Melcher v. Commissioner
| Decision Date | 24 August 1970 |
| Docket Number | Docket No. 73707,92295. |
| Citation | 1970 TC Memo 237,29 TCM (CCH) 1010 |
| Parties | Estate of Martin M. Melcher, Deceased, Terrance Paul Melcher, Administrator, and Doris Day Melcher v. Commissioner. |
| Court | U.S. Tax Court |
Robert Forst and Morton Rosen, for the petitioners. Eli Blumenfeld and Myron Weiss, for the respondent.
Respondent determined the following deficiencies in income tax:
Docket No. Year Deficiency
73707 1953 ........ $ 64,527.96
1954 ........ 134,547.67
1955 ........ 94,488.80
92295 1956 ........ 120,478.89
1957 ........ 31,747.94
___________
$445,791.26
The issues are: (1) Whether payments in each year in the following amounts were payments of interest on indebtedness within section 23(b), 1939 Code, and section 163(a), 1954 Code; and if not, whether they are deductible as losses, or otherwise:
1953 ........... $ 86,998.25
1954 ........... 143,547.14
1955 ........... 117,447.66
1956 ........... 68,590.68
1957 ........... 63,155.91
___________
$479,739.64
The above payments were made in connection with a transaction in $3,000,000 of Federal Land Bank bonds.
(2) Whether a payment in 1956 of $76,000 was interest on indebtedness within section 163(a), 1954 Code. The payment was made in connection with the purchase of residential real estate.
Martin M. Melcher and Doris Day Melcher, husband and wife, filed joint returns for the taxable years with the district director of internal revenue at Los Angeles, California. When the petitions in these cases were filed, they were residents of Beverly Hills, California.
Melcher died, a resident of California, on April 20, 1968. Terrance Paul Melcher is the administrator of the decedent's estate, appointed by the Superior Court of California for Los Angeles County.
Since the issues relate to transactions of Melcher during his lifetime, he is referred to herein as the petitioner. Such reference does not refer to the administrator of his estate.
Melcher was primarily a motion picture producer during the taxable years. Doris Day Melcher (Doris Day) is an actress and singer. In the transactions involving the Federal Land Bank bonds, Melcher was advised by Jerome B. Rosenthal,1 his lawyer, and other members of Rosenthal's law firm, Rosenthal and Norton. Rosenthal was Melcher's exclusive business and financial adviser, as well as his attorney, during the years involved. Rosenthal also was Doris Day's attorney, and he was a personal friend of the Melchers.
Rosenthal's law firm was located at 242 North Canon Drive, Beverly Hills, during the earlier years involved, and later at 250 North Canon Drive. During 1958 and before, the name of the firm was Rosenthal and Norton.2 The joint returns of the Melchers for each of the years 1953 through 1957 were prepared in the Rosenthal office. The address of the Melchers in the statutory deficiency notices and petitions in these cases is the same as that of Rosenthal's law office.
Rosenthal advised Melcher that he could enter into a transaction, in March 1953, by placing an order with Cantor, Fitzgerald Co. (C-F), in Beverly Hills, a brokerage firm, to purchase for his account $3,000,000 Federal Land Bank bonds bearing 1ž percent interest, under arrangements which would involve executing a note and making monthly payments of "interest" on the note. Rosenthal was acquainted with B. Gerald Cantor, a principal member of the Cantor, Fitzgerald firm, and they arranged the transaction for Melcher, who did not participate in the various steps, except to follow Rosenthal's advice and to sign papers prepared for his signature. Melcher had not ever before negotiated or entered into a securities transaction representing such a large amount. Cantor advised Rosenthal and Melcher that its correspondent in New York City, The Gibraltar Financial Corporation, would participate in the transaction, and that the note would be payable to Gibraltar. Gibraltar carried out most of the steps in the transaction. Melcher was not informed about the various steps taken by Gibraltar and Cantor, Fitzgerald Co.
Gibraltar was incorporated in New York early in 1953 (according to the record in these cases)( by Jack J. Bernstein, who acquired all of Gibraltar's stock for $2,000. Bernstein was a vice-president of C-F, and he was a vice-president and director of Gibraltar during 1953-1956. Thereafter, he became re-associated with C-F as a vice-president. John Fitzgerald was the president and a director of Gibraltar during 1953-1956; he was a vice-president of C-F prior to his employment by Gibraltar. Gibraltar was organized by former members of C-F in order to facilitate the carrying out of transactions resembling the one involved here, and there was a close connection between Gibraltar and C-F. The evidence does not show Gibraltar's working capital, cash position, net worth, or liquid assets in March 1953, or during the years involved. Gibraltar was not subject to the regulations of the Securities and Exchange Commission (SEC); and it was not a member of, or subject to the regulations of, the New York Stock Exchange.
