Miami Nat'l Bank v. Comm'r of Internal Revenue

• Decision Date: 14 February 1977
• Docket Number: Docket No. 580—74.
• Citation: 67 T.C. 793
• Parties: MIAMI NATIONAL BANK, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

67 T.C. 793

MIAMI NATIONAL BANK, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 580—74.

United States Tax Court

Filed February 14, 1977.

C transferred certain stock of P, owned by him prior to such transfer, to a broker to be held in a subordinated securities account. Under the terms of such account, C retained some of the incidents of ownership, including the right to dividends and the right to vote the stock; but the broker acquired legal title to the stock, and it could be sold to satisfy the claims of creditors of the broker. While such account was in effect, C and other persons purported to sell to DL their stock in P, which constituted in excess of 80 percent of P's stock. Held, C was the beneficial owner of the stock held in the account, and after the sale, DL ‘directly owned,‘ within the meaning of sec. 1504(a), I.R.C. 1954, at least 80 percent of the stock of P so that the two corporations were entitled to file a consolidated return. David Emanuel, for the petitioner.

Kevin A. Suffern and Alan Summers, for the respondent.

OPINION

SIMPSON, Judge:

The Commissioner determined the following deficiencies in the petitioner's corporate income taxes:

+------------------------------+
                ¦FYE Apr. 30—   ¦Deficiency  ¦
                +-----------------+------------¦
                ¦1970             ¦$394,746.52 ¦
                +-----------------+------------¦
                ¦1971             ¦833,513.58  ¦
                +------------------------------+
                

The parties have settled numerous issues; the only one remaining for decision is whether the petitioner, Miami National Bank, was eligible to file a consolidated return with Data Lease Financial Corp. (Data Lease). That issue turns on whether Data Lease ‘owned directly,‘ within the meaning of section 1504(a) of the Internal Revenue Code of 1954,¹ certain stock which was held in a subordinated securities account with a broker.

All of the facts have been stipulated, and those facts are so found.

The petitioner is a corporation which maintained its principal place of business in Miami, Fla., when it timely filed its petition herein. The petitioner filed a corporate income tax return for the period May 1, 1969, through December 15, 1969. For the period December 16, 1969, through June 30, 1970, and for the fiscal year ending June 30, 1971, it joined in the consolidated returns filed by Data Lease.

During the years in issue, the petitioner had issued and outstanding 1,084,733 shares of voting common stock, its only class of stock. Eighty percent of such stock was 867,787 shares. Sometime prior to September 18, 1969, Data Lease offered to purchase 870,000 shares of the petitioner's stock from Samuel Cohen and others (the sellers), and on September 18, 1969, Data Lease and the sellers executed an agreement of sale and purchase of such stock, under which part of the purchase price consisted of a promissory note. The closing of the agreement was held on December 16, 1969, at which time Data Lease delivered to the sellers the full purchase price for the 870,000 shares of stock but physically received the certificates to only 837,129 shares, which it owned throughout the years in issue.

The remaining 32,871 shares, the certificates for which were not delivered to Data Lease at the time of the closing, constituted a portion of the shares due from Mr. Cohen. At the closing, Mr. Cohen intended to make a present transfer to Data Lease of the ownership rights he had in such shares, but on the closing date, and continuously thereafter until May 25, 1972, such shares were held in a ‘subordinated securities account’ with First Devonshire Corp. (First Devonshire or the broker).

Mr. Cohen set up the subordinated securities account with the broker on July 19, 1969, by a subordination agreement. Such agreement recited that Mr. Cohen, the ‘customer,‘ for himself and his assigns, agreed to subordinate his claims, as owner, creditor, or otherwise, with respect to such account, to the claims of all other creditors of the broker, for any matters arising prior to the maturity date of the agreement, December 31, 1970. Until the maturity date, Mr. Cohen could not withdraw the securities from the account without prior written consent of an officer of the broker. However, at any time during the course of the agreement, he could reacquire the securities in his account if he substituted for them either cash or other readily marketable securities of equivalent value. Mr. Cohen also retained the right to the dividends and to vote the shares of stock in his account.

