Martin, Clara E., Estate of et al. v. Comm.

Decision will be entered for the respondent.

O. C. Parkinson, Esq., for the petitioners. Leonard A. Marcussen, Esq., for the respondent.

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The Commissioner determined deficiencies for the calandar year 1941 as follows:

                             Docket              Excess profits

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Each petitioner assigns as error the action of the Commissioner in treating the loss sustained "upon surrender of trust receipts issued in connection with the reorganization of San Joaquin Building and Loan Association" as a capital loss instead of allowing the amount to be deducted as an ordinary loss or as a bad debt. FINDINGS OF FACT.

Clara E. Martin died on October 24, 1942, and her estate is represented in this proceeding by her duly qualified executors. Irving Martin, Sr., is an individual. He was the husband of Clara. Stockton Daily Record is a California corporation. The returns for the period here in question were filed with the collector of internal revenue at San Francisco, California.

Mercantile Building-Loan Association (sometimes referred to as the association) was a building and loan association organized in 1925 under the laws of California. It issued shares of guaranteed capital stock, membership shares, and investment certificates. The certificates did not make the holders thereof members of the corporation or give them any of the rights, liabilities, or privileges of members. The relation between the association and each certificate holder was that of debtor and creditor. The investment certificates included installment certificates. Additional investments in those certificates could be made at any time and withdrawals could be made subject to written notice of 30 days. The association made a practice of waiving the notice of withdrawal.

Clara E. Martin and Irving Martin, Sr., jointly subscribed for five installment investment certificates in the association. Stockton Daily Record subscribed for one. All of those certificates were issued to the owners prior to January 1936 and some or all were issued prior to 1935, but the exact dates are not shown in the record. The following is typical of the certificate issued: Mercantile Building-Loan Association of California Certificate No. 1880

This Certifies That Irving Martin Sr. or Clara E. Martin has subscribed for and is owner of one unit or more and fractions thereof as indicated by balances shown on pass book attached hereto, of the Installment Investment Certificates of the Mercantile Building-Loan Association, of the par value of 100 each, on which credits may be made at any time and in any amount not less than one dollar, at the option of the holder. Interest will be credited semi-annually, January first and July first, at the rate of six per cent, on all

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sums placed with the Association, subject to regulations of the Board of Control of the Stockton Branch.

This Certificate is issued subject to the Articles, By-Laws and Rules of the Mercantile Building-Loan Association, and to Section 642 of the Civil Code, is non-negotiable, is transferable only on the books of the Association, and no payment will be received, or withdrawal paid, without the presentation of this Certificate.

In Witness Whereof, the said Association has caused this Certificate to be signed by its duly authorized officers, and to be sealed with the seal of the corporation, at Stockton, this 1st day of September, 1930.

Assistant Secretary [Signed] Harold A. Noble, Vice-President Incorporated under the laws of the State of California.

Each certificate was incorporated as a part of a small book in which was kept a record of deposits, withdrawals, interest credited to the account, and the balance in the account on the date of each transaction. The total of the balances shown on the Martin certificates in January 1936 was 38,448.12. The total balance shown on the Stockton Daily Record certificate at that time was 10,755.85. No further entries were thereafter made in the accounts attached to the certificates.

The association became insolvent prior to 1936. It was reorganized in 1936, pursuant to a decree of a California court, under the provisions of the Building and Loan Association Act of California. The association was continued under the slightly changed name of San Joaquin Building and Loan Association. The assets of the association at that time consisted mostly of foreclosed real estate and delinquent loans of uncertain value. The extent of the association's insolvency could not be determined at that time. Each holder of an investment certificate was directed by the terms of the reorganization order to surrender it for cancellation in exchange for (a) a certificate for membership shares of the association of the face value of 70 per cent of the balance shown on his certificate, and (b) a trust receipt representing the remaining 30 per cent of the balance shown in his certificate. The two Martins and the Stockton Daily Record surrendered their investment certificates and received new membership share certificates and trust receipts in 1936 pursuant to the order.

A bank was named trustee. The trust agreement under which the trust receipts were issued required the association to issue to the trustee a certificate for membership shares of the association, having a total face value equal to 30 per cent of the amount due on certificates, to be held by the trustee for a period ending December 31, 1940, for the purpose of offsetting the same against all losses which the association

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might suffer on its assets through sales or depreciation as compared to their appraised value. The shares, while held in trust, were not to be voted or to be counted in determining a quorum. No dividends were to be paid or credited on the shares while held in trust. The loss or profit of the association upon its capital assets in each year was to be charged against or credited to the value of the shares held in trust. An appraisal was to be made of all remaining assets at the end of the trust period and the final deficit or surplus was to be charged or credited upon the shares held in trust. The trustee was then to report to the association the name of each holder of a trust receipt and the amount of credit to which each was entitled. Each holder of a trust receipt was then, upon surrender of the trust receipts, to receive individual certificates for shares of the association in an amount equal to such portion of the final value of the shares held in trust as the 30 per cent represented by his trust receipt would bear to the total original face value of all of the shares held in trust. The following is a copy of a typical trust receipt:

 Trust Receipt

In exchange, there is herewith issued to the above named investor an Accumulative Share certificate of San Joaquin Building and Loan Association of the value of 70 per cent of the sum hereinabove specified.

