*57 Decisions will be entered for the respondent.
The petitioners' partnership (formed June 1, 1939) inventoried securities in which it was dealing. One petitioner entered military service on June 30, 1942. They formed another partnership with an employee. Thereafter, the securities of the old partnership were held by the Stock Exchange house which represented both partnerships, in an account labeled "old accounts"; and there was thereafter only a limited amount of buying and selling from the "old accounts." The new partnership, including the former employee, inventoried its securities, in which the partners were specialists. A partnership return was filed for 1942, showing the three partners, but also showing the partnership as formed May 31, 1939, the business as "dealers in securities," and reporting for all of 1942. For 1943 a return was filed for the old partnership, showing only the petitioners as partners. Another partnership return was filed for 1943 by the partnership consisting of the three partners. Both returns showed formation of partnership as May 31, 1939. No permission was secured for changing from the inventory method. No evidence showed the old partnership*58 closed, and the securities inventoried were not distributed to the partners. Held, profit from securities sold from "old accounts" was ordinary income and not capital gain.
*751 These proceedings, consolidated for hearing and disposition, involve deficiencies in income tax liabilities for the calendar year 1943, as follows:
| Docket | ||
| Petitioners | number | Amount |
| Vance and Katharine B. Lauderdale | 11395 | $ 5,806.92 |
| J. Robert and Enid V. Hewitt | 11398 | 7,058.10 |
*752 The only issue to be determined is whether profit from the sale of certain stock represents capital gains, as reported, or ordinary income, as held by Commissioner.
A stipulation of facts was filed. We adopt same by reference*59 and find the facts therein set forth. Such parts thereof as it is considered necessary to set forth are included with other facts found from evidence adduced in our findings of fact.
FINDINGS OF FACT.
Vance and Katharine B. Lauderdale and J. Robert and Enid V. Hewitt, petitioners herein, are husband and wife, respectively. They filed their Federal income tax returns for 1942 and 1943 with the collector of internal revenue for the second district of New York. Vance Lauderdale and J. Robert Hewitt will hereinafter be called the petitioners.
Prior to July 1, 1942, petitioners were the sole partners of the firm of Hewitt, Lauderdale & Co. (referred to hereafter as the "old partnership"), formed to engage in the general business of specialists on the New York Stock Exchange, under an agreement dated June 1, 1939. The net profits of the old partnership were apportioned as follows:
| J. Robert Hewitt (hereinafter referred to as Hewitt) | 61.111% |
| Vance Lauderdale (hereinafter referred to as Lauderdale) | 38.889% |
On or about June 30, 1942, Hewitt entered the service of the United States. At that time a new partnership arrangement, under the same name as the old partnership, was entered*60 into by Hewitt, Lauderdale, and Frank J. Warne. The net profits of the business (referred to hereinafter as the "new partnership") were apportioned as follows: J. Robert Hewitt, 51.111%; Vance Lauderdale, 38.889%; and Frank J. Warne, 10% of the net profits after deducting the sum of $ 50 per week guaranteed and payable by Hewitt.
The net losses of the new partnership were to be apportioned as follows:
| J. Robert Hewitt | 61.111% |
| Vance Lauderdale | 38.889% |
| Frank J. Warne | 0.00% |
Warne was a clerk in the office of the old partnership prior to June 30, 1942, and was paid a salary of "about forty dollars a week." He made no investment in the new partnership. The only purpose in making Warne a member of the new partnership was to have him act as alternate on the Stock Exchange while Hewitt was in the service of the United States.
