*942 Petitioner owned real estate of a value of approximately $10,000,000, nontaxable securities of a value of approximately $16,000,000, and taxable securities of a value of approximately $10,000,000. He resided during the taxable years and for several years before and after, in France; had no business in France and lived there by choice and for his health; maintained an office and several employees in New York, with duplicates of some of its records in an office adjacent to his residence in Paris, France, in which office he had one employee; was in almost daily communication with his New York office; and passed personally upon most important matters, both as to real estate leases and matters, which required about two-thirds of the attention of the New York office, and matters as to securities. His securities were purchased for him by a trust company and delivered to his New York office. He preferred long-term bonds rather than short-term bonds. He did not participate in the management of the companies in which he had investments, nor vote in corporate meetings, and has not been in the United States since 1921. He was not a dealer in securities. Purchases of securities in the taxable*943 years were small compared with the petitioner's total investments therein. Held, that under section 23(a), Revenue Act of 1932, he is not entitled to deductions as expense of trade or business so far as incurred in the ownership of securities, but is entitled to deduction of expenses so far as incurred in his real estate business, both in New York and in his Paris office, which are held to be business expenses.
*1005 The two proceedings above named were consolidated at the time of hearing. There are involved the income tax returns of Eugene Higgings for the years 1932 and 1933. The Commissioner determined *1006 a deficiency of $126,730.08 for the year 1932, and a deficiency of $24,542.65 for the year 1933. The only issue left for determination is the propriety of certain deductions claimed as ordinary and necessary expenses paid or incurred in carrying on trade or business, under section 23(a) of the Revenue Act of 1932. For the year 1932 petitioner claimed a deduction of $76,498.37 of which respondent, *944 contending that investment in securities was not trade or business, in the notice of deficiency disallowed $38,487.41; for the year 1933 the petitioner claimed a deduction of $74,502.26 of which respondent in the notice of deficiency disallowed $48,802.35. A stipulation was filed as to some of the facts involved, which stipulation we adopt (setting forth hereinafter facts stipulated only as necessary to discussion); and in addition thereto, we make the following findings of fact.
FINDINGS OF FACT.
The petitioner, a citizen of the United States, during the taxable years maintained an office in New York and an office in Paris, France. William S. Whitehead was office manager of the New York office and D. P. Cousteau constituted the personnel of the Paris office. William S. Whitehead had as assistants Martin J. Dietz, Gustav Zimmerman as accountant, and one Bessenbeck as stenographer and clerk. The office, which occupied rented space at No. 50 Union Square East, New York City, consisted of four rooms. The office in Paris consisted of a small two-story building, the second floor of which was entirely occupied as an office. It consisted of several rooms, the building measuring*945 about 50 by 20 feet. It was not connected with petitioner's residence, though upon the same grounds. It contained filing cabinets, desks, typewriters, and a sort of library.
The petitioner owned approximately 26 pieces of real estate in the Borough of Manhattan, County of New York, of which four were vacant land; and three pieces - two one-acre plots in Pelham Manor, New York, and another 1 3/4 acres in the city of Morristown, New Jersey, said three plots being undeveloped and vacant. The value of this real estate was approximately $10,000,000. In addition thereto the petitioner owned securities of a value of approximately $25,000,000 of $26,000,000.
Petitioner maintained in his New York office an organization known as a board of control, consisting of three members, which board in the taxable years consisted of William S. Whitehead, Gustav Zimmerman, and Marshall Stearns, who was an attorney and petitioner's personal counsel. The duties and functions of this board were to pass upon all applications for leases upon real estate and to pass upon all payments made by the office in New York, with the exception *1007 of payments for Federal and New York income taxes and*946 New York City real estate taxes and attorneys' fees, which items the petitioner paid by check or by authorizing a New York bank to do so upon advice from his New York office. The board of control met on Tuesday and Friday of each week. At such meetings the discussions were limited to matters pertaining to real estate. Minutes were kept of each meeting, which were signed by the members and sent to the petitioner, and a copy kept in the New York office. There were invariably recorded in the minutes of the board of control any propositions for new tenants and notations of the expiration of leases three months before expiration. The routine has been the same, under the petitioner's orders, since about 1902. The board of control had nothing to do with the petitioner's securities, but dealt with petitioner's real properties, most of which are leased for terms of various lengths. These leases were arranged by the board of control, which investigated the financial stability of the prospective tenant and all other details and submitted the proposition to the petitioner, who either rejected or accepted. If the offer was accepted, petitioner's attorneys prepared a lease, which was printed, *947 signed by the prospective tenant, and, after being approved by the attorneys, was sent to the petitioner in Paris for signature. The petitioner would not sign any document unless the approval thereof by his attorneys was endorsed upon the document. No one had authority to sign any lease for the petitioner, and no one has ever done so in 30 years. No lease was final until returned from the petitioner with his signature thereon, although the prospective tenant was required to sign first, and tentative payment of rent was required. Any modification of leases went through the board of control to the petitioner. This has been the procedure under instructions of the petitioner given many years ago. Petitioner seldom accepted the board's recommendation in total, and usually wished something changed. Upon receipt of a letter he would usually either cable or radio, being a prolific user of the cable and radio. He was in touch with his New York office by letter or cable almost daily.
