Opinion
Docket No. 203-62.
1963-10-29
MILTON HART AND VIVIEN HART, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Abraham S. Guterman, for the petitioners. Michael D. Weinberg, for the respondent.
Abraham S. Guterman, for the petitioners. Michael D. Weinberg, for the respondent.
On or about December 20, 1956, Federman, an employee of the firm which the petitioner principally used as his stockbroker, and who handled the petitioner's transactions with the firm, advised petitioner of a device whereby, in his opinion, the petitioner could obtain an income tax advantage by selling short a stock on which a large dividend arrearage had been declared, at a price which included the dividend, then pay the dividend to the broker, the amount of which would be deductible from ordinary income in his income tax return, and then covering the short sale by purchasing the stock at a price which did not include the dividend. Pursuant to the specific advice of Federman in each instance the petitioner during the years in issue made short sales of two stocks on which arrearage dividends had been declared and of one stock on which a liquidating dividend has been declared. In each instance the petitioner's purchase of the stocks to cover the short sales was made from or through the brokers who handled the short sales. During the time of the petitioner's dealings with respect to the respective stocks the petitioner never owned, borrowed, or delivered any shares of such stocks and there is no showing that the brokers owned, held, borrowed, or delivered any shares of such stocks with respect to their dealings with the petitioner. In each instance the petitioner paid to the broker with whom he was dealing an amount equal to the dividend on the particular stock involved and in each instance, upon the termination of the petitioner's dealings with respect to the stock, the broker returned to petitioner the full amount received from petitioner, less broker's commissions, Federal or State taxes, and some other small amounts. Held, that petitioner's dealings with respect to the stocks were mere formalities and without substance; that in engaging in such dealings the petitioner contemplated merely net expenditures of comparatively small amounts to the brokers as compensation for their services and other small charges for which he hoped to obtain net income tax advantages which were substantially in excess of such expenditures; and that the amounts paid by petitioner to the brokers equal to the dividends on the respective stocks were not ordinary and necessary expenses paid or incurred in carrying on any trade or business within the meaning of section 162(a), I.R.C. 1954, or ordinary and necessary expenses paid or incurred for the production or collection of income within the meaning of section 212(1) of the Code.
WITHEY, Judge:
The respondent has determined deficiencies in the income tax of the petitioners for the indicated years as follows:
+--------------------+ ¦Year ¦Deficiency ¦ +------+-------------¦ ¦1956 ¦$4,966.13 ¦ +------+-------------¦ ¦1957 ¦29,238.09 ¦ +------+-------------¦ ¦1958 ¦49,854.68 ¦ +--------------------+
The only issue for determination is the correctness of the respondent's action in disallowing deductions of $10,250, $41,250, and $65,700 taken for 1956, 1957, and 1958, respectively, as dividends paid in connection with short sales of corporate stocks.
FINDINGS OF FACT
Some of the facts have been stipulated and are found as stipulated.
The petitioners are husband and wife residing in Rye, N.Y. They filed their joint Federal income tax returns for 1956, 1957, and 1958 with the district director of internal revenue of the Upper Manhattan district, New York, N.Y.
Petitioner Milton Hart, sometimes hereinafter referred to as petitioner, is and has been engaged in the electrical contracting business in New York City for more than 30 years. For many years he has invested and speculated in securities. During that period he has purchased and sold securities at various times through various brokers. Some of such transactions were effected on the New York Stock Exchange, others on the American Stock Exchange, and some in the over-the-counter market.
L. D. Sherman & Co., sometimes hereinafter referred to as Sherman, is a registered broker-dealer in securities and an underwriter. As such it has been and is subject to e regulations of the Securities and Exchange Commission and the National Association of Securities Dealers and further is subject to examinations and audits of its books and records from time to time by both the Securities and Exchange Commission and the National Association of Securities Dealers.
In 1956 the petitioner principally used Ira Haupt & Co. as his stockbroker. The person who handled petitioner's transactions with that company was its account representative Hyman Federman.
During 1956 and 1957, Webb & Knapp, Inc., had outstanding shares of $6 cumulative preferred stock which were listed on the American Stock Exchange and sometimes hereinafter referred to as Webb stock. On December 18, 1956, a dividend of $20.50 per share was declared on the Webb stock payable to stockholders of record on December 26, 1956. Of the dividend of $20.50, $19 represented dividend arrearage on the stock and was payable December 27, 1956, and $1.50 represented a current dividend and was payable January 1, 1957. Trading in the Webb stock on the American Stock Exchange was on an ex-dividend basis on and after December 19, 1956.
