shares of the new stock to three named individuals and Adam's estate, each of which held 10 of the old shares and, in addition, the petitioner paid $1,000 to the estate of a deceased shareholder which then held 10 shares of the old stock. Upon the consummation of the plan, the petitioner held 1,700 shares of the new stock and 50 shares were held by qualifying shareholders. No other shares were issued or outstanding.
4. The petitioner paid the fees of counsel of the bank for his services in preparing and promulgating the plan, obtaining its approval, and all other expenses in connection with the plan.
5. The sum of $5,000 was paid to the bank by shareholders other than the petitioner in satisfaction and discharge of the judgment based on their shareholders' stock liability notes. Included in this sum was $1,000 paid by Adam's estate on Adam's stock liability note in the sum of $171,000, $1,000 of which related to the 10 shares of stock in the bank owned by Adam.
6. The bank surrendered to the petitioner the securities deposited with it in 1931 except those disposed of by the petitioner for $495. It was explained in the plan that these remaining securities had little or no value except for 51 shares with a par value of $100 each.
7. The bank surrendered the directors' guarantee notes, then reduced from $190,000 to $115,000, the guarantees of the directors, and the collateral security pledged therefor.
8. The bank surrendered the agreements of March 5, 1932, and surrendered to Adam's estate the library and released all interest therein.
9. The sums paid to the bank were in full compromise and settlement of all litigation (except two provisions in the judgment on the fourth cause of action which are not material here). All pending appeals of the defendants were withdrawn and dismissed.
10. The stockholders' notes in the sum of $175,000 were held by the bank until consummation of the plan, at which time they were cancelled.
11. Upon consummation of the plan, the ‘bill of sale‘ of the library and the library itself were returned to the estate of Adam.
Although in 1932 the stock certificates originally acquired by the petitioner were canceled and new certificates were issued to Adam who then held nominal title, the stock was always carried on the petitioner's books of account as an asset. After the old shares in the bank were declared valueless and canceled and new shares were issued in the taxable year 1944, the petitioner retained on its books an asset account entitled ‘Stock— A.M.&A. State Bank‘ representing its investment in the bank. Upon the issuance of the new shares, the petitioner continued to carry the investment in the same amount as previously. However, this sum was increased as the petitioner accepted the merchandise certificates it had issued to the bank's depositors.
The special counsel who was appointed by the bank in May 1940, was appointed upon the insistence of the superintendent for the purpose of taking steps to realize on the directors' guarantee notes and on the stockholders' notes. The superintendent approved of the appointment with the express understanding (agreed to by the bank) that although special counsel was being engaged by the bank to which he would look for his fees, he was to be guided by the superintendent as if the superintendent were the client and without interference by the bank.
The special counsel filed the action referred to above in behalf of the bank and represented the bank in this action. He also represented the bank in the negotiations, hearing on, and execution of the plan. Pursuant to the plan, the petitioner, after April 17, 1943, and during the taxable year 1944, paid to this individual for his services as special counsel to the bank $11,000, plus $180.50 for expenses incurred. The petitioner paid these fees and expenses in further compromise of the $188,373.58 judgment.
In the action referred to above, the petitioner was represented by a firm of attorneys to which it paid, after April 17, 1943, and during the taxable year 1944, the sum of $2,850 for legal fees and $4.28 for expenses incurred in connection with the action.
After April 17, 1943, and during the taxable year 1944, petitioner paid $2,500 as legal fees to an individual attorney for services rendered in connection with the action and in connection with the negotiations pertaining to the plan. Of this sum, $1,250 was for services rendered to petitioner in the acquisition of the new shares of bank stock under the plan and the balance of $1,250 was paid for defending the suit brought against petitioner by the bank.
On or about January 31, 1947, petitioner filed a claim for refund of excess profits tax for the taxable year. Petitioner's excess profits tax liability for the taxable year as shown on its return filed for the taxable year was paid within 3 years prior to the date of filing its refund claim.
The sum of $137,187.35 paid by the petitioner to the bank in the taxable year 1944 was paid in compromise of a $170,000 liability arising from the petitioner's statutory liability as a stockholder in the bank. The $170,000 represents the amount of statutory liability as a shareholder in the bank which the petitioner would have had to pay either directly or through Adam, its nominee, to the bank as an assessment in 1933 if Adam had not executed the promissory note in lieu of the assessment.
