*177 Decision will be entered for the respondent.
1. Excess Profits -- Accumulations Beyond Business Needs -- Section 102. -- A paper jobbing corporation which accumulated earnings beyond the reasonable needs of its business and invested large amounts in securities unrelated to its business is subject to tax under section 102.
2. Excess Profits -- Credit Based on Invested Capital -- Borrowed Money -- Section 719 (a) (1). -- A balance owed in a brokerage account through which securities were being purchased does not qualify as indebtedness under section 719 (a) (1), Internal Revenue Code.
*288 The Commissioner determined deficiencies for 1945 of $ 46.81 in income tax, $ 9,531.81 in tax under*178 section 102, and $ 3,690.32 in excess profits tax. The issues for decision are whether the petitioner is subject to tax under section 102 and whether funds borrowed by the petitioner qualify as borrowed invested capital under section 719.
FINDINGS OF FACT.
The petitioner, a New York corporation, filed its returns for 1945 with the collector of internal revenue for the third district of New York.
*289 Jacob Sincoff has been engaged in the business of buying and selling paper, paperboard, and twine since 1912. He owns two-thirds and his wife owns the remaining one-third of the stock of the petitioner which was incorporated under the laws of New York in January 1924 to take over the business which he had previously operated as an individual. He and his wife are also the directors of the petitioner. Sincoff made all purchases and his brother made most of the sales for the petitioner. Sincoff's wife was treasurer of the petitioner. Its only other employee was a bookkeeper. Sincoff and his wife gave only part time to the business of the petitioner. The salaries of the three Sincoffs represented most of the expenses of the petitioner.
The following table shows the gross sales, *179 gross profits from sales, interest, dividends, capital gains, total income, total expenses, and net profit or loss for the years 1936 through 1951:
| Year | Gross profits | |||
| Gross sales | from sales | Interest | Dividends | |
| 1936 | $ 153,033.19 | $ 30,684.91 | ||
| 1937 | 134,369.18 | 28,611.26 | $ 2,382.41 | |
| 1938 | 152,358.98 | 25,985.31 | 4,503.87 | |
| 1939 | 211,645.10 | 38,753.79 | 2,321.89 | |
| 1940 | 195,760.60 | 43,406.32 | 4,005.93 | |
| 1941 | 312,952.88 | 61,552.58 | 3,831.87 | |
| 1942 | 391,149.21 | 45,011.31 | 4,788.54 | |
| 1943 | 530,410.07 | 59,371.11 | 2,599.04 | |
| 1944 | 549,403.63 | 76,672.98 | 1,867.63 | |
| 1945 | 428,676.64 | 62,430.37 | 5,909.70 | |
| 1946 | 452,583.76 | 61,966.16 | 14,085.32 | $ 595.00 |
| 1947 | 623,454.63 | 102,206.19 | 9,036.80 | 450.00 |
| 1948 | 263,012.50 | 29,914.16 | 7,089.15 | 8,643.33 |
| 1949 | 290,839.69 | 27,137.80 | 22,211.23 | 1,325.00 |
| 1950 | 241,973.02 | 32,712.34 | 5,319.45 | 2,085.00 |
| 1951 | 195,237.37 | 27,997.51 | 18,310.85 |
| Year | Capital | Total | Total | Net profit |
| gains | income | expense | or loss | |
| 1936 | $ 31,089.07 | $ 28,456.87 | $ 2,632.20 | |
| 1937 | 30,993.67 | 31,589.59 | (595.92) | |
| 1938 | 30,489.18 | 28,850.90 | 1,638.28 | |
| 1939 | 41,075.68 | 33,764.00 | 7,311.68 | |
| 1940 | 47,412.25 | 37,049.55 | 10,362.70 | |
| 1941 | 65,384.45 | 48,409.51 | 16,974.94 | |
| 1942 | 49,799.85 | 43,662.72 | 6,137.13 | |
| 1943 | $ 4,425.06 | 66,395.21 | 50,802.12 | 15,593.09 |
| 1944 | 10,828.30 | 89,368.91 | 49,720.09 | 39,648.82 |
| 1945 | 31,699.59 | 100,039.66 | 54,014.54 | 46,025.12 |
| 1946 | 42,049.35 | 118,695.83 | 54,350.15 | 64,345.68 |
| 1947 | 111,692.99 | 64,973.59 | 46,719.40 | |
| 1948 | 45,646.64 | 48,208.43 | (2,561.79) | |
| 1949 | 13,075.60 | 63,749.63 | 47,645.10 | 16,104.53 |
