*181 Decisions will be entered under Rule 50.
1. Amounts equivalent to dividends paid by petitioner on account of stock borrowed for short sale transactions, held, deductible business expenses under section 23 (a) of the Internal Revenue Code. Dart v. Commissioner, 74 Fed. (2d) 845, and W. Hinckle Smith, 44 B. T. A. 104, followed.
2. Expenses incurred by petitioner in maintaining an office in connection with his stock trading business and legal fees paid in connection with income tax litigation, held, deductible expenses under section 23 (a) of the Internal Revenue Code.
3. Interest charged to petitioner by broker on debit balances of marginal accounts, held, paid by petitioner in the taxable year within the meaning of G. C. M. 23111, C. B. 1942-1, p. 47, and deductible under section 23 (b) of the Internal Revenue Code.
*1149 Respondent determined deficiencies in petitioner's income tax liability as follows:
| Docket No. | Year | Deficiency |
| 108911 | 1936 | $ 28,505.28 |
| 1937 | 10,738.61 | |
| 1939 | 9,600.68 | |
| 112741 | 1940 | 24,504.01 |
By stipulation, certain issues have been conceded by petitioner. The remaining questions are as follows:
1. Whether petitioner, under section 23 (a) of the Internal Revenue Code, can deduct amounts, equivalent to dividends, paid by him on account of stock borrowed to effectuate short sales of such stock.
2. Whether petitioner can, under section 23 (a) of the Internal Revenue Code, deduct the expenses of maintaining an office in connection with his stock dealings and certain legal fees paid in connection with certain income tax*183 litigation.
3. Whether petitioner can, under section 23 (b) of the Internal Revenue Code, deduct certain interest charged to him by his broker on the debit balances of his accounts.
Petitioner filed his returns for the taxable years with the collector of internal revenue at Detroit, Michigan. Docket Nos. 108911 and 112741 were consolidated for hearing. The record consists of oral testimony, stipulations of fact, and exhibits. The facts are found as stipulated. Other findings are based on oral testimony and exhibits.
FINDINGS OF FACT.
Petitioner is an individual, residing at 19472 Suffolk Drive, Detroit, Michigan. He filed his Federal income tax returns on a cash and calendar year basis.
Since July 1932 petitioner has opened various accounts with the stock brokerage firm of Paine, Webber & Co., hereinafter referred to as P & W. P & W were members of the New York Stock Exchange. The following schedule shows the designations of the various accounts *1150 opened by petitioner with P & W, the opening dates and the closing dates, if prior to December 31, 1940:
| Date closed, | |||
| Account | Date opened | if prior to | |
| Dec. 31, 1940 | |||
| Collateral account | July 31, 1932 | Open | |
| Account No. 2 | July 29, 1932 | Open | |
| 3 | Aug. 18, 1932 | Open | |
| 4 | Jan. 29, 1936 | Open | |
| 5 | Feb.1, 1936 | Jan. 19, 1938 | |
| 6 | Feb.1, 1936 | Jan. 19, 1938 | |
| 7 | Feb.1, 1936 | Jan. 19, 1938 | |
| Special cash account | Oct. 14, 1937 | Open | |
| Special account | Aug. 9, 1932 | * Mar. 23, 1933 |
Account No. 2 was opened by petitioner for the purpose of making short sales. During the entire history of this account it has been used by petitioner exclusively for the purpose of making short sales of General Motors Common stock, purchases to cover such sales, and deliveries into such account of General Motors stock to close out short sales theretofore made.
The collateral account was opened by petitioner for the purpose of depositing therein securities as collateral for his No. 2 and other accounts with P & W. The securities in the collateral account were not used to cover short sales in account No. 2, but only as collateral for that and other accounts. Petitioner initially deposited 10,000 shares of General Motors common stock in the collateral account.
