Opinion
Docket No. 61542.
Filed October 15, 1958.
Petitioner's personal activities, held, on the facts, not such as to constitute a trade or business in the course of which indebtedness was incurred, so as to be deductible as a business bad debt.
Louis Reiss, Esq., for the petitioners.
Clarence P. Brazill, Jr., Esq., for the respondent.
Respondent determined a deficiency in petitioners' income tax for 1950 of $5,787.28. The two issues are: (1) Whether petitioners' bad debt resulting from the unpaid loans and claims against a corporation liquidated in 1950 was a business or nonbusiness bad debt loss; (2) whether petitioners' additional loss from the purchase of debtor's stock in 1950 was a capital loss or a business bad debt.
FINDINGS OF FACT.
Certain facts have been stipulated and are hereby found.
Thomas Reed Vreeland and Diana D. Vreeland are husband and wife, residing in New York, New York, and filed their joint Federal income tax return for the calendar year 1950 with the collector of internal revenue for the then third district of New York.
Diana D. Vreeland is a petitioner herein because of having joined with her husband in filing a joint return, and Thomas Reed Vreeland will hereafter be referred to as petitioner.
Petitioner upon graduation from college entered into the banking business from 1921-1938 as an employee of various institutions both here and abroad. In 1939, he was persuaded by one D'Erlanger to become a director and president, at a $15,000 salary, of a privately owned Canadian investment bank, Moorgate Agency, Ltd., hereafter referred to as Moorgate, which was, prior to that time and up to its 1948 liquidation, engaged in promoting, organizing, managing, and financing businesses. Petitioner was to perform duties as a financial manager and officer-director in Moorgate's promotions. Although petitioner was never a stockholder, D'Erlanger gave him an option to buy Moorgate stock and the freedom to engage personally in any of the Moorgate ventures undertaken in his representative capacity, as well as ventures outside of Moorgate's. It was also understood that his position with Moorgate in Montreal was on a Tuesday-Friday basis, petitioner having his principal domicile in New York City.
In 1942, on behalf of Moorgate, petitioner formed around a scientist named Adler a corporation known as Anachemia, Ltd. The business of Anachemia, Ltd., hereafter referred to as Anachemia, was the manufacture and sale of chemicals. Its stock structure was: Moorgate — 50 per cent; Adler — 25 per cent; and Stern — 25 per cent. Prior to March 1, 1948, petitioner was not an Anachemia stockholder.
Because the wartime imposition of foreign exchange restrictions placed Moorgate in financial difficulties, petitioner not only voluntarily abandoned his salary from 1945-1950, but beginning in 1944, made a series of loans to Anachemia and also to Moorgate, which to a large extent were used by Moorgate to support Anachemia and other Moorgate affiliates. This was effected for the protection of Moorgate's investments and of petitioner's own indirect interest therein. On March 1, 1948, Anachemia owed petitioner and Moorgate the sums of $56,318.03 ($61,887.95 in Canadian dollars) and $177,102.16 Canadian, respectively; Moorgate owed petitioner $106,835.36 ($117,401.49 Canadian).
In satisfaction of this indebtedness from Moorgate to petitioner, the latter received both Moorgate's stockholdings, valued at zero, and creditor's claim, valued at $45,039.38, in Anachemia, and stock interests valued at $13,246.87 in Trans-American Mining Corp., Ltd., Andreef Sporting Goods, Ltd., and Propeller Woodworking Company of Canada, Ltd., hereafter referred to as Trans-American, Andreef I, and Propeller Wood, respectively. This resulted in petitioner's sustaining a 1948 bad debt loss in the sum of $48,549.11 upon Moorgate's liquidation.
This transaction, plus a minor loan to Anachemia after March 1, 1948, increased the amounts owed to petitioner by Anachemia to $104,087.41.