Accumulative Shares for the remaining 30 per cent of such value are held by a trustee selected by the Building and Loan Commissioner and the Federal Savings and Loan Insurance Corporation, under the terms of a Trust Agreement whereby for five years, or for such lesser period as may be agreed upon by the Building and Loan Commissioner and the Federal Savings and Loan Insurance Corporation, all losses through sale of present capital assets of the association shall be charged, and all profits therefrom shall be credited, to the shares so held in trust. At the expiration of said period, all surplus or deficit shown by appraisals to exist in the remainder of such assets not yet sold, above or below their book cost, shall be charged or credited to said trust shares. Thereupon, upon surrender of this receipt duly endorsed, the holder shall be entitled to a certificate for Accumulative Shares of a value equal to such proportion of the then existing value of the trust shares as 30 per cent of the face value hereinabove specified bears to the total face value of the shares so issued in trust. Shares held under the terms of the above trust do not accrue nor are entitled to dividends while so held, but upon release from the trust they will become entitled to dividends at the same rate as all other shares of like form. Such shares are not entitled to voting rights, nor to be counted in determining a quorum so long as they remain in such trust, but upon release therefrom will be entitled to vote as other shares. The accounts represented by such shares held in trust are not of an insurable type and are not insured by the Federal Savings and Loan Insurance Corporation.

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This receipt is transferable only upon the books of the trustee, upon payment of a fee of 50 cents for recording each transfer. San Joaquin Building and Loan Association, Trustor. By [Signed] Harold A. Noble, Authorized Officer.

(seal) Bank of America N. T. & S. A., Stockton Branch, Trustee. By [Signed] F. H. Fifield, Authorized Officer. Dated Jun 30, 1936.

The membership shares constituted the capital stock of the reorganized association. The holders of those shares were entitled to vote, to hold office, and to share in any profits of the association through declared dividends.

Most of the real estate, delinquent loans and other assets of undetermined value of the association were liquidated prior to 1941. The small remaining amount of unliquidated assets was appraised as of December 31, 1940. The liquidation and appraisal led to a determination in 1941 that the shares held against the trust receipts had a value equal to one-sixth of the face value of those receipts, and membership shares were issued in 1941 to holders of trust receipts, including the Martins and the Stockton Daily Record, representing one-sixth of the face value of the trust receipts, in exchange for the trust receipts.

The amount claimed by the petitioners as a bad debt in 1941 is the difference between the face value of the trust receipts received in 1936 and the par value of membership shares received pursuant to and in exchange for the trust receipts in 1941. Deductions for those amounts were claimed on the returns for 1941 as bad debts.

The Commissioner, in determining the deficiencies in income tax, disallowed as a deduction and added to income "Loss on San Joaquin Building and Loan Association trust receipts 2,403.," with the explanation that the loss was a capital loss and not an ordinary loss.

The Commissioner, in determining the deficiency in excess profits tax against Stockton Daily Record, added to income the amount claimed on the return in connection with the San Joaquin Building and Loan Association trust receipts, and explained that it was a capital loss and not an ordinary loss. ¹

The stipulation of facts is incorporated herein by this reference. OPINION

Both parties to this proceeding recognize that these petitioners sustained losses in 1941. The amount of those losses is not in dispute. The association owed the petitioners certain amounts

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shown as final credits upon their investment certificates at the beginning of 1936. The petitioners have recovered 75 per cent of those debts from their debtor, 70 per cent through shares of the debtor received in 1936, and 5 per cent through additional shares or additional credits to shares in 1941. The remaining 25 per cent of the amounts due upon those investment certificates has been lost. The Commissioner treated those losses as capital losses of 1941 and allowed such limited deductions as are permitted in the case of capital losses. He does not ask for any increase in the deficiency. ²

The petitioners claim that their losses are deductible in full as bad debts under section 23 (k) (1) of the Internal Revenue Code. ³ The respondent agrees that there were debts and he does not raise any question based upon the charge-off requirements of the section. One reason why deductions for 1941 might not be allowed under section 23 (k) (1) for the amount of the debts would be that that provision does not apply, in the case of taxpayers like these, with respect to a debt evidenced by a certificate issued by a corporation in registered form. The respondent argues that the installment investment certificates evidencing the debts due to these petitioners were certificates issued by a corporation in registered form, within the meaning and intent of section 23 (k). The petitioners argue to the contrary. They tacitly agree that their debts were evidenced by certificates issued by the debtor corporation. Cf. City Bond & Finance Co. Ltd. v. Welch, 9 Fed. Supp. 500. They do not advance any convincing argument that those certificates were not "in registered form."

