Opinion
Docket Nos. 21724, 21725, 21726, 22126, 22127, 22128, 22129, 22130, 22131, 22132, 22133, 22635, 22636, 22637, 22638.
Promulgated September 26, 1950.
Petitioners and others purchased as an investment certain past due notes of a corporation at less than face value and caused them to be transferred to a Trust Company which, pursuant to an agreement, collected payments made by the debtor and distributed them, less charges, to the purchasers pro rata. The Trust Company maintained the official list of the owners with their addresses and percentage shares and required that any transfer of an interest be evidenced by the filing of an assignment. The debtor paid part of the fee of the Trust Company. Held: The notes were not "in registered form," within the meaning of section 117 (f), I. R. C., and the petitioners' gains upon retirement of the notes were not capital gains.
Harry R. Horrow, Esq., and Francis N. Marshall, Esq., for the petitioners.
T. M. Mather, Esq., for the respondent.
The respondent has determined deficiencies in income and victory tax for the year 1943, in each of the proceedings which were consolidated for trial and consideration by the Court, as follows:
Docket Amount of No. Petitioner deficiency 21724 ..... Alice McCourt Lamm ................................ $4,246.73 21725 ..... Estate of W. E. Lamm, Deceased .................... 9,345.83 21726 ..... Winifred Carol Lamm ............................... 2,472.21 22126 ..... Estate of Edith E. Lamm, Deceased ................. 7,393.25 22127 ..... Edith Lamm ........................................ 7,487.07 22128 ..... Ethel Fisher ...................................... 7,012.02 22129 ..... Estate of Chas. C. Elliott, Deceased .............. 1,599.01 22130 ..... Estate of Eugene D. Elliott, Deceased ............. 1,164.99 22131 ..... Bess Kent ......................................... 508.54 22132 ..... Joseph S. Kent .................................... 437.34 22133 ..... Rolland G. Watt and Adele C. Watt ................. 8,478.60 22635 ..... Elsa Ehlers ....................................... 5,863.86 22636 ..... William E. Elliott ................................ 7,292.33 22637 ..... H. Edwin Nowell ................................... 261.80 22638 ..... Elizabeth V. Nowell ............................... 261.77 Each of the petitioners owned participating interests in notes of the Lamm Lumber Co. In 1943 the notes were retired upon payment of the balance of the principal and interest due thereon; and each of the petitioners realized gains upon the retirement of the notes in amounts proportional to his fractional ownership thereof. Each of the petitioners reported in his return for 1943 the gain realized as long term capital gain, of which 50 per cent was reported as income. The petitioners contend that the notes in question come within the provisions of section 117 (f) of the Internal Revenue Code. The respondent has determined that the notes in question did not come within the provisions of section 117 (f) and that, therefore, the gains were taxable as ordinary income rather than as long term capital gains. The only question to be decided is whether the notes in question came within the scope of section 117 (f). The question is common to all of the proceedings which have been consolidated.The petitioners filed their income and victory tax returns for the year 1943 with the collectors for the appropriate districts as set forth in the margin.
Docket Nos. 21724, 21725, and 21726, filed with the collector for the district of Oregon; Docket Nos. 22126, 22127, 22128, 22129, 22130, 22635, and 22636, filed with the collector for the sixth district of California; and Docket Nos. 22131, 22132, 22133, 22637, and 22638, filed with the collector for the first district of California.
FINDINGS OF FACT.
The facts which have been stipulated are found as facts, and the stipulation is incorporated herein by this reference.
Lamm Lumber Co., a corporation, issued two promissory notes, one dated May 6, 1930, in the principal sum of $150,000, and one dated September 5, 1930, in the principal sum of $250,000, both payable to the order of Consolidated Securities Co., hereinafter referred to as "Consolidated," in consideration of loans. Each of these notes was secured by a mortgage on a certain railroad owned by Lamm Lumber Co. On May 26 and September 30, 1930, Consolidated executed respective declarations of trust that it held these notes, mortgages and options for the benefit of Southern Pacific Land Co. Until July 1, 1941, Southern Pacific Land Co. was the beneficial owner thereof.
