*1032 Petitioners, in 1931, were stockholders in the Savings Co. The state bank examiner ordered the Savings Co. to write down or sell certain bank stocks which had depreciated in value. Petitioners and others formed the Elbamon Co. and paid $6,400 for its stock. Elbamon issued, and the stockholders of that company bought for cash, $636,600 worth of income debenture bonds. Elbamon also borrowed $100,000 from the Savings Co., pledging all of its assets. Elbamon then bought from the Savings Co. for cash certain bank stocks of a then value of $172,489.60, paying therefor $737,626.96, the cost of the stocks to the Savings Co. In 1935 Elbamon was dissolved and its assets were sold for $47,499.38, resulting in a distribution of 7.42 percent of original investment to bondholders. Petitioners claimed deductions as bad debts of the difference between amount paid for the bonds and amount distributed at dissolution. Held, the excess of the price paid over value of the assets of Elbamon was not paid as part of the cost of the bonds but was a contribution or gift, Majestic Securities Corporation v. Commissioner, 120 Fed.(2d) 12, and is not allowable as a bad debt deduction; *1033 held, further, in so far as the price represented actual payment for the bonds it may be used as a cost basis for a deduction, the deduction being limited by section 117(f) of the Revenue Act of 1934.
*1060 The Commissioner determined deficiencies in the income taxes of petitioners for the year 1935 as follows:
| Petitioner | Docket No. | Deficiency |
| Estate of Jay R. Monroe | 98216 | $32,015.08 |
| Charles Pinnell | 100249 | 4,014.89 |
| Estate of George Garrabrant | 100952 | 159.92 |
| J. Charles O'Brien | 100953 | 66.86 |
| Charles Day Moulton | 100960 | 1,133.76 |
| Louis McCloud | 100961 | $47.77 |
| Harry H. Thomas | 100962 | 522.97 |
| James C. Elms | 100963 | 3,247.04 |
| Estate of John G. Zeller | 101429 | 1,677.80 |
*1061 The single issue common to all of these proceedings is the deductibility as a bad debt or loss of the difference between the cost of the investment of the several petitioners in debenture bonds of the Elbamon Co. and the amount received by them upon the liquidation of the bonds in July 1935.
FINDINGS*1034 OF FACT.
Certain facts were stipulated and as so stipulated are adopted as our findings of fact. They are substantially as follows:
The late Jay R. Monroe resided during 1935 in Essex County, New Jersey, and filed his Federal income tax return for the year 1935 with the collector of internal revenue for the second collection district of New York. He died testate in April 1937. Edward F. Britten, Jr., William G. Zaenglein, and Malcolm Monroe were and are the duly qualified executors of his last will and testament. The return showed a net income of $54,813.05.
The late George Garrabrant and Margaret C. Garrabrant, his wife; petitioners J. Charles O'Brien and Charles D. Moulton; petitioners Louis McCloud and Minnie F. McCloud, his wife; petitioners Harry H. Thomas and Bessie J. Thomas, his wife; petitioners James C. Elms and Grace W. Elms, his wife (the latter now deceased); the late John G. Zeller and the late Abilene P. Zeller (who were husband and wife in 1935); and petitioner Charles Pinnell, all resided during 1935 in Essex County, New Jersey, and all filed their Federal income tax returns for the calendar year 1935 with the collector of internal revenue for the fifth*1035 collection district of New Jersey. The Garrabrant, O'Brien, Moulton, McCloud, Thomas, and Elms returns reported a net loss and no tax due. The Zeller return showed a net income of $3,531.06, but no tax due. The Pinnell return showed a net income of $1,946.94, but no tax due.
The Savings Investment & Trust Co. of East Orange, New Jersey, hereinafter called the Savings Co., was, prior to and during 1931, and has been to the present time, a corporation organized and existing under the laws of the State of New Jersey and engaged in the business of banking and the administration of trusts, and it was in 1931, and has been since and is now, a member bank of the Federal Reserve System. The affairs of the Savings Co. were and are under the supervision and control of the Commissioner of Banking and Insurance of the State of New Jersey, whose representative examined its books and records from time to time in his behalf and who had power to close its doors as a bank.
