*1271 1. COMMISSIONS - ACCRUAL BASIS. - The petitioner made real estate mortgage loans bearing interest at a specific rate. In addition to the interest, a commission was charged for making the loan and deducted from the face of each loan at the time the proceeds of the loan were paid over to the borrower. Petitioner kept its books on an accrual basis. Held, the total amount of commissions on loans so made in any particular year is taxable income for that year. (Columbia State Savings Bank,15 B.T.A. 219">15 B.T.A. 219, followed.)
2. DEDUCTIONS. Expenses, including brokerage fees for selling a bond issue, should be amortized and deducted ratably over the life of the bonds rather than in their entirety in the year when such expenses are incurred.
*965 This appeal involves deficiencies in income taxes for the fiscal years ending June 30, 1926, in the sum of $2,177.42 and for June 30, 1927, in the sum of $69.50. The errors assigned will be stated in the opinion.
FINDINGS OF FACT.
The facts were stipulated as follows:
The Bonded Mortgage Company*1272 (hereafter designated "the petitioner") was, during the taxable years in question, a corporation organized under the laws of the State of Delaware, with its place of business in the City of Baltimore.
It engaged principally in the business of making loans on fee simple or leasehold real estate, taking first mortgages as collateral, having these mortgages guaranteed by a bonding company, issuing bonds based on these mortgages and the sale of these bonds for the purpose of securing additional capital upon which to operate.
The method of operation employed was as follows:
The petitioner obtained from the prospective borrower an application which stated the sum proposed to be borrowed, the rate of interest and the rate of commission which the applicant would be willing to pay, and a brief description of the real estate which he would agree to mortgage as security.
With reference to the payment of the commission and other expenses connected with making the loan, by the borrower, the application contained the following provision: "And for your services in negotiating said loan, agree to pay you a commission of - per cent; and also agree to pay a reasonable fee to the attorney*1273 examining the title for the mortgagee * * *. If the undersigned fails to take the loan after it has been accepted by the company, the undersigned will pay one-half of the above sum. If the loan is declined because of a deficit in title, the undersigned agrees to pay one-half the examination fee".
*966 Following receipt of such application, a description of the property upon which loan was desired, was submitted to three appraisers; two appointed by the petitioner and the third appointed by and acceptable to the United States Fidelity and Guaranty Company and the Baltimore Trust Company. Reports in duplicate when received from the three appraisers were attached to the original application, which was then presented at the regular weekly meeting of the executive committee or petitioner's board of directors. If the application for the loan was approved by the board of directors, the prospective borrower was notified and he then furnished petitioner with title reference to his property, which reference was sent to petitioner's attorney for search. The attorney would trace the title to determine whether there were any legal defects and if defects were found he would take such*1274 action as was necessary to clear the title.
The loan committee then prepared a certificate of valuation in duplicate and forwarded it to the United States Fidelity and Guaranty Company for their acceptance. If accepted the original of the certificate of valuation was retained by them and duplicate was returned to the petitioner and attached to the report of the appraisers.
After the loan had been passed by petitioner's board of directors and accepted by the United States Fidelity and Guaranty Company, the mortgage and mortgage note were drawn up by petitioner's attorney and were duly executed by the borrower. The period of the loans ranged from one to three years. The rate of interest charged by the petitioner to borrowers on mortgage loans was six per cent (6%) per annum. The loan agreement provided for periodic payments of the interest by the borrower to petitioner, the period being either quarterly or semiannually.
In addition to interest, petitioner charged, as its commission in connection with the loan, from two per cent (2%) to five per cent (5%) of the face amount of the loan, depending on the terms and maturity periods. Petitioner's commission was collected in*1275 full from the borrower at the time the mortgage and mortgage note were executed. At that time a settlement was made between the petitioner, acting through its attorney, and the borrower and a written memorandum of settlement was prepared. The borrower acknowledged in writing on the mortgage that he had received the full consideration and petitioner's attorney then delivered to him a check for the amount of the loan less the deduction shown on the memorandum of settlement.
After the mortgage and the assignment had been placed on record, they were sent, together with the reference of search, to the Maryland Title Company who issued a title policy guaranteeing the title.