On or about December 20, 1956, Federman advised the petitioner of a device whereby in his opinion petitioner could obtain a tax advantage by selling stock short. The device as explained to the petitioner was: For the petitioner to sell short a stock, on which a large arrearage dividend had been declared, at a price which included the dividend; the petitioner would pay the dividend and deduct the amount of the payment on his income tax return; and then petitioner would cover the short sale by purchasing stock at a price which did not include the dividend. As further explained by Federman to petitioner, the device not only would enable petitioner to obtain a deduction from ordinary income of the amount of the dividend but would enable him to offset any capital gain realized from the short sale by applying thereto otherwise unused capital losses. Federman also advised petitioner to sell short shares of Webb stock.
Petitioner inquired of Federman if Ira Haupt & Co. would accept a short sale of the Webb stock from him. Federman replied that due to American Stock Exchange rules, Ira Haupt & Co. was not dealing in that type of transaction but if petitioner desired to sell Webb stock short, he, Federman, would see if such a sale could be arranged with Sherman. Federman contacted Sherman and informed petitioner that Sherman was interested in the sale. Although petitioner was not acquainted with Sherman and theretofore had not dealt with it, he thereupon telephoned Sherman and arranged a short sale to it of 500 shares of Webb stock at a price quoted by Sherman.
Respecting the petitioner's transaction with it, Sherman issued to petitioner a confirmation dated December 20, 1956, which recited Sherman's purchase on that date, as dealer for its account, from petitioner of 500 shares of Webb stock with the dividend on (including dividend of $20.50) at $153 per share, totaling $76,500 less Federal tax of $30 and a net amount of $76,470. The confirmation showed December 28, 1956, as the date for settlement of the transaction.
The high and low prices at which Webb stock sold per share on the American Stock Exchange were as follows on the indicated dates:
+--------------------------------+ ¦ ¦Sales price ¦ +--------------+-----------------¦ ¦Date ¦ ¦ ¦ +--------------+--------+--------¦ ¦ ¦High ¦Low ¦ +--------------+--------+--------¦ ¦Dec. 18, 1956 ¦$154 5/8¦$154 1/2¦ +--------------+--------+--------¦ ¦Dec. 19, 1956 ¦133 5/8 ¦131 1/2 ¦ +--------------+--------+--------¦ ¦Dec. 20, 1956 ¦133 ¦130 1/4 ¦ +--------------------------------+
On December 26, 1956, petitioner transmitted to Sherman a check in the amount of $10,250, an amount equal to the dividend of $20.50 per share on 500 shares of Webb stock.
On or about December 28, 1956, petitioner telephoned Sherman and arranged to purchase from it 500 shares of Webb stock at a price quoted by Sherman, such stock to be used by Sherman to cover petitioner's previous short sale to it. Subsequently, Sherman sent petitioner a confirmation dated December 28, 1956, which recited Sherman's sale on that date, as dealer for its account, to petitioner of 500 shares of Webb stock, ex-dividend, at $133 1/2 per share, totaling $66,750. The confirmation showed January 4, 1957, as the settlement date for the transaction. On December 28, 1956, the high and the low prices at which Webb stock sold per share on the American Stock Exchange were $131 and $130 1/3, respectively. On January 8, 1957, Sherman transmitted to petitioner a check for $9,720 which cleared petitioner's account with Sherman. Thus upon completion of his dealings with Sherman respecting 500 shares of Webb stock, the petitioner's net expenditure was $530. Of that amount, $30, or $6 per 100 shares of stock, represented payment of Federal tax and $500, or $1 per share, represented compensation paid to Sherman.
The weekly volume in shares of Webb stock sold on the American Stock Exchange was as follows for the indicated weeks:
+------------------------------+ ¦ ¦Weekly volume ¦ +-------------+----------------¦ ¦Week ended— ¦in shares ¦ +-------------+----------------¦ ¦Nov. 30, 1956¦980 ¦ +-------------+----------------¦ ¦Dec. 7, 1956 ¦790 ¦ +-------------+----------------¦ ¦Dec. 14, 1956¦600 ¦ +-------------+----------------¦ ¦Dec. 21, 1956¦11,070 ¦ +-------------+----------------¦ ¦Dec. 28, 1956¦2,640 ¦ +-------------+----------------¦ ¦Jan. 4, 1957 ¦900 ¦ +-------------+----------------¦ ¦Jan. 11, 1957¦420 ¦ +-------------+----------------¦ ¦Jan. 18, 1957¦1,250 ¦ +------------------------------+
The books and records of Sherman state that in December 1956, 11 individuals, including petitioner, sold short to Sherman 6,800 shares of Webb stock at a total price of $1,045,512.50. In each instance the sales price was dividend on (including the dividend of $20.50 per share). In each instance the seller paid to Sherman an amount equal to the dividends on the shares sold, which payments totaled $139,400. In each instance the seller bought back from Sherman the same number of shares previously sold short to it. Such purchases were made at a time and at a price which reflected that the stock was being traded ex-dividend.
