Opinion
Docket No. 9906.
1947-12-16
AMERICAN BUSINESS CREDIT CORPORATION, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Edward K. Hanlon, Esq., for the petitioner. Martin M. Lore, Esq., for the respondent.
Commissions paid by petitioner corporation to its broker agent as compensation for its services in selling petitioner's stock are not to be deducted from the price received for the stock in computing equity invested capital under section 718(a)(1), Internal Revenue Code. Edward K. Hanlon, Esq., for the petitioner. Martin M. Lore, Esq., for the respondent.
The respondent determined deficiencies of $10,892.60 and $118,476.49 in the petitioner's excess profits tax liabilities for the taxable years ended June 30, 1942 and 1943, respectively. He also determined a deficiency of $1,944.39 in the petitioner's income tax liability for the fiscal year ended June 30, 1942.
The single issue is whether the equity invested capital of the petitioner is properly measured by the amount paid by its stockholders for certain shares of its stock or should be diminished by the commission paid to a brokerage concern for its services in effecting the sales of such stock (section 718(a)(1) of the Internal Revenue Code.)
FINDINGS OF FACT.
The facts were stipulated. The portions relative to the issue are as follows:
The petitioner is a corporation organized and existing under the laws of the State of Delaware, having been incorporated on or about July 1, 1937. The principal executive office of the petitioner is located in New York City, and the returns for the periods involved in this proceeding were filed with the collector of internal revenue for the second district of New York.
The petitioner now is, and at all times herein mentioned has been, engaged in the finance business, principally in specialized forms of financing for manufacturers, wholesalers, and retailers, including the purchase of receivables, the purchase of conditional sales contracts or other lien instruments and notes thereunder, inventory financing secured by warehouse receipts or trust receipts or by obtaining possession of or title to merchandise, advances to finance companies and similar companies on a secured basis, and the purchase of installment lien receivables or installment receivables on a guaranteed basis.
Clarence Hodson & Co., a New York corporation, hereinafter referred to as Hodson, at all the times hereinafter mentioned, was engaged in the business of underwriting, brokerage of, dealing in, and buying and selling securities.
On August 11, 1937, the petitioner entered into a written agreement with Hodson. On October 13, 1937, the agreement was amended by a further written agreement between the parties. The original agreement of August 11, 1937, and its amendment of October 13, 1937, are hereinafter referred to as the first agreement. On September 1, 1938, the petitioner entered into a further agreement with Hodson, hereinafter called the second agreement. On February 26, 1940, the petitioner entered into an additional agreement with Hodson, hereinafter called the third agreement.
The 3 agreements provided for the sale by the petitioner and the purchase by Hodson of 3 blocks of 20,000 shares each of the petitioner's common stock, class A, at $5, $5.50, and $6 a share, respectively, and the reoffering of such shares by Hodson to the public at an additional price of $1.25 over the price paid by Hodson. In each agreement Hodson also agreed to use its best efforts to sell to the public on behalf of the petitioner corporation a certain number of shares of its stock at specified prices. A total of 980,000 shares were to be sold. Sale prices of $6.25, $6.75, and $7.25 per share, respectively, were fixed by the 3 agreements. Hodson was entitled to received from the petitioner ‘an amount equal to $1.25 in respect of the sale of each share‘ of the petitioner's stock so sold, such amount to be deducted from the established price of the shares.
Each agreement further provided that the petitioner should not be obligated to reimburse Hodson for losses incurred by it with respect to any of such shares which Hodson did not resell to the public nor for the loss of profits to Hodson in any form.
The first agreement provided as follows:
(3)(e) Delivery of certificates for shares of Common Stock so ordered shall be made (on the fourth business day following receipt of the order therefor by the Corporation) against payment of the sale price therefor (determined as provided in subdivision (b) of paragraph 3), less the amount of compensation to which the Hodson Company shall be entitled in respect thereof, as provided in subdivision (f) of this paragraph, by check drawn on funds payable through the New York Clearing House.
