Opinion
Docket No. 6016.
1945-12-26
THE LOGAN AND KANAWHA COAL COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Carl Runge, Esq., for the petitioner. John H. Pigg, Esq., for the respondent.
Petitioner was engaged in selling coal for its own account and as broker on commission. It acquired shares of the capital stock of certain coal-mining companies and a transportation company for the primary purposes of maintaining favorable relations and securing a supply of coal of various grades and sizes necessary and advantageous to the successful conduct of its business. Petitioner, in determining its excess profits tax for the year 1941, treated the loss from the sale of certain of such shares as an ordinary loss and the retained shares as noncapital assets in determining its invested and average invested capital. Held, such shares of stock, acquired for the aforesaid purposes, constituted ‘capital assets‘ under section 117 of the Internal Revenue Code and hence ‘inadmissible assets‘ under section 720(a)(1)(A). Carl Runge, Esq., for the petitioner. John H. Pigg, Esq., for the respondent.
This proceeding involves a deficiency in excess profits tax of $14,438.83 for the year 1941. The issues are: (1) Whether respondent erred in disallowing a claimed deduction of $26,900, representing the loss sustained from the sale of certain shares of the capital stock of the Standard Banner Coal Co., acquired in 1937; and (2) whether, in determining petitioner's invested capital and average invested capital for the taxable year, respondent erred in reducing its average invested capital by the amount of $27,460.36 on account of inadmissible assets. The case was submitted upon a stipulation of certain facts, depositions, and exhibits. The facts stipulated are so found. Other facts not stipulated are found from the evidence. Petitioner's assignment of error contained in paragraph 4(c) of the petition has been abandoned by stipulation.
FINDINGS OF FACT.
Petitioner is an Ohio corporation, with its principal office at Cincinnati, Ohio. It maintains branch offices in Norfolk and Chicago. Its income and declared value excess profits tax return and excess profits tax return for the period involved were filed with the collector of internal revenue for the first district of Ohio at Cincinnati, Ohio. Petitioner is engaged only in selling coal. It sells for its own account and as broker, receiving a commission of from 7 to 8 percent on such coal sold. Petitioner's customers are located throughout the country where bituminous coal is used. The mining companies from which petitioner purchases coal, or on whose behalf it acts as broker, are located in the States of Virginia, West Virginia, Kentucky, and Tennessee. Petitioner's customers include utilities, railroads, lake shippers, byproduct plants, and retail dealers. To meet their demands, petitioner must have available sources of supply of various sizes and grades of coal. From time to time petitioner has found it necessary and advantageous to the conduct of its business to make advances to some of the mining companies which supply it with coal. The advances were, in some instances, made on open account and in notes. In other instances, for the primary purpose of maintaining favorable relations, petitioner has acquired stock or other securities of mining companies with which it does business. During the period 1937 to 1941, inclusive, petitioner made advances on open accounts, notes, and securities to its vendor mining companies as follows:
+-------------------------------------+ ¦Year¦On account¦On notes ¦Securities¦ +----+----------+----------+----------¦ ¦1937¦$4,813.57 ¦$10,000.00¦$27,500 ¦ +----+----------+----------+----------¦ ¦1938¦4,408.36 ¦10,945.00 ¦32,500 ¦ +----+----------+----------+----------¦ ¦1939¦9,099.34 ¦12,000.00 ¦32,500 ¦ +----+----------+----------+----------¦ ¦1940¦20,728.47 ¦28,281.67 ¦44,850 ¦ +----+----------+----------+----------¦ ¦1941¦24,184.78 ¦47,000.00 ¦49,850 ¦ +-------------------------------------+
Except for the years 1938 and 1939, when petitioner sold fewer tons of coal than in 1937, its sales increased from 1,582,100 tons in 1937 to 2,511,400 tons in 1941. During the war years its sales tonnage increased to the amount of 4,040,100 tons in 1944.
On December 10, 1937, petitioner acquired from John Flanagan 300 of the 1,000 outstanding shares of the common stock of the Standard Banner Coal Co. at a cost of $27,500. At the time of the purchase of such shares, petitioner was acting as broker for some part of the production of that company. Flanagan objected to the arrangement. The majority stockholders advised petitioner that if it purchased Flanagan's shares it could market the entire output of the Standard Banner Coal Co. After the purchase of the 300 shares the tonnage of Standard Banner Coal Co. sold by petitioner increased from 21,805 tons in 1936 to 91,277 in 1941. The Standard Banner Coal Co. went into receivership and on December 22, 1941, petitioner sold the 300 shares of stock for $600, resulting in a loss of $26,900. In its 1941 tax return the petitioner reported an excess profits net income of $121,136.63. Among the deductions claimed in arriving at such amount is the above loss item of $26,900. In its return petitioner explained the deduction as follows:
Standard Banner Coal Company Investment was acquired and held under circumstances that indicate its inclusion under the classification of capital assets would be erroneous. The property classifies as an asset related to the regular business of the corporation, and the loss arising from disposition has therefore been given effect in the determination of income subject to Excess Profits Tax.
