Opinion
Docket No. 105108.
1944-11-17
DON A. DAVIS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Richard P. Jackson, Esq., Raymond C. Howe, Esq., and Henry J. Plagens, Esq., for the petitioner. Clay C. Holmes, Esq., for the respondent.
Selling commissions paid in connection with the disposition of securities by one not engaged in carrying on a trade or business, are not ordinary and necessary expenses within the meaning of section 23(a)(2) of the Internal Revenue Code. They are selling costs treated as an offset against the selling price in determining gain or loss incident to the transaction. Richard P. Jackson, Esq., Raymond C. Howe, Esq., and Henry J. Plagens, Esq., for the petitioner. Clay C. Holmes, Esq., for the respondent.
This proceeding involves a deficiency in income tax for the year 1937, determined by respondent in the amount of $86,489.24. The question presented is whether the sum of $155,000 expended by petitioner in connection with the registration and sale of certain stock owned by him, and the sum of $1,275 paid by petitioner to an attorney, are deductible as ordinary and necessary nontrade or nonbusiness expenses. Most of the facts were stipulated by the parties and are found accordingly. Other necessary facts are found from the evidence.
FINDINGS OF FACT.
Petitioner, Don A. Davis, an individual, is a resident of Mission Hills, Kansas, with business address at 2107 Grand Avenue, Kansas City, Missouri. For the taxable year 1937 he filed his Federal income tax return with the collector of internal revenue for the sixth district of Missouri at Kansas City, Missouri.
On January 1, 1916, petitioner purchased the controlling interest in the Western Auto Supply Co., a corporation organized in 1914 under the laws of the State of Missouri. Since 1916 he has been its principal stockholder and also its chief officer.
On January 6, 1937, and all times thereafter prior to its recapitalization, there were two classes of capital stock of Western Auto outstanding, 130,456 shares of no par, nonvoting class B common stock. The rights and participations of the class A and class B stocks with respect to earnings, dividends, and liquidation were identical; the only difference between the two classes being in regard to voting power, which was vested solely in the class B stock.
The class B voting common stock of Western Auto was never listed or admitted to trading on any stock exchange. In March 1928 the class A common stock was admitted to unlisted trading privileges and was bought and sold on the New York Curb Exchange up to and including the month of April 1937.
On April 5, 1937, petitioner owned of record 14,845 shares of the class A common stock and 41,467 shares of the class B common stock.
Petitioner could not sell his shares of Western Auto stock to the general public through an underwriter or distributor of securities unless a registration statement were in effect with respect to such shares, since under the Securities Act of 1933 no underwriter would purchase such shares for resale in view of petitioner's voting power (right to vote for election of directors of Western Auto).
On or about April 5, 1937, Western Auto was recapitalized under a plan whereby each share of its outstanding stock, consisting of class A and class B common stock, was converted into three shares of new common stock having a par value of $10.
On or about March 4, 1937, there was filed with the Securities and Exchange Commission, Washington, D.C., a registration statement covering 126,000 shares of the above mentioned new $10 par common stock of Western Auto, and pursuant to subsequent amendments to this statement the registration of the 126,000 shares was effected. These 126,000 shares were made up of the following:
+-------------------------------------------+ ¦Shares owned by petitioner ¦60,000 ¦ +-----------------------------------+-------¦ ¦Shares to be issued by Western Auto¦60,000 ¦ +-----------------------------------+-------¦ ¦Shares owned by George Pepperdine ¦6,000 ¦ +-----------------------------------+-------¦ ¦Total ¦126,000¦ +-------------------------------------------+
During the taxable year 1937 petitioner paid to Western Auto $5,000 representing his portion of the following expenses incurred in connection with the registration of said shares:
+------------------------------------------------------------------------+ ¦Counsel fees ¦$10,000.00¦ +-------------------------------------------------------------+----------¦ ¦Fee of auditors ¦2,000.00 ¦ +-------------------------------------------------------------+----------¦ ¦S. E. C. registration fee ¦367.50 ¦ +-------------------------------------------------------------+----------¦ ¦Registration or qualification under State Blue Sky laws ¦3,000.00 ¦ +-------------------------------------------------------------+----------¦ ¦Printing ¦6,000.00 ¦ +-------------------------------------------------------------+----------¦ ¦Miscellaneous expenses, including postage, telephone, and ¦ ¦ +-------------------------------------------------------------+----------¦ ¦telegraph charges, traveling expenses and other out-of-pocket¦ ¦ +-------------------------------------------------------------+----------¦ ¦expenses ¦6,000.00 ¦ +------------------------------------------------------------------------+
Pursuant to contract dated March 31, 1937, petitioner engaged the services of a group of underwriters, Cassatt & Co., A. G. Becker & Co., Lawrence Stern & Co., and Stern Brothers & Co., to offer to the public at $28.75 per share, the 60,000 shares of his new $10 par, common stock of Western Auto which had been registered with the Securities and Exchange Commission as hereinabove set forth. Cassatt & Co. contracted to offer to the public 24,000 shares of such stock; A. G. Becker & Co., 15,000 shares thereof; Lawrence Stern & Co., 12,000 shares thereof; and Stern Brothers & Co., 9,000 shares thereof.
