Affiliated Capital Corp. & Subsidiaries v. Comm'r of Internal Revenue

• Decision Date: 04 May 1987
• Docket Number: Docket No. 38021-84
• Citation: 88 T.C. 1157,88 T.C. No. 65
• Parties: AFFILIATED CAPITAL CORPORATION AND SUBSIDIARIES, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

88 T.C. 1157

88 T.C. No. 65

AFFILIATED CAPITAL CORPORATION AND SUBSIDIARIES, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 38021-84

United States Tax Court

Filed May 4, 1987.

In 1970, A incurred costs for the preparation and filing of a registration statement and prospectus with the Securities and Exchange Commission (SEC) for a public offering of 525,000 units of securities. Each unit consisted of two shares of common stock and one warrant for the purchase of a share of common stock at a stated or mathematically calculable price. In 1972 and 1975, A incurred additional costs for the preparation and filing with the SEC of post-effective amendments updating the registration statement and prospectus for the warrants.

HELD: A's costs in preparing and filing the post-effective amendments with the SEC are not deductible as ordinary and necessary business expenses under sec. 162(a), I.R.C. 1954, or amortizable as capital expenditures which were exhausted in the tax years under sec. 167(a), I.R.C. 1954.

On June 28, 1974, C, a subsidiary of A, sold three tracts of real estate to G for cash and three nonrecourse installment notes, each secured by a lien on one of the three tracts. On the same date, G sold the three tracts to B, T, and H, respectively, for nonrecourse installment notes and liens in somewhat larger amounts which called for slightly lower interest rates. To settle a lawsuit in 1975, G, among other things, assigned his B, T, and H notes to C and was eliminated as ‘middleman.‘

HELD: On the facts, the C-to-G notes were neither satisfied nor disposed of in 1975, within the meaning of sec. 453(d), I.R.C. 1954, and C's gain included in the deferred principal of the C-to-G notes was not accelerated for taxation in 1975. Donald W. Geerhart, for the petitioners.

Ana G. Cummings, for the respondent.

FEATHERSTON, JUDGE:

Respondent determined a deficiency in the amount of $66,821 in petitioners' Federal income tax for 1972. The deficiency arises from the partial disallowance of a claimed net operating loss carryback from 1975 to 1972 based on respondent's determination that petitioners recognized gain in 1975 from the disposition or satisfaction of an installment obligation. Although recognition of such gain would not be sufficient to cause a deficiency for 1975, it would cause a decrease in the loss carryback. Petitioners here claim expense deductions for 1972 and 1975 which would further affect the amount of the loss carryback from 1975 and the deficiency for 1972. The issues presented for decision are as follows:

1. Whether petitioners are entitled to deduct as ordinary and necessary expenses amounts expended in 1972 and 1975 for the preparation and filing of post-effective amendments to the original prospectus and registration statement filed with the Securities and Exchange Commission with respect to stock and warrants first offered for sale to the public in 1970.

2. Whether installment obligations received by petitioners on the sale of real estate in 1974 were satisfied at other than face value or otherwise disposed of in 1975, causing the recognition of gain for 1975 pursuant to section 453(d). ¹

GENERAL FINDINGS OF FACT

Petitioner Affiliated Capital Corporation (sometimes hereinafter Affiliated) is the parent corporation of a group of subsidiary corporations that filed consolidated returns for 1972 through 1975. Its principal place of business was in Houston, Texas, when the petition was filed. One of the subsidiary corporations in the group is Center Savings and Loan Association (Center).

1. THE POST-EFFECTIVE AMENDMENTS ISSUE

On March 26, 1970, Affiliated made a public offering of 525,000 units of securities at a sale price of $20 per unit. Each unit consisted of two shares of common stock and one warrant to purchase one share of common stock. The proceeds of the offering were to be used to acquire stock in Center and two other savings and loan associations.

The warrants were originally exercisable on June 25, 1970, or such earlier date as might be determined by the underwriters, and were scheduled to expire March 26, 1975. The warrants were later extended to March 26, 1977.

The warrants contained provisions designed to protect their holders against dilution by reason of stock dividends, stock splits, combinations, reclassifications, and the issuance of Affiliated's stock at a price lower than the prevailing warrant purchase price or its issuance of securities convertible into, or evidencing rights to purchase, Affiliated stock at prices below the warrant price.

