Opinion
Docket No. 36220.
1952-12-30
GENERAL AMERICAN INVESTORS COMPANY, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Robert A. McDowell, Esq., for the petitioner. Arthur L. Nims, Esq., for the respondent.
Robert A. McDowell, Esq., for the petitioner. Arthur L. Nims, Esq., for the respondent.
Held, that payments received by a corporation because of ‘insiders'‘ profits pursuant to section 16 (b) of the Securities Exchange Act of 1934 and section 30 (f) of the Investment Company Act of 1940 constituted ordinary income to the corporation under section 22 (a), I.R.C. Park & Tilford Distillers Corporation v. United States (Ct. Cl.), 107 F.Supp. 941.
Respondent determined a deficiency of $57,922.55 for the calendar year 1948. By appropriate assignment of error petitioner contests the entire deficiency and alleges the following error:
The Commissioner erroneously determined that the petitioner realized taxable income of $157,038.04 by its receipt in 1948 of $170,038.04 (in connection with the receipt of which it was entitled to an allowance of legal expenses of at least $13,000 which it did not deduct on its return) pursuant to Section 30 (f) of the Investment Company Act of 1940 and Section 16 (b) of the Securities Exchange Act of 1934.
FINDINGS OF FACT.
All the facts have been stipulated and are found accordingly.
Petitioner is a corporation organized under the laws of the State of Delaware, with its principal office in New York, New York. Petitioner is a registered closed-end investment company as defined in the Investment Company Act of 1940.
A Federal income tax return for the calendar year 1948, prepared on an accrual basis, was filed by petitioner with the collector of internal revenue for the second district of New York.
On or about April 1, 1944, an individual who was one of petitioner's directors, hereinafter referred to as ‘Director,‘ acquired warrants to purchase shares of the common stock of petitioner at five different prices ranging from $10 to $20 per share, the warrants covering an equal number of shares at each price. On the basis of his average cost of all the warrants then so acquired, the warrants to purchase 12,228 shares of petitioner's common stock which he exercised as stated hereafter had a cost basis to the Director of $4,800.
On or about April 1, 1944, a second individual, hereinafter referred to as ‘Stockholder‘ also acquired warrants of the type referred to above. On the basis of his average costs of all the warrants then so acquired, the warrants to purchase 27,027 of the 28,532 shares of petitioner's common stock which he exercised as stated hereafter had a cost basis to the Stockholder of $10,609.22. The Stockholder owned more than 10 per cent of the then outstanding warrants at all times between June 5, 1945, and June 17, 1946.
Between June 5, 1945, and June 17, 1946, the Director, individually and through a partnership of which he was a member, sold on the New York Stock Exchange an aggregate of more than 12,228 shares of petitioner's common stock in blocks of various sizes and for various amounts. Between June 5, 1945, and June 17, 1946, the Stockholder, individually, and through a partnership of which he was a member, sold on the New York Stock Exchange 27,027 shares of petitioner's common stock in blocks of various sizes and for various amounts.
On December 4 and 18, 1945, the Director exercised warrants to purchase an aggregate of 12,228 shares of petitioner's common stock at an average purchase price of $13.75 per share. On December 4 and 18, 1945, the Stockholder exercised warrants to purchase 28,532 shares of petitioner's common stock at an average purchase price of $13.75 per share. Of the proceeds received by the petitioner at the time of the exercise of the warrants by the said persons, $1 per share was credited to the petitioner's capital account and the balance thereof was credited to the petitioner's capital surplus account.
Pursuant to the provisions of section 30 (f) of the Investment Company Act of 1940 and section 16 (b) of the Securities Exchange Act of 1934, the above-described persons were required to pay in to the petitioner certain ‘profits‘ (as that term is used in the Securities Exchange Act of 1934) which they had realized upon the sale and purchase, or purchase and sale, of petitioner's common stock during the period June 5, 1945, to June 17, 1946, inclusive. The only purchases of petitioner's common stock by the above-described persons during said period were the purchases upon the exercise of the warrants described above. The determination of the ‘profits‘ so realized is tabulated as follows:
+-----------------------------------------------------------------------------+ ¦ ¦Stockholder ¦Director ¦ +---------------------------------------+------------------+------------------¦ ¦ ¦Shares¦Amount ¦Shares¦Amount ¦ +---------------------------------------+------+-----------+------+-----------¦ ¦a. Proceeds of sales ¦27.027¦$511,593.42¦12,228¦$254,027.33¦ +---------------------------------------+------+-----------+------+-----------¦ ¦b. Subscription to common stock ¦27,027¦371,621.25 ¦12,228¦168,135.00 ¦ +---------------------------------------+------+-----------+------+-----------¦ ¦c. Cost of warrants ¦ ¦10,609.22 ¦ ¦4,800.00 ¦ +---------------------------------------+------+-----------+------+-----------¦ ¦d. Calculated “profit” on sales ¦ ¦ ¦ ¦ ¦ ¦required to be paid in to petitioner ¦ ¦$129,362.95¦ ¦$81,092.33 ¦ ¦(line a minus the sum of lines b and c)¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
Of the above set forth amount of $81,092.33 required to be paid by the Director, $40,417.24 was paid by him to the petitioner on March 9, 1946, and the remainder thereof, together with the entire amount required to be paid by the Stockholder, was paid to petitioner on January 26, 1948. These amounts received by petitioner were received without litigation and were paid by the said persons upon the advice of their counsel that they were liable to petitioner therefor.