On or about April 6, 1937, an offering of the 60,000 shares was duly made to the public at $28.75 per share, which offering was subscribed in full.
On or about April 13, 1937, Cassatt & Co., as representative of the several underwriters, including itself, delivered to the Bankers Trust Co. (the stock transfer agent) on behalf of petitioner the following checks drawn to petitioner's order in the aggregate amount of $1,725,000: Certified check of Cassatt & Co. for $690,000, in payment for 24,000 shares of said stock; certified check of A. G. Becker & Co. for $431,250 in payment for 15,000 shares of said stock; certified check of Lawrence Stern & Co. for $345,000 in payment for 12,000 shares of said stock; cashier's check on National City Bank, New York City, on behalf of Stern Brothers & Co. for $258,750 in payment for 9,000 shares of said stock. Simultaneously therewith and acting in the representative capacities above described, the Bankers Trust Co. delivered to Cassatt & Co. check for $150,000 for services rendered by the underwriters in connection with said offering to the public, as per petitioner's agreement with Cassatt & Co.
Immediately after the sale of said stock, as above set forth, petitioner's remaining holdings of Western Auto's common stock amounted to 108,936 shares, which he held for investment with a view to collecting dividends therefrom and, if subsequently sold, the realization of gain upon such sale.
Petitioner sold his shares of Western Auto stock and paid the commissions to the underwriters for their services in respect of such sales in order to obtain the best possible price for such shares. Petitioner in computing his capital gain in his income tax return for the year 1937, did not reduce the sale price or increase his cost basis of the Western Auto stock sold by the $150,000 paid to the underwriters as commissions and the $5,000 paid as his allocated part of the cost of the registration, as set forth herein, but claimed both amounts as a deduction in computing ordinary net income. It is agreed that peitioner's cost basis of his Western Auto stock sold as aforesaid is $368,770 and it is further agreed that if the $155,000 is held to be deductible in computing ordinary income as an ordinary and necessary nonbusiness expense incurred in the production of income or in the management of property held for the production of income, as petitioner contends, the amount of the capital gain resulting from the sale of said Western Auto stock is $1,356,230. If the $155,000 is held to be either a part of petitioner's cost or an offset against the sale price in computing petitioner's capital gain, as respondent contends, it is agreed the amount of capital gain resulting from the sale of the Western Auto stock amounts to $1,201,230.
The foregoing amount of $150,000 paid to the underwriters by petitioner during the taxable year 1937 was reasonable in amount and represented the fees customarily charged by underwriters for their services during the year 1937 in comparable underwritings.
The above mentioned amount of $5,000 paid by petitioner as his share of the expenses of the registration hereinabove referred to was reasonable and in no event more than the usual and customary amount necessary to effect such a registration during the year 1937.
In order to effect the widespread distribution of the Western Auto stock among the general public and to obtain its listing on the New York Stock Exchange, and in order to realize the gain on the sale of said stock, petitioner deemed it expedient to enter into the agreement with the the underwriters as aforesaid.
On June 3, 1937, by reason of the consummation of the sale of stock by the underwriters to the general public, the stock of Western Auto was admitted to listing on the New York Stock Exchange. Such listing increased the marketability thereof.
As of January 6, 1937, there were 766 holders of the class A common stock of Western Auto and 14 holders of its class B common stock. As of the close of business on January 29, 1938, there were 2,174 holders of the new $10 par common stock.
During 1937 petitioner paid his attorney the sum of $1,275 for services rendered during that year. The services comprising the preparation of tax returns and legal and auditing services. Some part of the above amount was paid to reimburse the attorney for expenses connected with travel and long distance telephone calls made by him on behalf of the petitioner.
OPINION.