During 1931 there were outstanding 60,000 shares of capital stock of the Savings Co. having a par value of $100 each. In 1931 there was no other class of stock and there were no bonds authorized or *1062 issued*1036 by the Savings Co. In 1931 certain of the above named decedents and the petitioners herein, respectively, either in their own name or in the name of nominees, owned the number of shares of the said capital stock of the Savings Co. set opposite their names, respectively:
| Shares | |
| Jay R. Monroe | 822 |
| George Garrabrant | 640 |
| J. Charles O'Brien | 164 |
| Charles Day Moulton | 1,000 |
| Louis McCloud | 50 |
| Harry H. Thomas | 3,498 |
| James C. Elms | 984 |
| John G. Zeller | 250 |
| Charles Pinnell | 200 |
Each of the above named individuals was during 1931 and until 1935 a director in the Savings Co. Harry H. Thomas was president of the Savings Co. during 1931 and until November 5, 1934. The Savings Co. had a board of directors, 22 in number in 1931 and 21 in 1934.
In 1931 the Savings Co. became involved in financial difficulties because of the shrinkage in value of assets owned by it, and in the fall of 1931 it became necessary for it to obtain financial assistance.
Nineteen individuals who were members of the board of directors of the Savings Co., among them the persons heretofore mentioned, decided to form a corporation to be financed by them in cash and to cause the corporation*1037 to purchase for cash certain bank stocks, owned by the Savings Co., in 11 of the leading banks in New York City. Three directors, who are not involved in these proceedings, did not agree with the above conclusion and did not participate in the transactions hereinafter described. The said corporation was organized as a business corporation under the laws of the State of New Jersey, under the name "Elbamon Company," hereinafter sometimes called Elbamon, on or about November 16, 1931, and those directors who had so decided and agreed, and afterwards participated in the transactions described herein, became stockholders therein and holders and owners of the debenture bonds issued by the Elbamon Co. The total authorized capital stock of the Elbamon Co. was $125,000, divided into 1,250 shares of a par value of $100 each. A total of 64 shares was issued. These shares were purchased in cash at the full par value thereof in various amounts by the said 19 men.
The first meeting of the board of directors of the Elbamon Co. was held on December 8, 1931. At that meeting the following resolution was adopted:
Resolved that the officers of this company be and they hereby are authorized*1038 to borrow sums not exceeding $1,000,000 and to issue debenture bonds in the form submitted to this meeting.
Pursuant to that resolution, the Elbamon Co. issued its debenture bonds in the aggregate face value of $633,600, and they constitute *1063 the basis of the question at issue in these proceedings. The principal of the bonds was due and payable on December 31, 1942. The obligor promised to pay interest at the rate of 6 percent on January 1 of each year, or at a less rate if the net earnings and revenue of the maker were insufficient. The Elbamon Co. had the right to redeem the bonds or parts thereof at par, plus interest, upon due notice.
In 1931 the Savings Co. owned capital stock of 11 leading banks of New York City which had been acquired over a term of more than 10 years at a cost of $737,626.96. In september 1931 the bank examiners of the State of New Jersey instructed that the Savings Co. either sell such stock or arrange to carry it at a greatly reduced asset value, if the Savings Co. were to be allowed by the Commissioner of Banking and Insurance of the State of New Jersey to remain open. Such stock then had a market value far below its cost to the Savings*1039 Co. The market value of this stock had decreased to $172,489.60 by December 9, 1931.
