*1165 1. Petitioner received deficiency warrants from states, counties, municipalities and townships in payment for metal culverts. Many of such warrants were transferred to a bank under an agreement providing that the transferee should carry the warrants for petitioner, receiving 7 per cent interest on the face amount. Held, in the circumstances shown, that petitioner borrowed money, using the warrants as collateral security. Held, further, that amounts paid as interest to the bank in the taxable years were not paid on indebtedness incurred to carry tax-exempt securities.
2. The evidence does not establish what agreement, if any, existed between the petitioner and certain individuals to whom warrants were transferred. The respondent's determination that the warrants were sold by petitioner to such individuals is approved.
*1325 The respondent has asserted deficiencies in income tax for the fiscal years ended November 30, 1925, and November 30, 1926, in the respective amounts of $289.57 and $280.35. The only issue presented is whether the petitioner*1166 is entitled to deduct certain amounts as interest paid on borrowed money.
FINDINGS OF FACT.
The petitioner is a South Dakota corporation, organized in 1906. It maintains its principal office at Sioux Falls, South Dakota.
During the taxable years, and for many years prior thereto, the petitioner was engaged in manufacturing and selling metal culverts to the State of South Dakota and political subdivisions thereof. Payment to petitioner was usually made by issuing to it warrants of the purchaser, which were endorsed upon receipt by petitioner and returned to the treasurer for payment. In many instances money was not available for payment of the warrants and they were returned to petitioner after having been registered. Such registered warrants drew interest at the rate of 7 per cent per annum.
Petitioner required large amounts of capital in its business and from the date of its organization adopted the policy of selling the state, county, municipal, and township warrants as rapidly as it could. Many such warrants were sold to individuals in Sioux Falls, but petitioner was not able to sell all of the warrants received. Some time prior to 1925 arrangements were made with*1167 the Minnehaha National Bank of Sioux Falls so that, when greater amounts of cash were required than petitioner's line of credit permitted it to borrow from the bank, the petitioner delivered deficiency warrants to the bank and received credit for the face amount thereof. Each delivery of warrants was accompanied by an agreement between petitioner and the bank, of which the following is typical:
WARRANTS DEPOSITED WITH THE MINNEHAHA NATIONAL BANK OF SIOUX FALLS, JANUARY 23, 1925.
[List and description of warrants follows]
Memorandum: - It is understood that The Minnehaha National Bank is to carry the above listed warrants for the Sioux Falls Metal Culvert Co., and is to charge them interest on the face of the same at the rate of 7% from this date.
In the event any of these warrants are not taken up within one year, the bank reserves the right to collect interest on any such warrants remaining unpaid for one year.
Interest to be adjusted between the company and the bank whenever any warrants are paid.
*1326 When warrants were delivered to the bank under the above agreement, petitioner's account was credited with the face amount of the warrants, without regard*1168 to interest accrued at that time, and a corresponding debit was made to a "warrants" account. As warrants were called for payment the bank forwarded them to the issuing county or municipality and received the principal and interest, making adjustment with petitioner for any interest accrued when the warrant was deposited. If warrants were not collected within one year, the bank notified petitioner by letter in the following form:
In accordance with our agreement with you there is due on warrants remaining in our possession for a year, $638.50 as follows:
| 3-1-25 Interest | $435.55 |
| 5-11-25 Interest | 202.95 |
| Total interest | $638.50 |
When warrants which had been held for more than one year, and as to which petitioner had paid interest, were collected by the bank, the petitioner's account was credited with all of the interest received except that due the bank for the period from the last interest payment by petitioner to the date of collection.
During the taxable years 1925 and 1926 the petitioner paid $1,461.42 and $585.45, respectively, to the Minnehaha National Bank as interest on amounts received from the warrants transferred as described above. It also paid*1169 the amounts of $638.50 and $428.29, respectively, in the taxable years to certain individuals to whom it had transferred warrants which were not paid within one year. Upon the payment of such warrants held by individuals the petitioner received that amount of warrant interest which it had previously paid to the individuals.
On one or more occasions the petitioner withdrew warrants from the bank, paying the face amount plus interest for the time held by the bank.
On its income-tax return for each of the taxable years the petitioner deducted the total amounts paid to the bank and to individuals as interest paid on indebtedness. Upon audit, the respondent disallowed the deductions, holding that the amounts were only advances for which petitioner was later reimbursed.
OPINION.
LANSDON: The principal question in this proceeding is whether the transactions described in our findings of fact constitute sales of the warrants by petitioner, or borrowings of money upon the warrants as collateral security. If we hold that petitioner borrowed money, then we must determine whether such indebtedness was *1327 "incurred or continued to purchase or carry obligations or securities*1170 * * * the interest upon which is wholly exempt from taxation" within the meaning of section 234(a)(2) of the Revenue Act of 1926.
The evidence produced does not show what agreement, if any, existed between petitioner and the individuals to whom payments in the nature of interest were made. The testimony is that whenever possible the petitioner sold the warrants. The respondent has determined that the amounts paid to the individuals were mere advances and could not be deducted, since petitioner was later reimbursed therefor. We must sustain the respondent's position. ; ; .
The transactions between petitioner and the Minnehaha National Bank were covered by a memorandum providing that the bank should "carry" the warrants for petitioner and charge interest at the rate of 7 per cent per annum. The warrants also paid 7 per cent per annum, which makes the details of the transactions rather confusing. The language of the memorandum is that the warrants were "deposited" with the bank and the petitioner was to be "charged" *1171 7 per cent interest on the "face" of the warrants. If they had been sold on the same basis petitioner would undoubtedly have received the face, plus accrued interest.
The respondent places considerable emphasis on the fact that the warrants transferred were taken into the assets of the bank and were not carried as assets on petitioner's books. We do not think the bookkeeping methods necessarily determine the nature of the transactions. If a note had been given to the bank for the face of the warrants it would have appeared in the bank's assets instead of the warrants and petitioner would have carried the warrants as assets, with an offsetting liability for the note. The net effect of what was done is the same.
In our opinion the written agreement of the parties provides for a loan to petitioner rather than a sale of the securities transferred. ; affd., . The amounts paid by petitioner to the bank represent interest paid on indebtedness.
The remaining question, as to whether amounts paid to the bank in the taxable years represent interest paid on indebtedness incurred or continued to*1172 carry tax-exempt securities, has heretofore been decided in , where we held that warrants, similar to those involved in the instant proceeding, received in payment for machinery and used as security for a loan, were received and carried as an incident to petitioner's *1328 business, and that the interest paid was deductible. Upon authority of our decision in that case we hold that the petitioner is entitled to deduct as interest expense the amounts paid to the Minnehaha National Bank.
Decision will be entered under Rule 50.