Cahn v. Comm'r Internal Revenue

• Decision Date: 19 March 1964
• Docket Number: Dockets Nos. 84038,84039.
• Parties: SAMMY CAHN, PETITIONER, v. COMMISSIONER INTERNAL REVENUE, RESPONDENTGLORIA CAHN, PETITIONER, v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

41 T.C. 858

SAMMY CAHN, PETITIONER,
v.
COMMISSIONER INTERNAL REVENUE, RESPONDENTGLORIA CAHN, PETITIONER,
v.
COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Dockets Nos. 84038

84039.

Tax Court of the United States.

Filed March 19, 1964.

[41 T.C. 859]

Edward R. McHale, for the petitioners.

Douglas W. Argue, for the respondent.

T paid $14,128.10 to CFC purportedly as interest with respect to an alleged loan of $141,812.84. Held, no such loan was in fact made to T and the payment was not deductible as ‘interest paid * * * on indebtedness.’ Sec. 163(a), I.R.C. 1954.

The Commissioner determined a deficiency in each petitioner's 1957 income tax in the amount of $4,702.22. At issue is whether the Commissioner erred in disallowing as a deduction, under section 163(a), I.R.C. 1954, an amount paid allegedly as ‘interest’ on funds purportedly borrowed from Corporate Finance Corp. allegedly to purchase securities.

FINDINGS of FACT

The facts stipulated by the parties and exhibits introduced in evidence are incorporated herein by this reference.

The petitioners, husband and wife residing in southern California, filed their separate Federal income tax returns for 1957, on the cash basis, with the district director of internal revenue in Los Angeles, Calif. The income and deductions reported related primarily, if not entirely, to the husband's activities, but the returns based on California community property law, were substantially identical. The husband will hereinafter be referred to as petitioner.

Petitioner is a song composer and lyric writer. In their separate 1957 returns he and his wife each reported combined professional income of $152,079.19 and net income from other sources totaling $1,705.86. On each of the returns one of the components of the deduction claimed for ‘interest’ paid was an amount of $14,128.10, one-half of which was deducted on each of the separate returns as ‘interest’ paid to Corporate Finance Corp. of Boston, Mass. It is the Commissioner's disallowance of that deduction which is the sole issue in this case.

M. Eli Livingstone, hereinafter referred to as Livingstone, is a security dealer in Boston, Mass., doing business in the form of a sole proprietorship under the name of Livingstone & Co.; he also conducts his business activities through a wholly owned corporation, Livingstone Securities Corp.

Corporate Finance Corp., hereinafter referred to as CFC, a Massachusetts corporation incorporated in November 1956 with a capital contribution of $1,000, was organized for the purpose of doing business as a finance company. No further capital contributions have been made. Its only offices were in the law offices of its president and treasurer, Harry N. Cushing, who was one of the 10 initial shareholders; the remaining 9 shareholders were relatives, clients, and friends of Cushing. The directors, in addition to Cushing, were his son Malcolm and his wife Jeannette.

Cushing is a lawyer; he is not an investment banker, nor has he ever dealt in Government securities. He is a longtime friend and former law associate of Livingstone. Cushing at various times has

[41 T.C. 860]

also been the principal officer of seven other ‘finance’ companies similar to CFC, all incorporated in Massachusetts. All were organized and operated like CFC; these eight companies received substantially all, if not all, of their business ‘on reference’ from Livingstone. Their principal offices were the law offices of Cushing at 70 State Street, Boston. These law offices consisted of three rooms and a waiting room; one of the rooms was occupied by another lawyer on a space-sharing arrangement. Although Cushing had a secretary, all correspondence and instructions of CFC relating to its ‘clients' were dictated and typed at Livingstone's office, where a supply of CFC stationery was kept for this purpose. The files and records of CFC as well as of the other seven corporations were kept in Cushing's office in a single four-drawer cabinet, under the names of the ‘clients' of the various corporations and not under the corporate names. In addition to having Cushing as their principal officer, the corporations also had a salaried part-time clerk, either a son or daughter of Cushing. The clerk rendered services only at stockholders' and directors' meetings which were held two or three times a year and lasted about one-half hour each time.

The business of CFC was purportedly the making of loans to persons in high-income-tax brackets. A substantial part of the ‘interest’ received was paid to Livingstone as a ‘finder's fee.’ Such ‘interest’ was CFC's principal income item, and the ‘finder's fees' paid to Livingstone its principal item of expense. Livingstone was neither a shareholder nor a director of CFC. CFC never asked for nor received a credit report on any of the persons to whom it purportedly lent money.