A 5-year search for a purchaser of Anachemia's assets culminated with Robert Loane on November 30, 1950. Anachemia was liquidated with petitioner receiving all assets in satisfaction of the indebtedness. Petitioner then transferred these assets to Loane for the total consideration of $37,213.95 and realized a $66,873.46 bad debt loss. Prior thereto, on November 17, 1950, petitioner had purchased Adler's 25 per cent holdings in Anachemia for $11,445.50. Respondent determined that petitioner incurred a loss of $11,445.50 from securities that became worthless in 1950.
In addition to the above, between 1939 and 1949 petitioner engaged in the following activities, with which Moorgate had some direct or indirect connection: (1) Moorgate organized and partially financed Propeller Wood in 1941 to manufacture plastic products. Moorgate was one of Propeller Wood's principal stockholders and creditors, and petitioner was a director. (2) Petitioner, with one Andreef, formed in 1945 Andreef I and Andreef Corporation, hereafter referred to as Andreef II. The Andreef corporations acted as sales agents for Moorgate's Propeller Wood, which employed Andreef. Petitioner loaned Andreef II $8,000 and purchased $15,000 of Andreef I stock; Moorgate owned 1,200 shares of Andreef I. (3) In 1944 petitioner and Andreef formed and organized Northern Plastics, Ltd., and Northern Plastics, Inc., to manufacture laminated wood products. Petitioner invested $18,500 and guaranteed an $8,700 loan to Northern Plastics, Ltd.; he also loaned $7,000 to Northern Plastics, Inc. The plastic companies also employed Andreef and occupied the same offices as Andreef I and II. (4) Exploration Associates was a partnership organized by petitioner on behalf of eight partners, including himself, in 1944 to explore and develop mining properties. The partnership engaged Trans-American, a corporation in which Moorgate and petitioner were minority shareholders, to explore and develop mining properties in Canada. The partnership was dissolved in 1945. (5) Prospect Associates was formed in 1948, a partnership with personnel and purposes similar to the defunct Exploration Associates. (6) Moorgate refinanced Chromite, Ltd., in the midforties. Petitioner was an officer-director of Chromite. (7) Kemdico Corporation was formed in 1948 to develop pharmaceutical inventions of Adler, an employee of Anachemia. Anachemia permitted Adler to utilize its laboratories on behalf of Kemdico and itself. Petitioner was an officer-director of Kemdico Corporation and owned 33.7 per cent of its stock. Prior to 1950 petitioner loaned Kemdico $4,945.
Activities of petitioner from 1939 to 1949, completely exclusive of Moorgate, were a $6,000 loan to Skilam, Inc., in 1946; the unsuccessful effort at introduction of a bacteria-killing pressure bomb to a number of United States chemical corporations on behalf of a friend in 1948; the formation of Enterprise Development Corporation for the purpose of purchasing going businesses which could be used to produce new products and patents developed during World War II; and, in 1949, an unsuccessful attempt to finance a cartoonist who wished to expand his facilities. Petitioner was an officer, director, and 3 per cent stockholder of Enterprise Development Corporation.
During 1950, the year in which petitioner suffered the loss from the Anachemia liquidation and sale to Loane, petitioner engaged in the following activities: (1) A Canadian physicist requested petitioner's assistance in the financing of his corporation. Petitioner spent 2 to 3 weeks on this project but was unsuccessful. (2) Petitioner received $3,000 from Prospect Associates. (3) Petitioner loaned $5,000 to Kemdico Corporation. (4) Cement and General Development Corporation, hereafter referred to as Cement and General, employed petitioner as president in June 1950 at a $15,000 salary per annum. Charles Payson, a principal stockholder in Cement and General and an associate of petitioner in Kemdico Corporation, Enterprise Development Corporation, and Prospect Associates, was instrumental in obtaining petitioner's services. The corporation's purposes were the development of projects and the promoting and financing of business entirely without the United States. Petitioner also received $2,100 from Cement and General sometime in 1950. The stockholders of Cement and General agreed that petitioner could carry on his own businesses and utilize the office facilities of the corporation; furthermore, it was agreed that petitioner could spend as much time as he felt necessary in furthering the interests of the corporation. Petitioner in fact spent 20 to 25 per cent of his time while employed as president. (5) After 8 months' effort petitioner obtained an option to purchase the controlling interest in the International Bank of Washington. He then traveled extensively to form a group to take up the option which was exercised finally in July 1951. Charles Payson, 1 of 15 to 20 members of the group, subscribed to 21.7 per cent. Aside from the use of its office facilities and the relationship between petitioner and Payson, Cement and General had no interest in the bank. (6) Petitioner spent several weeks trying to interest a London finance house in Canadian mining ventures. They needed Canadian dollars and asked petitioner to raise the capital. Although petitioner partially complied, the London house succeeded in obtaining the Canadian funds themselves.