On December 17, 1957, a dividend of $13.75 was declared on Webb stock payable to stockholders of record on December 26, 1957. Of the dividend of $13.75, $12.25 represented dividend arrearage on the stock and was payable December 30, 1957, and $1.50 represented a current dividend and was payable January 1, 1958. Trading in the stock on the American Stock Exchange was on an ex-dividend basis on and after December 20, 1957.
As in 1956, Federman on or about December 19, 1957, advised petitioner to sell Webb stock short in order to obtain a tax advantage. As in 1956, he informed petitioner that Ira Haupt & Co. did not deal in that type of transaction and he contracted Sherman to see if such a sale by petitioner could be arranged with Sherman. Upon being informed by Federman that Sherman was interested in the sale, the petitioner contacted Sherman and arranged to sell short to it 3,000 shares of Webb stock.
Thereafter Sherman issued to petitioner a confirmation dated December 19, 1957, which recited Sherman's purchase on that date, as dealer for its account, from petitioner of 3,000 shares of Webb stock at $117 1/8 (including dividend of $13.75) per share, totaling $351,375 less Federal tax of $180 and a net amount of $351,195. The confirmation showed December 16, 1957, as the date of settlement for the transaction.
The high and low prices at which Webb stock sold per share on the American Stock Exchange were as follows on the indicated dates:
+------------------------------+ ¦ ¦Sales price ¦ +--------------+---------------¦ ¦Date ¦ ¦ +--------------+---------------¦ ¦ ¦High ¦Low ¦ +--------------+-------+-------¦ ¦Dec. 19, 1957 ¦$119 ¦$117 ¦ +--------------+-------+-------¦ ¦Dec. 20, 1957 ¦105 1/2¦103 5/8¦ +------------------------------+
On December 26, 1957, the petitioner transmitted to Sherman a check in the amount of $41,250, an amount equal to the dividend of $13.75 per share on 3,000 shares of Webb stock.
The petitioner then arranged to purchase from Sherman 3,000 shares of Webb stock to be used by Sherman to cover petitioner's short sale of such stock to it. Subsequently Sherman sent petitioner a confirmation dated December 27, 1957, which recited Sherman's sale on that date, as dealer for its account, to petitioner of 3,000 shares of Webb stock at $104 3/8 per share, totaling $313,125. The confirmation showed January 3, 1958, as the date of settlement for the transaction. On December 27, 1957, the high and low prices at which Webb stock sold on the American Stock Exchange were $105 1/8 per share and $104 per share, respectively. On January 6, 1958, Sherman transmitted to petitioner a check for $38,070 which cleared the petitioner's account with Sherman. Thus on completion of his dealings with Sherman respecting the 3,000 shares of Webb stock, the petitioner's net expenditure was $3,180. Of that amount $180, or $6 per 100 shares of stock, represented payment of Federal tax and $3,000, or $1 per share, represented compensation paid to Sherman.
The weekly volume in shares of Webb stock sold on the American Stock Exchange was as follows for the indicated weeks:
+------------------------------+ ¦ ¦Weekly volume ¦ +-------------+----------------¦ ¦Week ended— ¦in shares ¦ +-------------+----------------¦ ¦Nov. 29, 1957¦40 ¦ +-------------+----------------¦ ¦Dec. 6, 1957 ¦2,580 ¦ +-------------+----------------¦ ¦Dec. 13, 1957¦250 ¦ +-------------+----------------¦ ¦Dec. 20, 1957¦5,980 ¦ +-------------+----------------¦ ¦Dec. 27, 1957¦10,810 ¦ +-------------+----------------¦ ¦Jan. 3, 1958 ¦1,490 ¦ +-------------+----------------¦ ¦Jan. 10, 1958¦340 ¦ +-------------+----------------¦ ¦Jan. 17, 1958¦330 ¦ +------------------------------+
The books and records of Sherman state that in December 1957, 15 individuals, including petitioner, sold short to Sherman 10,350 shares of Webb stock at a total price of $1,217,906.25. In each instance the sales price was dividend on (including the dividend of $13.75 per share). In each instance the seller paid to Sherman an amount equal to the dividend on the shares sold, which payments totaled $142,312.50. In each instance the seller, or his assignee, bought back from Sherman the same number of shares previously sold short to it. Such purchases were made at a time and at a price which reflected that the stock was being traded ex-dividend.