The respondent, in his deficiency notice, explained the disallowance of the deduction as follows:
It is held that 300 shares of Standard Banner Coal Company common stock sold in 1941 constituted capital assets as defined by section 117 of the Internal Revenue Code. The loss sustained from the sale of said stock of $26,900.00 represents a long-term capital loss, and does not, therefore, constitute an allowable deduction for the purpose of computing excess profits net income under the provisions of section 711(a)(2)(D) of the Internal Revenue Code.
In its excess profits tax return for the year 1941, petitioner reported an average invested capital of $391,095.40 and an invested capital of $384,251.23. The difference of $6,844.17 represents the amount of the reduction of the former, on account of inadmissible assets, as reported on that return. In his determination of the excess profits tax deficiency, the respondent increased the ‘reduction on account of inadmissible assets‘ by the amount of $27,460.36, and in explanation of this adjustment the deficiency notice stated:
Average invested capital for the year 1941 has been reduced to (sic) $27,400.36 to effect the exclusion of additional inadmissible assets as required by section 720 of the Internal Revenue Code.
The word ‘to‘ in the foregoing quotation should be ‘by.‘
The above stated amount of $27,460.36 was computed or determined by respondent as follows:
Petitioner's excess profits tax return disclosed its total admissible and inadmissible assets to be $914,031.54, its total inadmissible assets to be $16,006.84, the ratio of inadmissibles to total assets to be 1.75 percent, and the amount of the reduction on account of inadmissible assets to be $6,844.17. The respondent accepted as correct the reported figure of $914,031.54 as the total of petitioner's admissible and inadmissible assets, but he determined its average total inadmissible assets to be $80,237.44, and the percentage of that amount to the total of admissible and inadmissible assets ($914,031.54) to be 8.77841 percent. By an adjustment to correct a mathematical error, as to which there is here no controversy, the respondent changed petitioner's reported average invested capital of $391,095.40 to $390,782.94. He then determined the statutory amount of the reduction for inadmissible assets to be $34,304.53, representing 8.77841 percent of $390,782.94. The amount of $27,460.36, by which respondent increased the reduction on account of inadmissible assets, as above stated, represents the excess of $34,304.53 over $6,844.17.
Included in petitioner's inadmissible assets, as determined by respondent, is the cost to petitioner of the common stock of the following domestic corporations:
+-----------------------------------------+ ¦Corporation ¦Number of¦Cost ¦ +-----------------------+---------+-------¦ ¦ ¦shares ¦ ¦ +-----------------------+---------+-------¦ ¦Standard Banner Coal Co¦300 ¦$27,500¦ +-----------------------+---------+-------¦ ¦Diamond Coal Mining Co ¦(* ) ¦17,350 ¦ +-----------------------+---------+-------¦ ¦Ames Mining Co ¦300 ¦30,000 ¦ +-----------------------+---------+-------¦ ¦River Transportation Co¦50 ¦2,500 ¦ +-----------------------------------------+
FN* Number of shares not shown by the evidence.
The Ames Mining Co. produced a smokeless coal for which there was a heavy demand at all times. The Diamond Coal Mining Co. produces one of the finest grades of coal on the market. Because of its location, freight rates to consumers in the south were very favorable. The River Transportation Co. operates a river dock located some 8 miles below Cincinnati. This dock unloaded and prepared coal that is shipped by river transportation from the West Virginia mines, from which petitioner obtains coal. Petitioner's primary purpose in acquiring the stock of these companies, as in the case of the Standard Banner Coal Co. was to improve its relations with those companies as an available source of supply of various grades of coal and to facilitate the handling thereof, which it required in the conduct of its wholesale coal business.
During the taxable year petitioner held stock, as investments, in other corporations, as follows:
West Virginia Coal & Coke Co.
Huntington-Ohio Bridge Co.
American Laundry Co.
Mead Corporation
General Motors Corporation
Aluminum Industries
National Cash Register Co.
Chesapeake and Ohio Railroad Co.
American Rolling Mills Co.
Textiles, Inc.
Louisville & Nashville Railroad Co.
Marietta Realty Co.
The stocks of the Standard Banner Coal Co., the Diamond Coal Mining Co., the Ames Mining Co., and the River Transportation Co., which petitioner owned all or some part of the year 1941, were capital assets.
OPINION.
LEECH, Judge:
The correctness of the respondent's action with respect to both issues involves the basic question whether the capital stock of certain coal-mining companies which petitioner purchased constitutes capital assets, for determining its excess profits tax. Petitioner claimed as an ordinary loss the sum of $26,900, sustained from the sale of 300 shares of the capital stock of the Standard Banner Coal Co. The stock was acquired in 1937 at a cost of $27,500 and sold in December 1941 for $600. Petitioner contends such shares were acquired as a necessary incident to the successful operation of its business and do not constitute capital assets within the purview of section 117(a)(1) of the Internal Revenue Code.
