39 T.C. 294 (1962), 84357, Investors Diversified Services, Inc. v. C. I. R.
|Citation:||39 T.C. 294|
|Opinion Judge:||SCOTT, Judge:|
|Party Name:||INVESTORS DIVERSIFIED SERVICES, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.|
|Attorney:||Kenneth M. Anderson, Esq., and Joseph A. Maun, Esq., for the petitioner. Donald W. Geerhart, Esq., and Willard J. Kiser, Jr., Esq., for the respondent.|
|Case Date:||November 02, 1962|
|Court:||United States Tax Court|
Petitioner originated mortgages at par without charging a fee to affiliated builders and sold these mortgages at a discount price to wholly owned subsidiaries over whom it had complete control and whose affairs it managed. Held, the differences between the par-originated amount of the mortgages and the discounted sales price are not deductible losses. Held, further, that losses on sales of mortgages to nonaffiliates are capital and not ordinary losses.
Respondent determined deficiencies in petitioner's income tax for the calendar years 1954 and 1955 in the amounts of $364,706.59 and $314,565.30, respectively. Petitioner claims an overpayment of tax in the amount of $28,521.78 for the year 1955.
The issues for decision are:
(1) Whether Investors Diversified Services, Inc., sustained losses aggregating $1,307,886.60 on sales of mortgage loans to two wholly owned subsidiaries during the years 1954 and 1955.
(2) Whether such losses, if sustained, are deductible for Federal income tax purposes.
(3) Whether losses aggregating $102,467.66 sustained by Investors Diversified Services, Inc., on sales of mortgage loans to nonaffiliated vendees during the year 1955 are deductible as ordinary losses.
FINDINGS OF FACT.
Some of the facts have been stipulated and are found accordingly.
Investors Diversified Services, Inc. (formerly Investors Syndicate and hereinafter referred to as petitioner), is a Minnesota corporation having its principal place of business in Minneapolis, Minnesota.
Petitioner's Federal income tax returns for the years 1954 and 1955 were filed with the district director of internal revenue at St. Paul, Minnesota.
From its incorporation in 1894 until December 31, 1940, after the enactment of the Investment Company Act of 1940, petitioner was engaged in the business of issuing face-amount certificates. These certificates evidenced the obligation of petitioner to pay the holders thereof designated amounts upon maturity of the certificates and the agreement of petitioner to invest the amounts paid to it by the certificate holder in designated securities.
Petitioner discontinued the issuance of face-amount certificates on December 31, 1940, as it was financially unable to adjust its reserves to comply with the requirements of the Investment Company Act of 1940. However, petitioner had outstanding during the years here in issue face-amount certificates issued prior to December 31, 1940.
In 1940 petitioner organized as a wholly owned subsidiary, Investors Syndicate of America, Inc. (hereinafter referred to as I.S.A.), a Minnesota corporation with its principal place of business in Minneapolis, Minnesota. I.S.A. met the investment requirements of the Investment Company Act of 1940 and has issued since its organization, face-amount certificates to the public.
During the years 1940 through 1955, I.S.A. had no personnel of any kind. Its entire operations were conducted and managed by petitioner. I.S.A.‘ s face-amount certificates were sold through petitioner's sales force. I.S.A.‘ s corporate officers were also officers of petitioner. I.S.A. utilized a portion of petitioner's offices and had no separate offices of its own. Three of I.S.A.‘ s eight directors were also on petitioner's board of directors.
Certain of the face-amount certificates issued by I.S.A. contained an ‘ additional credits' provision. Such provision gave I.S.A.‘ s board of directors discretionary authority to determine additional credits in any amount for the accounts of the face-amount certificate holders. It further provided that no cash dividends could be distributed to I.S.A.‘ s stockholders in any calendar year unless an additional credit for each certificate in an amount equal to at least one-half of 1 percent of its surrender value was first determined by the board of directors.
On May 17, 1945, petitioner and I.S.A. executed an agreement providing, inter alia, that in consideration of stated fees to be paid by I.S.A., petitioner would have the sole and exclusive right to sell and distribute any and all investment certificates authorized or to be authorized and issued by I.S.A. The contract was for a 2-year term, terminable by either party on 60 days' notice thereof. Petitioner's income tax return for 1954 shows income from underwriting fees of $8,092,276.41.