(f) As full compensation for all services rendered and expenses incurred by the Hodson Company in connection with the sale of the 305,000 shares of Common Stock as herein contemplated, it shall be entitled to receive from the Corporation an amount equal to $1.25 in respect of the sale of each share of Common Stock for which payment shall have been received by the Corporation—such amount to be deducted from the price of such shares as provided in subdivision (b) of this paragraph 3.
The counterpart of this provision is found in the other two agreements in almost identical language.
On or about August 11, 1937, pursuant to the first agreement, Hodson purchased from the petitioner 20,000 shares of the petitioner's common stock, class A, at a price of $5 per share, and the petitioner received from Hodson the sum of $100,000 in payment for the 20,000 shares. Thereafter Hodson resold all of such 20,000 shares for its own account.
Between January 10 and August 15, 1938, both dates inclusive, pursuant to the first agreement, the petitioner sold through Hodson 180,000 additional shares of the petitioenr's common stock, class A, at a price to the persons to whom such shares were issued of $6.25 per share, or a total selling price of $1,125,000. In further pursuance of the agreements, Hodson deducted the sum of $1.25 for each of such shares so sold, or a total of $225,000 for all of the shares so sold, as full compensation for all services rendered by it and expenses incurred by it in respect to the sale of the 180,000 additional shares. The balance of the total sales price, i.e., $900,000, was paid over to the petitioner and the receipt of this sum was recorded by the petitioner on its books. One dollar per share was credited to its capital stock account and the excess was credited to paid-in surplus. The commission of $225,000 was not entered by the petitioner on its books.
On or about October 3, 1938, pursuant to the second agreement, Hodson purchased from the petitioner 20,000 shares of the petitioner's common stock, class A, at a price of $5.50 per share, and the petitioner received from Hodson the sum of $110,000 in payment for said 20,000 shares. Thereafter Hodson resold all of the said 20,000 shares for its own account.
Between November 7, 1938, and December 13, 1939, both dates inclusive, pursuant to the second agreement, the petitioner sold through Hodson 480,000 additional shares of the petitioner's common stock, class A, at a price to the purchasers of $6.75 per share, or a total sales price of $3,240,000. In further pursuance of the second agreement, Hodson deducted the sum of $1.25 for each of such shares so sold, or a total of $600,000 for all of said shares so sold, as full compensation for all services rendered by it and expenses incurred by it in respect to the sale of the 480,000 additional shares. The balance of the total sales price, i.e., $2,640,000, was paid over to the petitioner and the receipt of this sum was recorded by the petitioner on its books. One dollar per share was credited to its capital stock account and the excess was credited to paid-in surplus. The commission of $600,000 was not entered by the petitioner on its books.
On or about March 20, 1940, pursuant to the third agreement, Hodson purchased from the petitioner 20,000 shares of the petitioner's common stock, class A, at a price of $6 per share, and the petitioner received from Hodson the sum of $120,000 in payment for said 20,000 shares. Thereafter Hodson resold all of the 20,000 shares for its own account.
Between July 22, 1940, and April 19, 1941, both dates inclusive, pursuant to the third agreement, the petitioner sold through Hodson 243,713 additional shares of the petitioner's common stock, class A, at a price to the persons to whom said shares were issued of $7.25 per share, or a total sales price of $1,766,919.25. In further pursuance of the said agreement, Hodson deducted the sum of $1.25 for each of such shares so sold, or a total of $304,641.25 for all of the shares so sold, as full compensation for all services rendered by it and expenses incurred by it in respect to the sale of the 243,713 additional shares. The balance of the total sales price, i.e., $1,462.278, was paid over to the petitioner and the receipt of this sum was recorded by the petitioner on its books. One dollar per share was credited to its capital stock account and the excess was credited to paid-in surplus. The commission of $304,641.25 was not entered by the petitioner on its books.