The following schedule shows the long and short position of petitioner with respect to General Motors common stock as reflected by the collateral and No. 2 accounts on December 31 of the taxable years:
| Shares long | Shares short | |
| Year | in collateral | in account |
| account | No. 2 | |
| 1936 | 17,405 | 16,700 |
| 1937 | 16,705 | 16,700 |
| 1938 | 16,705 | 15,700 |
| 1940 | 16,205 | 15,700 |
P & W, in accordance*185 with established brokerage practice, credited to petitioner in the collateral account the dividends payable on the number of shares of General Motors common stock in which petitioner was long in that account on dividend dates during each of the taxable years. P & W likewise charged to petitioner in account No. 2 the dividends payable on the number of shares of General Motors common stock in which petitioner was short in that account on dividend dates during the taxable years. The dividends so credited to petitioner in *1151 the collateral account and so charged to him in account No. 2 for the taxable years are as follows:
| Dividends | Dividends | |
| credited in | charged in | |
| Year | collateral | account |
| account | No. 2 | |
| 1936 | $ 78,322.50 | $ 76,725 |
| 1937 | 65,718.75 | 62,625 |
| 1939 | 58,542.50 | 55,250 |
| 1940 | 62,268.75 | 58,875 |
In his income tax returns for the years 1936 and 1937 petitioner offset the dividends charged against him in account No. 2 against the dividends credited to him in the collateral account, and reported as dividend income in each year only the excess of the dividends credited in the collateral account over the dividends charged in account No. 2. In his returns*186 for 1939 and 1940 he reported as dividend income the amount of the dividends credited to him in his collateral account for each year, less the portion thereof credited on account of borrowed shares which he had deposited in the account, and he claimed as deductions against gross income in the returns for 1939 and 1940 the dividends charged against him in those years, respectively, in account No. 2. Respondent in his determination of a deficiency has considered the dividends credited to petitioner in the collateral account less those on borrowed shares as taxable income to him and has disallowed as offsets or deductions the dividends charged against him in account No. 2 for each of the years 1936, 1937, 1939, and 1940.
The following is a summary of the number of shares of stock bought and sold by petitioner through his accounts with P & W and other brokers, and the consideration involved from 1936 to 1940, inclusive:
| Shares purchased | Shares sold | |||
| Year | ||||
| Number | Amount | Number | Amount | |
| 1936 | 41,106 | $ 1,763,674.04 | 36,100 | $ 1,553,052.97 |
| 1937 | 21,200 | 596,632.50 | 28,410 | 729,989.47 |
| 1938 | 6,000 | 164,199.00 | 9,670 | 161,561.72 |
| 1939 | 900 | 22,571.70 | 5,425 | 117,544.48 |
| 1940 | 2,000 | 37,598.50 | 3,575 | 83,168.21 |
| Total | 71,206 | 2,584,675.74 | 83,180 | 2,645,316.85 |
*187 The decline in petitioner's trading activities commencing in 1938 was largely due to a decline in market values in that year and thereafter. Regulation T promulgated by the Board of Governors of the Federal Reserve System, effective January 1, 1938, increased the margin required for short sales, which further restricted petitioner's short selling activities.
*1152 From 1932 until November 1, 1937, petitioner engaged in no other business activities aside from his trading in stock. After November 1, 1937, and until January 1, 1938, petitioner was employed by the National Bank of Detroit. On the latter date and throughout the taxable years petitioner was employed by the Wabeek State Bank of Detroit. Petitioner reported in his returns the following amounts as salary received by him from these banks from 1937 to 1940, inclusive:
| Year | Bank | Salary |
| 1937 | National Bank of Detroit | $ 350.00 |
| 1938 | do | 980.00 |
| 1938 | Wabeek State Bank of Detroit | 1,200.00 |
| 1939 | do | 2,450.00 |
| 1940 | do | 2,812.50 |
Petitioner's duties with these banks concerned credits and loans and required him to keep informed concerning stock market trends and conditions as they affected listed securities. *188 Petitioner, while employed by these banks from 1937 to 1940, inclusive, continued to maintain his own business office in connection with his personal market activities. Petitioner kept in daily contact with his employee, Earnshaw, either by telephone or by having Earnshaw call at the bank. Petitioner also maintained daily contact with his brokers during this period and personally gave all orders to purchase or sell stock on his accounts. After banking hours petitioner worked at his own office with Earnshaw, analyzing reports and statistics bearing on petitioner's trading activities.