| 1950 | 8,899.30 | 49.016.09 | 35,122.53 | 13,893.56 |
| 1951 | 46,361.13 | 27,293.45 | 19,067.68 |
*180 The mills from which the petitioner obtained merchandise usually shipped the petitioner's orders directly to its customers and billed the petitioner, allowing it 30 days within which to pay. The petitioner allowed its customers 20 days within which to pay it amounts due on goods. The merchandise inventory of the petitioner at the end of the years 1935, 1936, and 1937 averaged about $ 12,050, dropped to *290 half of that at the end of 1938 and thereafter ranged from a low of about $ 1,500 at the end of 1949 to a high of about $ 3,600 at the end of 1948. The petitioner, prior to 1945, showed investments on its balance sheets which began with about $ 25,000 in 1935, increased to almost $ 53,000 in 1937, dropped off to $ 5,000 in 1940 and 1941, and increased to a little over $ 70,000 in 1943. They were shown on the balance sheet as "Other Investments" and "Other Assets" but were not further explained in the record.
The opening and closing balance statements of the petitioner for 1945 were as follows:
| Assets: | Dec. 31, 1944 | Dec. 31, 1945 |
| Cash | $ 45,398.54 | $ 35,464.06 |
| Accounts Receivable | 26,455.37 | 23,784.81 |
| Merchandise Inventory | 3,036.35 | 1,835.46 |
| Other Investments | 40,275.00 | 54,200.00 |
| Other Assets | 59,118.48 | 64,915.08 |
| Deferred Assets | 847.68 | 678.45 |
| Investments in Government Obligations | 302,484.38 | |
| Total Assets | $ 175,131.42 | $ 483,362.24 |
| Liabilities and Capital: | ||
| Accounts Payable | $ 29,966.20 | $ 32,173.90 |
| Due to brokers for purchase of Government | ||
| securities | 281,225.27 | |
| Accrued Expenses | 2,137.69 | 4,197.18 |
| Reserve for Federal income taxes | 18,240.54 | 15,516.67 |
| Due to stock brokers | 5,046.22 | |
| Capital Stock (Common) | 70,000.00 | 100,000.00 |
| Earned Surplus and Undivided Profits | 49,740.77 | 50,249.22 |
| Total Liabilities and Capital | $ 175,131.42 | $ 483,362.24 |
*181 The record does not show how much, if any, money or other property was paid in for capital stock but shows that at least $ 20,000 of the capital stock at the beginning of 1945 and $ 50,000 of the capital stock at the end of 1945 was a capitalization of earnings with the result that the accumulated earnings of the petitioner at the end of 1945 amounted to at least $ 100,249.22 of which at least $ 30,508.45 was accumulated during 1945.
The petitioner never declared or paid a dividend, except stock dividends, during its existence through 1945.
The petitioner had an account in 1945 with the brokerage firm of Eisele & King, Libaire, Stout & Co. That company customarily used an instrument in connection with transactions wherein a client remained indebted to it in which the client stated, inter alia:
I will always maintain such margin for my account or accounts as you may require, and without notice or demand therefore will always comply with the margin requirements fixed by yourselves or by the Securities Exchange Act *291 and any amendments thereto and/or by any other governmental department or agency having jurisdiction thereof. In the event you deem any account of mine insufficiently*182 margined or secured or unsatisfactory, my accounts may be closed out and any securities or commodities sold, or bought for short account, and contracts closed, disposed of, adjusted and released in your discretion, including contracts for unissued securities, and contracts closed without demand for margin, notice, tender or advertising and either by stop-loss orders or otherwise and any prior tender, demand or notice shall not be deemed a waiver or modification by you of the provisions hereof.