In November 1958, Mohasco Industries, Inc., sometimes hereinafter referred to as Mohasco, had outstanding 4.20-percent cumulative preferred stock, sometimes hereinafter referred to as Mohasco stock, which was and is listed on the New York Stock Exchange. On November 19, 1958, a dividend of $15.75 per share was declared on Mohasco stock payable December 22, 1958, to stockholders of record on December 1, 1958. Of the dividend of $15.75, $14.70 represented dividend arrearage and $1.05 represented a current dividend. Trading in the Mohasco stock on the New York Stock Exchange was on an ex-dividend basis on and after November 25, 1958.
As he had done with respect to Webb stock in 1956 and 1957, Federman advised petitioner to sell Mohasco stock short in order to obtain a tax advantage. As in prior years, he contacted Sherman to see if such a sale by petitioner could be arranged with Sherman. Upon being informed by Federman that Sherman was interested in the sale, the petitioner contacted Sherman and arranged with Sherman to sell short to it 4,000 shares of Mohasco stock. Thereafter Sherman sent petitioner a confirmation dated November 24, 1958, which recited Sherman's purchase on that date, as dealer for its account, from petitioner of 4,000 shares of Mohasco stock at $87 per share, totaling $348,000 less Federal tax of $240 and a net amount of $347,760. The confirmation showed December 1, 1958, as the date of settlement for the transaction.
The high and the low prices at which Mohasco stock sold per share on the New York Stock Exchange were as follows on the indicated dates:
+--------------------------+ ¦ ¦Sales price¦ +--------------+-----------¦ ¦Date ¦High ¦Low¦ +--------------+-------+---¦ ¦Nov. 24, 1958 ¦$87 3/4¦$86¦ +--------------+-------+---¦ ¦Nov. 25, 1958 ¦72 1/2 ¦71 ¦ +--------------------------+
On December 1, 1958, the petitioner transmitted to Sherman his check in the amount of $63,000, an amount equal to the dividend of $15.75 on 4,000 shares of Mohasco stock.
Thereafter the petitioner arranged to purchase from Sherman 4,000 shares of Mohasco stock to be used by Sherman to cover the petitioner's short sale of such stock to it. Subsequently Sherman sent to petitioner a confirmation dated January 5, 1959, which recited Sherman's sale on that date, as dealer for its account, to petitioner of 4,000 shares of Mohasco stock at $72 1/4 per share, totaling $289,000. The confirmation showed January 9, 1959, as the date of settlement for the transaction. There were no sales of the Mohasco stock on the New York Stock Exchange on January 5, 1959. However, the stipulated bid and asked prices per share on that date were a high of $72 and a low of $70. On January 5, 1959, Sherman transmitted to petitioner a check for $58,760 which cleared the petitioner's account with Sherman. On completion of his dealings with Sherman respecting the 4,000 shares of Mohasco stock, the petitioner's net expenditure was $4,240. Of that amount $240, or $6 per 100 shares of stock, represented payment of Federal tax and $4,000, or $1 per share, represented compensation paid to Sherman.
The weekly volume in shares of Mohasco stock sold on the New York Stock Exchange was as follows for the indicated weeks:
+------------------------------+ ¦ ¦Weekly volume ¦ +-------------+----------------¦ ¦Week ended ¦in shares ¦ +-------------+----------------¦ ¦Oct. 31, 1958¦250 ¦ +-------------+----------------¦ ¦Nov. 7, 1958 ¦240 ¦ +-------------+----------------¦ ¦Nov. 14, 1958¦220 ¦ +-------------+----------------¦ ¦Nov. 21, 1958¦6,340 ¦ +-------------+----------------¦ ¦Nov. 28, 1958¦4,990 ¦ +-------------+----------------¦ ¦Dec. 5, 1958 ¦2,180 ¦ +-------------+----------------¦ ¦Dec. 12, 1958¦460 ¦ +-------------+----------------¦ ¦Dec. 19, 1958¦520 ¦ +-------------+----------------¦ ¦Dec. 26, 1958¦140 ¦ +-------------+----------------¦ ¦Jan. 2, 1959 ¦440 ¦ +-------------+----------------¦ ¦Jan. 9, 1959 ¦450 ¦ +------------------------------+
The books and records of Sherman state that in November 1958, 7 individuals, including petitioner, sold short to Sherman 5,800 shares of Mohasco stock at a total price of $505,050. In each instance the sales price was dividend on (including the dividend of $15.75). In each instance the seller paid to Sherman an amount equal to the dividend on the shares sold, which payments totaled $91,350. In each instance the seller, or his assignee, bought back from Sherman the same number of shares previously sold short to it. Such purchases were made at a time and at a price which reflected that the stock was being traded ex-dividend.
