Gen. American Investors Co. v. Comm'r of Internal Revenue
| Decision Date | 30 December 1952 |
| Docket Number | Docket No. 36220. |
| Citation | 19 T.C. 581 |
| Parties | GENERAL AMERICAN INVESTORS COMPANY, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Robert A. McDowell, Esq., for the petitioner.
Arthur L. Nims, Esq., for the respondent.
Held, that payments received by a corporation because of ‘insiders'‘ profits pursuant to section 16 (b) of the Securities Exchange Act of 1934 and section 30 (f) of the Investment Company Act of 1940 constituted ordinary income to the corporation under section 22 (a), I.R.C. Park & Tilford Distillers Corporation v. United States (Ct. Cl.), 107 F.Supp. 941.
Respondent determined a deficiency of $57,922.55 for the calendar year 1948. By appropriate assignment of error petitioner contests the entire deficiency and alleges the following error:
The Commissioner erroneously determined that the petitioner realized taxable income of $157,038.04 by its receipt in 1948 of $170,038.04 (in connection with the receipt of which it was entitled to an allowance of legal expenses of at least $13,000 which it did not deduct on its return) pursuant to Section 30 (f) of the Investment Company Act of 1940 and Section 16 (b) of the Securities Exchange Act of 1934.
All the facts have been stipulated and are found accordingly.
Petitioner is a corporation organized under the laws of the State of Delaware, with its principal office in New York, New York. Petitioner is a registered closed-end investment company as defined in the Investment Company Act of 1940.
A Federal income tax return for the calendar year 1948, prepared on an accrual basis, was filed by petitioner with the collector of internal revenue for the second district of New York.
On or about April 1, 1944, an individual who was one of petitioner's directors, hereinafter referred to as ‘Director,‘ acquired warrants to purchase shares of the common stock of petitioner at five different prices ranging from $10 to $20 per share, the warrants covering an equal number of shares at each price. On the basis of his average cost of all the warrants then so acquired, the warrants to purchase 12,228 shares of petitioner's common stock which he exercised as stated hereafter had a cost basis to the Director of $4,800.
On or about April 1, 1944, a second individual, hereinafter referred to as ‘Stockholder‘ also acquired warrants of the type referred to above. On the basis of his average costs of all the warrants then so acquired, the warrants to purchase 27,027 of the 28,532 shares of petitioner's common stock which he exercised as stated hereafter had a cost basis to the Stockholder of $10,609.22. The Stockholder owned more than 10 per cent of the then outstanding warrants at all times between June 5, 1945, and June 17, 1946.
Between June 5, 1945, and June 17, 1946, the Director, individually and through a partnership of which he was a member, sold on the New York Stock Exchange an aggregate of more than 12,228 shares of petitioner's common stock in blocks of various sizes and for various amounts. Between June 5, 1945, and June 17, 1946, the Stockholder, individually, and through a partnership of which he was a member, sold on the New York Stock Exchange 27,027 shares of petitioner's common stock in blocks of various sizes and for various amounts.
On December 4 and 18, 1945, the Director exercised warrants to purchase an aggregate of 12,228 shares of petitioner's common stock at an average purchase price of $13.75 per share. On December 4 and 18, 1945, the Stockholder exercised warrants to purchase 28,532 shares of petitioner's common stock at an average purchase price of $13.75 per share. Of the proceeds received by the petitioner at the time of the exercise of the warrants by the said persons, $1 per share was credited to the petitioner's capital account and the balance thereof was credited to the petitioner's capital surplus account.