The stockholders of the Elbamon Co., being also its directors as well as directors of the Savings Co., among them the persons heretofore mentioned, subscribed and bought and paid in cash for said debenture bonds at their face value to an aggregate of $633,600. With the total cash proceeds of its debenture bonds and of the sale of 64 shares of common stock of a par value of $100 per share, at par, and with the proceeds of a loan of $100,000 borrowed from the Savings Co. upon the pledge of all its assets (including the bank stock thus bought from the Savings Co.) the Elbamon Co. purchased from the Savings Co. certain bank stocks which had cost the said bank $737,626.96 for $737,626.96 cash, on December 9, 1931, at which time the bank stock, so purchased, had a market value of $172,489.60. The stockholders and directors of the Elbamon Co., who were also each stockholders and directors of the Savings Co., knew that the bank stocks were issued by 11 of the preeminently leading banks of New York City, knew the market value thereof when so purchased by the Elbamon Co., and knew that the Elbamon Co. *1040 paid the Savings Co. $565,137.36 in excess of the market value of those stocks.
Harry H. Thomas, George Garrabrant, and Louis McCloud were officers of the bank. Thomas' salary was $27,000 a year; Garrabrant's salary was $11,700 a year; and McCloud's salary was $5,175 a year. Thomas had substantial funds on deposit with the Savings Co. and a substantial portion, if not all, of the life savings of each of them was invested in its capital stock. Each possessed an excellent reputation for ability and integrity in the community.
In 1931 Thomas' average deposits with the Savings Co. during the months specified were in the average amounts indicated in each instance, viz: September, $8,646; October, $21,894; November, $16,507; and December, $13,301.
*1064 George Garrabrant maintained a small deposit, averaging about $200, during the same period. Louis McCloud had no account with the bank.
Jay R. Monroe was president of the Monroe Calculating Machine Co. and its affiliated corporations of Orange, New Jersey, and owned directly or indirectly about 54 percent of its common capital stock. That corporation had no more than thirty common stockholders and the stock was not*1041 listed on any exchange or dealt in over the counter and there was no market therefor. The company was and is known throughout the world as a manufacturer of calculating machines. Monroe was also sole stockholder of Jay R. Monroe, Inc. At the time of the organization of Elbamon Co. and during the period hereinafter specified the Monroe Calculating Machine Co., Jay R. Monroe, Inc., Monroe's wife, Edith Monroe, and Monroe had on deposit in the Savings Co. the average amounts indicated in each instance, respectively, as follows:
| September | October | November | December | |
| Jay R. Monroe - personal | $3,052 | $4,323 | $1,739 | $2,252 |
| Monroe Calculating Machine Co | 251,369 | 184,718 | 154,308 | 150,155 |
| Jay R. Monroe, Inc | 2,555 | 15,454 | 1,899 | 2,915 |
| Edith Monroe (wife) | 2,137 | 2,049 | 1,780 | 1,785 |
At the same time Jay R. Monroe, Inc., owed the Savings Co. $495,000, consisting of:
| Note dated November 30, 1931, due February 29, 1932, being a renewal of | |
| loans aggregating $ 130,000 made prior to December 31, 1930, plus | |
| $20,000 borrowed on June 1, 1931, and used to reduce real estate | |
| mortgage indebtedness | 150,000 |
| Demand note dated March 22, 1928, (collateralized by 658 46/48 shares | |
| of Monroe Calculating Machine Co. preferred stock and 100 shares of | |
| New Jersey Zinc) | 60,000 |
| Demand notes each dated May 1, 1931, (collateralized by 2,646 shares of | |
| Monroe Calculating Machine Co. common stock, out of 100,000 shares of | |
| common stock outstanding, 400 shares of bank of Manhattan stock and | |
| the other collateral already held in pledge by the bank and endorsed | |
| by Monroe personally) | 190,000 |
| 35,000 | |
| Mortgage indebtedness dated July 15, 1926, and overdue on his | |
| (Monroe's) home at Halsey Street, South Orange, New Jersey | $40,000 |
| Mortgage indebtedness dated October 18, 1927, and overdue, on Townsend | |
| Place real estate adjoining his (Monroe's) home | 20,000 |
*1042 In addition, Monroe was liable as guarantor of a note held by the Savings Co. made by one Leighton Forbes and collateralized by the deposit of Monroe Calculating Machine Co. common stock owned by Forbes, on which note there was unpaid the sum of $75,000.