The $40,417.24 received in 1946 from the Director was in that year credited to petitioner's capital surplus account. The amounts received from the said persons in 1948 as aforesaid were recorded by petitioner in its cash book as ‘Capital Surplus— add'l amt recd in connection with common stock issued in 1945,‘ and the aggregate amount so received in 1948 was credited to petitioner's capital surplus account. Thereafter, on March 31, 1948 (after receiving a letter-ruling from the Bureau of Internal Revenue dated February 26, 1948, to the general effect that the said amount received in 1948 should be returned as income), petitioner debited its capital surplus account for the said amount and credited a receipts-in-suspense account with an equal amount. At the close of the year 1948, the receipts-in-in suspense account was debited with the amount of a reserve for taxes in respect of the amounts received in 1946 and 1948, and with the amount of legal expenses incurred up to December 31, 1948, in respect of the amounts recovered in that year, and the balance of $92,038.04 in said receipts-in-suspense account was simultaneously transferred to capital surplus.
Petitioner expended the sum of $13,000 as legal fees in connection with the recovery of the amounts due from the Director and the Stockholder, which fees respondent allowed as a credit against the gross amount received.
From the foregoing facts we find the following ultimate facts: The amounts which were paid to the petitioner by the Director and by the Stockholder under compulsion of section 16 (b) of the Securities Exchange Act of 1934 and section 30 (f) of the Investment Company Act of 1940 constituted gross income to the petitioner for the year 1948.
OPINION.
BLACK, Judge:
The applicable statutes in this proceeding are section 22 (a) of the Internal Revenue Code, section 30 (f) of the Investment Company Act of 1940, 54 Stat. 837, 15 U.S.C. section 80a-29 (f) and section 16 (b) of the Securities Exchange Act of 1934, 48 Stat. 896, 15 U.S.C. section 78p (b). Section 22 (a) of the Code is so familiar that it is unnecessary to incorporate it herein. The other two applicable statutory provisions are printed in the margin.
Section 30 (f) of the Investment Company Act of 1940, 54 Stat. 837, 15 U.S.C. section 80a-29 (f):(f) Every person who is directly or indirectly the beneficial owner of more than 10 per centum of any class of outstanding securities (other than short-term paper) of which a registered closed-end company is the issuer or who is an officer, director, member of an advisory board, investment adviser, or affiliated person of an investment adviser of such a company shall in respect of his transactions in any securities of such company (other than short-term paper) be subject to the same duties and liabilities as those imposed by section 16 of the Securities Exchange Act of 1934 upon certain beneficial owners, directors, and officers in respect of their transactions in certain equity securities.Section 16 (b) of the Securities Exchange Act of 1934, 48 Stat. 896, 15 U.S.C. section 78p (b):(b) For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner, director, or officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale, or any sale and purchase of any equity security of such issuer (other than an exempted security) within any period of less than six months, unless such security was acquired in good faith in connection with a debt previously contracted, shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner, director, or officer in entering into such transaction of holding the security purchased or of not repurchasing the security sold for a period exceeding six months. Suit to recover such profit may be instituted at law or in equity in any court of competent jurisdiction by the issuer, or by the owner of any security of the issuer in the name and in behalf of the issuer if the issuer shall fail or refuse to bring suit within sixty days after request or shall fail diligently to prosecute the same thereafter; but no such suit shall be brought more than two years after the date such profit was realized. This subsection shall not be construed to cover any transaction where such beneficial owner was not such both at the time of the purchase and sale, or the sale and purchase, of the security involved, or any transaction or transactions which the Commission by rules and regulations may exempt as not comprehended within the purposes of this subsection.
The only question presented is whether amounts which were paid to the petitioner in 1948 by certain persons under compulsion of section 16 (b) of the Securities Exchange Act of 1934 and section 30 (f) of the Investment Company Act of 1940, both printed in the margin, constitute income to the petitioner. The statutes in question were designed to curb the abuses of short term speculations in securities based on inside information or power to manipulate corporate policy. See S. Rept. No. 792, 73d Cong., 2d Sess. (1934), at pp. 7-9. William F. Davis, Jr., 17 T.C. 549. Section 16 (b), supra, provides that any profits realized by corporate insiders from ‘any purchase and sale, or any sale and purchase, of any equity security * * * (of their own corporation) within any period of less than six months, * * * shall inure to and be recoverable by‘ the corporation.
The instant case presents the same issue as was involved in Park & Tilford Distillers Corporation v. United States (Ct. Cl.), 107 F.Supp. 941. The Court of Claims held that the ‘insider profits‘ were taxable income to the recipient corporation under the broad provisions of section 22 (a), I.R.C., as ‘gains or profits and income derived from any source whatever.‘ The fact that the income represented nondeductible penalty payments to the payors was not deemed to militate against their taxability.