Section 117 (f) of the Revenue Act of 1934 contained language quite similar to that with which we are concerned. The Circuit Court of Appeals for the Second Circuit, in Gerard v. Helvering, 120 Fed. (2d) 235, affirming 40 B. T. A. 64, was considering whether the language of section 117 (f) covered a bond accompanying a mortgage given by a corporation to the taxpayer in obtaining a loan. The Circuit Court

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pointed out that no provision was made for registering any transfer of the bond on any of the books of the corporation and there was no provision that the bond and mortgage could be transferred only by registry or other entry upon the books of the corporation. It then discussed what was meant by the phrase "in registered form." It said that the phrase refers in the case of a bond to one "registered" upon the books of the obligor or of a transfer agent, the purpose being to protect the holder by making invalid unregistered transfers. It pointed out that the bond always provides on its face that it can be transferred only in that way. See also George Peck Caulkins, 1 T. C. 656; affd., 144 Fed. (2d) 482; Rieger v. Commissioner, 139 Fed. (2d) 618, reversing 47 B. T. A. 727; Matilda S. Puelicher, 6 T. C. 300; Encyclopedia of Banking and Finance, Munn, 4th Ed. 1935, p. 620. The explanation of the phrase as it applies to a certificate is not different in principle. The instrument here in question is a numbered certificate issued in the name or names of the creditors. It "certifies" that the person named is the owner of certain units or fractions thereof as indicated by balances shown on a passbook attached to the certificate. It further provides for interest and states that the certificate "is nonnegotiable, is transferable only on the books of the association, and no payment will be received or withdrawal paid, without the presentation of this certificate." It recites that the association has caused the certificate to be signed by its duly authorized officers and to be sealed with the seal of the corporation. Not only have the petitioners failed to show that the certificates were not "in registered form," within the meaning of the statute, but the proof, or at least the irresistible implication from such proof as there is, is that they were in registered form.

The petitioners argue that the meaning of "securities" is the same throughout chapter 1, particularly that it is the same in section 23 (k) (3) and in section 117 (f) as it is in section 112 (b) (3). We disagree. The courts, in considering section 112, have held that short term indebtedness is not an adequate link in the chain of continuing interest necessary to certain reorganizations defined in that section. No question of continuity of interest is involved in the present case and there is no sound reason for bringing such a question into the interpretation of section 23 (k), which supplies its own specific definition of securities.

Consideration of the legislative history of section 23 (k) (3) and of somewhat similar language found in section 117 (f) does not aid the petitioners' case. Congress first provided in section 117 (f) of the Revenue Act of 1934 that amounts received by the holder upon the retirement of bonds, debentures, notes, or certificates or other evidence of indebtedness issued by any corporation with interest coupons or in registered form should be considered as received in exchange

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therefor for the purpose of the capital gain provisions. The courts held, nevertheless, that deductions for bad debts on debts evidenced by such securities were allowed by section 23 (k) of the Revenue Act of 1934 and subsequent revenue acts, and that the capital loss limitations did not touch such losses. Congress then changed 23 (k) in the Revenue Act of 1938 so that the capital loss provisions would apply if certain types of indebtedness described therein became worthless just as would be the case if they were sold or retired at a loss. The present case comes within the letter of the definition of securities given in those changed provisions. These debts were evidenced by certificates issued by a corporation in registered form. It is suggested that they differ from ordinary securities in certain respects. They were somewhat like savings accounts in a bank in that the amount of the debt could be changed by the creditor through deposits and withdrawals. They have no fixed maturity date. The rate of interest was changed apparently, but that must have been by agreement with the creditors, since the certificates expressly provided for interest at a stated rate. However, since they were certificates, one of the classes specifically mentioned in the statutory definition of securities, we could not hold under the principle of noscitur a sociis, or under any other principle, that these certificates were not certificates, since they were not like some other certificates. Nor do we find anything about these certificates which convinces us that they were not of the kind which Congress intended to include in that definition. There is not a sufficient reason for taking this case out of the express language of the statute by resolving any doubt as to the intent of Congress in favor of the petitioners. Cf. Commissioner v. Caulkins, supra. We hold that the debts here in question are not deductible under section 23 (k) (1). Since no justification for disturbing the Commissioner's determination has been advanced by the petitioners, we leave the parties as we found them.

Decision will be entered for the respondent.

² He abandoned an issue raised in amended answers.

³ SEC. 23. DEDUCTIONS FROM GROSS INCOME. * * * * (k) Bad Debts. --

(1) General rule. -- Debts which become worthless within the taxable year; or (in the discretion of the Commissioner) a reasonable addition to a reserve for bad debts; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction. This paragraph shall not apply in the case of a taxpayer, other than a bank, as defined in section 104, with respect to a debt evidenced by a security as defined in paragraph (3) of this subsection.

(2) Securities becoming worthless. -- If any securities (as defined in paragraph (3) of this subsection) become worthless within the taxable year and are capital assets, the loss resulting therefrom shall, in the case of a taxpayer other than a bank, as defined in section 104, for the purposes of this chapter, be considered as a loss from the sale or exchange, on the last day of such taxable year, of capital assets.

(3) Definition of securities. -- As usedin paragraphs (1), (2), and (4) of this subsection the term "securities" means bonds, debentures, notes, or certificates, or other evidences of indebtedness, issued by any corporation (including those issued by a government or political subdivision thereof), with interest coupons or in registered form.