1938 BTA LEXIS 854">*854 Corporations which had absorbed large earnings in their business of making small loans were not formed or availed of for the purpose described in section 104(a) of the Revenue Acts of 1928 and 1932.
38 B.T.A. 560">*561 The Commissioner determined deficiencies as follows:
| Name | Docket No. | Year | Amount |
| Seaboard Security Co | 79970 | 1932 | $10,875.02 |
| Seaboard Small Loan Corporation | 79971 | 1932 | 36,797.26 |
| Southern Security Co | 79972 | 1932 | 11,324.19 |
| Do | 79973 | 1931 | 13,039.92 |
A number of issues have been settled by agreement and the only issue in each case is whether the provisions of section 104 of the Revenue Acts of 1928 and 1932 apply.
FINDINGS OF FACT.
Scott B. Appleby, Jr., has been engaged in the small loan business since 1901. He first operated as an individual, then through a corporation for several years, then as an individual again. He, at all times material hereto, devoted practically all of his time to the management of the business of1938 BTA LEXIS 854">*855 these petitioners and was responsible for their success. His chief ambition was to build up, through the petitioners, a large volume of business. He furnished the capital and property used in the business and obtained credit when necessary. His return for 1931 showed tax due in the amount of $1.44 upon a balance of $127.58 after deducting dividends, $6,520.05; personal exemption, $3,500; and credit for dependent, $400, from net income of $10,547.63. He reported for 1932 net income of $2,587.28, which included dividends of $7,280.42. He claimed a personal exemption of $2,500 and a credit for dependent of $400. His return showed no tax due. His salaries for each of those years from the petitioners were $12,000 from the Seaboard Small Loan Corporation and $3,000 from each of the other two.
Seaboard Small Loan Corporation.
This petitioner was incorporated by Appleby in 1924 under the name of Seaboard Security Co., a Virginia corporation. Shortly thereafter its name was changed to Seaboard Small Loan Corporation. Appleby's purposes in forming it were to combine his various offices so that management, bookkeeping, and financing might be consolidated, simplified, and made1938 BTA LEXIS 854">*856 more convenient for him, to bring about greater cohesion and economies, and to permit the business to continue in case of his death. The corporation was not formed for 38 B.T.A. 560">*562 the purpose described in section 104(a) of the Revenue Act of 1932.
The Corporation operated under the Uniform Small Loan Act as enacted in Virginia. It has had from eight to twelve branch offices in Virginia, Tennessee, and Georgia. The assets with which it began business were transferred to it by Appleby in exchange for 250 shares of its capital stock and the petitioner's note for $345,000. The assets were worth $627,548.41 and the petitioner had a paid-in surplus of $32,548.41 at its inception. The indebtedness to Appleby was reduced a little later when the Atlanta assets were sold back to Appleby and by him transferred to the two Georgia corporations. This indebtedness had been reduced to $50,000 prior to 1932.
The following are the opening and closing balance sheets of the petitioner for the year 1932:
| Opening | Closing | |
| ASSETS | ||
| Cash | $14,388.42 | $28,614.74 |
| Accounts receivable | 40,000.00 | |
| Small loans receivable | 776,924.50 | 631,788.77 |
| Furniture and fixtures | 16,958.44 | 17,528.29 |
| Automobiles | 4,314.25 | 1,792.75 |
| Buildings | 30,090.00 | 70,090.00 |
| Total | 882,675.61 | 749,814.55 |
| Less depreciation | 16,264.18 | 18,954.42 |
| 866,411.43 | 730,860.13 | |
| Land | 139,910.00 | 297,410.00 |
| Investments | 14,000.00 | |
| Special deposit account | 51,000.00 | 51,000.00 |
| S. B. Appleby, trustee | 100,608.72 | 145,527.79 |
| Total | 1,157,930.15 | 1,238,797.92 |
| LIABILITIES | ||
| Notes payable | $50,000.00 | $50,000.00 |
| Accounts payable | 1,600.21 | 1,600.21 |
| Mortgages | 65,000.00 | 160,000.00 |
| Dividends payable | 6,000.00 | |
| Notes payable bank | 35,500.00 | |
| Capital stock | 345,089.00 | 345,089.00 |
| Stock dividends | 125,000.00 | 502,500.00 |
| Surplus: | ||