Fire insurance policy covering the borrower's property was secured and the mortgage was then sent with the mortgage note, fire insurance policy, appraiser's report and mortgage guarantee by petitioner to the United States Fidelity and Guaranty Company, together with certificate of valuation in duplicate. The said United States Fidelity and Guaranty Company, after approving said papers, guaranteed the mortgage as to payment of principal and interest, returned to the petitioner the mortgage, one copy of certificate*1276 of valuation and two copies of their mortgage guarantee. Prior to February, 1927, the United States Fidelity and Guaranty Company charged $3.50 per thousand per annum for guaranteeing each mortgage loan. This rate was increased to $5 per thousand per annum. Payments were made monthly by petitioner to the United States Fidelity and Guaranty Company of the premiums due on outstanding loans guaranteed. After the petitioner had accumulated a sufficient number of these mortgages it assigned them to the Baltimore Trust Company, as trustee, to be held as collateral for a bond issue. This procedure was employed *967 to supply petitioner with capital necessary for the continuation of its business. The bonds, which were prepared by the Trust Company, were coupon bonds which bore the same rate of interest as petitioner's mortgages which secured them. The period of the bonds ranged from one to ten years.
The Trust Company, acting through its own investment department, prepared prospectuses describing the bonds and, by use of its own personnel, sold the bonds to investors. The bonds were in all cases sold to the investors at par.
As the interest coupons on the bonds matured, *1277 they were received by the Trust Company and paid from funds obtained by it from petitioner; as the bonds themselves matured they were paid by the Trust Company in the same manner. For acting as trustee under the trust indenture, the Trust Company charged a "trustee fee," which fee is not involved in this case. In addition to its "trustee fee" the Trust Company charged petitioner a brokerage commission for selling the bonds. The rate of the commission varied from 1/2 per cent to 6 per cent, depending upon the maturity of the particular issue. The amount of this brokerage commission was deducted by the Trust Company from the proceeds of the sale of bonds at the time they were sold to the investors and the balance of said proceeds then was remitted to petitioner.
The manner in which the various fees, charges, and commissions were entered on the books of the petitioner was as follows:
The amount of commissions received by the petitioner from borrowers for mortgages made during the fiscal years was as follows:
| Fiscal year ended June 30, 1925 | $30,152.50 (not involved here) |
| Fiscal year ended June 30, 1926 | 29,095.75 |
| Fiscal year ended June 30, 1927 | 13,857.10 |
*1278 The entire amount of said commissions was treated by the petitioner as income to it at the time the loans were made.
All the commissions received by the petitioner from the borrowers during the fiscal years ended June 30, 1925, and June 30, 1926, were received through cash. During the fiscal year ended June 30, 1927, most all commissions were received through cash, and when they were not, journal entry was made crediting commissions received and debiting the borrower's accounts for said commissions.
The total brokerage commissions paid by the petitioner to the Baltimore Trust Co., for sale of its bonds for the fiscal years were as follows:
| Fiscal year ended June 30, 1925 | $3,965.00 (not involved here) |
| Fiscal year ended June 30, 1926 | 16,987.50 |
| Fiscal year ended June 30, 1927 | 14,820.00 |
The total amount of brokerage commissions paid by petitioner to the Baltimore Trust Company for the sale of its bonds for the years ended June 30, 1925, and June 30, 1926, viz., $3,965 for the fiscal year ended June 30, 1925, and $16,987.50 for the fiscal year ended June 30, 1926, was charged to expense on the books of petitioner for these years.
During the year ended*1279 June 30, 1927, there were issued $247,000 series E, 6 per cent, bonds due August 1, 1936, on which commission of $14,820 was paid by the petitioner to the Baltimore Trust Company to cover their sale. On December 31, 1926, adjustment was made on the books of the company setting up prepaid bond premiums in the amount of $25,962.83. The actual amount of commission paid and charged to expense for the fiscal year ended June 30, 1927, was $5,845.86, leaving $8,974.14 paid but not charged to expense for this fiscal year.