Prior to his dealings with Sherman in December 1956 respecting Webb stock, the petitioner had had no dealings with that firm. The petitioner never was requested to nor did he deposit any margin with Sherman nor did he ever have any margin agreement with Sherman respecting his dealings with it as to Webb stock or Mohasco stock. Nor did petitioner at any time furnish Sherman a statement of his financial condition. The petitioner did not own or borrow any certificate or certificates for shares of Webb stock or shares of Mohasco stock at the times of or during the periods of his dealings with Sherman with respect to such stocks. The petitioner did not deliver to Sherman any certificate or certificates for shares of such stock in Webb or Mohasco nor did Sherman deliver to petitioner any certificate or certificates for shares of such stock. There is no showing that at the time of or during the periods of petitioner's dealings with Sherman the latter owned or had in its possession any shares of stock in Webb or in Mohasco. Except for his dealings with Sherman with respect to Webb and Mohasco stocks, the petitioner never has made a short sale to an over-the-counter dealer. In every other instance when petitioner made a short sale he had a margin account with the broker.
Prior to entering into the above-mentioned transactions with respect to Webb stock and the transaction with respect to Mohasco stock the petitioner never made any investigation as to the financial condition and business prospects of the respective companies. The above-mentioned transaction of petitioner as to 500 shares of Webb stock involving a recited amount of $76,500 was the largest single stock transaction the petitioner theretofore had engaged in. The subsequent transaction of petitioner as to 3,000 shares of Webb stock involving a recited amount of $351,375 was the largest single stock transaction the petitioner has ever engaged in. However, in 1958, the petitioner purchased $1,500,000 par value of U.S. Treasury bonds with respect to which he deposited a 5-percent margin, or $75,000.
Hayden, Stone & Co., sometimes hereinafter referred to as Hayden, is a stockbroker and a member of the American Stock Exchange and of the New York Stock Exchange. D. H. Blair & Co., sometimes hereinafter referred to as Blair, is a stockbroker and an associate member of the American Stock Exchange and of the New York Stock Exchange.
In October 1958, Cuban Atlantic Sugar Co. (Delaware), sometimes hereinafter referred to as Cuban, had outstanding shares of common stock, sometimes hereinafter referred to as Cuban stock, which were listed on the American Stock Exchange. On October 1, 1958, a liquidating dividend of $9 per share was declared on Cuban stock payable October 22, 1958, to stockholders of record on October 10, 1958. Trading in Cuban stock on the American Stock Exchange was on an ex-dividend basis on and after October 7, 1958.
In October 1958, Federman was in the employ of Blair and advised petitioner to sell short Cuban stock. Upon being informed by petitioner that he desired to sell short 300 shares of Cuban stock, Federman informed petitioner that he could handle the sale and that it would not be necessary for petitioner to go to another broker to make it. Thereupon petitioner instructed Federman to proceed. Thereafter Hayden, which by arrangement with Blair handled transactions for it, issued to petitioner confirmations which recited short sales by petitioner on October 6, 1958, of a total of 300 shares of Cuban stock at $23 1/2 per share for a total amount of $7,050 less commissions and other charges in the total amount of $105.30 and a total net amount of $6,944.70. The confirmations showed October 10, 1958, as the date of settlement for the transaction.
Prior to or on October 7, 1958, the petitioner instructed Blair to purchase 300 shares of Cuban stock to cover his short sale of the stock. Subsequently Hayden issued to petitioner a confirmation which recited a purchase by petitioner on October 7, 1958, of 300 shares of Cuban stock at $14 1/2 per share of $4,350 plus commission of $48.75, or a total amount of $4,398.75. The confirmation showed October 14, 1958, as the date of settlement for the transaction. Although the dividend on the stock was not payable until October 22, 1958, the petitioner on October 9, 1958, delivered to Hayden a check in the amount of $2,700, an amount equal to the liquidating dividend of $9 per share on the 300 shares of Cuban stock. Subsequently and on October 14, 1958, Hayden delivered to petitioner a check in the amount of $2,545.95 to balance the account with petitioner. On completion of his dealings with respect to the 300 shares of Cuban stock, the petitioner's net expenditure was $154.05. Of that amount, $13.05 represented Federal and State taxes and miscellaneous charges and the remainder, $141, represented commissions paid to Hayden.