The following table summarizes the character and amount of the sales of the petitioner's additional stock made pursuant to the three agreements:
+-----------------------------------------------------------------------------+ ¦ ¦Number ¦Price ¦Total paid ¦Compensation ¦Net amount ¦ ¦ ¦of ¦paid per ¦for all ¦deducted by ¦received by ¦ ¦ ¦shares ¦share ¦shares ¦Hodson ¦petitioner ¦ +---------------+-------+---------+-------------+--------------+--------------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-------+---------+-------------+--------------+--------------¦ ¦First agreement¦180,000¦$6.25 ¦$1,125,000.00¦$225,000.00 ¦$900,000 ¦ ¦1/10/38-8/15/38¦ ¦ ¦ ¦ ¦ ¦ +---------------+-------+---------+-------------+--------------+--------------¦ ¦Second ¦ ¦ ¦ ¦ ¦ ¦ ¦agreement, 11/7¦480,000¦6.75 ¦3,240,000.00 ¦600,000.00 ¦2,640,000 ¦ ¦/38-12/13/39 ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-------+---------+-------------+--------------+--------------¦ ¦Third ¦ ¦ ¦ ¦ ¦ ¦ ¦agreement, 7/22¦243,713¦7.25 ¦1,766,919.25 ¦304,641.25 ¦1,462,278 ¦ ¦/40-4/19/41 ¦ ¦ ¦ ¦ ¦ ¦ +---------------+-------+---------+-------------+--------------+--------------¦ ¦Total ¦903,713¦ ¦6,131,919.25 ¦1,129,641.25 ¦5,002,278 ¦ +-----------------------------------------------------------------------------+
Hodson did not purchase any of the additional shares of stock not held by it and resold on its own account, but in each case found purchasers for the stock, and it caused the petitioner to issue shares of stock against payment of the purchase price therefor by the purchasers thereof, in pursuance of the three agreements. The petitioner has not deducted or attempted to deduct as an expense or otherwise, for the purposes of its Federal income or excess profits taxes, any of the compensation so paid to Hodson as heretofore set forth.
The petitioner's tax returns have at all times been made on the fiscal year basis for a fiscal year beginning July 1 and ending on the subsequent June 30. The petitioner has kept its book and reported its income on the accrual basis.
The following is a schedule for the petitioner's fiscal years ended June 30, 1938, to June 30, 1943, both inclusive, of its net income after taxes, dividends paid, and balance of undistributed net income (the deficiencies in issue in this proceeding have not been reflected in the following schedule, but all other taxes for the period covered have been deducted from income):
+-----------------------------------------------------------------------------+ ¦ ¦Undistributed ¦ ¦ ¦ ¦ +----------+------------------+------------+----------+-----------------------¦ ¦ ¦net income at ¦Net income ¦Dividends ¦Undistributed net ¦ ¦Period ¦beginning of ¦after taxes ¦paid ¦income at end of period¦ ¦ ¦period ¦ ¦ ¦ ¦ +----------+------------------+------------+----------+-----------------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +----------+------------------+------------+----------+-----------------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +----------+------------------+------------+----------+-----------------------¦ ¦9/2/37 to ¦None ¦$20,085.44 ¦$18,898.80¦$1,186.64 ¦ ¦6/30/38 ¦ ¦ ¦ ¦ ¦ +----------+------------------+------------+----------+-----------------------¦ ¦7/1/38 to ¦$1,186.64 ¦129,882.31 ¦119,707.26¦11,361.69 ¦ ¦6/30/39 ¦ ¦ ¦ ¦ ¦ +----------+------------------+------------+----------+-----------------------¦ ¦7/1/39 to ¦11,361.69 ¦300,648.20 ¦270,268.40¦41,741.49 ¦ ¦6/30/40 ¦ ¦ ¦ ¦ ¦ +----------+------------------+------------+----------+-----------------------¦ ¦7/1/40 to ¦41,741.49 ¦330,380.00 ¦342,067.24¦30,054.25 ¦ ¦6/30/41 ¦ ¦ ¦ ¦ ¦ +----------+------------------+------------+----------+-----------------------¦ ¦7/1/41 to ¦30,054.25 ¦667,622.53 ¦385,476.56¦312,200.22 ¦ ¦6/30/42 ¦ ¦ ¦ ¦ ¦ +----------+------------------+------------+----------+-----------------------¦ ¦7/1/42 to ¦312,200.22 ¦526,377.11 ¦361,382.27¦* 477,195.06 ¦ ¦6/30/43 ¦ ¦ ¦ ¦ ¦ +----------+------------------+------------+----------+-----------------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +----------+------------------+------------+----------+-----------------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
FN* $75,000 transferred from earned surplus to reserve for contingencies not reflected in this item.
