*1114 1. The return charged for the use of money loaned in small amounts is "interest" as that word is used in section 353(a), Revenue Act of 1936, as amended by the Revenue Act of 1937, and, therefore, taxpayer whose business consisted of making small loans was taxable as a personal holding company where its interest income constituted more than 80 percent of its gross income, and more than 50 percent of its stock was owned by not more than five individuals.
2. Where petitioner filed no personal holding company return on Form 1120H as required by the law and the applicable regulations and failed to show that its failure to file such a return was due to reasonable cause, the penalty provided by section 291 of the Revenue Act of 1936 was correctly imposed.
*510 The respondent determined a deficiency against petitioner in personal holding company surtax for the fiscal year ended March 31, 1938, in the amount of $8,582.40 and a penalty for failure to file a personal holding company return, Form 1120H, in the amount of $2,145.60.
The statement attached*1115 to the deficiency notice recites, among other things:
It is held that you are subject to the surtax on personal holding companies as provided in section 351 of the Revenue Act of 1936 for the reason that at least 80% of your gross income was derived from interest and more than 50% of your stock weas owned by not more than five individuals during the last half of the taxable year.
Inasmuch as you failed to file a personal holding company tax return, 25 percentum of the tax has been added thereto in accordance with the provisions of section 291 of the Revenue Act of 1936.
The petitioner contests the determination of the deficiency and penalty by appropriate assignments of error, and asks for a redetermination of its tax liability.
*511 FINDINGS OF FACT.
The petitioner is a corporation, with its principal office in Atlanta, Georgia.
It filed its income and excess profits tax return with the collector of internal revenue for the district of Georgia, at Atlanta, Georgia.
Petitioner was organized in 1935 under the laws of the State of Georgia. During its taxable year ended March 31, 1938, more than 50 percent in value of its outstanding common stock weas owned*1116 by or for not more than five individuals. On February 28, 1938, its charter was amended to change its name from "Seaboard Loan and Savings Association, Inc." to "Seaboard Loan Corporation."
Petitioner was organized for the purpose of engaging in the general loan business or the general savings business or both. Its operations are in the nature of those of a building and loan association. Under the powers granted in its charter petitioner may make loans to members, and to nonmembers in the manner provided by title 16, section 101, of the Code of Georgia, 1933. Its loans may be unsecured or secured in whole or in part, by personal endorsement and its own fully paid or installment stock, or its own fully paid or installment "investment certificates", or by personal or real property, or upon such other form of security as it may deem best.
Any person subscribing for or holding one or more shares of stock or one or more permanent investment certificates of the association is a member of the association.
The petitioner's method of doing business is to make each borrower a member of the association by selling him 2 percent "investment certificates", having a face value of $5 each, *1117 equal to the face amount of the loan, payable in monthly installments with interest at 6 percent. The borrower in turn pledges these certificates as collateral for his loan. When the purchase price of the "investment certificates" has been fully paid, the certificate is applied against the loan and each is canceled. The borrower never actually receives and holds the 2 percent investment certificate. He does not pay the 6 percent interest specified in the note given for their purchase price, nor does petitioner pay any interest on the certificates at 2 percent. The investment certificates are merely used as a method of handling payments on the loans. They are not set up as a liability on petitioner's books.
The borrower is required to fill out an "application for loan", giving certain personal and financial information, family connections, and references required therein. Thereafter, appraisers inspect the borrower's property and file a written report as to its value. Petitioner then secures the borrower's credit rating from the Credit Service Exchange by telephone.
*512 If the loan is granted, the borrower signs a note for the full amount of the loan, payable at*1118 the end of a given number of months and secured by a bill of sale or deed covering the property to be used as security, and the borrower purchases "Two percent investment certificates" equal to the face value of his loan and gives his note payable in installments for the purchase price.
If the loan is made the borrower is required to pay a service charge of 2 percent of the face amount of the loan. The service for which this charge is made includes the appraisal of his property, the checking of his credit rating, the preparation of mortgage deeds, bills of sale, and other papers, notarization of papers, and recording services. These charges were carried on petitioner's books under separate headings designated "fees" or "investigating fees." At the end of the year the balance in this account was transferred to profit and loss. In the taxable year ended March 31, 1938, the petitioner collected "fees" in this manner in the amount of $20,519.71.
The notes given for loans are discounted at 8 percent of their face value. This discount plus the 2 percent service or investigation fee and the recording fee are subtracted from the face of the note and the borrower is given a check*1119 for the balance. If a loan is renewed at the expiration date an additional fee of $2 is charged.
With respect to each loan made a "jacket" containing records of the transaction was kept by the Association. Each of these jackets contained the credit service report obtained as result of check-up on the applicant's credit standing. In making the credit investigation the Association obtained a report from the credit service exchange at a cost of from 25 cents to $1 for each report. Where the loan was joint, an affidavit of disclaimer was obtained and filed in each case where one of the joint obligors failed to join in the mortgage deed or bill of sale. The jacket also contains the original note and a typed summary of the transaction which shows the amount of the loan, the interest, the investigating and reporting fee, the total amount of deduction, and the amount of the check that is given the borrower. This served as the basis for permanent bookkeeping records of the Association.