The high and low prices at which the Cuban stock sold per share on the American Stock Exchange were as follows on the indicated dates:
+----------------------------+ ¦ ¦Sales price ¦ +------------+---------------¦ ¦Date ¦ ¦ +------------+---------------¦ ¦ ¦High ¦Low ¦ +------------+-------+-------¦ ¦Oct. 6,1958 ¦$23 3/4¦$23 1/8¦ +------------+-------+-------¦ ¦Oct. 7,1958 ¦14 5/8 ¦14 1/4 ¦ +----------------------------+
The weekly volume in shares of Cuban stock sold on the American Stock Exchange was as follows for the indicated weeks:
+------------------------------+ ¦ ¦Weekly volume ¦ +-------------+----------------¦ ¦Week ended— ¦in shares ¦ +-------------+----------------¦ ¦Sept. 12,1958¦11,100 ¦ +-------------+----------------¦ ¦Sept. 19,1958¦3,600 ¦ +-------------+----------------¦ ¦Sept. 26,1958¦6,100 ¦ +-------------+----------------¦ ¦Oct. 3,1958 ¦3,900 ¦ +-------------+----------------¦ ¦Oct. 10,1958 ¦6,500 ¦ +-------------+----------------¦ ¦Oct. 17,1958 ¦2,400 ¦ +-------------+----------------¦ ¦Oct. 24,1958 ¦1,200 ¦ +-------------+----------------¦ ¦Oct. 31,1958 ¦3,300 ¦ +------------------------------+
At the time of the dealings of petitioner with respect to the Cuban stock he had a margin agreement with Blair and he was not requested to deposit any margin with respect to such dealings. The petitioner did not own, borrow, or deliver any certificate or certificates for shares of Cuban stock at the time of or during the period of his dealings with respect to such stock. There is no showing that petitioner's brokers, Blair and Hayden, owned, held, borrowed, or delivered a certificate for the Cuban stock involved in his dealings with them.
Prior to entering into the above-mentioned dealings with respect to the Cuban stock the petitioner never made any investigation as to the financial condition and business prospects of Cuban. As far as petitioner was concerned his dealings with respect to Cuban stock represented ‘a book transaction.’
In his income tax returns for 1956, 1957, and 1958, the petitioner took deductions for dividends paid by him on short sales of the indicated stocks as follows:
+--------------------------------+ ¦Return for year—¦Stocks ¦Amount ¦ +----------------+-------+-------¦ ¦1956 ¦Webb ¦$10,250¦ +----------------+-------+-------¦ ¦1957 ¦Webb ¦41,250 ¦ +----------------+-------+-------¦ ¦1958 ¦Mohasco¦63,000 ¦ +----------------+-------+-------¦ ¦1958 ¦Cuban ¦2,700 ¦ +--------------------------------+
The petitioner reported in his income tax returns for the indicated years short-term capital gains in the following amounts on short sales of the indicated stocks:
+----------------------------------+ ¦Return for year—¦Stocks ¦Amount ¦ +----------------+-------+---------¦ ¦1957 ¦Webb ¦$9,720.00¦ +----------------+-------+---------¦ ¦1958 ¦Webb ¦38,070.00¦ +----------------+-------+---------¦ ¦1958 ¦Cuban ¦2,545.95 ¦ +----------------+-------+---------¦ ¦1959 ¦Mohasco¦58,760.00¦ +----------------------------------+
The excess of capital loss over capital gain, including the gain reported on short sales reported as set out in the preceding paragraph, reported and deducted by petitioner in his income tax returns for the indicated years was as follows:
+------------------------------------+ ¦ ¦Amount of¦Amount of¦ +----------------+---------+---------¦ ¦Return for year—¦excess ¦excess ¦ +----------------+---------+---------¦ ¦ ¦reported ¦deducted ¦ +----------------+---------+---------¦ ¦1956 ¦$333.74 ¦$333.74 ¦ +----------------+---------+---------¦ ¦1957 ¦13,167.35¦1,000.00 ¦ +----------------+---------+---------¦ ¦1958 ¦72,546.87¦1,000.00 ¦ +----------------+---------+---------¦ ¦1959 ¦3,114.33 ¦1,000.00 ¦ +------------------------------------+
In determining the deficiencies in issue respondent disallowed the deductions taken by petitioner in his returns for 1956, 1957, and 1958 as dividends paid by him on short sales of the stocks involved herein.
The amounts of the deductions so disallowed by respondent were not ordinary and necessary expenses paid or incurred by petitioner during the respective taxable years in carrying on any trade or business nor were they ordinary and necessary expenses paid or incurred during such years by petitioner for the production or collection of income.