On its corporation excess profits tax returns for its fiscal year ended June 30, 1941, 1942, and 1943, the petitioner included in that portion of its ‘equity invested capital at the beginning of the taxable year‘ represented by ‘money paid in for stock, or as paid-in surplus, or as a contribution to capital,‘ $6,131,919.25, the entire amount paid by the purchasers of the 903,713 shares of its common stock, class A, and also included $330,000, the net amount received by the petitioner from Hodson for the 60,000 shares sold to Hodson. Respondent determined no deficiency with respect to the 60,000 shares sold to Hodson and resold by it.
In his notices of deficiency, the Commissioner appended the following explanation of his adjustments, varying as to the taxable years only in amount:
It is held that commissions paid by you for the sale of your capital stock are not includible in equity invested capital under the applicable provisions of the Internal Revenue Code. Therefore, the amount of $1,129,641.25 has been excluded in determining your equity invested capital for the fiscal year ended June 30, 1942.
OPINION.
VAN FOSSAN, Judge:
The question at issue can be stated simply. For equity invested capital purposes and under section 718(a)(1) of the Internal Revenue Code,
is the amount paid in by stockholders for their stock the criterion, or is it the net amount of cash made available to the corporation after redeeming its commitment to pay its broker agent certain commissions for making the sale of such stock?
SEC. 718. Equity Invested Capital.(a) DEFINITION.— The equity invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following amounts reduced as provided in subsection (b)—(1) MONEY PAID IN.— Money previously paid in for stock, or as paid-in surplus, or as a contribution to capital;
We have examined the history of the origin and use of the term ‘invested capital‘ and find that throughout the consideration of invested capital as a measure of allowing credit against the proposed excess profits tax the question has been approached from the viewpoint of the stockholders' cash contribution for stock.
In one of the earlier cases, LaBelle Iron Works v. United States, 256 U.S. 377, the Supreme Court discussed the term at length and there said:
In order to adhere to its restricted meaning and avoid exaggerated valuations, the draftsman of the act resorted to the test of including nothing but money, or money's worth, actually contributed or converted in exchange for shares of the capital stock, or actually acquired through the business activities of the corporation or partnership (involving again a conversion) and coming in ab extra, by way of increase over the original capital stock. * * *
It is clear enough that Congress adopted the basis of ‘invested capital‘ measured according to actual contributions made for stock or shares and actual accessions in the way of surplus, valuing them according to actual and bona fide transactions and by valuations obtaining at the time of acquisition, not only in order to confine the capital, the income from which was to be in part exempted from the burden of this special tax, to something approximately representative of the risks accepted by the investors in embarking their means in the enterprise, but also in order to adopt tests that would enable returns to be more easily checked by examination of records, and make them less liable to inflation than if a more liberal meaning of ‘capital and surplus‘ had been adopted; thus avoiding the necessity of employing a special corps of valuation experts to grapple with the many difficult problems that would have ensued had general market values been adopted as the criteria.