CFC listed its assets and liabilities as of December 3, 1956 and 1957, as follows:

+-----------------------------------------------------------+
                ¦ASSETS ¦Dec. 31,1957 ¦
                +--------------------------------------------+--------------¦
                ¦Cash ¦ ¦$196,369.91 ¦
                +----------------------------------+---------+--------------¦
                ¦Accounts receivable, customers ¦ ¦1,423,744.98 ¦
                +----------------------------------+---------+--------------¦
                ¦Accounts receivable, others ¦$1,000.00¦ ¦
                +----------------------------------+---------+--------------¦
                ¦Notes receivable, customers ¦ ¦47,479,833.70 ¦
                +----------------------------------+---------+--------------¦
                ¦Prepaid insurance, interest, taxes¦ ¦60.84 ¦
                +----------------------------------+---------+--------------¦
                ¦Total assets ¦1,000.00 ¦49,100,009.43 ¦
                +-----------------------------------------------------------+
                

LIABILITIES
                Accounts payable 385,599.39
                Notes and acceptances payable 13,000.00
                Deferred interest 1,948,134.07
                Accrued taxes 7,623.25
                Bonds—borrowed 46,732,805.96
                Capital stock without par value (number of
                shares, 200) 1,000.00 1,000.00
                Surplus 11,846.76
                Total liabilities 1,000.00 49,100,009.43
                

[41 T.C. 861]

Edward Traubner is the president and chief executive officer of Edward Traubner & Co., Inc., of Beverly Hills, Calif., a management firm. Its clients are prominent in the entertainment field; their incomes vary from approximate $75,000 to $400,000 or $500,000 per year. Traubner has known petitioner for approximately 34 years and has managed petitioner's business affairs for approximately 26 years. Traubner's company, as a service to its clients, keeps books of account, prepares monthly statements, files tax returns, invests money for its clients and manages their investments, which are primarily in stocks, bonds, and real estate, and helps them with their budgets. The company performed all of these various services for petitioner. It has prepared petitioner's income tax returns since 1944 or 1945 and prepared his return for the taxable year 1957.

Petitioner has complete confidence in Traubner and follows his advice with respect to financial matters implicitly. He has, on Traubner's advice, borrowed substantial sums of money with which to enter into various business ventures or to make other investments. Petitioner has given Traubner a general power of attorney which Traubner has exercised in petitioner's behalf. Traubner has also signed checks for petitioner.

On two occasions prior to 1956, in 1953 and in 1944 or 1945, petitioner, upon the advice of Traubner, purchased U.S. Government securities on credit. In the transaction which took place in 1944 or 1945, notes were purchased in the face amount of $100,000; petitioner borrowed 95 percent of the purchase price of the notes from the Cleveland Trust Co., depositing the notes as security for the loan and paid the other 5 percent of the purchase price himself. In 1953, Traubner, in behalf of petitioner, entered into a transaction involving the purported purchase of Federal land bank notes. All of the funds necessary to purchase the notes were borrowed from the Gibraltar Financial Corp. In a statutory notice of deficiency dated February 5, 1959, the Commissioner disallowed claimed interest deductions in the years 1953, 1954, and 1955 in connection with this transaction; the controversy was disposed of pursuant to stipulation of the parties.

Subsequent to 1957, Traubner entered into transactions in behalf of his clients whereby he purchased bonds through a broker and borrowed the requisite funds from banks, depositing the bonds as security; in all of these transactions he has never borrowed on any other basis except 95 percent. The only such transactions in which he has ‘borrowed’ 100 percent of the purchase price were those involving Livingstone.

Traubner first became acquainted with Livingstone in either 1956 or 1957 in connection with Livingston's inquiry into the progress of the controversy between some of Traubner's clients, including petitioner,

[41 T.C. 862]

and the Government involving the disallowance of deductions for interest purportedly paid to Gibraltar Financial Corp.

In the fall of 1957 Livingstone proposed to Traubner that he enter into a transaction in behalf of certain of his clients whereby they would ‘purchase’ Treasury notes and ‘borrow’ all of the funds necessary to effectuate this purchase from Livingstone. Traubner professed not to be interested in this proposal; he explained to Livingstone that he would not be interested unless there was ‘some form of economic gain’ in the transaction. Traubner felt that one of the reasons a tax deduction was being disallowed by the Internal Revenue Service for interest paid on funds ‘borrowed’ to purchase Treasury bonds or notes was that there was no ‘economic gain’ in the transaction. When Livingstone inquired of Traubner as to the type of deal that would appeal to him, Traubner asked Livingstone if stocks and corporate securities could be purchased on the same basis as Livingstone's offer of the Treasury notes; namely, the borrowing of 100 percent of the total purchase price of the stocks and corporate...