From March 5, 1932, to September 5, 1934, various additional notes were issued by Lamm Lumber Co. to Consolidated representing unpaid interest on said corporate indebtedness. On December 24, 1936, Lamm Lumber Co. and Consolidated entered into a supplementary agreement compromising the unpaid interest as to its amount, funding the interest and accruals to January 1, 1938, by adding them to the principal, restating the new principal at January 1, 1938, as $497,845, and providing for interest from January 1, 1938, at 3 per cent. Lamm Lumber Co. covenanted to pay monthly $5 for each car of logs shipped over the railroad with minimum payments of $15,000 a year until December 31, 1941, and $35,000 a year thereafter.
On February 8, 1940, Consolidated endorsed all the notes to The Anglo California National Bank of San Francisco, without recourse, and assigned to that bank its rights as mortgagee. Lamm Lumber Co. paid $250 per year service charges to The Anglo California National Bank.
From February 10, 1938, to June 11, 1941, Lamm Lumber Co. made various payments on the debt, so that as of June 12, 1941, the sum owing by Lamm Lumber Co. thereon was $411,264.99. All the notes were then on their face past due.
Southern Pacific Land Co. was desirous of liquidating its lumber interests in Northern California and Oregon and let it be known that it would be willing to sell its interest in the Lamm Lumber Co. notes at a substantial discount. In order to avail themselves of the investment opportunity, certain individuals, including petitioners herein (petitioners' decedents in the cases of the four estates) each on his or her own behalf, offered to purchase undivided fractional interests in the notes, making in total 100 per cent of the ownership of said notes. These offers were presented to Southern Pacific Co. (parent company of Southern Pacific Land Co.) on behalf of Southern Pacific Land Co. as an offer to purchase the notes for 50 per cent of the balance of the principal of the loan plus the interest currently due at the time of the completion of the purchase. Such offer was accepted, and on July 1, 1941, the individuals paid over to the Southern Pacific Land Co. the sum of $206,388.55, and the beneficial ownership of the notes and mortgages was transferred from Southern Pacific Land Co. to the individuals in proportion to their undivided fractional interests.
The purchasers, as beneficial owners of undivided fractional interests in the notes, entered into a written agreement called "Instructions and Agreement," dated July 15, 1941, with American Trust Co., hereinafter referred to as "Trust Company." Each individual signed a counterpart of the agreement stating his or her percentage interest. Also, a list was made of the names, addresses, amounts invested, and percentage interests of the aforesaid beneficial owners which was given to the Trust Company.
Pursuant to the Instructions and Agreement, the notes were endorsed and mortgages assigned to Trust Company to hold and keep in its possession.
The Instructions and Agreement described the obligation of the Lamm Lumber Co. and the documents evidencing it, directed Trust Company to hold certain documents as agent for the joint owners of the notes, and further provided, in part:
You are to receive for the account of the undersigned and as their Agent such payments on account of interest and principal as may be made to you from time to time by Lamm Lumber Company. * * * On or within a reasonable time after the 10th day of each September, December, March and June, you are to remit to each of the undersigned a check for his share of the interest payments and separate check for his share of the principal payments, less your charges.
You shall have no duty to take any steps to enforce the collection of said obligation, nor to prevent it or any part of it or any of the notes, mortgages, agreements, or other documents evidencing or modifying it, from outlawing, nor to take any action of any other kind other than as herein specifically set forth, except upon the written instructions of the persons who, at the time, shall be the owners in the aggregate of 75% or more of the entire interest in said obligation, and after the furnishing to you of such indemnity as you shall require, any and all action taken by you pursuant to such instructions shall be your complete acquittance relative thereto.