The legislative history of the controlling section (718(a)) and of its predecessors shows clearly that the dominant factor in determining the amount of equity invested capital to be credited to the corporation in computing its excess profits taxes is the sum paid in, contributed or ‘risked‘ by the stockholders for their stock.
The phraseology employed in the several statutes is substantially the same. In the Revenue Act of March 3, and October 3, 1917 (section 202 and 209, respectively) the words used are ‘actual cash paid in‘; in the Revenue Act of 1918 and 1921 they are ‘actual cash bona fide paid in‘; while in the Internal Revenue Code (section 718(a)) they are ‘money previously paid in for stock.‘
In an early Bureau interpretation, in I.C.B. 281 (Apr.-Dec., 1919), the Advisory Tax Board, in T.B.R. 40, stated:
The opinion of the Advisory Tax Board has been asked as to whether commissions paid by a corporation for the sale of its capital stock are to be deducted in computing invested capital. Upon this question section 326(a) states that invested capital means (1) ‘Actual cash bona fide paid in for stock or shares. ‘ * * * These words signify the actual cash paid in to the corporation or to its duly authorized agents by the shareholders. * * *
and appended the following headnote:
Reasonable commissions or other forms of compensation lawfully paid by a corporation for the sale of its capital stock not to be deducted in computing invested capital.
In discussing the bill which was incorporated in the Revenue Act of 1940 and Internal Revenue Code, section 718(a), it was manifestly the understanding of Congress that one basis of equity invested capital is the price the stockholder pays for his stock (Hearings on H.R. 10,413, Senate Committee on Finance, 76th Cong., 3d sess., p. 198; Congressional Record, 76th Cong., 3d sess., p. 12,251; Joint Hearings on H.R. 10,413, 76th Cong., 3d sess., p. 149).
When the phrase ‘invested capital‘ is used, it is logical to impute an investment by someone who ‘previously paid in (money) for stock,‘ and that person can be only the stockholder. Such is the natural and normal interpretation of the phrase.
In the case at bar the stockholders acquiring the petitioner's stock paid the scheduled amounts for their stock to the petitioner through its agent, Hodson. The petitioner agreed to pay Hodson, as compensation for its services in selling the stock $1.25 per share, which Hodson should deduct from the amounts paid for stock by the stockholders. This is a common procedure, as the Supreme Court recognized in Helvering v. Union Pacific Railroad Co., 293 U.S. 282, when it stated:
But even if the commissions, unlike discount, may, as the Government insists, be regarded as a contemporary expense of procuring capital, it is one properly chargeable to capital account. In practice it is taken out of the proceeds of the bonds by the banker.
The delivery of the stock to the new stockholders was to be made by the petitioner through its agent on the fourth business day following the receipt of the order therefor by the petitioner. Hodson thus acted as a distributing agent for the petitioner, as well as its selling agent, and deducted its commission when the stock was paid for by the purchaser.
The stockholder purchasing the shares of petitioner's stock sold under the three agreements paid the scheduled price for his stock when he then received in exchange therefor. Although the payment of such commissions is an established custom in effecting stock sales, the shareholder knew only what amount of money he had invested in the enterprise. He had no means of knowing the terms of the sale or brokerage contract.
We think it clear that the question before us is to be approached and answered from the viewpoint of the stockholder, i.e., ‘money previously paid in for stock.‘ So approached, the conclusion is obvious that the full amount which the stockholder paid for his stock is to be included in equity invested capital, as contemplated by the statute. The stockholder paid one sum, viz., the purchase price of the stock.
The respondent's principal argument is that the petitioner has attempted to increase its equity invested capital by the amount of the commissions. He expresses his position as follows:
* * * Respondent is not attempting to reduce the equity invested capital by excluding commissions which are already part of such capital, but is denying that the commissions contested could have been included in equity invested capital in the first instance. Respondent also urges that the effect of petitioner's position is to increase equity invested capital by including commissions which under the decisions may not be done.