Pursuant to the provisions of section 30 (f) of the Investment Company Act of 1940 and section 16 (b) of the Securities Exchange Act of 1934, the above-described persons were required to pay in to the petitioner certain ‘profits‘ (as that term is used in the Securities Exchange Act of 1934) which they had realized upon the sale and purchase, or purchase and sale, of petitioner's common stock during the period June 5, 1945, to June 17, 1946, inclusive. The only purchases of petitioner's common stock by the above-described persons during said period were the purchases upon the exercise of the warrants described above. The determination of the ‘profits‘ so realized is tabulated as follows:
+-----------------------------------------------------------------------------+
¦ ¦Stockholder ¦Director ¦
+---------------------------------------+------------------+------------------¦
¦ ¦Shares¦Amount ¦Shares¦Amount ¦
+---------------------------------------+------+-----------+------+-----------¦
¦a. Proceeds of sales ¦27.027¦$511,593.42¦12,228¦$254,027.33¦
+---------------------------------------+------+-----------+------+-----------¦
¦b. Subscription to common stock ¦27,027¦371,621.25 ¦12,228¦168,135.00 ¦
+---------------------------------------+------+-----------+------+-----------¦
¦c. Cost of warrants ¦ ¦10,609.22 ¦ ¦4,800.00 ¦
+---------------------------------------+------+-----------+------+-----------¦
¦d. Calculated “profit” on sales ¦ ¦ ¦ ¦ ¦
¦required to be paid in to petitioner ¦ ¦$129,362.95¦ ¦$81,092.33 ¦
¦(line a minus the sum of lines b and c)¦ ¦ ¦ ¦ ¦
+-----------------------------------------------------------------------------+
Of the above set forth amount of $81,092.33 required to be paid by the Director, $40,417.24 was paid by him to the petitioner on March 9, 1946, and the remainder thereof, together with the entire amount required to be paid by the Stockholder, was paid to petitioner on January 26, 1948. These amounts received by petitioner were received without litigation and were paid by the said persons upon the advice of their counsel that they were liable to petitioner therefor.
The $40,417.24 received in 1946 from the Director was in that year credited to petitioner's capital surplus account. The amounts received from the said persons in 1948 as aforesaid were recorded by petitioner in its cash book as ‘Capital Surplus— add'l amt recd in connection with common stock issued in 1945,‘ and the aggregate amount so received in 1948 was credited to petitioner's capital surplus account. Thereafter, on March 31, 1948 (after receiving a letter-ruling from the Bureau of Internal Revenue dated February 26, 1948, to the general effect that the said amount received in 1948 should be returned as income), petitioner debited its capital surplus account for the said amount and credited a receipts-in-suspense account with an equal amount. At the close of the year 1948, the receipts-in-in suspense account was debited with the amount of a reserve for taxes in respect of the amounts received in 1946 and 1948, and with the amount of legal expenses incurred up to December 31, 1948, in respect of the amounts recovered in that year, and the balance of $92,038.04 in said receipts-in-suspense account was simultaneously transferred to capital surplus.
Petitioner expended the sum of $13,000 as legal fees in connection with the recovery of the amounts due from the Director and the Stockholder, which fees respondent allowed as a credit against the gross amount received.
From the foregoing facts we find the following ultimate facts: The amounts which were paid to the petitioner by the Director and by the Stockholder under compulsion of section 16 (b) of the Securities Exchange Act of 1934 and section 30 (f) of the Investment Company Act of 1940 constituted gross income to the petitioner for the year 1948.
The applicable statutes in this proceeding are section 22 (a) of the Internal Revenue Code, section 30 (f) of the Investment Company Act of 1940, 54 Stat. 837, 15 U.S.C. section 80a-29 (f) and section 16 (b) of the Securities Exchange Act of 1934, 48 Stat. 896, 15 U.S.C. section 78p (b). Section 22 (a) of the Code is so familiar that it is unnecessary to incorporate it herein. The other two applicable statutory provisions are printed in the margin.1
The only question presented is whether amounts which were paid to the petitioner in 1948 by certain persons under compulsion of section 16 (b) of the Securities Exchange Act of 1934 and section 30 (f) of the Investment Company Act of 1940, both printed in the margin, constitute income to the petitioner. The statutes in question were designed to curb the abuses of short term speculations in securities based on inside information or power to manipulate corporate policy. See S. Rept. No. 792, 73d Cong., 2d Sess. (1934), at pp. 7-9. William F. Davis, Jr., 17 T.C. 549. Section 16 (b), supra, provides that any profits realized by corporate insiders from ‘any purchase and sale, or any sale and purchase, of any equity security * * * (of their own corporation) within any period of less than six months, * * * shall inure to and be recoverable by‘ the corporation.
The instant case presents the same issue as was involved in Park & Tilford Distillers Corporation v. United States (Ct. Cl.), 107 F.Supp. 941. The Court of Claims held that the ‘insider profits‘ were taxable income to the recipient corporation under the broad provisions of section 22 (a), I.R.C., as ‘gains or profits and income derived from any source whatever.‘ The fact that the income represented nondeductible penalty payments to the payors was not deemed to militate against their taxability.
Petitioner in its brief argues that:
* * * the relevant fact is that a section 16 (b) recovery does not...
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