Petitioner during the taxable years was engaged in the business of trading in securities.
From 1936 to 1940, inclusive, petitioner maintained an office in Detroit for the purpose of carrying on his stock market operations. During 1936 and until late in 1937 petitioner employed a Miss Youngblood as his secretary and bookkeeper in such office. In 1937 petitioner employed Earnshaw on a full time basis, who performed various research and statistical services in connection with petitioner's stock trading activities. In addition to such work Earnshaw assumed Miss Youngblood's bookkeeping activities when*189 she left petitioner's employ late in 1937.
In connection with maintaining such office, petitioner incurred and paid the following expenses during 1936, 1937, 1939, and 1940:
| 1936 | 1937 | 1939 | 1940 | |
| Office rent, light and telephone | $ 1,690.33 | $ 845.67 | $ 125.15 | |
| Salaries | $ 1,820 | 2,850.00 | 1,770.00 | 1,950.00 |
| Miscellaneous | 599.36 | 835.45 | 149.25 | |
| Total | 1,820 | 5,139.69 | 3,451.12 | 2,224.40 |
*1153 Petitioner in his income tax returns for 1937, 1939, and 1940 claimed the respective amounts of $ 5,139.69, $ 3,451.12, and $ 2,224.40 as deductions, which were disallowed by respondent. Petitioner did not claim the salary of $ 1,820 paid by him as a deduction on his 1936 return. On March 5, 1940, however, petitioner filed a claim for refund of taxes in the amount of $ 234 on account thereof, which has been disallowed by respondent.
During the calendar year 1940 petitioner paid the sum of $ 1,500 to attorneys for services in representing him in a proceeding before this Court (then the United States Board of Tax Appeals) involving his income tax liability for the years 1933, 1934, and 1935. Petitioner claimed the $ 1,500 so paid as a deduction on his 1940 income*190 tax return. Respondent has disallowed this deduction.
During the calendar year 1940 petitioner maintained five accounts with P & W. In those accounts which had average credit balances throughout the year, P & W credited petitioner with interest on the credit balances. In those accounts which had average debit balances throughout the year, P & W charged petitioner interest on the debit balances. The following schedule shows the interest credited and charged to petitioner by P & W on his various accounts for 1940:
| Account | Interest | Interest | |
| credited | charged | ||
| Collateral account | $ 13,453.16 | ||
| Special cash account | 566.74 | ||
| Account No. 4 | 255.78 | ||
| 3 | $ 7,094.95 | ||
| 2 | 8,121.44 | ||
| Total | 14,275.68 | 15,216.39 |
During 1940 there was in effect a continuing agreement between petitioner and P & W originally executed by petitioner on July 20, 1936. This agreement provided in pertinent part as follows:
I hereby advise you that the following accounts carried by you in my name are to be kept and handled separately merely for my convenience but they are to be considered as one and the same for the purpose of computing margins:
* * * *
In consideration of your carrying*191 the above mentioned accounts, or of your opening any new account or accounts in my name which may be designated or identified with a number, I agree that you shall have a lien on and may hold as collateral security for said account or accounts and for any and all debit balances, liabilities, obligations and losses thereon, and for any and all obligations, any and all securities, equities, obligations and credit balances of mine which you may at any time have or hold in your possession or in any account or accounts for me at any time, or such parts thereof as may be necessary in your discretion.