Respondent concludes that commissions are not within the express terms of Section 718(a), nor are they ‘money paid in for stock‘ or its equivalent. Commissions cannot add to the available capital of a corporation as they belong to the agent and not to the corporation. Therefore, commissions cannot be included in equity invested capital. If they are included they would increase invested capital in violation of the statute and the decisions.
The respondent thus contends that the net amount of capital derived from the sale of stock and made ‘available‘ to it is the proper sum to be included in equity invested capital. He views the commission as a distinct and separate sum of money paid by the stockholder to Hodson as compensation for the procurement of the stock for the stockholder. We find nothing to support this theory. The transaction with the purchasing stockholder was very simple. He paid his money to the petitioner's broker agent for the stock and in due time received it. He was not a party to the arrangement between the petitioner and Hodson for the use and disposition of the amount so paid by him.
In his brief, the respondent himself says:
* * * While it might be true that the buyers of stock did not know they were paying for an agent's commission when they made their purchases from the agent, it is, nevertheless, true that only the net amount of the sale price was ever received by petitioner; only this amount was available as capital and actually only this amount was ever ‘embarked‘ in the venture. * * *
We can not follow the reasoning by which the respondent seeks to sustain his action. He cites and relies largely on Simmons Co. v. Commissioner, 33 Fed.(2d) 75, affirming 8 B.T.A. 631; certiorari denied, 280 U.S. 588. Singularly enough, petitioner also relies on the Simmons case. As we read that case, it is in accord with our conclusion above expressed.
In Magee Furnace Co., 11 B.T.A. 1216, we said:
The only issue remaining to be considered is whether or not the respondent erred in excluding from invested capital an item of $42,000, which the petitioner alleges represented commissions paid to the bankers upon the sale of its first preferred stock. Substantially the same question was before the Board in Simmons Co., 8 B.T.A. 631, and we there discussed fully the underlying principles. Following the reasoning of the Simmons case, we hold that respondent was in error in reducing invested capital by the amount paid out in commissions. The entire amount received in payment for stock properly went into invested capital. The fact that the commissions were immediately paid out would not, of itself, reduce invested capital.
The Commissioner acquiesced in the above decision VIII-1 C.B. 28. See also Finance Corporation of New England, 16 B.T.A. 763.
Our conclusion is entirely consistent with the holding of this Court in the recent case of Palomar Laundry, 7 T.C. 1300. In that case the broker sold 1,600 shares of preferred stock at $100 per share. Subsequently 5 shares were canceled, leaving 1,595 shares sold to the public. For these shares the corporation received $159,500 in cash. We observe as to this sum, ‘that, of course, goes into petitioner's invested capital, and as to this amount there is no dispute.‘ The dispute arose over 400 shares subsequently issued to the broker for its services in marketing the 1,595 shares. It was agreed the 400 shares had a fair market value of $40,000. This amount the corporation contended should also be added to its equity invested capital, arguing that the services rendered constituted ‘property paid in‘ for stock within the meaning of this statute. Respondent argued that the 400 shares of preferred stock were not issued to the broker ‘for money paid in‘ or ‘property paid in,‘ as required by the governing statute. Relying chiefly on the Simmons case, we held that the corporation's equity invested capital would not include the value of the 400 shares issued to the broker. The above statement of the facts and the contentions in the Palomar case are sufficient to point the distinction between it and the case at bar. Obviously, the 400 shares of stock constituted neither money nor property paid in to the corporation and, therefore, such stock did not come within the intendment of the statute.
No question was raised by the parties or argued by counsel as to the relationship of such commissions to accumulated earnings and profits as of the beginning of the taxable year, and we therefore omit any discussion of that phase of the question.
We hold that, under 718(a)(1), the petitioner's equity invested capital in the taxable years resulting from money previously paid in for stock should not be reduced by the amount of commissions paid for the sale of such stock.
Reviewed by the Court.
Decision will be entered under Rule 50.