Prior to 1940, petitioner had acquired as a wholly owned subsidiary a corporation organized and existing under the laws of New York, Investors Syndicate Title and Guaranty Company (hereinafter referred to as I.S.T. & G.). I.S.T. & G. sold face-amount certificates in the State of New York. I.S.T. & G. maintained offices in New York and had its own sales force through which its face-amount certificates were sold. Such certificates gave the holders thereof undivided interests in securities deposited with a designated trust company as a depository, a minimum return on such deposited securities,
and 60 percent of excess income from the securities above the minimum rate. During the years in issue four of I.S.T. & G.‘ s seven directors were also on petitioner's board of directors.
I.S.A. has never declared or paid a dividend to its stockholder. I.S.T. & G. has not declared or paid any dividends since 1953.
During the years here in issue, petitioner was engaged in developing and originating first mortgage loans on residential properties and other real estate, selling those loans to investors and the Federal National Mortgage Association, and servicing those loans for the account of the investors for the lifetime of the loans.
Petitioner sold mortgage loans either to its subsidiaries or to non-affiliated third parties in the following quantities and received therefor the following net proceeds during the 11-year period, 1948 through 1958, inclusive:
Year of loans Net proceeds
1948 8,090 $61,721,559.94
1949 10,655 97,563,207.66
1950 16,550 156,611,715.39
1951 13,586 103,164,677.63
1952 11,586 74,096,120.34
1953 11,267 83,405,296.86
1954 6,458 59,130,185.35
1955 7,241 74,948,929.10
1956 2,858 31,401,215.50
1957 998 11,928,926.17
1958 73 1,324,850.72
Since petitioner, I.S.A., and I.S.T. & G. were all registered investment companies, the Investment Company Act of 1940 prohibited the sale of mortgages by petitioner to either subsidiary. However, sections 6(c) and 17(b) of that Act empowered the Securities and Exchange Commission (hereinafter referred to as the SEC) to issue exemption orders permitting sales of investments between affiliated persons upon the basis of a finding that it was in the public interest and the interest of investors to do so. On December 26, 1940, petitioner filed an application with the SEC for an exemption order permitting the sale of certain mortgages by petitioner to I.S.A. The terms of sale proposed in this application included a provision for an initial fee or premium to be paid by I.S.A. equal to ‘ 1 1/2% of the principal amount of the loan and mortgage involved in the transfer, or the cost thereof to the parent, Investors Syndicate, (petitioner) if acquired at a discount.’ In an affidavit attached to this application, petitioner represented to the SEC that the purpose of the proposed 1 1/2 percent premium was merely to reimburse petitioner for its costs of originating the mortgages and that I.S.A. would be compelled to pay a premium of 2 1/2 percent to 3 percent if it undertook to buy similar mortgages on the open market. This representation was subsequently repeated in another Page 297 affidavit dated December 19, 1945, submitted by petitioner to the SEC. Pursuant to petitioner's application, an order exempting sales of certain mortgages by petitioner to I.S.A. from the prohibition of sections 17(a)(1) and 17(a)(2) of the Investment Company Act of 1940 was granted to petitioner by the SEC under date of November 13, 1941. This exemption order contained, inter alia, the following provisions: 1. Investors Syndicate shall not sell to Investors Syndicate of America, Inc., nor shall Investors Syndicate of America, Inc. purchase from Investors Syndicate any loan secured by mortgage or other first lien on real estate except at a price equivalent to the unpaid principal amount of such loan at the date of sale or purchase or the cost of such loan to Investors Syndicate, whichever is less, plus the fees and servicing charges permitted by paragraph 5 hereof; * * * 5. Investors Syndicate of America, Inc. shall neither make any payment nor be subjected to any fees, commission charges, costs or expenses by Investors Syndicate or any affiliated person thereof on account of any such mortgage transaction or the servicing of any such mortgage or mortgage loan or other lien, exclusive of costs, disbursements and expenses exempted by this order, except (a) an amount which may be charged by Investors Syndicate as a single premium payable at the time of transfer or sale, not to exceed 1 1/2% of the principal amount of the loan and mortgage involved in the transfer, or of the amount of the investment therein by Investors Syndicate if acquired at a discount, whichever is the lesser amount; (b) a charge made each calendar...
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