*968 Guaranty fees were paid by the petitioner to the United States Fidelity and Guaranty Company as follows:
| Fiscal year ended June 30, 1925 | $1,061.03 |
| Fiscal year ended June 30, 1926 | 2,102.48 |
| Fiscal year ended June 30, 1927 | 3,997.69 |
All of these guaranty fees were charged to expense for the year in which paid. In addition at the end of the fiscal year June 30, 1925, the petitioner charged to expense as guaranty fees $2,122.05, although these guaranty fees were not paid until the years ended June 30, 1926, and June 30, 1927. As they had been charged to expense during the year ended June 30, 1925, they were not again charged to expense*1280 during the years ended June 30, 1926, and June 30, 1927, but were charged against the reserve set up at the end of the year June 30, 1925. They were in addition to the guaranty fees set forth as paid above.
On the federal income tax return for the fiscal year ended June 30, 1925, petitioner reported all commissions received on loans made during said year as income; deducted as expense brokerage commissions paid for sale of petitioner's bonds and the guaranty fees paid of $1,061.03 and the $2,122.05 set up as reserve.
On the federal income tax return for the fiscal year ended June 30, 1926, the petitioner reported as income all commissions received on loans made during said year; deducted as expense brokerage commissions paid for sale of petitioner's bonds and deducted also as expense guaranty fees paid.
An amended return was filed by petitioner for the fiscal year ended June 30, 1926. In said return it reported as income only those commissions which it regarded as applicable to the year. For example, if a mortgage loan was for a period of three years, they would regard as income for each of said years one-third of the total commissions paid by borrower. In said fiscal*1281 year petitioner deducted as expense brokerage commissions and guaranty fees accruing for this year.
On the federal income tax return for the fiscal year ended June 30, 1927, the petitioner reported all commissions received on loans made during said year as income; deducted as expense guaranty fees paid and also as expense brokerage commissions accruing for this year.
An amended return was filed by petitioner for the fiscal year ended June 30, 1927. In said return it reported as income only those commissions which it regarded as applicable to the year. For example, if a mortgage loan was for a period of three years they would regard as income for each of said years one-third of the total commissions paid by borrower. Petitioner charged as expense brokerage commissions and guaranty fees accruing for this year.
The books of the corporation were kept and federal income tax returns were prepared on the accrual basis.
OPINION.
BLACK: The two issues in this proceeding are, (1) Whether or not the commissions on mortgage loans referred to in the findings of fact are to be treated as income in the year in which the mortgages are made or are to be prorated over the life of the*1282 mortgages and reported as income ratably for each year over which said loans *969 extend, and (2) Whether or not expenses, including brokerage charges paid by the petitioner for the sale of its bonds, are to be treated as expense in the year in which paid and deducted in their entirety in that year, or are to be prorated over the life of the bonds and deducted ratably.
As to issue (1), in cases where the taxpayer keeps his accounts on an accrual basis, as has been stipulated in the instant case, we have held that commissions charged for making loans are returnable and taxable in the year when the loans are made and the services performed. ; affd., ; . In affirming our decision in , the court said:
In the instant case petitioner was acting in the two capacities of lender of the money and of loan broker. It charged its commission for the services of procuring the loan, and this was earned at the time the loan transaction was closed. Had the borrower received the full amount*1283 of the loan and then paid the commission or had it paid the commission independently of the loan, there could be no question but that it constituted income at that time, taxable as of that time, even if on a cash basis.
The court in its opinion distinguished on the facts , pointing out that in the latter case the taxpayer kept its books and made its returns on the cash receipts basis and that, moreover, as stated by the Board of Tax Appeals, the taxpayer treated on its books the commissions as unearned until such time as the notes were paid or sold, . On issue (1) we hold for the respondent.
We will now discuss issue 2. The Board has held in numerous cases that expenses of floating bond issues, including brokerage fees for selling them and bond discount, can not be deducted in their entirety in the year when such bonds are sold, but must be spread over the life of the bonds. ; *1284 ; .
The expenses and commissions incurred in the sale of bonds subsequent to March 1, 1913, are amortized ratably over the term for which the bonds are issued. ; .