P & W kept its books during 1940 on the cash receipts and disbursements basis. Interest credited or charged to a customer was computed monthly on the basis of the cash debit or credit balance of such customer's *1154 account or accounts. P & W maintained for each customer an interest account. In such interest account were entered each month as credits and debits the interest computed on such customer's debit or credit balances. For each trading account maintained by a customer involving interest a separate debit or credit entry was made in the interest account of such customer. Net*192 debits or credits in the interest account were respectively considered as interest received or paid by P & W by virtue of either a decrease or increase in the customer's overall equity or margin with P & W.
In his books of account during 1940 petitioner treated and recorded as interest received the interest credits to the collateral account, the special cash account, and account No. 4. Petitioner treated the interest charges to account No. 3 and account No. 2 as interest paid. In his income tax return for 1940 petitioner reported as gross income the interest credited to him and claimed as deductions the interest charged to him by P & W. Respondent has disallowed as a deduction the $ 8,121.44 interest charged to petitioner in 1940 on account No. 2, but has otherwise accepted petitioner's treatment in his return of the other above mentioned interest credits and charges.
OPINION.
The first question is whether the dividends charged to petitioner with respect to account No. 2 can be offset or deducted by him as business expenses under section 23 (a) (1) of the Internal Revenue Code. 1 The dividends charged in the years 1936, 1937, and 1939 are involved in Docket No. 108911, and the*193 dividends charged in 1940 are involved in Docket No. 112741. Respondent contends that such dividend charges are capital expenses which should be included in the cost basis of the stock purchased to cover the short sales.
There is no question that the sales transacted through account No. 2 are short sales. The parties have so stipulated. Nor apparently is there any question that petitioner was engaged in the business of trading in securities. We have found as a fact that he was so engaged. Respondent does not contend on brief to the contrary nor do we think, on the facts of this case, it could be successfully argued that petitioner was not so engaged. Consequently, we are not here concerned with the type of situation*194 involved in such cases as Deputy v. duPont, 308 U.S. 488">308 U.S. 488, and Gladys G. Terbell et al., Executors, 29 B. T. A. 44; affd., 71 Fed. (2d) 1017.
Under these circumstances the present question is controlled in favor of petitioner by Dart v. Commissioner, 74 Fed. (2d) 845, and *1155 W. Hinckle Smith, 44 B. T. A. 104. These cases hold that amounts equivalent to dividends paid on account of stock borrowed to make short sales are deductible business expenses for a taxpayer engaged in the business of stock trading. The Dart case, supra, was cited with apparent approval by the Supreme Court in Deputy v. duPont, supra.Contrary conclusions were reached in Commissioner v. Levis' Estate, 127 Fed. (2d) 796; certiorari denied, 317 U.S. 645">317 U.S. 645, reversing B. T. A. memorandum opinion; and Helvering v. Wilmington Trust Co., 124 Fed. (2d) 156, reversing Alice duPont Ortiz, 42 B. T. A. 173,*195 and reversed on other grounds in Wilmington Trust Co. v. Helvering, 316 U.S. 164">316 U.S. 164.
On the authority of the Dart and Smith cases, supra, we hold that petitioner is entitled to deduct as business expenses the amounts paid by him on account of dividends on the stock borrowed for his short sale transactions during the taxable years.
The next question is whether petitioner is entitled to deduct, under section 23 (a) (1) or (2), certain expenses incurred by him during the taxable years in maintaining an office for his stock trading activities and for legal fees in connection with income tax litigation. The amount and nature of these expenses have been set out in the findings of fact. The expenses incurred in 1936, 1937, and 1939 are involved in Docket No. 108911 and the expenses incurred in 1940 are involved in Docket No. 112741. As has been said above, it seems undisputed that petitioner was engaged during the taxable years in the business of stock trading and we have so found. It seems equally clear from the facts of this case that the salary and office maintenance expenses here involved are directly related to and proximately resulted*196 from this business. The legal fees were incurred for legal services rendered in representing petitioner in this Court in Docket No. 97597, involving deficiencies in income taxes for the years 1933 to 1935, inclusive. This litigation involved petitioner's stock trading activities and in our opinion clearly represents an expense within the purview of section 23 (a).
