RL Blaffer & Company v. COMMISSIONER OF INTERNAL REVENUE
| Decision Date | 17 May 1938 |
| Docket Number | Docket No. 81007,87762. |
| Citation | 37 BTA 851 |
| Parties | R. L. BLAFFER & COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Board of Tax Appeals |
Walter E. Barton, Esq., and J. L. Block, C. P. A., for the petitioner.
DeWitt M. Evans, Esq., for the respondent.
The Commissioner determined deficiencies of $15,734.03, $11,866.06, and $12,649.78 in petitioner's income tax for the fiscal years ending September 30, 1932, 1933, and 1934, respectively, by computing income and applying the rate of tax prescribed by section 104 (a) of the Revenue Act of 1932. Petitioner charges error in the application of this section, denying that it was formed, used, or availed of to prevent the imposition of surtax on its shareholders. In an amended answer, the Commissioner prays the addition to income for the fiscal years ending in 1933 and 1934 of gains from the sales of securities by petitioner to its shareholders, but only in the event that section 104 (a) is held applicable.
FINDINGS OF FACT.
The petitioner, a Texas corporation with principal office at Houston, Texas, was organized on September 18, 1929, by R. L. Blaffer:
* * * to subscribe for, purchase, invest in, hold, own, assign, pledge, and otherwise deal in and dispose of shares of capital stocks, bonds, mortgages, debentures, notes, warrants, rights, and other securities or obligations, contracts and evidences of indebtedness of foreign or domestic companies as permitted under the laws of Texas, and to have and to perform all powers necessary and incidental to the conduct of such a business.
Blaffer organized petitioner on the recommendation of W. E. Barton, his attorney, and J. L. Block, a certified public accountant and tax consultant, who recommended the step as a means of facilitating stock trading. Blaffer also expected that his son, then in college, would take an active interest in petitioner's business. The son was later made a director and assistant secretary.
Two years before petitioner was formed, Barton and Block had made a survey of Blaffer's properties, consisting chiefly of securities, and, after an extensive consideration of the tax laws, had advised that a transfer of all the property to a corporation would decrease prospective inheritance taxes and facilitate the estate's administration. They did not think that it would effect any substantial saving in income taxes, partly because "* * * it would be necessary * * * for the corporation to distribute a portion of its earnings, * * *" to avoid the 50 percent tax imposed on corporate income if gains and profits were accumulated to relieve shareholders of surtaxes. They also recommended that portions of the stock of the proposed corporation be transferred to trusts for the benefit of the several members of Blaffer's family. Blaffer's properties then had a value of about five million dollars.
When petitioner was formed, the community property of Blaffer and his wife had a value of thirteen and a quarter million dollars, of which thirteen million dollars was the value of stocks and bonds of eighty corporations organized in eighteen different states and Canada. Their liabilities were three million dollars.
Petitioner's capital of $250,000 was represented by 2,500 shares of a par value of $100 each. Of these shares, 1,275 were issued to Blaffer, 1,222 to his wife, and one qualifying share each to three other individuals, in consideration of Blaffer's transfer to petitioner of stocks and bonds issued by corporations of 12 states. The fair market value of these stocks and bonds was $1,540,158.80. They had cost Blaffer $968,961.75, and when transferred to petitioner they were held as collateral by brokerage firms for Blaffer's indebtedness of $968,961.75, which petitioner assumed. On petitioner's opening balance sheet, the transferred securities were listed as assets at a value of $1,218,961.75, which amount comprised their cost to Blaffer and the par value of the capital stock. The excess of fair market value over the book value, $321,197.05, was not entered on the books.
Petitioner's business and activities consisted of buying, selling, and investing in stocks and bonds.