No provision in the agreement prohibited Mr. Cohen from assigning his rights to any securities in the account, and the agreement expressly stated that it was binding on Mr. Cohen's assigns. The broker agreed to pay Mr. Cohen interest on the stock in his account at the rate of 4 percent per annum. The agreement enabled the broker to take such stock into account in meeting the net capital requirements of rule 325 of the New York Stock Exchange, as in effect when the agreement was signed.

Other relevant provisions of the agreement are set forth below:

in the event of any receivership , insolvency, bankruptcy, assignment for the benefit of creditors, reorganization, whether or not pursuant to bankruptcy laws, liquidation, or any other marshalling of the assets and liabilities of the Corporation, the Customer shall not be entitled to participate or share ratably or otherwise, in the distribution of the assets of the Corporation until all claims of all other present and future creditors of the Corporation arising out of any matter occurring prior to the Maturity Date have been fully satisfied, or provision has been made therefor.

Any money, securities, other property, or interests therein, in said account or accounts may be used, pledged, sold, disposed of or transferred or otherwise treated by the Corporation as its own property and such money, securities, other property, or interests therein, in said account or accounts or the proceeds of sale thereof may be applied by the Corporation to the claims of all other creditors of the Corporation as fully to all intents and purposes as though the same were property of the Corporation.

If any of the securities, other property or interests therein in said account or accounts are sold, transferred or disposed of by anyone to whom such securities, other property or interests therein have been pledged, the Customer shall have a contract claim against the Corporation for the return of like securities, other property, or interests therein, to the same extent he would have had he loaned the securities, other property, or interests therein, to the Corporation at the time of sale, but such contract claim shall be and remain subordinated to the claims of all other creditors as above provided. * * *

(Paragraphed for emphasis.)

The broker issued brokerage statements to Mr. Cohen on a monthly basis from July 1969 to June 1972 with respect to his account. In those statements, the broker reported Mr. Cohen's account as ‘long’ on 60,261 shares of the petitioner's stock. However, during that period, the broker was listed as record owner of such shares.

Throughout the period in issue in this case, dividends on the 32,871 shares of the petitioner's stock, held in Mr. Cohen's subordinated securities account and to be delivered to Data Lease, were treated as follows: Dividend payments were made by the petitioner to the record owner, First Devonshire, and it then paid them to Mr. Cohen or credited them to his account. Data Lease treated such amounts as its income on its books and records and as payments on the unpaid purchase price owed to Mr. Cohen.

In August 1970, the New York Stock Exchange suspended First Devonshire from further trading, and the Securities and Exchange Commission secured the appointment of a receiver for First Devonshire by the United States District Court for the Southern District of New York. In the following month, the receiver sought and secured authority to sell the securities in subordinated securities accounts, but such authority was never exercised.

In late September 1970, the creditors of First Devonshire filed a petition for involuntary bankruptcy. In the following month, First Devonshire was adjudicated a bankrupt, and a receiver was appointed. On October 24, 1970, such receiver notified Mr. Cohen of his intention to liquidate the securities in Mr. Cohen's subordinated securities account, unless Mr. Cohen substituted cash or readily marketable securities for them within 30 days thereafter. In October 1970, the receiver in bankruptcy was authorized to sell securities held in subordinated securities accounts, but such authority was never exercised by him.

On December 30, 1970, a petition was filed, on behalf of all customers of First Devonshire with subordinated securities accounts, seeking to restrain the receiver from selling their securities or treating them any differently than those of other customers. By order dated March 17, 1971, the relief sought in the petition was granted pending the outcome of the issues raised in such petition. On April 20, 1972, or sometime thereafter, the restraining order was lifted, and on May 25, 1972, Mr. Cohen delivered to First Devonshire $291,295.85 in cash and received certificates for 60,061 shares of the petitioner's stock which had been in his account throughout the period in issue in this case. Throughout such period, Mr. Cohen could have reacquired 32,871 such shares because he had sufficient resources to substitute for them. In July 1972, Mr. Cohen physically delivered to Data Lease certificates for 32,871 shares of the petitioner's stock.

The petitioner filed a corporate income tax return for the short period May 1, 1969, through December 15, 1969. It then filed consolidated returns in accordance with the fiscal years of Data Lease ending June 30, 1970, and June 30, 1971. In the notice of deficiency, the Commissioner determined that Data Lease did not own 80 percent of the...