The costs of the original 1970 offering totaled $982,396.42 consisting of the following:

+------------------------------------+
                ¦Underwriting commissions¦$761,250.00¦
                +------------------------+-----------¦
                ¦Audit fees              ¦86,984.26  ¦
                +------------------------+-----------¦
                ¦Legal fees              ¦60,000.00  ¦
                +------------------------+-----------¦
                ¦Printing costs          ¦74,162.16  ¦
                +------------------------+-----------¦
                ¦Total                   ¦982,396.42 ¦
                +------------------------------------+
                

Of these total original issuance costs, petitioner's accountant allocated 12.1951 percent, or $119,804.22, to the warrants.

In order to offer its stock and warrants for sale to the public, Affiliated was required to file a registration statement in 1970 with the Securities and Exchange Commission (hereinafter the SEC) on Form S-1 pursuant to the provisions of 15 U.S.C. secs. 77e through 77j (1982) (sometimes hereinafter the Securities Act of 1933). This registration statement consists basically of two parts: (1) a prospectus setting forth information relevant to the purchase of the securities and (2) other information used generally by the SEC.

Following the original filing of the SEC registration statement covering the public offering of its stock and warrants, Affiliated was required by the Securities Act of 1933 to file what are called post- effective amendments to that registration statement and prospectus. The purpose of the post-effective amendments is to update the information contained in the registration statement so that it will continue in effect. The post-effective amendments are intended to make information available to warrant holders to assist them in deciding whether to exercise their warrants.

Affiliated incurred expenses in filing post-effective amendments to update its Form S-1 original registration statement. The amounts verified as expended for this purpose in 1972 and 1975 were $48,752.86 and $21,516.78, respectively.

If Affiliated had not complied with the annual updating requirements of the Securities Act of 1933, trading in its warrants could have been suspended by either the stock exchange or the SEC if their exercise price had been less than Affiliated's common stock trading price. In addition, Affiliated would have subjected itself to potential liability to the warrant holders.

2. THE INSTALLMENT OBLIGATION ISSUE

In May 1974, Center, as seller, and Bruce G. Gaylor, Trustee (Gaylor), as purchaser, entered into three earnest money contracts providing for the sale of three contiguous tracts (designated as Tracts A, B, and C, respectively) of land totaling 97.325 acres. The transaction was closed on June 28, 1974, when pursuant to each contract Gaylor made a stated downpayment and gave Center a nonrecourse promissory note. Each note was secured by a vendor's lien on the related tract, and bore interest, which was to be prepaid annually at a rate of 8 percent per annum. Each of the notes called for nine annual payments in stated equal amounts and a final payment of the unpaid balance at the end of the tenth year. The following table shows for each tract the price for which it was sold and the amount of the related note:

+-----------------------------+
                ¦Tract¦Price      ¦Note       ¦
                +-----+-----------+-----------¦
                ¦A    ¦$511,136.00¦$496,320.00¦
                +-----+-----------+-----------¦
                ¦B    ¦539,873.00 ¦523,688.27 ¦
                +-----+-----------+-----------¦
                ¦C    ¦731,916.42 ¦726,586.42 ¦
                +-----------------------------+
                

The notes signed by Gaylor provided that the maker had no personal liability for the payment of the notes and that the holder's sole recourse and remedy was the right to foreclose the lien on the tract to which it pertained.

On the same day, June 28, 1974, Gaylor sold Tract A to Robert H. Bye, Trustee (Bye), Tract B to Robert H. Tennant, Trustee (Tennant), and Tract C to Herbert V. Hildebrand, Trustee (Hildebrand), and closed the transaction simultaneously with the purchase from Center. The consideration for each sale was a down payment and a nonrecourse promissory note which was made payable to Gaylor and which was secured by a vendor's lien on the related tract. Each note, like the ones signed by Gaylor, dated June 28, 1974, called for nine annual payments in stated equal amounts and a final payment of the unpaid balance at the end of the tenth year. The following table shows for each tract the price for which it was sold, the amount of the related note, and the prepaid interest rate thereon:

+-------------------------------------------+
                ¦Tract¦Price      ¦Note       ¦Interest rate¦
                +-----+-----------+-----------+-------------¦
                ¦A    ¦$561,320.56¦$507,933.40¦7.75%        ¦
                +-----+-----------+-----------+-------------¦
                ¦B    ¦577,366.65 ¦529,936.75 ¦7.75         ¦
                +-----+-----------+-----------+-------------¦
                ¦C    ¦892,773.74 ¦854,167.30 ¦7.50         ¦
                +-------------------------------------------+
                

Each note provided that the maker was not personally liable for the payment of the note and that the holder's sole recourse and remedy was the right to foreclose the lien securing the payment thereof. Each of the three notes payable to Gaylor referred to the June 28, 1974, note executed by Gaylor to Center as the ‘Existing Note‘ and to the lien securing it. The liens securing the three notes payable to Gaylor were made subordinate to the liens securing the Existing Notes. The...