Petitioner in its brief argues that:
* * * the relevant fact is that a section 16 (b) recovery does not compensate the issuer for any impairment of capital or loss of profits; it does not result from any activity on the part of the issuer, but if not received by it as part of the subscription price for its stock, is a pure windfall, gratuitously received.
Petitioner argues further in its brief, as follows:
* * * In the present instance, however, as the respondent concedes, the Section 16 (b) recovery was not a restitution to make the issuer whole for a loss of corporate profits, or even of corporate capital; it was a pure windfall, measured by an objective measure of proof having no relationship to the actual profit of the fiduciary or to any loss by the corporation. It did not result from any action on the part of the corporation nor was it derived from corporate capital or the labor of corporate employees. If it were true that a Section 16 (b) recovery amounts in effect to a payment ‘into the corporate treasury of profits which may * * * have been realized at the expense of the outside stockholders,‘ it would nevertheless be a windfall or gratuitous contribution from the standpoint of the corporation.
It seems to us that the Court of Claims in the Park & Tilford case, supra, took into consideration much the same arguments as petitioner here uses and rejected them and held against the taxpayer there involved. We agree with the conclusion reached by the Court of Claims that the payments thus received were taxable income and decide the issue here involved against petitioner. The Court of Claims discussed the issue involved in a comprehensive manner and we feel it unnecessary to here repeat at any great length what the court there said.
We think it is appropriate, however, that we should say that our decisions in Edward H. Clark, 40 B.T.A. 333, and Highland Farms Corporation, 42 B.T.A. 1314, to which the Court of Claims referred in the concluding paragraph of its opinion are clearly distinguishable on their facts from the instant case. The Clark case was a case where in the taxable year the petitioner received a sum of money from his tax counsel as recompense for an error made by the latter in preparing and filing petitioner's 1932 return, the error having caused petitioner to pay more tax than he would have owed had the correct method been employed. Under such circumstances, we held that the compensatory payment was not includible in the taxpayer's gross income. In the Highland Farms Corporation case we held that damages against a bank mortgage awarded to a corporation for injuries resulting from a course of conduct pursued by the bank's president against the corporation was a restoration of lost capital and not taxable income. We also held in that case that punitive damages recovered by the taxpayer were not taxable income to it. We do not think that either of these cases is in conflict with our decision here.
Petitioner urges in its brief that our recent decision in Glenshaw Glass Co., 18 T.C. 860, is apposite here. In that case we said:
The first issue is whether the sums received in settlement of the punitive damages claims constitute taxable income. It has long been established that punitive damages do not meet the test of taxable income set forth in Eisner v. Macomber, 252 U.S. 189, 193, as ‘’* * * the gain derived from capital, from labor, or from both combined', provided it be understood to include profit gained through a sale or conversion of capital assets * * * .‘ Central R. Co. v. Commissioner, 79 F. 2d 697; Highland Farms Corporation, 42 B.T.A. 1314. This basic definition has been recently cited with complete approval in Commissioner v. Culbertson, 337 U.S. 733, 740, and has been adhered to by the respondent in his Regulations 111, section 29.22 (a)-1. Therefore, on the authority of those cases, we follow this rule of long standing that has never been questioned in any court and hold that the sums received in settlement of the punitive damages claims do not constitute taxable income. The $170,038.04 here involved was not received by petitioner in payment of punitive damages. We do not think Glenshaw Glass Co., supra, which dealt with punitive damages paid to the taxpayer corporation is controlling here.
Petitioner here raises to alternative arguments that were not discussed in the Park & Tilford case, supra. Petitioner characterizes the amounts in question as a capital contribution, citing Edwards v. Cuba R.R. Co., 268 U.S. 628, and Brown Shoe Co. v. Commissioner, 339 U.S. 583. However, since the corporation had unrestricted discretion to use the funds for any purpose whatsoever, Texas & Pacific Railway Co. v. United States, 286 U.S. 285, and received a windfall benefit by operation of a Federal statute, there is no capital contribution.
Petitioner also contends that the amounts paid in constituted additional payments on the original issuance price of the stock, citing no authority. We do not think that the facts which have been stipulated sustain petitioner in that contention.
It seems to us under the facts which have been stipulated, we must hold that the amounts here involved were not payments of part of the purchase price of petitioner's stock acquired by its Director and its Stockholder and cannot be so treated. We hold, therefore, that the sums in question are income to petitioner under section 22 (a), I.R.C.
Reviewed by the Court.
Decision will be entered for the respondent.
TIETJENS, J., concurs in the result.
ARUNDELL, J., dissents.
MURDOCK, J., concurring:
Section 16 (b) of the Securities Exchange Act of 1934 provided that ‘any profit realized‘ under circumstances like those here present ‘shall inure to and be recoverable by the issuer,‘ that is, the corporation. Thus the profits here in question were income of the petitioner within the words and intention of section 22 (a) since they were ‘profits‘ either from ‘sales or dealings in property * * * growing out of the ownership of * * * or interest in such property‘ or ‘from any source whatsoever.‘