OPINION
The petitioner deducted in his income tax returns for the following years the indicated amounts as dividends paid with respect to short sales of Webb, Mohasco, and Cuban stocks and with respect to which the petitioner made net expenditures of the indicated amounts of which the indicated portions represent compensation to the named firms:
+---------------------------------------------------------------------------+ ¦ ¦ ¦ ¦ ¦Portion of net ¦ +-----+-----------+-----------------------+------------+--------------------¦ ¦ ¦Deducted as¦ ¦ ¦expenditures ¦ +-----+-----------+-----------------------+------------+--------------------¦ ¦ ¦dividends ¦ ¦Amount of ¦paid as compensation¦ +-----+-----------+-----------------------+------------+--------------------¦ ¦Year ¦paid with ¦Stocks ¦petitioner's¦to— ¦ +-----+-----------+-----------------------+------------+--------------------¦ ¦ ¦respect to ¦ ¦net ¦ ¦ +-----+-----------+-----------------------+------------+--------------------¦ ¦ ¦short sales¦ ¦expenditures¦ ¦ ¦ +-----+-----------+-----------------------+------------+-----------+--------¦ ¦ ¦ ¦ ¦ ¦Sherman ¦Hayden ¦ +-----+-----------+-----------------------+------------+-----------+--------¦ ¦1956 ¦$10,250 ¦500 shares of Webb ¦$530.00 ¦$500 ¦ ¦ +-----+-----------+-----------------------+------------+-----------+--------¦ ¦1957 ¦41,250 ¦3,000 shares of Webb ¦3,180.00 ¦3,000 ¦ ¦ +-----+-----------+-----------------------+------------+-----------+--------¦ ¦1958 ¦63,000 ¦4,000 shares of Mohasco¦4,240.00 ¦4,000 ¦ ¦ +-----+-----------+-----------------------+------------+-----------+--------¦ ¦1958 ¦2,700 ¦300 shares of Cuban ¦154.05 ¦ ¦$141 ¦ +-----+-----------+-----------------------+------------+-----------+--------¦ ¦Total¦117,200 ¦ ¦8,104.05 ¦7,500 ¦141 ¦ +---------------------------------------------------------------------------+
Although conceding that the dealings of the petitioner with respect to the Webb, Mohasco, and Cuban stocks ‘had a tax motivation,‘ the petitioners take the position that such dealings represented bona fide short sales of such stocks, and contend that the amounts paid by petitioner as dividends with respect to the stocks were properly deductible from gross income as dividends paid on short sales of the stocks and that the respondent erred in disallowing the deductions taken therefor in the returns for the respective years.
It is now well established that deductions are a matter of legislative grace and that one who seeks a deduction must be able to point to a statute which provides for the allowance of the deduction and show that he comes within the terms of that statute. New Colonial Co. v. Helvering, 292 U.S. 435 (1934), affirming 24 B.T.A. 886 (1931); Deputy v. Du Pont, 308 U.S. 488 (1940); Interstate Transit Lines v. Commissioner, 319 U.S. 590 (1943); Empire Press, Inc., 35 T.C. 136 (1960).
The petitioners have not pointed us to the provision or provisions of the Internal Revenue Code upon which they rely as graining the deductions contended for. However, provisions of the Internal Revenue Code of 1954 which grant deductions are set out below.
Section 162(a) provides in general for the allowance as a deduction of all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. The petitioner's trade or business during the taxable years in issue was that of electrical contracting. The petitioners have made no attempt to relate to that business the petitioner's dealings with respect to the Webb, Mohasco, and Cuban stocks. In view of that and since we are unable to find that any relationship existed, we are without any basis for concluding that the deductions in issue were allowable as business expenses under the provisions of section 162(a).
SEC. 162. TRADE OR BUSINESS EXPENSES.(a) IN GENERAL.— There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * *SEC. 212. EXPENSES FOR PRODUCTION OF INCOME.In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year—(1) for the production or collection of income;
Section 212(1) provides for the allowance as a deduction of all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income. The contention of the petitioners as to the allowance of the deductions in issue rests upon the well-established rule that one who borrows securities in order to make a short sale may deduct interest or dividends payable with respect to such securities during the period of the loan where the borrower in fact pays such amounts to the lender of the securities. I.T. 3989, 1950-1 C.B. 34. Essential to the application of that rule here is a showing that there was an actual loan of such securities by a lender and that there was an actual payment to the lender by the petitioner. The burden was upon the petitioner to make such a showing, and any facts essential to such a showing which he has failed to present may not be presumed to have been favorable to him.