The old partnership carried a large amount of stocks and securities, as its stock in trade, inventoried them at cost, and used the "first in, *753 first out" method in computing net income. Upon the formation of the new partnership, all of the securities which the old partnership had held as its stock in trade and inventoried, composing in part those*61 herein in question, were held by a Stock Exchange house through which firm the old and new partnerships cleared their transactions. The securities were held after June 30, 1942, by the Stock Exchange house in an account labeled "old accounts," which referred to the old partnership. The activities of this account are indicated in the following schedule:
| Hewitt, Lauderdale & Company | |||
| PURCHASES AND SALES -- OLD ACCOUNTS JULY 1, 1942, TO DEC. 31, 1944 | |||
| 7/1/42 to 12/31/42 | |||
| Inventory | |||
| Security | 7/1/42, | Shares | Shares |
| shares | purchased | sold | |
| Bangor & Aroostook | 500 | ||
| Congoleum-Nairn | 400 | 200 | |
| Detroit Edison | 300 | 300 | |
| General Realty & Utility | 12,240 | ||
| General Realty & Utility pfd | 500 | 100 | |
| Libby Owens Ford | 500 | 500 | |
| Remington Rand com | 700 | 100 | 500 |
| Reynolds Spring | 1,700 | 300 | |
| Worthington Pump & Mach | 2,400 | 1,400 | 1,600 |
| Worthington Pump & Mach pr. pfd | 600 | 100 | |
| Worthington Pump & Mach conv. pfd | 300 | 100 | |
| Total | 20,140 | 1,500 | 3,700 |
| Hewitt, Lauderdale & Company | ||||
| PURCHASES AND SALES -- OLD ACCOUNTS JULY 1, 1942, TO DEC. 31, 1944 | ||||
| 1/1/43 to 12/31/43 | 1/1/44 to 12/31/44 | |||
| Shares | Shares | Shares | Shares | |
| Security | purchased | sold | purchased | sold |
| Bangor & Aroostook | 200 | 500 | 200 | |
| Congoleum-Nairn | 200 | |||
| Detroit Edison | ||||
| General Realty & Utility | 11,740 | 500 | ||
| General Realty & Utility pfd | 100 | 500 | ||
| Libby Owens Ford | ||||
| Remington Rand com | 300 | |||
| Reynolds Spring | 1,200 | 200 | ||
| Worthington Pump & Mach | 400 | 1,800 | ||
| Worthington Pump & Mach pr. pfd | 100 | 400 | ||
| Worthington Pump & Mach conv. pfd | 200 | |||
| Total | 300 | 15,140 | 3,100 |
*62 The activities of the new partnership are indicated in the following schedule:
| PURCHASES AND SALES -- NEW ACCOUNTS | ||
| JULY 1, 1942, TO DEC. 31, 1944 | ||
| 7/1/42 to 12/31/42 | ||
| Security | ||
| Shares | Shares | |
| purchased | sold | |
| Bangor & Aroostook | 700 | 200 |
| Congoleum-Nairn | 2,955 | 2,955 |
| Detroit Edison | 4,200 | 4,700 |
| Fidelity-Phenix Insurance | 1,100 | 1,100 |
| General Realty & Utility | ||
| General Realty & Utility pfd | ||
| Hecht Co | ||
| Libbey Owens Ford | 5,100 | 4,900 |
| Norfolk & Western | 880 | 810 |
| Norfolk & Western pfd | 10 | |
| Remington Rand | 600 | 600 |
| Reynolds Spring | 600 | 400 |
| Worthington Pump | 1,800 | 1,300 |
| Worthington Pump pr. pfd | ||
| Worthington Pump cu. pfd | 100 | |
| Total | 18,045 | 16,965 |
| PURCHASES AND SALES -- NEW ACCOUNTS JULY 1, 1942, TO DEC. 31, 1944 | ||||
| 1/1/43 to 12/31/43 | 1/1/44 to 12/31/44 | |||
| Security | ||||
| Shares | Shares | Shares | Shares | |
| purchased | sold | purchased | sold | |
| Bangor & Aroostook | 8,600 | 8,600 | 4,100 | 4,300 |
| Congoleum-Nairn | 4,900 | 4,800 | 6,700 | 6,800 |
| Detroit Edison | 13,800 | 13,200 | 10,100 | 10,100 |
| Fidelity-Phenix Insurance | 4,200 | 4,200 | 3,700 | 3,400 |
| General Realty & Utility | 9,500 | 8,000 | 25,100 | 23,100 |
| General Realty & Utility pfd | 1,000 | 1,000 | 900 | 900 |
| Hecht Co | 200 | 200 | ||
| Libbey Owens Ford | 11,400 | 11,600 | 9,900 | 9,600 |
| Norfolk & Western | 2,200 | 2,110 | 1,790 | 1,980 |