The circumstances under which petitioner acquired the shares are set forth in our findings of fact.
Decision will be entered for the respondent. SEC. 117. CAPITAL GAINS AND LOSSES.(a) DEFINITIONS.— As used in this chapter—(1) CAPITAL ASSETS.— The term ‘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, or property, used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23(a) * * *
Petitioner relies upon Hercules Motors Corporation, 40 B.T.A. 999; Joe B. Fortson, 47 B.T.A. 158; Helvering v. Community Bond & Mortgage Corporation, 74 Fed.(2d) 727; and Bishop Trust Co., Ltd., 47 B.T.A. 737. In the Hercules case, supra, it was customary for the company to receive trade acceptances in lieu of cash in payment of goods and materials which it sold. The status of these acceptances as capital assets in the hands of the taxpayer was the issue. In the Fortson case, supra, bonds were received in lieu of cash for services performed. A similar question as to these bonds was there involved. In both cases it was properly found as a fact that they were held primarily for sale to customers in the regular course of the taxpayer's business. Petitioner makes no claim that the securities involved were so held. Nor would the facts here support such a finding. In both the Community Bond & Mortgage Corporation case, supra, and the Bishop Trust Co., Ltd., case, supra, the securities were acquired for the purpose of minimizing further losses resulting from past acts in the conduct of their respective businesses. Petitioner purchased the Standard Banner Coal Co. shares to enable it to acquire and maintain a source of supply of coal.
Petitioner further argues, the purchase of the shares, under the circumstances set forth, is similar to a ‘hedging transaction,‘ Kenneth S. Battelle, 47 B.T.A. 117; Ben Grote, 41 B.T.A. 247; Commissioner v. Farmers & Ginners Cotton Oil Co., 120 Fed.(2d) 772. We are unable to see the analogy. Petitioner was engaged in wholesaling coal and was not engaged in the purchase and sale of securities. The term ‘capital assets‘ means ‘property held by the taxpayer,‘ except (1) stock in trade or of the kind which would be properly included in the inventory of the taxpayer, (2) property held primarily for sale to customers in the ordinary course of business, and (3) property used in the trade or business of a character which is subject to the statutory allowance for depreciation. Under the facts presented, no one of the three exceptions applies to the shares of stock of the Standard Banner Coal Co. They are capital assets, as defined by section 117(a), and the loss from the sale is not one falling within section 23(f) of the code.
SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(f) LOSSES BY CORPORATIONS.— In the case of a corporation, losses sustained during the taxable year and not compensated for by insurance or otherwise.
Since the shares were held for more than eighteen months, the loss is a long term capital loss, as defined in section 117(a)(5), and the respondent properly excluded such loss as a deduction in computing petitioner's excess profits net income under the provisions of section 711(a)(2)(D) of the code.
Cf. Camp Manufacturing Co., 3 T.C. 467; Thompson Lumber Co., 43 B.T.A. 726.
SEC. 711. EXCESS PROFITS NET INCOME.(a) TAXABLE YEARS BEGINNING AFTER DECEMBER 31, 1939.— The excess profits net income for any taxable year beginning after December 31, 1939, shall be the normal-tax net income, as defined in section 13(a)(2), for such year except that the following adjustments shall be made:(2) EXCESS PROFITS CREDIT COMPUTED UNDER INVESTED CAPITAL CREDIT.— If the excess profits credit is computed under section 714, the adjustments shall be as follows:(D) Long-term Gains and Losses.— There shall be excluded long-term capital gains and losses. * * *
During all or some part of the taxable year, petitioner held, in addition to the stock of Standard Banner Coal Co., stock of the Diamond Coal Mining Co., the Ames Mining Co., and the River Transportation Co. As in the case of the Standard Banner Coal Co. shares, the primary purpose of their acquisition was to furnish petitioner with a source of coal, and they are likewise held to be capital assets. In determining petitioner's invested capital and average invested capital under the provisions of sections 715 and 716 of the code for the taxable year, respondent reduced average invested capital to the extent provided by section 720(b) by reason of the shares of stock petitioner held in the four above mentioned companies. Respondent determined such shares to be inadmissible assets. Petitioner does not question the propriety of respondent's computation in the event such shares are held to be capital assets. We have so found. Therefore, they are ‘inadmissible assets‘ as defined in section 720(a)(1)(A) of the code.
The respondent's determination is upheld.
SEC. 720. ADMISSIBLE AND INADMISSIBLE ASSETS.(a) DEFINITIONS.— For the purpose of this subchapter—(1) The term ‘inadmissible assets‘ means—(A) Stock in corporations except stock in a foreign personal-holding company, and except stock which is not a capital asset; and