The following sets forth in summary the arrangements which are in issue, which began as of March 11, 1953; were concluded as of September 6, 1957; and were closed by a payment by Melcher on December 4, 1957, of $11,131.20. Hereinafter are several schedules. The transaction involved Cantor, Fitzgerald (C-F) in Beverly Hills, which acted as Melcher's broker, and its clearance agent in New York City, Chemical Bank & Trust Co.; Gibraltar in New York City and its clearance agent in New York, Irving Trust Co., where Gibraltar maintained an account; and C. F. Childs & Co., a securities dealer in New York City.
1. On March 11, 1953, C-F purchased $3,000,000 Federal Land Bank bonds, bearing 1ž percent interest, due October 1, 1957, callable October 1, 1955. The interest on the bonds was payable on April 1 and October 1, $26,250 on each date, $52,500 a year. The purchase price of the bonds was, at the market price of 95-14/32, $2,863,125. The broker's statement made out as a charge to Melcher, set forth a total charge of $2,888,333.34:
Purchase price, 95-14/32 ........... $2,863,125.00
Commission of C-F .................. 1,875.00
Bond interest accrued to 3/11/53 ... 23,333.34
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Total Charge ..................... $2,888,333.34
Melcher did not make any payment on account for this charge.
2. The bonds were in New York. On March 11, 1953, upon Gibraltar's order, C. F. Childs sold the bonds at 95-13/32 (1/32 of 1 point less than the purchase price) for the net amount $2,885,520.84, which was $2,812.50 less than the purchase price. Irving Trust handled this step.
3. The bonds were purchased and sold on March 11, 1953. The mechanics used were: C-F instructed Chemical Bank to deliver the bonds to Irving Trust, Gibraltar's clearance agent, against payment of $2,888,333.34. Gibraltar instructed Irving Trust "to receive" them from Chemical against payment, and to deliver them against payment to C. F. Childs Co., which had sold them. Irving charged Gibraltar's account $2,888,333.34, and credited the account $2,885,520.84, leaving a balance on the books owing by Gibraltar to Irving of $2,812.50.
4. On March 11, 1953, Gibraltar opened an account on its books in the name of Melcher, a "Secured Account", in which an entry was made that $3,000,000 Federal Land Bank bonds due 10/1/57 had been "Bought or Received" for the account, and were held "Long"; also Melcher's account was charged $3,156,000, which represented the face amount of a promissory note of Melcher payable to Gibraltar. This entry reflected the execution of the note.
5. The face amount of the note represented the total of $2,888,333.34 the cost of the bonds, and $267,666.66 a "reserve" fund. The $2,888,333.34 was never paid to or loaned to Melcher; Gibraltar did not have that sum to loan to Melcher. Gibraltar paid Melcher, by checks, between March 11, 1953, and October 1, 1955, $267,666.66 in installments on about the same dates as Melcher made payments, by checks, of installments of purported "interest" on his note. The facts about both installment payments are set forth later.
6. Melcher executed a printed note of Gibraltar dated March 11, 1953, in the amount of $3,156,000, payable to Gibraltar on October 1, 1955, bearing 4z percent interest, payable in monthly installments on the dates and in the amounts typed on the note. This note was security for the purported loan by Gibraltar to Melcher of the above amount, and it was stated on the note that it was secured by the pledge to Gibraltar of the $3,000,000 Land Bank bonds, as described hereinbefore.
The provisions of the note included the following: That Gibraltar had the right to borrow, re-hypothecate, use, or transfer the pledged bonds for any purpose whatsoever, and at its option to use the pledged bonds "to cover delivery of any securities of similar kind which may have been sold to others by The Gibraltar Financial Corporation, as principal and for its own account." The note provided further that the signer of the note, Melcher, could obtain the return of the pledged bonds, or "collateral of like kind" upon the full payment of the principal of the note, together with interest due, on the due date, October 1, 1955, or upon payment of the indebtedness, with interest, prior to September 1, 1955, (which would be a prepayment of the note before its due date). However, there was a charge for the exercise of the right to make prepayment of the note before its due date of 1? percent per year of the principal amount from the date of prepayment to...
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