Petitioner on schedule C of his 1950 income tax return reported $5,100 in receipts from his business of "Financial and Management Adviser." This represented $3,000 from Prospect Associates as reimbursed office expenses and $2,100 from Cement and General as additional compensation.
Petitioner in 1950 was not engaged individually in the business of promoting, organizing, forming, managing, and financing business enterprises. The activities from 1939 through 1950 were not extensive enough to constitute a trade or business carried on by him and the bad debt loss was not proximately related to any business of the petitioner.
OPINION.
I.
The question here of whether petitioner was individually engaged in the business of "promoting, managing, financing and making loans to a number of corporations" so as to make an admittedly bad debt deductible as a business debt is complicated by the fact that practically throughout the period covered by the evidence petitioner was working for and otherwise connected with corporations which were themselves in the business of promoting and financing other enterprises.
SEC. 23. DEDUCTIONS FROM GROSS INCOME.
(k) BAD DEBTS. —
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(4) NON-BUSINESS DEBTS. — In the case of a taxpayer, other than a corporation, if a non-business debt becomes worthless within the taxable year, the loss resulting there. from shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months. The term "non-business debt" means a debt other than a debt evidenced by a security as defined in paragraph (3) and other than a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.
Our conclusion that petitioner as an individual was not engaged in the business of carrying on promotions is grounded upon our inability to find from the evidence that the overwhelming proportion of the ventures in which he participated was in fact his individual activity as opposed to that of the corporations with which he was associated. It is recognized by both parties that the business of a corporation is not that of the individuals connected with it. Burnet v. Clark, 287 U.S. 410; Charles G. Berwind, 20 T.C. 808, affirmed per curiam (C. A. 3) 211 F.2d 575. And this must be as applicable to the business of promoting as it is to any other activity.
Moorgate, with which petitioner was associated for about 10 years ending in 1948, and Cement and General, with which he was connected in the tax year 1950, were both primarily in the promoting and financing business. Petitioner, to be sure, was permitted to engage in ventures of his own, and to some small extent he did so; and he was free to engage "privately in any of the ventures that were being undertaken by him for Moorgate Agency." But with the limited exceptions noted, the promotional activity (as opposed to mere investment) appears to have been undertaken by petitioner directly or indirectly as an officer and employee of one or the other of the promoting companies which employed him; and we have been unable to find from the evidence that in any of these instances he himself as an individual and on his own account participated in the capacity of promoter. Petitioner referred to his "own indirect interest" in the Moorgate investments and we think that when he bought stock or made loans to the Moorgate companies he was not himself acting as a promoter but rather as an investor or speculator, the promotion itself having been the act of Moorgate.
Petitioner testified:
Q. Well, to quote your affidavit, "consequently, in order to permit these companies to develop and in order to keep them alive for the protection of Moorgate Agency's investment and my own indirect interest therein, I commenced advancing personal funds to Moorgate Agency against its demand notes, and later on commenced to make direct loans to companies in which Moorgate Agency was interested."
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Q. Is that not correct?
A. Yes.
Similarly, when petitioner undertook to liquidate the corporations in which he already held stock or made loans to them in order to keep them alive, he was not carrying on an independent business but conducting himself as any stockholder might who has funds invested in an enterprise. See Higgins v. Commissioner, 312 U.S. 212.