Respondent does not seriously contest the deductibility of these expenses. On brief respondent states in part as follows:
The deductibility of expenses similar to the ones here incurred by petitioner was considered and the deduction allowed in the following cases: Edward Mallinckrodt, Jr., (1943) 2 T. C. 1128; Acq. (1944) I. R. B. No. 7; Barbara S. Kirkland, et al., T. C. Memo. Op. (1942); Acq. (1943); Edward G. Acheson, Jr., T. C. Memo. Op. (1943); Acq. (1943); Trust u/w of Mary Lily ( Flagler) Bingham v. Commissioner, (1945) 325 U.S. 365">325 U.S. 365; Howard E. Cammack, et al., (1945) 5 T.C. 467">5 T. C. 467; Acq. (1945) I. R. B. No. 18; Herbert Marshall, et al., (1945) 5 T. C. 1032; Acq. (1946) I. R. *197 B. No. 3. If the Court should determine that the instant situation is controlled by the foregoing cases, then the expense deduction here sought by petitioner should be allowed; if not the disallowance thereof by the Commissioner should be sustained.
*1156 We think the cases cited by respondent do control the instant situation. See also William Heyman, 6 T. C. 799. We therefore hold that the expenses in question are deductible by petitioner under section 23 (a).
The last question is whether petitioner is entitled to deduct the $ 8,121.44 interest charged to his account No. 2 as a business expense in 1940. This issue is involved in Docket No. 112741.
Petitioner, in 1940, was credited with interest by P & W on his collateral account, special cash account, and account No. 4 in the aggregate amount of $ 14,275.68. Petitioner was charged interest in 1940 by P & W on accounts Nos. 3 and 2 in the respective amounts of $ 7,094.95 and $ 8,121.44. Petitioner included as income the interest so credited him and deducted as an expense the interest charged him by P & W in 1940. Respondent has disallowed as a deduction the amount of $ 8,121.44 representing*198 the interest charge in account No. 2, but has otherwise accepted petitioner's treatment of the interest credits and charges.
Respondent explained this disallowance in the statement attached to the notice of deficiency as follows:
(a) It is held that interest in the aggregate amount of $ 8,121.44 charged by your broker on brokerage account captioned "General Account No. 2" is not deductible under the provisions of Section 23 (b) of the Internal Revenue Code since payment thereof was not made during the year 1940.
On brief, respondent in this connection argues in part as follows:
Since it appears that no interest was credited in account No. 2, the only possible basis for justifying the petitioner's contention that interest charged in this account was paid in 1940 would be the consolidation of the five accounts into one account. * * *
The Court's attention is directed to G. C. M. 23111, C. B. 1942-1, page 49, in which it is stated:
In cases in which a customer maintains more than one margin account with the same broker, interest charged to one account is not paid by a credit of that amount from another account if the total indebtedness of the customer is in*199 effect increased by the interest charged. Such bookkeeping entries merely serve to transfer the interest charge from one account to another.
Respondent argues that the interest charged on account No. 2 was offset by preexisting credit balances from other accounts and that such procedure does not constitute payment under the quoted G. C. M. Respondent apparently brushes aside the fact that the accounts were consolidated by provision of the agreement set out in the findings of fact. Moreover, if respondent's contention is sound, we do not understand why it would not be equally applicable against a deduction of the interest charged in account No. 3, which respondent has allowed.
