Stern Bros. & Co. v. Comm'r of Internal Revenue
| Decision Date | 08 February 1951 |
| Docket Number | Docket No. 19579. |
| Citation | 16 T.C. 295 |
| Parties | STERN BROTHERS & CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
1. Petitioner, a dealer and broker in securities, carried all securities in inventory prior to March 20, 1943, whether they were owned by it and held for sale to customers, owned by it and held for investment, or simply in its possession as agent for its customers. On March 20, 1943, petitioner established a separate investment account. Certain securities then owned by petitioner were transferred to the investment account on that date. Certain securities also owned by petitioner prior to March 20, 1943, were transferred to the investment account after that date during the taxable years. Certain other securities also owned by petitioner prior to March 20, 1943, remained in inventory throughout the taxable years. Certain securities acquired by petitioner after March 20, 1943, were entered in the investment account at once. Held, that certain of above mentioned securities owned by petitioner were held for sale to customers during the taxable years and thus did not constitute capital assets within section 117(a)(1) of the Internal Revenue Code. Held, that certain of the above mentioned securities owned by petitioner were held for purposes other than sale to customers during the taxable years and thus constituted capital assets within section 117(a)(1) of the Code. Held, further, that the remainder of the securities owned by petitioner were first held for sale to customers and then subsequently were held for purposes other than sale to customers during the taxable years and thus constituted capital assets within section 117(a)(1) only during the latter period.
2. A dividend received in 1945 from a security owned by petitioner was designated by the issuing corporation as a capital gain dividend. Held, that the issuing corporation was a regulated investment company within section 361 of the Code in 1945 and this dividend was a capital gain dividend within section 362(b)(7) of the Code.
3. Petitioner kept its books and filed its returns upon a hybrid system of accounting which was predominantly accrual in nature. Held, that respondent was authorized under section 41 of the Code to make certain adjustments to petitioner's returns in accordance with the accrual basis.
4. Held, that the excess profits tax deficiency of petitioner for each of the years 1942, 1943, and 1944, to the extent determined under Rule 50, must be accrued as a liability in that year and must be subtracted in computing its accumulated earnings and profits as of the beginning of the succeeding taxable year.
5. Held, that petitioner is entitled, to the extent excess profits tax liability is determined, to accrue as an asset in each of the taxable years 1942, 1943, and 1944 the postwar refund credit provided by section 780 of the Code and to reflect such credit in its accumulated earnings and profits at the beginning of the succeeding taxable year. Reece A. Gardner, Esq., John H. McEvers, Esq., and G. Lee Burns, Esq., for the petitioner.
George E. Gibson, Esq., for the respondent.
Respondent determined a deficiency in petitioner's declared value excess-profits tax for the year 1944 in the amount of $1,943.12, and deficiencies in petitioner's excess profits tax for the years 1942, 1943, 1944, and 1945 in the respective amounts of $6,657.62, $34,251.40, $53,820.66, and $39,787.94. Petitioner denies that it is liable for any of the above-determined deficiencies. Two of the issues raised by the pleadings were disposed of by oral stipulation of the parties at the hearing. The remaining issues for our determination are as follows:
1. Were certain securities owned by petitioner capital assets within the meaning of section 117(a)(1) of the Code during the taxable years so it was proper to credit the dividends received thereon in computing petitioner's excess profits net income under section 711(a)(2)(A) of the Code?
2. Were certain securities owned by petitioner capital assets within the meaning of section 117(a)(1) of the Code during the taxable years so that gains realized therefrom in the form of sales and liquidating dividends were excludible in computing petitioner's excess profits net income under section 711(a)(2)(D) of the Code?
3. If it be determined that stock of Lehman Corporation owned by petitioner was not a capital asset, did a dividend thereon in 1945 qualify as a capital gain dividend under section 362(b)(7) of the Code, so as to be excludible in computing petitioner's excess profits net income in that year under section 711(a)(2)(D)?
4. Did respondent err in adjusting certain items on petitioner's tax returns in accordance with the accrual basis of keeping books and filing returns?
5. If it be determined that respondent was authorized to adjust items on petitioner's tax returns in accordance with the accrual basis, was it proper for the Commissioner to accrue in each of the taxable years, 1942, 1943, and 1944 the excess profits tax liability for that year here in dispute, and subtract such liability from petitioner's accumulated earnings and profits as of the beginning of the succeeding taxable year?
6. To the extent the above question be answered in the affirmative, was petitioner entitled to accrue as an asset in each of the years 1942, 1943, and 1944 the postwar refund credit provided by section 780 of the Code and to reflect such credit in its accumulated earnings and profits at the beginning of the succeeding taxable year?
Part of the facts were stipulated and are so found.
Petitioner is a corporation organized under the laws of the State of Delaware with its principal place of business located at 1009 Baltimore Avenue, Kansas City, Missouri. Its returns for taxable years 1942 through 1945 were filed with the collector of internal revenue for the sixth district of Missouri. It was organized over 30 years ago and since that time it has been and now is engaged in the investment banking business. Its business consists generally of underwriting and distributing security issues, managing and assisting in corporate reorganizations, and handling securities both as a dealer and as a broker. In addition to its business activities, petitioner also purchases and holds securities for its own investment. Petitioner has never been a member of a stock exchange. A trading department was maintained during the taxable years for the purchase and sale of securities by petitioner both as principal and as agent. This department kept a position record showing at all times the securities available for sale to customers. Petitioner's salesmen were instructed they were not to sell any securities not listed on the daily position sheet. Securities held by petitioner for sale to customers and those held for investment were never segregated physically during the taxable years.
Prior to March 20, 1943, all securities in petitioner's possession were carried in inventory. Some of these securities were acquired and held for sale to customers, some were acquired and held for other purposes such as investment, and some were not owned by petitioner but were in its possession as purchasing or selling agent for its customers. Before that date petitioner maintained no separate investment account on its books, and consequently those securities held for investment were not segregated on its books in any manner from the securities which constituted the dealer business. It was the accounting practice of petitioner at all times to compute its gross income from security sales by the use of inventories. All securities carried in inventory were valued at cost or market, whichever was lower.
Some time prior to March 20, 1943, petitioner's president, Sigmund Stern, discovered that some securities held for investment purposes had been sold to customers by mistake, and he gave instructions this was not to occur again, and to make certain of this he directed that certain securities be taken out of inventory and transferred to a separate investment account. Following this instruction an investment account was set up on the books of petitioner, and certain securities were transferred out of inventory to this new account by a journal entry on March 20, 1943, reading in part as follows:
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