I shall be responsible for any debit balance in or for my account which shall include interest thereon charged monthly, commissions, transfer tax stamps and any moneys advanced by you for my account, and any other charges usual and proper in the business.
The client also authorized the broker to repledge, rehypothecate, or loan any securities in the account and to use them for delivery or other purposes not connected with the account, but any premiums received by the broker for the loan or delivery of securities of the client were to be credited to the account of the client.
The Commissioner, in determining the deficiencies, held that the petitioner was availed of during 1945 for the purpose*183 of preventing the imposition of surtax upon its shareholders within section 102, and the indebtedness relied upon to create an excess profits credit based upon invested capital does not meet the requirements of section 719 (a) (1) and section 35.719-1 of Regulations 112.
The record does not show what amount of money was actually used by the petitioner at any time material hereto in carrying on its paper, paperboard, and twine business or what amount was reasonably needed at the close of 1945 to carry on that business in the future.
The earnings or profits of the petitioner were permitted to accumulate during 1945 beyond the reasonable needs of its business and the corporation was availed of during that year for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting earnings or profits to accumulate instead of being divided or distributed.
The outstanding indebtedness of the petitioner during 1945 was not at any time during that year in whole or in part evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust within the meaning of section 719 (a) (1) of the Internal Revenue*184 Code.
All facts stipulated by the parties are incorporated herein by this reference.
OPINION.
The first contention of the petitioner is that its earnings were not accumulated beyond the reasonable needs of the business and it was not availed of during 1945 for the purpose of preventing *292 the imposition of the surtax on its stockholders within the meaning of section 102. It argues that it had two businesses, one, the paper, paperboard, and twine business, which was becoming less important, and the other, called the primary one, the securities business. The petitioner was not a mere holding or investment company during 1945 because it operated as a jobber in the paper business. One of the arguments advanced to justify its accumulated earnings is its large indebtedness in order to buy securities as a part of its distinct and separate securities business. If its sole business had been the purchase, sale, and retention of securities it would have been a mere holding or investment company within the meaning of section 102 (b). Investment of surplus funds of a closely owned business instead of distributing them is one way of avoiding surtax on the stockholders. Obviously, the*185 petitioner can not plead an investment business, distinct from its paper, paperboard, and twine business, as an excuse for the accumulation of any of its earnings in order to avoid the application of section 102. Therefore, the only business needs which may properly be considered are the needs of the paper, paperboard, and twine business.
Sincoff's testimony indicates that his reason for not declaring a cash dividend in 1945, and his only justification relating to the paper business for the accumulation of the 1945 earnings, was that prognostications in trade papers and other publications of a business slump to follow the close of World War II convinced him that no dividend should be paid because all available funds would be needed to survive the slump. No attempt was made to show the amount of capital actually used or needed in the paper, paperboard, and twine business or what the future needs of that business, which could be reasonably anticipated, were. Most of the goods purchased were shipped directly by the manufacturer to the customer under terms which permitted the petitioner to collect from its customers before it had to pay the manufacturers. Little was invested in plant, *186 equipment, and inventories. Rents were extremely small and the principal expenses of the business were the salaries of the Sincoffs. The funds available in the business at the beginning of the year were more than ample to take care of the accounts receivable and payable in addition to all of the other needs of the business, present or reasonably forseeable in the future, shown by the record. A depression in the business would mean that even less would be required to operate the paper, paperboard, and twine business of the petitioner. Counsel for the petitioner mentions a number of threats to the business, some of which are not supported by the evidence, but, in any event, there has been no showing that funds in addition to those available at the beginning of 1945 were held to meet such threats or were reasonably necessary for any *293 such purpose. The evidence as a whole clearly indicates that no expansion in the business was contemplated at the close of 1945.