You shall not be responsible or liable in any manner whatever for the sufficiency, genuineness, or validity of said obligation, or the Mortgages securing the same, or the agreements or assignments, or other documents or instruments, affecting them or it, or with the respect to their form or execution. You shall be fully protected in acting upon any notice, request, waiver, consent, receipt or other paper or document believed by you to be genuine and to be signed by the proper party or parties. You may advise with legal counsel in the event of any dispute or question as to the construction of these instructions, or your duties thereunder, and you shall incur no liability and shall be fully protected in acting in accordance with the opinion and instructions of such counsel.
* * * * * * *
The undersigned agree jointly and severally to indemnify and hold you harmless for all taxes, expenses, costs, demands, claims and liabilities of every kind and character arising out of or in connection with these instructions and the property held hereunder.
All rights and obligations of the undersigned hereunder shall inure to and be binding on their successors in interest which term shall include their heirs, assigns and personal representatives.
You shall not be bound to take notice of any change in the ownerships of the interests of any of the undersigned unless and until there shall have been filed with you such documentary evidence as you shall consider necessary to establish such change.
These instructions may be terminated at any time by the then holders of 100% of the interest in said obligation, but not otherwise. In such event, after the payment or provisions for your compensation and other charges, the property then held hereunder shall be returned to the undersigned, or their successors in interest, or their order.
When there shall have been paid to you by or on behalf of Lamm Lumber Company in lawful money of the United States sums totaling $411,264.99, plus simple interest on the decreasing balances at the rate of 3% per annum, you are authorized to cancel all of the notes held by you hereunder, and to return them to Lamm Lumber Company and to execute and deliver to it any and all releases, satisfactions, and other instruments necessary or desirable to evidence the extinguishment of its said obligation.
These instructions may be signed in any number of counterparts with the same effect as though they were one and the same document. They shall not become effective for any purpose unless and until they have been signed by the owners of 100% of the interest in said obligation.
Dated as of July 15, 1941.
The owners of the undivided interests in the notes, the amount which each paid for his or her undivided interest, and the percentage of the total interest which each owned are as follows:
The total amount paid to Southern Pacific Land Company was $206,388.55. This was slightly in excess of the total amount of the consideration paid by the owners of interests who paid $205,632.50. The discrepancy is not explained.
Trust Company's charges for its services in collecting and remitting interest and principal payments and in maintaining a record of ownership were shared by the participating owners of record and by Lamm Lumber Co. in the following manner: Trust Company charged the sum of $500 as an acceptance fee, an annual fee of $100 plus 1/10 of 1 per cent of the unpaid balance of the obligation at the beginning of each year, and $250 as a closing fee, plus reimbursement for out-of-pocket expenses. Of these charges Lamm Lumber Co. agreed by letter dated August 26, 1941, to Trust Company, to pay sums at the rate of $250 per annum which were credited against the foregoing total charges.
On December 7, 1943, the notes were retired by payment of the balance of the principal and interest due thereon. During the year 1943 petitioners realized gains on the retirement of the notes in amounts proportionate to their fractional ownership thereof.
The Trust Company's procedure in carrying out its duties under the agreement was as follows: A memorandum of instructions was furnished to employees handling the account. The original list of owners of interests was placed in the Trust Company's documentary file. A copy was furnished the bookkeeping department. A card list was prepared and maintained showing the names and addresses of the participants, their percentage shares, and the dates when payments were expected for distribution. On receipt of any installment payment the bookkeepers computed the amount of interest and posted that on a cash ledger sheet, the balance being posted as principal. A computation was then made of the amount of principal and interest to be apportioned to each of the owners on the list and checks were prepared, one for interest and one for principal, for payment to each of the owners of interests. A statement was prepared for each participant showing the total amount received, the amount divided among the participants and the balance of the principal remaining due. The notes were held by the Trust Company until final payment was received after which they were marked "canceled" and returned to the debtor.
There were no transfers of interests by the owners of the Lamm Lumber Co. notes; but had a transfer been made, the Trust Company would have required notice of such transfer and the filing of an assignment, properly witnessed or acknowledged, before remitting any proceeds to the transferee and would have changed its card record and list of owners accordingly, and would have marked the signed counterpart of the agreement to show the transfer.