In addition, he had borrowed from certain New York banks an aggregate of $510,060 and collateralized the loans by the deposit of *1065 over 40,000 additional shares of Monroe Calculating Machine Co. common stock.
J. Charles O'Brien was the leading real estate broker in South Orange and Maplewood and an expert appraiser of realty values throughout the Oranges and Maplewood. For years he had been a director of the Savings Co. and was a member of the executive committee and of the mortgage appraisal committee of its board of directors, and had derived a substantial income annually from the fees regularly charged and paid him by mortgagors for appraisals which he, as a member of the mortgage appraisal committee, had made for the use and information of the bank in making mortgage loans. He also from time to time acted as broker in sales of real estate in which the bank and its customers were interested through its trust*1043 department and otherwise. During 1931 his company, the J. Charles O'Brien Co., maintained deposits with the Savings Co. which during the months specified were of the average amounts indicated in each instance:
| September | $1,043 |
| October | 4,009 |
| November | 4,684 |
| December | 1,691 |
Charles Day Moulton has been for years a leading physician and surgeon of East Orange and vicinity. He had a wealthy clientele and a fine following. Many of them were depositors in the Savings Co. During that year Moulton maintained average balances on deposit with the Savings Co. during the months specified and in the amounts indicated in each instance:
| September | $6,600 |
| October | 4,000 |
| November | 2,500 |
| December | 4,110 |
James C. Elms was and is a retired merchant and a prominent citizen of East Orange. He, with Grace W. Elms, his wife, kept substantial sums on deposit with the Savings Co. During 1931 Elms and his wife had on deposit with the Savings Co. during the months specified the average sums indicated in each instance:
| September | October | November | December | |
| James C. Elms | $5,600 | $8,425 | $6,865 | $4,884 |
| Grace W. Elms | 10,019 | 5,531 | 5,196 | 6,619 |
*1044 John G. Zeller was vice president and director of the National Biscuit Co., as well as a director of the Savings Co. He, with his wife, Abilene P. Zeller, had large sums on deposit with the Savings *1066 Co. In 1931 Zeller and his wife had on deposit with the Savings Co. during the months specified the sums indicated in each instance:
| September | October | November | December | |
| John G. Zeller | $43,266 | $43,464 | $29,894 | $20,360 |
| Abilene P. Zeller | 50,284 | 50,335 | 49,929 | 52,659 |
Charles Pinnell was in 1931 president of Fred Butterfield & Co., a large textile company. Pinnell depended primarily upon his salary or earnings for the support of his family and himself. The Corporation employing him in 1931 was not prospering and there was a strong likelihood that he would have to find a new position. The other directors whom he joined in the Elbamon Co. transaction were influential in business and financial circles.
Each stockholder in the Elbamon Co. was a director in the Elbamon Co. and also owned its debenture bonds. No person not a director in the Savings Co. became a stockholder in the Elbamon Co. and an owner of its debenture bonds; but not*1045 all of the directors of the Savings Co. became stockholders and directors of the Elbamon Co. and holders of its debenture bonds, and no one acted or was under any compulsion to participate in the Elbamon Co. The persons who were directors (and stockholders) of the Elbamon Co. were also the leading business men of the community and all but one of them were substantial depositors in as well as directors of the Savngs Co. and owned a total of 12,400 shares out of the 60,000 shares outstanding.
Only 64 shares of the Elbamon Co. of a par value of $100 per share were ever issued, and they were issued to the said 19 directors who were all the directors of the Elbamon Co. and were members of the board of directors of the Savings Co., which had 3 other directors also. The amount of such shares owned and held by each was not proportionate to the amount of the stock interest which each owned in the Savings Co.