The purchase of the Government obligations and the incurring of the indebtedness incident thereto was in no way necessary to the paperboard and twine business, despite statements that the paper manufacturers were *187 interested in bond drives. The principal reason advanced for the purchase of the Government obligations was to make money in the security business apart from the paper, paperboard, and twine business. Those purchases and debts in no way benefited the latter business. Cf. Whitney Chain & Mfg. Co., 3 T. C. 1109, affd. 149 F.2d 936">149 F. 2d 936. Cases in which funds were accumulated to discharge debts incurred in the regular business or in which funds reasonably needed in that business were temporarily invested in securities are not helpful to the petitioner. The evidence as a whole supports the determination of the Commissioner and fails to show that the accumulated earnings of 1945 were reasonably needed in any way in the future operation of the business of the petitioner.
The remaining issue for decision is whether the Commissioner erred in determining the excess profits credit based upon invested capital by failing to include 50 per cent of the alleged borrowed capital for the reason that the indebtedness on which the petitioner relies does not meet the requirements of section 719 (a) (1) of the Internal Revenue Code and section 35.719-1*188 of Regulations 112. The record is somewhat vague as to just what amounts the petitioner is contending qualify as indebtedness under section 719 (a) (1). Its argument is that it borrowed money from brokers in order to purchase Government securities and the amount due to the brokers in that connection qualifies as indebtedness under section 719 (a) (1). The petitioner had an account during 1945 with the brokerage firm of Eisele & King, Libaire, Stout & Co. The exhibits include two cards which the petitioner signed in connection with that account for later years and it might be fairly inferred from the record that somewhat similar cards had been signed as early as 1945. The record does not show what transactions the petitioner had with that particular brokerage firm in 1945, that the Government obligations were bought from it, or the extent, if any, to which the amount "due to brokers for purchase of Government securities" was owed to that particular brokerage firm. The petitioner purchased some Government securities during 1945 and owed amounts shown in the record to brokers in connection with those purchases. The record does not show the details of the purchases or the arrangement*189 between the petitioner and its brokers under which the debts were incurred. If it may be assumed for the purpose of discussion that the amounts were all borrowed from the Eisele firm and the cards are explanatory of the relationship, and certainly no *294 assumption more favorable to the petitioner is justified by the record, even so, the determination of the Commissioner must be upheld. The petitioner in such a case would appear to have a running account with a broker, the debit balance in which would vary from time to time, there would be no date for payment of any particular amount, and the case would be controlled by the decision in Pacific Affiliate, Inc., 1175">18 T. C. 1175, in which case at page 1205 this Court said:
In the instant proceeding the basic agreement, as witnessed by the documents in evidence, pursuant to which the petitioner's margin account was established and maintained, was of the sort commonly found in the investment brokerage business. As we read it, it did nothing more than establish a certain line of credit to petitioner for the purchase in the financial market of securities which were to be held as collateral against *190 default in payment of the full purchase price. There was no actual assignment of specific securities to secure the repayment of any fixed sum to be advanced. In fact, the record discloses no advance of moneys actually received by petitioner. We cannot say that the instruments involved legally constituted a mortgage within the meaning of section 719, supra. Cf. Consolidated Goldacres Co. v. Commissioner, 165 F. 2d 542, affirming 8 T. C. 87, certiorari denied 334 U.S. 820">334 U.S. 820; Bernard Realty Co. v. United States, 188 F. 2d 861; Pendleton & Arto, Inc., 8 T.C. 1302">8 T. C. 1302.
See also Parshall v. Eggert, 54 N. Y. 18; Utica Trust & Deposit Co. v. Decker, 244 N. Y. 340, 120 N. E. 692; Peter Barrett Mfg. Co. v. Wheeler, 212 N. Y. 90, 105 N. E. 812, supporting the conclusion that a brokerage account such as this does not represent a mortgage. The petitioner has not shown that the amount of its outstanding indebtedness*191 during 1945 was to any extent evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust within the meaning of section 719 (a) (1).
Decision will be entered for the respondent.