| Norfolk & Western pfd | 20 | 30 | 200 | 200 |
| Remington Rand | 11,400 | 11,100 | 9,805 | 9,905 |
| Reynolds Spring | 7,300 | 7,200 | 6,200 | 6,400 |
| Worthington Pump | 13,300 | 13,100 | 17,900 | 18,300 |
| Worthington Pump pr. pfd | 1,700 | 1,500 | 2,200 | 2,300 |
| Worthington Pump cu. pfd | 1,300 | 1,000 | 900 | 1,200 |
| Total | 90,620 | 87,440 | 99,695 | 98,685 |
*63 Hewitt, Lauderdale & Co. filed a single partnership return for the year 1942, which reflected the income of the old and the new partnerships for that year. The return shows that the business of the company *754 was "dealers in securities." Salaries and wages (other than compensation for partners) were shown at $ 3,715. The date of the organization of the partnership was shown as May 31, 1939. Hewitt, Lauderdale, and Warne were listed as partners. The return shows an inventory at the end of the year of $ 129,695.26.
Hewitt, Lauderdale & Co. filed two partnership returns for the year 1943. The return designated No. 1 shows the receipt of dividends of $ 6,200, the payment of interest and taxes of $ 2,147.52, net short term capital gains of $ 835.78, and net long term capital gains of $ 15,165.62. The return shows no inventory. It showed the partners as Hewitt and Lauderdale and that their business or profession was that of investors. The date of organization of the partnership was shown as May 31, 1939. According to a schedule attached to the return, the date of acquisition of the 15,040 shares of stock sold during 1943 and reported as long term capital gains ranged from*64 December 30, 1940, to December 17, 1942. Another schedule indicated the 100 shares sold and reported as a short term capital gain were acquired March 9, 1943, and sold June 14, 1943. The return designated No. 2 shows the same name and address of the business as does No. 1. It covers the operation of the partnership as specialists and reflected a net income of $ 36,579.50. It shows a beginning inventory of $ 26,234.67, and showed the partners as Hewitt, Lauderdale & Warne and that their business or profession was that of brokers. The date of organization of the partnership was shown as May 31, 1939.
No application was made to the Commissioner to change the method of inventorying the securities held by Hewitt, Lauderdale & Co.
In their individual income tax returns for 1943, petitioners reported their respective shares of the profits realized from the sale of securities held by the Stock Exchange house for the old partnership account, as reflected in the partnership return marked No. 1 for the year 1943, as capital gains. The Commissioner determined that the capital gains reported in the partnership return No. 1 for 1943 were ordinary gains and increased the income reported in*65 the No. 1 partnership return from $ 4,052.48 to $ 34,466.26.
OPINION.
In the taxable year 1943 the petitioners sold certain securities. Were the profits taxable as ordinary income, or at capital gain rates? The securities had, earlier at least, belonged to a partnership composed of the petitioners. The answer here depends upon the view taken as to what happened to that partnership and the securities. That partnership had been dealing in the securities, and inventoried them. No permission was secured from the Commissioner to change from the inventory method. Therefore, if the partnership continued to own the securities until they were sold in 1943, they would not be capital assets, within the text of sections 117 (a) (1) and 22 (c) of *755 the Internal Revenue Code, 1*66 and Regulations 111, section 29.22 (c)-5, 2 which is not challenged as not being within the statute.