| Paid in | 52,728.49 | 52,728.49 |
| Earned | 483,012.45 | 120,880.22 |
| Total | 1,157,930.15 | 1,238,797.92 |
1938 BTA LEXIS 854">*857 Small loans receivable exceeded $800,000 at the close of 1929. The S. B. Appleby, trustee, item ranged from a low of $19,295.93 at the close of 1924 to a high at the close of 1932 and disappeared at the close of 1934. The mortgages were on real estate purchased for the purpose of obtaining credit. They were gradually reduced. The petitioner's gross income for 1932, amounting to $325,099.92, included rents, $10,094.10; recovery of bad debts, $15,475.46; and charges on small loans, $299,518.25. Its expenses for that year amounted to $282,682.11 and included a charge-off of $124,970.36 for bad debts. The bad debt charge-off for previous years ranged from $27,857.04 in 1926 to $81,992.54 in 1930. The petitioner paid Federal income tax of $13,070.27 for 1932, which was slightly less than the average for the five-year period ending in 1932. It paid cash dividends of $5,000 in 1927, $7,500 in 1928, $3,000 in 1929, and $9,000 in 1932. It distributed stock dividends of $125,000 in 1928 and $502,500 in 1932, and in 1932 canceled the stock dividend of $125,000 distributed in 1928. The increase in capital from $250,000 in 1928 to $345,098 thereafter is not explained.
38 B.T.A. 560">*563 1938 BTA LEXIS 854">*858 The petitioner was not availed of during 1932 for the purpose described in section 104(a) of the Revenue Act of 1932.
The Commissioner in determining the deficiency applied section 104 of the Revenue Act of 1932.
Seaboard Security Co.
This petitioner was organized in 1925, under the laws of Georgia, to take over a part of the Atlanta business of the petitioner now known as the Seaboard Small Loan Corporation. The purpose for which it was organized was to avoid the tax which Georgia imposed upon foreign corporations doing business in the state. It was not formed for the purpose described in section 104 of the Revenue Act of 1932.
It began business with assets worth $111,213.05 which the Seaboard Small Loan Corporation had sold to Appleby and which Appleby had immediately transferred to this petitioner in exchange for all of its stock ($10,000) and its note for $70,000. This gave it a paid-in surplus of $31,213.05. It engaged exclusively in the small loan business under the Uniform Small Loan Act as enacted in Georgia. It gradually paid off its indebtedness to Appleby so that $50,000, which was still due at the beginning of 1932, was paid during that year. This petitioner1938 BTA LEXIS 854">*859 from 1926 through 1931 had a small line of credit with banks which it desired and tried to build up, but the difficulties were too great and the loans were paid off.
The following are the balance sheets for the beginning and end of the year 1932:
| Dec. 31, 1931 | Dec. 31, 1932 | |||
| ASSETS | ||||
| Cash | $2,354.32 | $2,991.34 | ||
| Notes receivable | 147,874.94 | 114,226.15 | ||
| Trustee account (spec. funds) | 70,649.82 | 114,280.32 | ||
| Furniture and fixtures, auto, and improvements on leased property | $2,364.50 | $2,550.03 | ||
| Less: Reserve for depreciation | 1,141.60 | 1,222.90 | 1,509.22 | 1,040.81 |
| Total | 222,101.98 | 232,538.62 | ||
| LIABILITIES | ||||
| Notes payable (S.B.A.) | 50,000.00 | 50,000.00 | ||
| Notes payable (banks and others) | 3,000.00 | |||
| Capital stock | 10,000.00 | 10,000.00 | ||
| Surplus: | ||||
| Paid in | 31,213.05 | 31,213.05 | ||
| Earned | 127,888.93 | 141,325.57 | ||
| Total | 222,101.98 | 232,538.62 |
Notes receivable for prior years ranged from $103,497.20 at the close of 1925 to $151,709.41 at the close of 1930. The trustee account ranged from nothing at the close of 1924 to $54,091.72 at the close of 1930. Gross income for 1932 amounted to $56,887.74, and consisted1938 BTA LEXIS 854">*860 38 B.T.A. 560">*564 entirely of interest and recovery on notes. Expenses amounted to $39,110.15, including a charge-off of $12,796.78 for bad debts. Bad debt charge-offs for previous years ranged from $2,553.15 in 1928 to $14,513.29 in 1931. It paid Federal income tax of about $2,500 annually and paid dividends of $2,000 annually from 1927 through the taxable year.