The certificate of incorporating of the Elbamon Co. contains, among other matters, the following:
THIRD: The objects for which the corporation si formed are:
To acquire by purchase, subscription or otherwise and to own, hold, sell, and otherwise dispose of, exchange, deal in*1046 and deal with stocks, bonds, debentures, obligations, evidences of indebtedness, and securities issued by any public or private corporation, government or municipality, or otherwise, and to issue in exchange for all such shares, stocks, bonds, debentures or other evidences of indebtedness or obligations, the stocks, bonds, debentures or other evidences of indebtedness of the corporation; and the corporation shall have express power to hold, sell, assign, transfer, mortgage, pledge or otherwise dispose of the shares of the capital stock, bonds, debentures or other evidences of indebtedness or obligations created by any other corporation so acquired and to exercise all of the powers of a stockholder in any such other corporation.
*1067 In November and December 1931 the nine directors of the Savings Co. named heretofore purchased the debenture bonds issued by the Elbamon Co. and at that time paid cash therefor to the Elbamon Co. in the amounts hereinafter set forth opposite their respective names. The amount of debenture bonds so purchased was not proportionate to the amount of the shares of capital stock which each of them owned in the Savings Co. and has no relationship to*1047 the number of shares owned.
During the years 1932 and 1933 the Elbamon Co. sold the bank stock so purchased by it from the Savings Co. for $207,152.33, or $530,474.63 less than it had cost the Elbamon Co. in 1931 (and the Savings Co. in the decade preceeding), and reinvested the proceeds in various industrial, public utility, and railroad enterprises.
From the time the Elbamon Co. bought the bank stocks above referred to from the Savings Co. until its dissolution, it had a total of 127 transactions in securities, and during the period of its existence the cash receipts and disbursements amounted to $1,285,515.55, or thereabouts, including the proceeds of the original bank stocks.
In November 1934 H. E. Willer was elected president of the Savings Co. to succeed Harry H. Thomas. Willer insisted that the directors of the Savings Co. should not be officers or directors of the Elbamon Co., which was engaged in the purchase, sale, and negotiation of securities. He recommended and insisted that the above named nine directors of the Savings Co. terminate their interests in the Elbamon Co. and that the affairs of the Elbamon Co. be wound up.
In December 1934 it was decided to*1048 liquidate the Elbamon Co. At a meeting of the board of directors of the Elbamon Co. held December 4, 1934, the following action was taken by the board:
After general discussion the suggestion was made that a committee be appointed to study the question of dissolution of the company and discontinuing this company as an affiliate company of the Savings Investment & Trust Company. Upon motion duly seconded the President appointed the following committee: Messrs. Baird, Garrabrant, Jones, Moulton and Pinnell, with full power to act in the above matter.
At a meeting of the board of directors of the Elbamon Co. held December 13, 1934, that committee reported that:
* * * after a full investigation and careful consideration of the affairs of Elbamon Company they recommended that the affairs of the company be placed in voluntary liquidation.
In February 1935 the Elbamon Co. was duly and legally dissolved. In July 1935 the said nine individuals heretofore mentioned received as a first and final distribution on account of their ownership of said debenture bonds the respective amounts set forth opposite their names as follows:
| Paid in 1931 | Received in 1935 | |
| Jay R. Monroe | $74,250 | $5,782.12 |
| George Garrabrant | 19,800 | 1,541.90 |
| J. Charles O'Brien | 9,900 | 770.95 |
| Charles Day Moulton | 24,750 | 1,927.37 |
| Louise McCloud | 19,800 | 1,541.90 |
| Harry H. Thomas | $49,500 | $3,854.74 |
| James C. Elms | 74,250 | 5,782.12 |
| John G. Zeller | 24,750 | 1,927.37 |
| Charles Pinnell | 29,700 | 2,312.85 |
*1049 *1068 Each of such individuals delivered his debenture bonds to the treasurer of the Elbamon Co., who punched holes through the signatures of the president and secretary of the Elbamon Co. inscribed on the debenture bonds.