The petitioner in its brief lays stress on the proposition that, when a taxpayer keeps its books on an accrual basis, the same treatment must be accorded gross income items as is applied to expense items and vice versa, and cites in support thereof , and other Supreme Court cases. Petitioner points out that in , the Supreme *970 Court said, with reference to sections 12(a) and 13(d) of the Revenue Act of 1916, followed by similar language in later acts: "It was to enable taxpayers to keep their books and make their returns according to scientific accounting principles by charging against income earned during the taxable period the expenses incurred in and properly*1285 attributable to the process of earning income during that period."
Were the expenses, including brokerage fees which petitioner paid to the Baltimore Trust Company for selling its bonds, in the respective taxable years "incurred in and properly attributable to the process of earning its commissions" within the meaning of the Supreme Court's decision in United Statesv. Anderson, so as to make such bond expense and brokerage fees deductible in their entirety in the year when incurred, notwithstanding the numerous decisions which we have cited above which hold that such bond expenses are not deductible in their entirety in the year when incurred, but must be spread ratably over the life of the bonds? We think not. The facts stipulated do not show the gross amount of loan business which petitioner was doing in any of the taxable years or what relation the amount of bonds sold in any particular year had to the amount of loan business done by petitioner in that particular year. But even if such figures had been shown, the fact remains that the sale of petitioner's bonds from time to time to replenish its funds were transactions separate and apart from the making of loans to*1286 its customers. The bonds had a maturity ranging from one to ten years, whereas the period of the mortgage loans ranged from one to three years. This we think presents a vital distinction and emphasizes the separateness of the two transactions. True it is that petitioner's mortgage loans were used as collateral for its bonds, but we do not think that fact would change the well established rule that expenses of floating bond issues must be amortized over the life of the bonds. The situation we have here is not the same as existed in . In that case the taxpayer for its services in making loans required the borrower to execute a note due in two years without interest for 10 per cent of the total amount of the loan. The amount represented by these notes was accrued by the taxpayer on its books as income. In order to secure money with which to operate its business, the taxpayer sold the mortage notes (not the commission notes) and executed a separate contract with the purchaser of the notes to pay him one per cent annually to the maturity date of the notes as a bonus in addition to the regular interest which the*1287 maker of said mortage notes was to pay.
*971 The taxpayer thereupon accrued on its books as an expense liability the full amount of such bonus payments which it had incurred in any particular year. The Supreme Court sustained taxpayer's method of keeping its books and making its tax returns on that point, saying:
In the present case, we think that the amount of the bonus contracts was "an expense incurred and properly attributable" to the Company's process of earning income during the year 1917. These contracts were not analogous to obligations to pay interest on money borrowed, but were expenses incurred in selling the loan notes in as real a sense as if under its original system of doing business the Company had paid these amounts to brokers as fees for selling the loans or given them notes for such fees. The Company's net income for the year could not have been rightly determined without deducting from the gross income represented by the commission notes, the obligations which it incurred under the bonus contracts, and would not have been accurately shown by keeping its books or making its return on the basis of actual receipts and disbursements. The method which*1288 it adopted clearly reflected the true income. And, just as the aggregate amount of the commission note was properly included in its gross income for the year - although not due and payable until the expiration of two years - so, under the doctrine on the Anderson case, the total amount of the bonus contracts was deductible as an expense incurred within the year, although it did not "accrue" in that year in the sense of becoming then due and payable.
Manifestly in the instant case if petitioner had used the method of selling its mortgage notes to investors and had paid brokerage fees in connection therewith as, in the American National Co. case, and contracted to make bonus payments direct to investors to induce them to purchase the notes, it would have been proper to have accrued such selling expenses in their entirety in the year when the sales were made. That would be true under the doctrine announced by the Supreme Court in But petitioner did not sell its mortgage notes, but on the contrary retained title to them, subject to their being held as collateral security to secure the payment of the bonds, *1289 ranging in maturity from one to ten years, as against maturities of the notes ranging from one to three years.
This sort of a situation we do not think is the same as in the American National Co. case, and therefore does not justify us in holding that the expenses of petitioner's bond issues, including brokerage fees paid to the sellers of the bonds, should be accrued in their entirety in the year when the bonds were sold, but should be amortized over the life of the bonds as we have held in numerous decisions, already cited. On this issue we hold for respondent.
Reviewed by the Board.
Decision will be entered under Rule 50.