It was not availed of during 1932 for the purpose described in section 104(a) of the Revenue Act of 1932.
The Commissioner in determining the deficiency applied section 104 of the Revenue Act of 1932.
Southern Security Co.
This petitioner was organized in 1924, under the laws of Georgia, to take over a part of the Atlanta business of the petitioner now known as the Seaboard Small Loan Corporation. The purpose for which it was organized was to avoid the tax which Georgia imposed upon foreign corporations doing business in the state. It was not formed for the purpose described in section 104 of the Revenue Acts of 1928 and 1932.
The assets, worth $113,098.95, with which this petitioner began business were sold by Seaboard Small Loan Corporation to Appleby, who then transferred them to this petitioner in exchange1938 BTA LEXIS 854">*861 for all of its stock ($10,000) and its note for $95,000. Thus, it had a paid-in surplus of $8,098.85. It paid $15,000 on its debt to Appleby in 1926 and the balance during 1933. It began to purchase automobile finance paper in December 1931, and thereafter that branch of its business grew rapidly, requiring all of the capital which it could obtain, while its small loan business declined.
Its balance sheets for the period here involved were as follows:
| 1930 | 1931 | 1932 | |
| ASSETS | |||
| Cash | $718.48 | $505.75 | $10,905.20 |
| Trustee account | 73,140.73 | 73,896.43 | 57,486.23 |
| Auto finance notes | 32,469.10 | ||
| Small loan accounts | 133,096.25 | 144,030.67 | 121,180.48 |
| Total | 206,955.46 | 218,432.85 | 222,041.01 |
| LIABILITIES | |||
| Notes payable (S.B.A.) | $80,000.00 | $80,000.00 | $80,000.00 |
| Notes payable (banks and others) | 5,000.00 | ||
| Capital stock | 10,000.00 | 10,000.00 | 10,000.00 |
| Surplus: | |||
| Paid in | 8,098.85 | 8,098.85 | 8,098.85 |
| Earned | 103,856.61 | 120,334.00 | 123,942.16 |
| Total | 206,955.46 | 218,432.85 | 222,041.01 |
38 B.T.A. 560">*565 The trustee account for prior years ranged from nothing at the close of 1924 to $58,531.75 at the close of 1929. The petitioner had gross income of $54,447.631938 BTA LEXIS 854">*862 in 1931 and $58,813.92 in 1932. Its expenses were $34,319.80 for 1931 and $51,085.23 for 1932. It charged off $6,566.10 for 1931 and $18,630.33 for 1932 as bad debts. Bad debt charge-offs for prior years had ranged from $2,219.39 for 1928 to $12,646.51 for 1930. It paid Federal income tax of between $1,650.44 and $2,798.95 annually. It paid annual dividends of $2,000, beginning in 1927, except for 1929 when only $1,000 was paid.
It was not availed of during 1931 or 1932 for the purpose described in section 104(a) of the Revenue Acts of 1928 and 1932.
The Commissioner in determining the deficiencies applied section 104 of the Revenue Acts of 1928 and 1932.
Scott B. Appleby Trustee Account.