All events fixing the petitioner's obligation to pay the $137,187.35 to the bank did not occur until April 19, 1943, the effective date of the plan. The petitioner's liability accrued at that time during the taxable year 1944 and constituted a loss sustained by the petitioner during that year which was not compensated for by insurance or otherwise.
All events fixing the petitioner's obligation to surrender the certificates of withheld deposits with an unpaid balance of $2,767.47 did not occur until April 19, 1943, the effective date of the plan. The petitioner's liability accrued during the taxable year 1944 and constituted a loss in the amount of $2,767.47 sustained by the petitioner during the taxable year which was not compensated for by insurance or otherwise.
During the taxable year 1944, the liabilities of the bank exceeded its assets by an amount in excess of $175,000 (the book value of the capital stock).
The new stock in the bank was acquired by the petitioner from the holders of certificates of withheld deposits in consideration of the merchandise certificates, and was not received because of or in consideration of the payment of $137,187.35, the surrender and cancellation of the petitioner's certificates of withheld deposits, or the cancellation of the old shares.
The petitioner's 1,700 shares of bank stock canceled by the superintendent pursuant to the New York Banking Law, section 609, subdivision 8, subparagraph (i), became worthless by April 17, 1943, and during the taxable year 1944.
OPINION.
ARUNDELL, Judge:
In our findings, we have set forth in considerable detail the various and involved steps incident to the closing, reopening, and reorganizing of a New York state bank. Petitioner was required to and did pay to the bank during the taxable year before us $137,187.35, and the deductibility of this item under the taxable statutes is one of the questions posed in this proceeding. The petitioner urges the deduction of the sum as an ordinary and necessary expense or, in the alternative, as an ordinary business loss, and the respondent contends that the sum should be capitalized as an additional cost of the shares petitioner had owned in the bank.
We think it must now be accepted as settled law that the so-called double liability assessment which is placed by law on the owners of bank stock must be treated as an additional cost of the stock to the stockholder, First Nat. Bank in Wichita v. Commissioner, 46 F. 2d 283, affirming 16 B.T.A. 1399; Porter Property Trustees, Ltd., 42 B.T.A. 681, affirmed without discussion of this point, 130 F. 2d 276; Regulations 111, sec. 29.24-2; see also B. Estes Vaughan, 17 B.T.A. 620; S.M. 4510, IV-2 C.B. 185. But no formal assessment as such was made and petitioner's chief stockholder, Adam, took title to the bank shares and assumed any liability that might arise from the bank's condition, subject only to petitioner's agreement to reimburse Adam should the occasion ever arise. In the posture of this case, we do not think there arose a situation which gave rise to an accrued liability on the part of the petitioner until the rights of the parties were determined as a result of extended litigation and a compromise agreement, all of which occurred during the taxable year. During this taxable year, the entire matter was resolved and a plan worked out to settle all the bank's problems, together with those of its depositors and stockholders.
The petitioner's shares in the bank were declared valueless by the superintendent of the Banking Department of the State of New York and the certificates were canceled at the time the petitioner's liability to pay the $137,187.35 accrued. Hence, when petitioner paid the sum, which was undoubtedly in the nature of or in lieu of an assessment, it suffered a complete out-of-pocket loss for petitioner's stockholdings in the bank had then ceased to exist. We think it follows, when the sum was paid, petitioner suffered a deductible loss.
It is true that had the shares continued to have value and remained in petitioner's ownership, the sum of $137,187.35 would have been a capital loss, limited worthless, then their loss would have been a capital loss, limited by section 23(g) of the Internal Revenue Code, but the settlement brought about under the plan left no ownership in the petitioner of the shares it had theretofore owned and the sum was, in our opinion, deductible as a loss under section 23(f) of the Code. I.T. 3351, 1940-1 C.B. 87; see George H. Stanton, 36 B.T.A. 112; Jamieson Associates, Inc., 37 B.T.A. 92, reversed on other points sub nom, Seaside Improvement Co. v. Commissioner, 105 F.2d 990, certiorari denied 308 U.S. 618; Henry Adamson, 17 B.T.A. 17; Marjorie Fleming Lloyd-Smith, 40 B.T.A. 214, affirmed without discussion of this point, 116 F. 2d 642, certiorari denied 313 U.S. 588; I.T. 2843, XIV-1 C.B. 77; I.T. 2617, XI-1 C.B. 29; cf. Champlain Coach Lines v. Commissioner, 138 F. 2d 904; Messenger Corporation v. Smith, 136 F.2d 172.