A typical example of the summary of the loan transaction referred to above is shown by petitioner's Exhibit No. 4, E. E. Bengtson, borrower, and is as follows:
| Amount of loan | $400.00 | |
| Interest | $32.00 | |
| Investigating | 8.00 | |
| Recording fee | .75 | 40.75 |
| Amount of check | 359.25 |
*1120 *513 About 50 percent of the loans made by the Association from time to time became delinquent. In the case of a delinquency, due to the system of making nonthly payments and the fact that the average loan was small, an additional burden was thrown upon the Association of making additional bookkeeping entries. The delinquent borrower would have to be contacted; the outside men would make the call upon him; and occasionally the delinquent would be taken into court. In the case of these delinquencies the Association charged the delinquent borrower a fine. The fine was not levied in each instance of delinquency, the office manager exercising his discretion in favor of the borrower in cases where there was a reasonable excuse, such as unemployment or illness. The imposition and collection of these fines was authorized by article X of the Association's bylaws. The fines in the taxable year in question amounted to $8,940.48.
All sums of money received from discount, fees, and fines are deposited in the general account of the petitioner at the bank and not earmarked in any way.
From the date of its incorporation petitioner has employed a staff of eleven persons, two of*1121 whom are appraisers and investigators. Each of the appraisers is furnished by the Association with an automobile and gasoline to enable him to perform his duties.
During the taxable year petitioner had loans outstanding in the average amount of $325,000. The average number of loans was about 2,750 and the average individual loan was approximately $118. The petitioner makes no loans for less than 12 months and the average period for which loans are made is approximately 15 months.
For the taxable year ended March 31, 1938, petitioner reported income as follows:
| Accrued income (interest from notes) | $49,171.55 |
| Fees charged | 20,519.71 |
| Fines | 8,940.48 |
| Other income | 1,009.12 |
| Total | 79,640.86 |
In the taxable year ended March 31, 1937, petitioner had net earnings of $21,750.61 and paid dividends in that year in the amount of $34,500. In the year ended March 31, 1938, petitioner had net earnings of $33,457.77 and paid dividends of $23,000. The determination to pay only $23,000 in 1938 was made January 11, 1938, and was based upon the assumption of George K. Spring, certified public accountant, who had charge of auditing petitioner's books and preparing its income*1122 tax returns, that the petitioner had a dividend carry-over in excess of $11,000 from the previous year.
No personal holding company return on Form 1120H was filed by petitioner for the taxable year ended March 31, 1938. This was due *514 to the opinion of the auditor who made out the returns that the income from interest was less than the 80 percent of gross income required by the statute.
The Seaboard Loan & Savings Association, Inc., was in competition with the Morris Plan Bank and other similar banking organizations operating in Atlanta, Georgia, and it had constant need for its capital.
OPINION.
BLACK: The issues presented for decision are whether the respondent erred in determining that the petitioner was a personal holding company in the taxable year and in assessing a penalty of 25 percent for failure to file a personal holding company return on Form 1120H.
Although the taxable year of petitioner which is before us ended March 31, 1938, the Revenue Act of 1836 is the applicable act. This is so because section 1 of the Revenue Act of 1938 provides that "The provisions of this title shall apply only to taxable years beginning after December 31, 1937." The*1123 taxable year before us began April 1, 1937.
The applicable provisions of the 1936 Act and regulations thereunder are printed in the margin. 1
*1124 The petitioner concedes that more than 50 percent of the value of its outstanding stock is owned by not more than five of its stockholders, but denies that 80 percent of its gross income for the taxable year was personal holding company income within the meaning of the statute Counsel for the petitioner argues that the collection from "fees" and "fines" are not interest; that Congress did not intend to include operating small loan companies within the scope and operation of the act; *515 and that petitioner should not be subject to a penalty for failure to file a return. The respondent contends that "fees" and "fines" received by petitioner from its debtors were amounts received for the use of money loaned and, therefore, come within the term "interest" as defined in the statute and applicable regulations.
Petitioner's gross income for the taxable year was $79,640.86. Of this amount $49,171.55 was admittedly interest from notes; $20,519.71 was from "fees" charged (2 percent of the face value of the loan for investigation); and $8,940.18 was from fines. It is, therefore, obvious that unless the amounts collected as "fees" are considered as interest, 80 percent of petitioner's*1125 gross income for the taxable year was not personal holding company income within the statutory definition. The case, therefore, turns on whether amounts collected by petitioner from its debtors of 2 percent on each loan made for "investigation" are in fact "interest" within the meaning of the statute and regulations. The question of whether fines are interest becomes immaterial to the decision of the case if we hold that the 2 percent collected on each loan for "investigation" is interest, because in that event concededly more than 80 percent of petitioner's gross income in the taxable year would be from interest.