The Trust Company also acts as a registrar for some issues of corporate securities. In such cases it maintains a card record showing the name of the debtor corporation and the name and address of the registered owner, the card also showing transfers and cancellations and giving a history of the ownership of the particular security.
OPINION.
The only question in these proceedings is whether notes of Lamm Lumber Co. were in registered form within the meaning of section 117 (f) of the Internal Revenue Code.
SEC. 117. CAPITAL GAINS AND LOSSES.
* * * * * * *
(f) RETIREMENT OF BONDS, ETC. — For the purposes of this chapter, amounts received by the holder upon the retirement of bonds, debentures, notes, or certificates or other evidences of indebtedness issued by any corporation (including those issued by a government or political subdivision thereof), with interest coupons or in registered form, shall be considered as amounts received in exchange therefor.
On and after May 6, 1930, Lamm Lumber Co. gave its notes in exchange for loans to Consolidated Securities Co. The petitioners concede the fact that none of the notes were registered notes at the time of issuance. The narrow question presented is whether the notes were "in registered form" after the petitioners purchased undivided interests in them in 1941.
The evidence in these proceedings is clear on the point that the debtor, Lamm Lumber Co., did not at any time take back any of the notes and reissue registered notes in place of the original unregistered notes. Section 117 (f) refers to the retirement of notes, bonds, debentures, certificates or other evidences of indebtedness issued by any corporation with interest coupons or in registered form. We understand the wording of section 117 (f) to refer to evidence of indebtedness which is put into registered form by a debtor-corporation, and that one of the requirements of section 117 (f) is that the evidence of indebtedness be put in registered form by the debtor if the retirement of the indebtedness is to be recognized as an exchange so that gain or loss shall be treated as capital gain or loss.
The petitioners have based their contention that the gains which they realized upon the payment of the notes should be treated as capital gains because of the arrangements which they made with the American Trust Co. under the agreement of July 15, 1941. That is to say, the petitioners appear to take the view that the notes were "in registered form" because of the records which were kept for purposes of distributions to them and because any transfers of their respective interests had to be recorded by their agent.
We are unable to agree with the petitioners that the debtor-corporation ever placed the notes in question in registered form. The Lamm Lumber Co. was not a party to the agreement with American Trust Co. and we think that it involves too strained a construction of the facts to conclude that the agreement between the petitioners and the American Trust Co. operated in some way to effect a registration of the notes by the Lamm Lumber Co. The Lamm Lumber Co. did not maintain any register of the notes, or of the owners, or of the payments to the owners of undivided interests. The American Trust Co. was not an agent of the Lamm Lumber Co. Instead, it was an agent of the petitioners who had purchased the notes at a discount. They appointed the American Trust Co. as their agent to receive payments of principal and interest on the notes for them, and to make distributions thereof to them. The records of the American Trust Co. which were kept for the purposes of acting as a collecting and disbursing agent are not the kind of register which satisfies the requirements of section 117 (f). Since we cannot agree with the petitioners that the requirements of section 117 (f) are satisfied in these proceedings by virtue of the records which the petitioners had their own agents establish, we must sustain the respondent's determination.
The petitioners rely upon Lurie v. Commissioner, 156 Fed. 2d 436, reversing 4 T.C. 1065; and other cases. All of the authorities which have been cited have been considered. In the Lurie case, as shown by the Findings of Fact and Opinion of this Court, supra, notes were taken back by a corporation and were reissued in the form of registered notes. The debtor-corporation registered the evidences of its indebtedness. That was not the fact with respect to the notes which are involved here. Therefore, we believe that this proceeding is distinguishable from the Lurie case.
It is held that the notes of Lamm Lumber Co. were not "in registered form" within the requirements of section 117 (f) of the Code at any time, either before or after the petitioners acquired their interests therein. The respondent's determinations are sustained.
Reviewed by the Court.
Decisions will be entered for the respondent.