Each of said persons deducted from his gross income as reported in his 1935 income tax return the difference between what he paid in 1931 and what he received on the liquidation of the Elbamon Co., explaining th ededuction in his return as follows:
| Jay R. Monroe: | |
| Bad debt | $68,467.88 |
| Investment in debenture bond of the Elbamon Co | 74,250.00 |
| Company dissolved and all assets liquidated, and received | |
| distributive shares of | 5,782.12 |
| Balance remaining unpaid, determined worthless | 68,467.88 |
| George Garrabrant: | |
| Bad debt amount subscribed | 19,800.00 |
| Amount received | 1,541.90 |
| Loss | 18,258.10 |
| J. Charles O'Brien: | |
| Bad debt Dec. 3/31 | 9,129.05 |
| Elbamon Co. debenture bond | 9,900.00 |
| Rec'd. in liquidation - July 9/35 | 770.95 |
| Charles Day Moulton: | |
| Bad debt | $22,822.63 |
| Elbamon Co. debenture bonds purchased | 24,750.00 |
| First and final liquidation (not sold) | 1,927.37 |
| Balance deductible as bad debt | 22,822.63 |
| Louis McCloud and Minnie F. McCloud: | |
| Bad debt | $18,258.10 |
| Elbamon Co. bond - Co. dissolved and liquidated | 18,258.10 |
| Harry H. Thomas and Bessie J. Thomas: | |
| Bad debt | $45,645.26 |
| Bad debt - debenture bonds of Elbamon Co. purchased | |
| 12/9/31 | 49,500.00 |
| Company dissolved - assets liquidated 1935. May | |
| distributive share | 3,854.74 |
| James C. Elms and Grace W. Elms: | |
| Bad debt | $68,835.35 |
| Elbamon Co. debenture bonds subscribed | 74,250.00 |
| Company liquidated - Received | 5,782.12 |
| Loss | 68,467.88 |
*1050 Note - Upon formation of the Elbamon Company J. C. Elms subscribed to $75,000, receiving $74,250 - par of debenture bonds and 7 1/2 shares of stock per and subscription price $750 - ; the company was liquidated in July 1935 and J. C. Elms received $5,782.12. The bonds being a prior lien payment on liquidation is applied to the bonds, reflecting a loss of $68,467.88, which is considered a bad debt in accordance with Treasury Department Regulations 86 Article 23(K-4). Loss on the stock is taken into consideration in Schedule C.
| John G. Zeller and Abilene P. Zeller: | |
| Bad debts | $22,822.63 |
| Bad debts: On November 14, 1931 taxpayers subscribed to $24,750 | |
| debenture bonds of Elbamon Co. for which $24,750 was paid. The | |
| Company was dissolved in 1935 and under date of July 9, 1935, | |
| taxpayer received $1,927.37 in full liquidation for the | |
| bonds which were surrendered. Stock of the same Company which | |
| cost $250 - subscribed and paid for Nov. 14, 1931, likewise became | |
| worthless in July 1935. | |
| Charles Pinnell: | |
| Bad debts | $27,387.15 |
| Bad debts: | |
| Cost of bond | 29,700.00 |
| Received in liquidation | 2,312.85 |
*1069 In determining the deficiencies here in issue*1051 the Commissioner disallowed the said deductions, as is shown in the notices of deficiency. Such disallowance resulted in the deficiencies in issue in all of the above nine appeals except the appeal of the estate of Jay R. Monroe. The disallowance of the deduction taken by the late Jay R. Monroe resulted in part of the deficiency determined against his estate, as is shown in the notice of deficiency, attached to the petition in the appeal of his estate.
On the books of the Elbamon Co. the debenture bonds were and still are carried, after dissolution and after the first and final distribution on dissolution, at their face values and amounts and in the respective names of the said individuals, subject to disbursement in the respective amounts above set forth. All assets of the Elbamon Co. were completely distributed to the holders of the debenture bonds on July 20, 1935.
The record discloses the following additional facts:
The Elbamon Co. was formed for the purpose of saving the Savings Co.
With the exception of the Bank America-Blair Corporation tock, all bank stocks purchased by the Elbamon Co. were sold off by the Elbamon Co. within two or three years after the transfer.