The questions raised here have heretofore been before the Board and the courts and have been decided adversely to the petitioner's contentions. Seaboard Small Loan Corporation,42 B.T.A. 715">42 B.T.A. 715; Girard Investment Co. v. Commissioner, 122 Fed.(2d) 843, affirming memorandum opinion of the Board. Both Seaborard Small Loan Corporation and Girard Investment Co., supra, were decided on authority of *1126 Noteman v. Welch, 108 Fed.(2d) 206.
*516 All of the questions raised here were raised in Noteman v. Welch, supra, and were decided adversely to the petitioner's contentions.
The petitioner's argument that the segregation on its books of amounts received for "fees", "fines", and "interest" differentiates this case from the Noteman case, supra, and the Girard case, supra, is not persuasive. In both those cases amounts collected from the borrower for services were treated as interest, i.e., amounts paid by the borrower for the use of money loaned. In those cases, as in the instant case, substantially all the services charged for were for the benefit of the lender and not for the benefit of the borrower, and the only consideration received for the amounts paid by the borrower was the money loaned. As to the fines paid, the court in Noteman v. Welch, supra, indicates there might be a difference, but, as we have already stated, it is unnecessary to decide that question in this proceeding.
Petitioner urges that Congress never intended to include small loan corporations such as petitioner within*1127 the provisions of the personal holding company provisions of the applicable revenue act. This question was thoroughly considered by the courts of appeal in both the Noteman v. Welch and Girard Investment Co.v. Commissioner cases, and weas decided adversely to petitioner's contentions. In both cases the legislative history of section 351 was reviewed by the court. On the authority of these cases we decide this issue in favor of the Commissioner.
The second issue is whether petitioner is liable for the 25 percent penalty which the Commissioner has added to the tax in accordance with the provisions of section 291 of the Revenue Act of 1936.
The evidence shows that petitioner did not file a personal holding company return on Form 1120H for the taxable year ended March 31, 1938. Petitioner's accountant, who prepared petitioner's return on Form 1120, testified at the hearing and gave as his reason for not preparing a return for petitioner as a personal holding company on Form 1120H: "Simply that in my opinion the amount of the interest did not reach the necessary 80 percent."
This being the state of the evidence, we think petitioner has failed to show that its*1128 failure to file a personal holding company return on Form 1120H was due to reasonable cause. Lone Pine Lawn Corporation,41 B.T.A. 638">41 B.T.A. 638; affd., Lone Pine Lawn Corporation v. Helvering, 121 Fed.(2d) 935. On this issue we sustain respondent.
Decision will be entered for respondent.
Footnotes
1. Title IA of the Revenue Act of 1936, as amended by the Revenue Act of 1937 provides, among other things, as follows:
"SEC. 351. SURTAX ON PERSONAL HOLDING COMPANIES.
"There shall be levied, collected, and paid, for each taxable year (in addition to the taxes imposed by Title I), upon the undistributed adjusted net income of every personal holding company a surtax equal to the sum of the following:
"(1) 65 per centum of the amount thereof not in excess of $2,000; plus
"(2) 75 per centum of the amount thereof in excess of $2,000."
"SEC. 352. DEFINITION OF PERSONAL HOLDING COMPANY.
"(a) GENERAL RULE. - For the purposes of this title and of Title I the term 'personal holding company' means any corporation if -
"(1) GROSS INCOME REQUIREMENT. - At least 80 per centum of its gross income for the taxable year is personal holding company income as defined in section 353; * * *
"(2) STOCK OWNERSHIP REQUIREMENT. - At any time during the last half of the taxable year more than 50 per centum in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals."
* * *
"SEC. 353. PERSONAL HOLDING COMPANY INCOME.
"For the purposes of this title the term 'personal holding company income' means the portion of the gross income which consists of:
"(a) Dividends, interest, royalties (other than mineral, oil, or gas royalties), annuities."
* * *
"SEC. 358. ADMINISTRATIVE PROVISIONS.
"All provisions of law (including penalties) applicable in respect of the taxes imposed by Title I of this Act, shall insofar as not inconsistent with this title, be applicable in respect of the tax imposed by this title * * *."
Regulations 94, as amended by T.D. 4791 (1 C.B. 102">1938-1 C.B. 102), is as follows:
"ART. 353-1. Personal holding company income. - The term 'personal holding company income' means the portion of the gross income which consists of the following:
* * *
"(2) Interest. - The term 'interest' means any amounts, includible in gross income, received for the use of money loaned."
Section 291, Title I, of the Revenue Act of 1936 is as follows:
"SEC. 291. FAILURE TO FILE RETURN.
"In case of any failure to make and file return required by this title, within the time prescribed by law or prescribed by the Commissioner in pursuance of law, unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the tax: 5 per centum if the failure is for not more than thirty days with an additional 5 percentum for each additional thirty days or fraction thereof during which such failure continues, not exceeding 25 per centum in the aggregate. The amount so added to any tax shall be collected at the same time and in the same manner and as a part of the tax unless the tax has been paid before the discovery of the neglect, in which case the amount so added shall be collected in the same manner as the tax. The amount added to the tax under this section shall be in lieu of the 25 per centum addition to the tax provided in section 3176 of the Revised Statutes, as amended." ↩