In our opinion, the securities sold clearly did remain the property of the partnership. The burden is upon the petitioner to show otherwise. No attempt was made to show dissolution of the partnership. Evidence was introduced that on or about June 30, 1942, a new partnership agreement entered into was between the petitioners and one Warne, formerly an employee of the old partnership, because Hewitt entered the military service of the United States, and a partner was*67 necessary to represent him as alternate in the Stock Exchange, of which he was a member. The new partnership, composed of Hewitt, Lauderdale, and Warne, dealt in securities, including those of the same companies formerly dealt in by the partnership between Hewitt and Lauderdale. The securities held by the "old partnership" (including those later sold and here in question) after June 30, 1942, were held by a Stock Exchange house in an account labeled "old accounts," which referred to the old partnership. There was purchase and sale in that account, but much smaller in amount than was conducted by the new partnership in securities in which it dealt. The securities in the "old accounts" were not distributed to Hewitt and Lauderdale. They consisted of 20,140 shares. All but 3,100, together with later purchases of 1,800 shares, were sold prior to December 31, 1943, and the 3,100 remaining were sold in 1944.
It is apparent that the petitioners did not regard the old partnership as terminated on June 30, 1942, for a partnership return was filed for 1942, reflecting income of both the old and the new partnerships, that is, *756 for the entire year 1942, with no suggestion of dissolution*68 of the old partnership, but, on the contrary, a statement that the partnership reporting was formed May 31, 1939, which was the date of inception of the old partnership. Only one partnership return was filed for 1942. For 1943 two partnership returns were filed, and both showed the date of formation as May 31, 1939. One of the 1943 returns showed Hewitt and Lauderdale as the partners. The other return showed Hewitt, Lauderdale, and Warne as partners. The latter showed a net income of approximately $ 36,000, as against about $ 22,000 for the other return by the Hewitt-Lauderdale partnership. To us it is apparent from all this that Hewitt and Lauderdale in the taxable year, and in fact at all times after June 30, 1942, regarded themselves as a partnership as they were before June 30, 1942, and separate from that in which Warne participated. At trial it was suggested by counsel for petitioner that the matter here is one of intention. The intention as to continuation of the old partnership is plain. It was not dissolved. Its property was not distributed. Therefore, that partnership continued to report as such, and, since it did not secure permission to change from the inventory*69 method, the securities so inventoried, including those sold, can not be viewed as capital assets, in the face of the statute saying assets properly includible in inventory are not.
The petitioners urge that the partners considered themselves only as investors after June 30, 1942, as to the "old accounts," and cite Vaughan v. Commissioner, 85 Fed. (2d) 497; certiorari denied, 299 U.S. 173">299 U.S. 173. But that case is distinguishable. Here the same entity continued, to a considerable extent, to buy and sell, and to report as such, without permission to change from the inventory method, while in the Vaughan case the former activity in the stocks involved passed from Vaughan to a partnership formed. A mere desire by the partners to regard certain securities as no longer inventory, but as investments, and themselves as no longer dealers, can not suffice to meet the statute. There is ample and sound reason for the requirement that permission be given before change from the inventory method. Stokes v. Rothensies, 61 Fed. Supp. 444; affd., 154 Fed. (2d) 1022. The statutes*70 and regulations require the conclusion here that the stocks sold were not capital assets, and we therefore hold that the Commissioner did not err in taxing the profits from their sales as ordinary income.
Decisions will be entered for the respondent.
Footnotes
1. SEC. 117. CAPITAL GAINS AND LOSSES.
(a) Definitions. -- As used in this chapter --
(1) Capital assets. -- The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business * * *.
SEC. 22. GROSS INCOME.
* * * *
(c) Inventories. -- Whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.↩
2. Sec. 29.22 (c)-5. Inventories by Dealers in Securities. -- A dealer in securities who in his books of account regularly inventories unsold securities on hand either --
(a) At cost,
(b) At cost or market, whichever is lower, or
(c) At market value,
may make his return upon the basis upon which his accounts are kept; provided that a description of the method employed shall be included in or attached to the return, that all the securities must be inventoried by the same method, and that such method must be adhered to in subsequent years, unless another method be authorized by the Commissioner↩ * * *. [Italics supplied.]