*1052 The Elbamon Co. was dissolved on the insistence of H. E. Willer. who became president of the Savings Co. on November 1, 1934, and in compliance with the demand of the Federal Reserrve Board. The Elbamon Co. was construed to be a bank affiliated with the Savings Co. within the meaning of section 78, Title 12, of the United States Banking Act.
*1070 Upon the dissolution of the Elbamon Co. the securities then held by it were sold for $47,499.38 and the proceeds (7.42 percent of the original investment) were distributed to the bondholders pro rata. Immediately before such distribution George L. McCloud, secretary and treasurer of the Elbamon Co., solely on his own motion and responsibility, wrote to each bondholder of that company requesting the return of the bonds (and the stock certificates) to him. The several petitioners, holders of such bonds, returned them to McCloud in order to secure the payment of the 7.42 percent distribution. Upon receiving the bonds, McCloud punched holes in the signatures of the officers of the Elbamon Co. appearing thereon.
The debenture bonds of Elbamon were income bonds, interest being payable only out of net earnings and being noncumulative. *1053 The bonds were unsecured and were in registered form.
OPINION.
VAN FOSSAN: In their tax returns each of the petitioners claimed a deduction as a bad debt of the difference between the amount paid in cash for debenture bonds of the Elbamon Co. in 1931 and the amount received in 1935 in final distribution of its assets in complete liquidation.
As fully appears above, the Savings Co. was in financial difficulty because of the shrinkage in value of its assets. In order to eliminate from the Savings Co.'s holdings certain stocks in eleven leading New York City banks, which it was compelled by the New Jersey bank examiners to sell or to carry at a greatly reduced valuation, the petitioners and ten other directors of the Savings Co. organized the Elbamon Co. The nineteen stockholders paid in cash $6,400 for their stock and also bought for cash at par debenture bonds of Elbamon totaling $633,600. Elbamon then borrowed $100,000 from the Savings Co. and, with the proceeds of the loan and the cash paid for its stock and bonds, bought the bank stocks for $737,626.96, the original cost price. Such stock had a market value of $172,489.60 at the time.
During 1932 and 1933 Elbamon*1054 sold the bank stock for $207,152.33 and reinvested the proceeds in industrial, public utility, and railroad securities. During its existence Elbamon concluded 127 transactions in securities.
In November 1932 H. E. Willer was made president of the Savings Co. He insisted that Elbamon, which had been construed to be an affiliate of the Savings Co., cease functioning and be dissolved. After much objection from the stockholders they acceded to his demands and Elbamon was dissolved in February 1935. Its assets were distributed *1071 in July 1935, each stockholder-bondholder receiving 7.42+ percent of his investment as his final liquidating distribution.
Respondent originally disallowed the deductions for failure of taxpayers to submit substantiating evidence. On brief he maintains that they are not allowable either as bad debts or losses and, in the alternative, argues that, if allowable as losses, the deductions are limited by sections 23(j) and 117 of the Revenue Act of 1934.
Petitioners, on brief, rely chiefly on the case of *1055 . The reliance which petitioners place on the Gaylord case is obviously misplaced. The deduction in that case was allowed as an ordinary and necessary business expense of a corporation on facts differing gratly from those here present. Here the taxpayers are individuals and on the record it coudl not be held by any stretch of reason that the purchase of the bonds was an ordinary and necessary expense of their several trades or businesses.