The cases on which the petitioner relies are not in point. The authority contained in such cases as Weldon D. Smith, 17 T.C. 135, revd. 203 F.2d 310, Henry E. Sage, 15 T.C. 299, and Vincent C. Campbell, 11 T.C. 510, is applicable only to the exceptional situations where the taxpayer's activities in promoting, financing, managing, and making loans to a number of corporations have been regarded as so extensive as to constitute a business separate and distinct from the business carried on by the corporations themselves. Whether the petitioner is employed as a director or officer in 1 corporation or 20 corporations, he was no more than an employee or manager conducting the business of the various corporations. [ Charles G. Berwind, supra at 815.]
Eliminating the instances in which his corporate employers rather than petitioner must be considered the original promoters, and petitioner no more than an investor, corporate officer, or both, only a handful of activities over more than a 10-year period can be attributed to petitioner personally, most of which were attempts on his part which turned out unsuccessfully. See Koch v. United States, (C.A. 9) 264 F.2d 334. No more than in the case of a real estate subdivision can we view such sparse and infrequent transactions as business activity, Allen Moore, 30 T.C. 1306; 512 W. Fifty-Sixth Corp. v. Commissioner, (C. A. 2) 151 F.2d 942, affirming a Memorandum Opinion of this Court, nor characterize petitioner as one engaged independently in promotion or financing as a business.
1939-1949 ( Moorgate)
Anachemia Propeller Wood Kemdico Andreef I Andreef II Northern Plastics, Ltd. Northern Plastics, Inc.
Chromite, Ltd. Exploration Associates Trans-American Prospect Associates1950
Anachemia Kemdico Prospect Associates Cement and General
1939-1949
Skilam, Inc. (1946, Loan) Enterprise Development (1948) Pressure bomb (1948, petitioner had no apparent financial interest) Cartoonist (1949)
1950
Canadian physicist International Bank (concluded in 1951) Canadian mining venture
Pressure bomb
Cartoonist Canadian physicist Canadian mining venture
That this parallel is not fanciful can be illustrated by a hypothesis based on the present record. Petitioner's asserted motive for the attempted formation of the few independent projects in which he engaged was "to build up the corporations and eventually dispose of them." Had he done so, on his theory they would have been held by him for sale to customers in the ordinary course of his business. Yet who can doubt that, as in the real estate cases, if he had profitably secured purchasers for his interests the proceeds would have been viewed — probably at his insistence — as capital gains?
To this it may be added that even if it could be found that petitioner was independently engaged in some kind of promotional business, the debt as to which he claims the deduction could not be said to have arisen in connection with any such business of his own. The debtor was Anachemia, and as our findings demonstrate, Anachemia was clearly "promoted" by Moorgate and not by petitioner. Once petitioner became a creditor, it was understandable for him to attempt to protect his interest as such, and in the course of that operation to make additional loans, or investments, in the corporation in which he was interested. But this no more entitles him to have the debt considered as one incurred in his trade or business than would be the case with any other investor. Wheeler v. Commissioner, (C. A. 2) 241 F.2d 883, affirming per curiam a Memorandum Opinion of this Court.
We conclude that the debt in question was deductible only as a nonbusiness bad debt.
II.
Petitioner bought the concededly worthless stock of one of his fellow stockholders purportedly in order to facilitate the liquidation and sale of a company in which they were jointly interested. This he treated as increasing the amount of the bad debt. Apparently petitioner had other business associations with the vendor of the stock, but whatever his motives, and although the stock was worthless when acquired, respondent for some reason has allowed a deduction as a short-term capital loss. In the view we have taken of the main issue this is identical with the tax result of a bad debt, a nonbusiness bad debt being treated similarly to a short-term capital loss.
See footnote 1; sec. 117 (a) (3), I. R. C. 1939.
Although the parties have not said so, it thus appears that there could have been no real issue on this aspect of the case except as the principal question were decided in petitioner's favor. Having held otherwise in this respect, we find it unnecessary to consider further the supposed second issue.
Decision will be entered for the respondent.