None of these corporations ever had a bank account, except the minor accounts of the branch managers necessary to operate their offices. The branch managers were bonded for small amounts, usually about $5,000. It was the policy of each petitioner to call upon each branch manager promptly for all accumulations of cash in his hands in excess of the amount of his bond. The petitioner then charged the amounts received to an account on its books called either "Scott B. Appleby, Trustee" 1938 BTA LEXIS 854">*863 or "Trustee account." The balance in each of these three accounts was held by Appleby and the money was deposited by him in a bank under his own name. If a branch needed additional money, the money would be furnished, sometimes by transfer from another branch, but usually by a personal check from Appleby. All such transactions were accounted for through these trustee accounts. Appleby sometimes made purchases of securities or of real estate for the petitioners and those transactions were accounted for through these trustee accounts. Such purchases were made for the purpose of having permanent assets which would be useful in obtaining credit from banks. Appleby at all times had on deposit in bank an amount equal to or in excess of the amount charged to him in the trustee accounts. He received no interest upon bank deposits and paid none to petitioners. The excess funds were handled in this way for convenience and safety so that Appleby, who traveled from one branch to another, could place funds quickly where they were most needed. The balance charged to Appleby increased as business declined and decreased as the demand for loans increased. Appleby tried to anticipate the needs1938 BTA LEXIS 854">*864 of the business, i. e., he invested excess funds in income producing assets which would be useful in obtaining credit, but he tried to retain as ready cash amounts sufficient to meet the anticipated needs of the business.
38 B.T.A. 560">*566 Bad Debts.
The petitioners did not set up any account for a reserve for bad debts. They charged off each year debts ascertained to be worthless in that year. The officers believed that about 10 percent of their small loans outstanding would approximate the amount of their loss from bad debts. This would be increased sharply in case of legislation reducing the interest rate on small loans. Such legislation was being urged in Georgia during 1931 and 1932 and was adopted in 1935.
OPINION.
MURDOCK: These cases are separate, although they were heard together. The question in each is whether that particular petitioner was formed or availed of within the taxable year for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed. Sec. 104(a) of the Revenue Acts of 1928 and 1932. The purposes behind the formation1938 BTA LEXIS 854">*865 of these corporations have been explained by the witnesses. They were business purposes as opposed to tax reducing or avoiding purposes. There was no thought of avoiding surtaxes upon Appleby, who was the sole original stockholder. We have no hesitation in holding that none was formed for the purpose described in section 104.
The question of whether any one, or more, was availed of for that purpose is somewhat more difficult to answer because it involves consideration of a complication of figures in each case. These were not mere holding or investment companies within the meaning of section 104(b), nor has the Commissioner made any finding that any one had permitted its gains and profits to accumulate beyond the reasonable needs of its business. The evidence indicates that such was not the case.
Seaboard Small Loan in 1931 was using almost all of its available funds in its business. That business fell off somewhat in 1932 and the corporation had more funds than it was able to use in that particular year. But the reasonably anticipated needs of the future would absorb all of those excess funds. Those in charge believed that the demand for small loans would increase as1938 BTA LEXIS 854">*866 soon as business recovered somewhat and then all of the available funds would be used in the business once more. There is no evidence to the contrary. Subsequent events bore out the expectation which the witnesses had in 1931 and 1932.
Appleby paid but little Federal income tax. In some years he could have received increased dividends from these corporations without having to pay any tax or no more than a negligible amount. His 38 B.T.A. 560">*567 reason for not paying dividends was not to avoid taxes on the shareholders, but was to build up the business of the corporations so that they could earn more. The business was able to absorb the earnings just about as fast as they were realized. Cash was the stock in trade of these corporations, and they had to have an ample supply constantly and readily available. Their business was a highly competitive one. They were relatively small corporations as compared to their principal competitors. The business was rather risky. Large amounts were lost annually in bad debts. Adverse legislation was a threat. Considering all of the circumstances, it seems reasonably clear that no one of these three corporations ever had on hand an excess of1938 BTA LEXIS 854">*867 earnings beyond the reasonable needs of its business.
Appleby did not withdraw funds from the business for his own use either directly through loans or indirectly through any other channel. The trustee accounts were not used by him for that purpose. The evidence shows that those accounts had a real business purpose and that they did not benefit Appleby personally in any way, except that they enabled him to conduct the business of these corporations more conveniently. The corporations at most times owed him more than he owed them. Appleby was constantly trying to build up Seaboard Small Loan to the point where bankers and investors would be interested in it as a credit risk. He seems to have attained his goal a few years after the years in question. But even during these years he was not merely putting earnings aside for the future but was currently using those earnings except as business temporarily declined during the unusual business depression.
Decision will be entered under Rule 50.