It should be pointed out in passing that section 23(g) provides that if any securities, including shares of stock in a corporation or rights to subscribe for or to receive such shares shall become worthless during the taxable year, the loss resulting therefrom shall be considered as a loss from a sale or exchange of capital assets and such loss shall be allowed only to the extent provided in section 117. As we have heretofore pointed out, the immediate loss with which we are here concerned does not fall in the category of a share of stock or a right to subscribe for such share, but arises from the payment of money incident to a prior ownership of shares of stock.
The conclusion we have reached with reference to the treatment of the $137,187.35 makes unnecessary a consideration of petitioner's argument that the sum paid was deductible as an ordinary and necessary expense.
From what we have already said, it follows that the petitioner's surrender of certificates of withheld deposits gave rise to a further loss in the sum of $2,767.47, deductible under section 23(f), since pursuant to the plan this surrender was an additional step in compromise of the same judgment or liability for which the $137,187.35 was paid.
A further issue arises with reference to the loss suffered incident to the old shares that petitioner had held in the bank. Petitioner's cost of those shares is set forth in our findings and is in the amount of $205,700. The shares became worthless and were canceled by order of the superintendent of the Banking Department of New York State in 1943.
During the taxable year 1944, the liabilities of the bank were in excess of its assets, plus the $175,000 carried in the bank's capital stock account. Although this financial condition prevailed for some years prior to the taxable year 1944, it was not until the taxable year 1944 that the shares were canceled and declared worthless by the superintendent of the Banking Department. Prior to that event, the bank was operating occasionally at a profit, the petitioner remained a stockholder entitled to share in the success of the enterprise, and the stock was not worthless.
The cancellation of the shares of stock was not a mere recapitalization formality such as where old stockholders surrender old stock for new stock without the intervention of a new group of stockholders or the payment of consideration for the new stock. The plan was designed and carried out in the manner authorized by subdivision 8 of section 609
of the New York Banking Laws, and under its terms the old certificates were canceled and, as stated in the banking statute, ‘such stock certificates shall be null and void for all purposes and the rights of the holders thereunder shall cease and determine.‘
Section 609, subdivision 8, of the New York Banking Law, sets forth the steps that must be taken in a plan for the retirement of certificates of withheld deposits. One of the steps set forth in subparagraph (i) of this subdivision is the entering of an ‘order declaring that such plan shall be effective upon the filing by the superintendent in the office of the county clerk of the certificate required to be filed pursuant to subparagraph (k) * * *.‘ Subparagraph (i) then continues: ‘Within 10 days after the entering of such order, the superintendent shall issue an order * * * directing that such bank * * * shall forthwith make good the impairment of its capital. Upon receipt of such order, the directors of the bank * * * shall give notice to each stockholder of such requisition and of the amount of the assessment he must pay, which amount shall be the aggregate par value of his shares. * * * shall give notice to each stockholder of such requisition and of the amount of the assessment he must pay, which amount shall be the aggregate par value of his shares. * * * all outstanding stock certificates of the bank * * * shall be cancelled of record not less than 30 days after notice of assessment is given to stockholders as herein provided, and thereupon such stock certificates shall be null and void for all purposes and the rights of the holders thereunder shall cease and determine * * *.‘ Pursuant to this subparagraph, however, the old stockholders are given an opportunity to acquire new shares. If a stockholder pays the full amount of the assessment, he shall receive ‘new stock in the amount to which he would be entitled if he held certificates issued by such bank * * * pursuant to the provisions of this section in an aggregate unpaid principal and interest amount equal to the assessment so paid.‘
Under the terms of the instant plan, new shares in the bank were to be issued to the holders of certificates of withheld deposits who were to become the stockholders of the bank. It is true that under the terms of the plan the new shares received by the depositors were to be transferred by them to petitioner in exchange for merchandise certificates issued by petitioner, but this arrangement was a purchase by petitioner on a value basis of these new shares and the acquisition of the new shares in no wise resulted from petitioner's previous ownership of the old shares.
It is our view that the cancellation and voiding of the old stock during the taxable year 1944 was a positive, definitive event, marking the point at which petitioner's ownership in the bank was extinguished and the old shares representing that ownership in the bank was extinguished and the old shares representing that ownership became worthless.