G. C. M. 23111, C. B. 1942-1, p. 47, recommended the modification of I. T. 3484, C. B. 1941-1, p. 207. This recommendation was adopted and I. T. 3484 was accordingly modified by I. T. 3536, C. B. 1942-1, *1157 p. 49. Prior to modification I. T. 3484 had provided, in effect, that a reduction of a customer's withdrawable credit constituted payment of interest charged by a broker on such customer's account. G. C. M. 23111 modified this interpretation and provided in effect that*200 payment of interest charged by a broker can only be considered paid by the customer when some new credit is added to such customer's account. G. C. M. 23111 concludes as follows:
In view of the foregoing, it is the opinion of this office that interest charged by a broker on indebtedness due him from the customer, under the usual type of margin account, is actually or constructively paid for Federal income tax purposes only as the broker receives payments from the customer or makes collections for the account of the customer. As indicated by the above-quoted statement, such payments may consist of amounts received from -- (a) the collection by the broker of dividends or interest for the account of the customer; (b) the sale by the customer of securities held by the broker or to be received by him; (c) the deposit of cash by the customer, either in answer to a call from the broker for additional margin or voluntarily.
As we interpret the above quotation, the ruling now is that interest is considered paid by a customer only when subsequent to, or concurrently with, the interest charges, the broker has collected dividends or interest for the customer's*201 account or when cash has been made available either by sale of securities held by the broker or by the customer's deposit. In other words, the former ruling that an offset of a withdrawable credit against an interest charge constituted payment pro tanto of the latter has been so limited that to constitute such payment the interest charge must be offset, not by a prior existing credit, but by a new and additional credit arising simultaneously with or subsequent to the charge in the form of collected dividends, interest, or cash.
We think petitioner paid the interest charged on account No. 2 in 1940 within the meaning of G. C. M. 23111. In 1940 P & W credited interest to petitioner's various accounts which had average credit balances throughout the year and charged petitioner with interest on his accounts which had average debit balances throughout the year. Such credits and charges were obviously made concurrently, hence, on the basis of the yearly period, the credits did not antedate the interest charges. It follows, under the ruling set forth in G. C. M. 23111, that interest in the aggregate amount of $ 14,275.68 credited*202 to petitioner in 1940 is available as an offset and pro tanto payment in 1940 of interest charged to petitioner in the aggregate amount of $ 15,216.39 in such year. This would leave a balance of $ 940.71 unpaid interest charges. P & W also credited petitioner with dividends in 1940 in the amount of $ 62,268.75 and charged him for dividends in the amount of $ 58,875, leaving a credit balance in petitioner's favor of dividends collected of $ 3,393.75 as of the end of 1940. This amount, we think, clearly constitutes "the collection by the broker *1158 of dividends * * * for the account of the customer," and on the basis of the yearly accounting period it did not antedate the interest charge. It follows that the collected dividend credit could also be considered payment of petitioner's interest charge, and this credit is more than sufficient to cover the unpaid balance of $ 940.71. Furthermore, petitioner sold stock in 1940 in the amount of $ 83,168.21 and bought stock in the same year in the amount of $ 37,598.50. These sales and purchases were all made through P & W. The sales exceeded the purchases by the amount of $ 45,569.71, which constituted a net credit to petitioner*203 in respect thereof as of the end of 1940. We think this fact constitutes "the sale by the customer of securities held by the broker or to be received by him" within the meaning of G. C. M. 23111. It again follows that this excess of sales over purchases could constitute payment of petitioner's interest and is more than sufficient to cover such interest charge.
Respondent does not contend that the treating of petitioner's five accounts with P & W as one account for determining net debit or credit balances was improper. This was done pursuant to the letter of authorization set out in our findings. Such practice is compatible with stock exchange regulations and customer's agreements as recognized by G. C. M. 23111 in the illustrative example set forth therein.
We hold that petitioner is entitled to deduct in 1940 the interest of $ 8,121.44 charged to him on account No. 2 in that year.
Decisions will be entered under Rule 50.
Footnotes
*. Transferred to No. 3 account.↩
1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(a) Expenses. --
(1) Trade or business expenses. --
(A) In General. -- All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. * * *↩