The purchase of debenture bonds is usually motivated by investment considerations. It contemplates normally a situation in which there is a purchase at market price with reasonable expectation of profit either from interest or appreciation in value. The mere statement of the facts in the present cases suggests an abnormal situation. Nineteen persons paid $6,400 for Elbamon's stock. These stockholders paid $633,600 for Elbamon income bonds when that company had no assets. The bonds were not secured by a mortgage or otherwise. Elbamon borrowed $100,000 from the Savings Co. and pledged all of its assets (including the bank stock to be acquired). At this point Elbamon had $740,000 in*1056 cash. Elbamon then paid $737,626.96 for the bank stocks, admittedly worth but $172,489.60. Thereafter, assuming as we must the priority of the rights of the Savings Co. as the pledgee of the assets over the rights of the bondholders, the debenture bonds had but $74,862.64 worth of assets behind them. The value of the debenture bonds, qua bonds, at the time of the purchase, could not have been in excess of the value of its assets thus marshalled. This wide disparity between price and vlaue suggests that the excess of the purchase price was not paid for an investment. The only reasonable inference is that the excess of price was paid for some other purpose. See , in which it was observed:
* * * It is clear from the stipulated facts that at the time the securities were acquired from the bank their market value was much less than their original cost and that the assets of the bank were depreciated proportionately. When the relation of petitioner's stockholders to the bank and their resulting interest in the bank's financial condition are considered in connection with this fact it is a reasonable*1057 inference that the payment of the excess over market value was for the purpose of improving the condition of the bank. If this be true the excess was paid "for a purpose other than the acquisition of the securities", and such excess did not represent a part of the cost.
*1072 The reasoning of this case is pertinent here. The "other purpose" in the instant cases was to provide Elbamon with funds so that it in turn might relieve the Savings Co. of its investment in the stocks of several New York banks, the write-down or disposition of which stocks had been ordered by the bank examiner. Thus, looked at as an investment in Elbamon, the excess can not be said to be part of the cost of the debentures. It was a contribution or gift, with no reasonable expectation of recovery. If the corporate entity of Elbamon be overlooked, the excess might be said to be a contribution to the Savings Co., which company is still in existence. In neither view can petitioners find comfort. Thus it is that the excess expenditure can form no part of a bad debt deduction.
The question remains whether the bondholders are entitled to deductions in an aggregate amount measured by the difference*1058 between a cost equal to the net amount of Elbamon's assets ($74,862.64) at the time of purchase and the amount received in liquidation ($47,499.38).
It would seem that such a deduction should be allowed. The corollary of the holding in , is that to the extent that the payment was not a gift or contribution, i.e., in so far as it represented a payment for the bonds themselves and not for some other purpose, it was a true cost of the bonds. This cost we find to be $74,862.64, the amount available to the bondholders if liquidation had taken place in 1931.
A further question arises however: Are petitioners limited by the provisions of section 117 respecting capital gains and losses? The answer to this question depends on whether petitioners come within the scope of section 117(f). 2 We have found as a fact that the bonds were, in the language of the statute, issued "in registered form." We also hold that there was a "retirement" of the bonds within the meaning of that term in the cited section. See *1059 , where the Court observed, "it is plain that Congress intended by the new subsection (f) to take out of the bad debt provisions certain transactions and to place them in the category of capital gains and losses." This holding requires the application of the provisions of section 117 to the deductions here involved. To the limited extent above indicated the deductions are allowed.
Decisions will be entered under Rule 50.
Footnotes
1. Proceedings of the following petitioners are consolidated herewith: Charles Pinnell; Estate of George Garrabrant, by Margaret C. Garrabrant, Executrix, and Margaret C. Garrabrant, Individually; J. Charles O'Brien; Charles Day Moulton; Louis McCloud and Minnie F. McCloud; Harry H. Thomas and Bessie J. Thomas, his wife; James C. Elms and Estate of Grace W. Elms, by James C. Elms, Alfred H. Corwin and Earl S. Johnson, Executors; Estate of John G. Zeller, Deceased, John E. Zeller and Savings Investment and Trust Company, Executors; and Estate of Abilene P. Zeller, his wife, Deceased, John E. Zeller and Savings Investment & Trust Company, Executors. ↩
2. SEC. 117. CAPITAL GAINS AND LOSSES.
* * *
(f) RETIREMENT OF BONDS, ETC. - For the purposes of this title, amounts received by the holder upon the retirement of bonds, debentures, notes, or certificcates 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, shall be considered as amounts received in exchange therefor. ↩