The petitioner seeks to deduct its basis for these old shares as an ordinary loss under section 23(g)(4). Paragraph (2) of that section provides that if securities that are capital assets become worthless, the loss shall be a capital loss. Paragraph (4) provides that for the purposes of paragraph (2), stock in a corporation ‘affiliated‘ with the taxpayer is not a capital asset. Paragraph (4) further provides that a corporation is ‘affiliated‘ with the taxpayer only if at least 95 per cent of each class of its stock is owned directly by the taxpayer (which must be a domestic corporation) and, in addition, more than 90 per cent of the aggregate of the corporation's gross income for all taxable years must have been from sources other than interest and certain other types of income not relevant here.
The crucial provision here is the requirement that 90 per cent of the income be from sources other than interest since the bank is the corporation which the petitioner seeks to qualify as an ‘affiliated‘ corporation within the meaning of section 23(g)(4).
The petitioner does not deny that more than 90 per cent of the aggregate of the bank's income was from interest, and concedes on brief that ‘virtually all of any bank's income is derived from interest.‘ However, the petitioner refers to the legislative history of section 23(g) in an attempt to establish that in enacting that section Congress did not intend to include an operating bank within the exclusionary limitation of paragraph (4).
The meaning of this limitation is clear and plain. It is distinctly expressed in language that is easily understood and contains no ambiguities or incompleteness. Under these circumstances, we have no authority to look to its legislative history to determine its purview. We have no choice but to follow the plain meaning of the provision. Caminetti v. United States, 242 U.S. 470; 50 Am.Jur.,Statutes, Sec. 22. We, therefore, hold that the bank is not an ‘affiliated‘ corporation of the petitioner within the meaning of section 23(g)(4) and petitioner may not deduct the loss as an ordinary loss under that section.
Finally, we come to the question whether petitioner may deduct or must capitalize the various sums totaling $16,534.78 which it paid in the taxable year 1944 for legal fees and expenses. The liability to pay these sums accrued during the taxable year 1944. We agree with the parties that the treatment of the sought deduction is dependent upon the nature and purpose of the litigation or circumstances under which they were incurred and, further, that legal expenses incurred in the acquisition of property must be capitalized. S. Cupples Scudder, Executor, 22 B.T.A. 1294; Safety Tube Corporation v. Commissioner, 168 F.2d 787; Virginia Hansen Vincent, 18 T.C. 339.
Included in the total sought to be deducted in connection with the litigation is the sum of $2,854.28 which was paid by petitioner to counsel in the defense of the action which resulted in petitioner being required to pay the sum of $137,187.35 which we have already discussed in some detail. We think this amount is deductible either as an ordinary and necessary expense under section 23(a) or as a loss under section 23(f).
Also included in the fees sought to be deducted is one of $2,500, a portion of which was in connection with the setting up of the plan under which petitioner later acquired new shares in the bank and a portion of which was paid in defense of the bank's effort to collect from petitioner the liability resulting from its previous ownership of the old shares. In the absence of a definite allocation by the parties, we have allocated, under the principle of Cohan v. Commissioner, 39 F.2d 540, one-half of the fee, or $1,250, as incident to the acquisition of the new shares of stock and the remaining $1,250 to defending the claim against petitioner incident to its ownership of the old shares. It follows that one-half of the fee should be capitalized and the remaining one-half is deductible either as an ordinary and necessary expense or as a loss.
There remains the treatment of the legal expenses in the amount of $11,180.50, which was the sum paid by petitioner to counsel for the bank. Normally a fee paid by one taxpayer for services rendered to another taxpayer would not be deductible, but it appears in this case that the sum was paid by petitioner as a part of the over-all settlement between petitioner and the bank, and while the sum was paid directly to counsel it was, in fact, a payment to the bank in settlement of the bank's judgment against petitioner. Therefore, for reasons set forth in our discussion of the first issue, it is deductible as an ordinary loss under section 23(f).
Reviewed by the Court.
Decision will be entered under Rule 50.
TURNER, J., dissenting:
In my opinion, the loss to the petitioner of the amount of the assessments on the bank stock owned by it was as much a loss on the stock as was the loss of its original investment and, under the rule laid down by the Supreme Court in Arrowsmith v. Commissioner, 344 U.S. 6, the loss was a capital loss, deductible as such, and not as an ordinary loss, as this Court holds.