Petitioner kept its books and filed its income tax returns on the basis of a fiscal year ending September 30. For the fiscal years 1930 to 1934, inclusive, its books indicate the following receipts, losses, and disbursements:
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| Dividends | Interest | Trading | Total
| | received | profits |
-----------------------------|-------------|------------|-------------|--------------
1930 _______________________ | $64,332.32 | $3,530.43 | $100,227.85 | $168,090.60
1931 _______________________ | 60,500.00 | 2,457.96 | 7,714.50 | 70,672.46
1932 _______________________ | 40,415.90 | 2,032.50 | 130,422.91 | 172,871.31
1933 _______________________ | 38,972.53 | 2,706.50 | 32,341.08 | 74,020.11
1934 _______________________ | 52,234.51 | 4,409.71 | 32,736.49 | 89,380.71
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| Interest | Trading | Minor |
| paid | losses | expenses | Total
-----------------------------|-------------|------------|-------------|--------------
1930 _______________________ | $109,856.59 | $48,986.09 | $2,057.38 | $160,900.06
1931 _______________________ | 64,147.00 | 2,185.00 | 738.05 | 67,070.05
1932 _______________________ | 62,601.63 | 75,141.92 | 106.91 | 137,850.46
1933 _______________________ | 38,953.98 | 10,487.53 | 837.89 | 50,279.40
1934 _______________________ | 38,371.40 | Nil | 1,212.33 | 39,583.73
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Net
1930 _____________________________________________ $7,190.54
1931 _____________________________________________ 3,602.41
1932 _____________________________________________ 35,020.85
1933 _____________________________________________ 23,740.71
1934 _____________________________________________ 49,796.98
Petitioner never declared or paid a dividend. Its shareholders did not include in their reported gross income their distributive shares of petitioner's net income for any year.
Earned surplus based upon petitioner's books was as follows:
1930 __________________________________________ $6,900.54
1931 __________________________________________ 10,502.95
1932 __________________________________________ 58,003.87
1933 __________________________________________ 71,843.60
1934 __________________________________________ 123,552.28
Comparative balance sheets, as of the end of the fiscal years, taken from petitioner's books, indicate:
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| Assets | Liabilities | Net worth
----------------------------------|---------------|---------------|---------------
1930 ____________________________ | $2,616,293.94 | $2,356,733.17 | $259,560.77
1931 ____________________________ | 3,133,945.60 | 2,404,146.54 | 263,163.18
1932 ____________________________ | 2,554,963.71 | 1,761,598.73 | 793,364.98
1933 ____________________________ | 2,752,558.47 | 1,945,353.76 | 807,204.71
1934 ____________________________ | 3,230,107.45 | 1,923,694.06 | 1,306,413.39
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The assets consisted almost entirely of stocks and bonds, all of which were held by brokers as collateral, and of cash of $342.51 in 1932, $23,950.09 in 1933, and $3,966.84 in 1934. The liabilities were practically all to brokers; $7,035.25 was owed to Blaffer in 1932 and 1933. The net worth comprised a contributed capital surplus of $485,361.11 in 1932 and 1933, and of $932,861.11 in 1934.
Shortly after petitioner's organization, sharp drops in the stock market greatly reduced the market value of its assets, and on December 10, 1931, Blaffer and his wife transferred to it, as paid-in surplus, 13,563 shares of Humble Oil & Refining Co. stock having a value of $637,461. Petitioner sold the stock at that price on December 26, following, and applied the proceeds to its brokerage accounts. The cost of these shares to Blaffer was $486,686.65. Again, on December 26, 1933, Blaffer and his wife made a further contribution to paid-in surplus of 10,000 shares of Standard Oil Co. of New Jersey having a value of $447,500. This stock was used as collateral for petitioner's brokerage accounts. As a result of the great decline in market values, petitioner's securities were worth much less at the end of its fiscal years than the figure at which they were carried on its books; its total assets' value was in fact less than its liabilities, as shown by the table below:
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| Book value | Market value | Liabilities
--------------------------|---------------|---------------|---------------
1931 ____________________ | $2,667,309.72 | $906,127.54 | $2,404,146.54
1932 ____________________ | 2,554,963.71 | 801,841.38 | 1,761,598.73
1933 ____________________ | 2,752,558.47 | 1,453,712.82 | 1,945,353.76
1934 ____________________ | 3,230,107.45 | 1,800,075.71 | 1,923,694.06
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Petitioner's brokerage accounts were personally guaranteed by Blaffer, and all of its securities were kept on deposit with brokers as collateral for the accounts.
Blaffer was petitioner's president and sole directing head. In ...
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