ARUNDELL, Judge:
It has now been definitely established by the Supreme Court in Spreckles v. Helvering, 315 U.S. 626, that selling commissions paid in connection with the disposition of securities may not be deducted as ordinary and necessary expenses by one not a dealer in securities, and there commissions are to be treated as offsets against the sale price in determining the gain or loss incident to the disposition of the property. As petitioner was not a dealer in securities, it is evident that the commissions he here seeks to deduct would not be allowable for tax purposes under section 23(a)(1) of the Internal Revenue Code,
even if they had been in connection with the carrying on of a trade or business.
SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(a) EXPENSES.—
(1) TRADE OR BUSINESS EXPENSES.—
(2) NON-TRADE OR NON-BUSINESS EXPENSES.— In case of an individual, all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income.
Petitioner does not make claim under section 23(a)(1) of the code, but under section23(a)(2),1 which was added to the law by section 121 of the Revenue Act of 1942. This provision is retroactively applicable to our taxable year. Section 23(a)(2) permits the deduction of ordinary and necessary expenses paid or incurred for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income. Profit was realized from the sale of the securities here in question, and petitioner argues that the selling commissions paid to the brokers were an expense incurred for the production of this income.
Petitioner's argument is plausible, but we are not persuaded. The purpose of section 23(a)(2), supra, was to relieve from the harshness of the rule announced in Higgins v. Commissioner, 312 U.S. 212, and other cases of like import. It was intended to give a deduction for ordinary and necessary expenses to one not engaged in carrying on a business, limited, however, to the extent set forth in this subsection and under circumstances where such expenditures would be allowable to one engaged in carrying on a trade or business. It was not intended, however, to go any further, as the following quotation from the congressional reports states.
Senate Finance Committee Report 1631, 77th Cong., 2d sess., 1942-2 C.B., pp. 504, 571, and Ways and Means Committee Report 2333, 77th Cong., 1st sess., 1942-2 C.B. pp. 372, 430.
A deduction under this section is subject, except for the requirement of being incurred in connection with a trade or business, to all the restrictions and limitations that apply in the case of the deduction under section 23(a)(1)(A) of an expense paid or incurred in carrying on any trade or business. * * *
We think it clear that Congress had no intention of changing the language of this section as construed by the Treasury regulations, which construction before 1942 had received the approval of the Supreme Court. In other words, the treatment of the selling commissions as an offset against the sale price and not deductible as an ordinary and necessary expense, except to dealers, was not to be disturbed.
It has already been decided that section 23(a)(2) did not change the the rule that expenses incident to the protection of title to property are not deductible, but are to be treated as capital expenditures, thus recognizing that expenditures under this new subsection are not to be given a broader interpretation than under section 23(a)(1). We think that such items as are not deductible as ordinary and necessary expenses under section 23(a)(1) may not be deducted as ordinary and necessary expenses under section 23(a)(2). Bowers v. Lumpkin, 140 Fed.(2d) 927.
The expenditure of $5,000 for registration of the securities with the Securities and Exchange Commission, under the circumstances here present, is in the nature of a selling cost and requires the same treatment as has been accorded the commissions. Motion Picture Capital Corporation v. Commissioner, 80 Fed.(2d) 872.
The remaining issue concerns the deductibility of the $1,275 paid by petitioner to an attorney for legal services and claimed by petitioner to be an ordinary and necessary nontrade or nonbusiness expense. The respondent disallowed the deduction on the ground that it represented personal expenses. At least $150 of the above amount was paid by petitioner for services connected with the preparation of his income tax returns. The remainder of the amount represents fees for legal and auditing services and payment to the attorney for traveling expenses and long distance telephone calls in behalf of petitioner. We have held that the cost of tax advice and of the preparation of income tax returns may not be deducted as a nontrade or nonbusiness expense under section 23(a)(2) of the Internal Revenue Code, in the absence of a showing that such cost is proximately related to the production or collection of income, or the management, conservation, or maintenance of property held for the production of income. Higgins v. Commissioner, 2 T.C. 948; affd., 143 Fed.(2d) 654. Under the circumstances here present, the expenditures must be held to be personal and, therefore, not deductible. As to the remainder of the claimed deduction, the petitioner has furnished no definite evidence upon which a division between personal expenses and deductible nonbusiness expenses, if such there were, could be made. The burden is upon the taxpayer to show that his claimed deductions fall clearly within the deductions provided for by statute. New Colonial Ice Co. v. Helvering, 292 U.S. 435. Upon the failure of proof by petitioner, we sustain the determination of the respondent that the total sum of $1,275 is not deductible.
Decision will be entered for the respondent.