The record shows that prior to the first short sale by petitioner of Webb stock in 1956 Hyman Federman gave petitioner a detailed explanation of what he considered to be the income tax advantages to be derived from making short sales of stocks on which there were large dividend arrearages and on which dividends had been declared in payment of all or part of such arrearages. In addition, Federman informed petitioner of the detailed procedure to be followed in effecting such short sales and the covering purchases therefor in order to obtain the explained income tax advantages. Pursuant to such explanation and information and in each instance upon the advice of Federman, the petitioner made the short sales of Webb, Mohasco, and Cuban stocks here involved.
Although in his testimony he admitted he made no investigation of the financial condition and business prospects of the corporations, the stocks of which are here involved, before engaging in an attempt to establish the bona fides of his dealings, stated that he would have made the short sales under consideration even though the income tax benefit explained by Federman had not been present. The petitioner's statement that absent the anticipated income tax benefit he nevertheless would have made the short sales here involved lacks corroboration in the record.
At the times the petitioner entered into and was engaged in his dealings with respect to the Webb, Mohasco, and Cuban stocks, respectively, he owned no shares thereof and he never made any borrowing or delivery of any. Nor is there any showing that Sherman, during the times of its dealings with petitioner with respect to the Webb and Mohasco stocks, either owned, held, borrowed, or delivered any shares thereof with respect to its dealings with petitioner or that Blair or Hayden, during the time of their dealings with petitioner with respect to the Cuban stock, either owned, held, borrowed, or delivered any shares thereof with respect to their dealings with petitioner.
The petitioner testified that as far as he was concerned his dealings with respect to the Cuban stock represented ‘a book transaction.’ Despite the sending by Hayden of confirmations to petitioner and the petitioner's delivery to Hayden of a check in the amount of the dividend on the Cuban stock, the fact remains that petitioner's dealings with respect to the stock terminated by Hayden returning to petitioner the full amount of the petitioner's check less Hayden's charges for commissions and some other small items. In the situation presented we are of the opinion that petitioner's dealings with respect to the Cuban stock were mere formalities and without substance and that his characterization thereof as ‘a book transaction’ is particulary apt. In view of the factual similarity of petitioner's dealings with Sherman with respect to the Webb and Mohasco stocks to his dealings with respect to the Cuban stock, we also are of the opinion that his dealings with respect to the Webb and Mohasco stocks were mere formalities and without substance and that they too may be characterized appropriately as only book transactions.
From the record presented it is clear that petitioner in engaging in his dealings with respect to the Webb, Mohasco, and Cuban stocks contemplated merely net expenditures of comparatively small amounts of funds as compensation to Sherman and Blair or Hayden as compensation for their services and other small charges for which he hoped to obtain net income tax advantages which were substantially in excess of such expenditures. However, as was said in Carl Shapiro, 40 T.C. 34 (1963): But the avoidance of taxes hardly qualifies as ‘the production or collection of income’ under the statute (sec. 212(1)), either literally or by any implication that is supported by any relevant legislative history.
In view of the foregoing we conclude that the deductions in controversy were not allowable under the provisions of section 212(1).
Reviewed by the Court.
Decision will be entered for the respondent.
OPPER, J., concurring: A short sale is necessarily in part a ‘paper’ transaction. This is inherent in the concept of selling property that the vendor does not own. At least as to the ‘Cuban’ transaction it seems to me neither necessary nor reasonable to dispose of the issue on that theory. Petitioners were not in the business of trading or dealing in securities and the dividend cannot be deducted as a business expense. Deputy v. DuPont 308 U.S. 488, 495-496 (1940); Main Line Distributors, Inc., 37 T.C. 1090 (1962), affd. 321 F.2d 562 (C.A. 6).
It is no greater extent a cost of the collection or production of income nor an expense of conserving income-producing property under I.R.C. 1954, section 212. The opinion adequately relies on Carl Shapiro, 40 T.C. 34, 39-40 (1963), on appeal (C.A. 1), for the proposition that ‘the avoidance of taxes hardly qualifies as ‘the production or collection of income’ under the statute.' On the contrary, the dividends were— paid by petitioners in connection with the sale of capital assets and were directly attributable to such sale. As such, they were not ordinary and necessary expenses for the production or collection of income within the meaning of section 23(a)(2) (the predecessor of I.R.C. 1954, section 212), but were clearly capital expenditures * * * . (L.B. Maytag, 32 T.C. 270, 280 (1959).)
And of course there was no property, income-producing or otherwise, for the conservation of which the dividend was paid.
As in any short sale, delivery by petitioner was not made to the purchaser. But since the sale was covered by a confirmed purchase, before the specified date for performance, this can have no significance. I would not cast doubt on technically impeccable short sales by holding here that the transactions had no economic substance.