Petitioner's policy for the last 10 or 15 years has been never to sell real property. The last sale was in 1927. He had his finger on every piece of business and his instructions were followed. The*948 principal activity of petitioner's New York office was the management of his real estate. A weekly statement of receipts and disbursements was sent to petitioner every Friday and an annual report of receipts and disbursements was also sent to him. The annual report showed the percentage earned by petitioner's investments in real estate and in stocks and bonds, as against each individual parcel of real estate and each item *1008 of securities. The annual report took about two weeks to prepare and a week to typewrite.
The system of keeping petitioner's securities was that the New York office had two boxes, to one of which the petitioner only had access, and to the other of which William S. Whitehead and Marshall Stearns had access. In the box to which the petitioner only had access were kept mostly tax-exempt securities and railroad bonds, in about equal proportions.
Petitioner's securities were purchased for him by the United States Trust Co. In his directions to that company as to investments, the petitioner often stressed that investments be entirely safe. He often authorized the United States Trust Co. of New York to purchase registered bonds at prices within its*949 discretion, within limits. In the year 1932 petitioner held nontaxable securities in the amount of $16,453,000, and in 1933 held nontaxable securities to the extent of $17,278,000. The nontaxable securities were fully registered as to the principal and interest, and no coupons were attached thereto. The income was paid on these registered bonds every six months by check. When these were received the envelopes were opened and deposit made, the big deposit days being four times a year. A record of the deposits was kept in the cash book and in the interest registry. After the deposit was made, that was the end of a matter, so far as the New York office was concerned. No one in that office had anything to do with the purchase of nontaxable securities, except to receive them from the United States Trust Co., to check them off with the Trust Co. list, and to place them in the safe deposit vault, which was done by Whitehead and Stearns. No one in the New York office made any recommendations or carried out any recommendations as to the purchase of nontaxable securities. In 1932 the only securities purchased by the petitioner were $675,000. These comprised bonds issued by the city*950 of Boston in the sum of $361,000, the State of Massachusetts in the sum of $100,000, and the State of New York in the amount of $214,000. In 1933 the only securities purchased were United States of America bonds in the total sum of $1,052,000.
Petitioner's income all came to his New York office as rents, checks for interest coupons, checks for dividends, and other items of that kind, and was deposited to his account as it came in. The checks for interest and dividends which came to petitioner's office were endorsed by rubber stamp and deposited. Petitioner maintained two accounts in New York banks, the National City Bank and the United States Trust Co., in which all income of petitioner of every name and nature was deposited, and from which no one ever held any authority to withdraw funds except the petitioner himself, whose signature was necessary on all checks on those two bank accounts. He maintained *1009 for office expenses another bank account in the Chase National Bank, into which were transferred the proceeds of one check at a time from him, the check being sent by him marked for deposit to his credit, upon application of some one in his New York office. This*951 was used as the office needed money for office expenses, salaries, repairs, and the like. Upon that account William S. Whitehead and Marshall Stearns wrote checks, but from that account no securities were bought. Petitioner did not borrow any money to invest in nontaxable securities.
Of the deductions claimed in the 1932 income tax return as to the New York office, the item of stationery, $287.69, represented writing paper, ink, and general run of stationery for the office use; radiograms, $476.76, were sent in connection with petitioner's office; postage, $150.60, was used in connection with petitioner's office; petty cash, $70, was for car fares, office help, and little incidentals, used in connection with petitioner's office; newspapers, $189.57, were real estate bulletins, the Financial Chronicle and the Commercial Bulletin, and some daily papers, part of which were kept in the New York office and part of which were sent to the petitioner, but all used in connection with petitioner's business. Some of the periodicals relate entirely to real estate and others to stocks and bonds. The deduction did not include such personal items as the Chess Bulletin. Careful effort was*952 made to keep petitioner's personal matters separate from business charges. The item of "Miscellaneous", $853.96, represented in the main payment of an audit company, $360, Christmas gifts for the help of the building, and items of that general nature. The audit was of the business books. For the year 1933 similar items of substantially the same nature as those claimed as deductions for 1932 were claimed by the petitioner.
The petitioner has not been in the United States since 1921, having been in Europe, particularly in France, during that time. He had no business whatever in France or Europe, and in the taxable years reported no income from foreign corporations. He lived there as a matter of choice because he liked to live there for his own pleasure and for his health. He has a seagoing yacht. In investing, he chose registered bonds, rather than coupon bonds, because he wanted to be in full control of his money, and to handle it all himself, did not want any one clipping coupons on his bonds, and preferred to have the interest come in the form of checks. His office in New York kept records both of his real estate enterprises and of his stocks and bonds. Petitioner preferred*953 to invest in long-term bonds rather than in short-term bonds. Books were not kept separately for the real estate enterprises as distinguished from the investments in securities, the matters all being in one set of books with, *1010 however, separate accounts. Most of the work of the New York office was caused by the real estate investments. The rents took up more time than receipt of tax-exempt interest, because the rents came in piecemeal, at various times in each month, and were added to the weekly statement sent to the petitioner. A record was kept of the various securities to see whether interest and dividends were received. The weekly report to the petitioner included information with respect not only to the real estate, but also with respect to the securities. Tax-exempt securities required a considerable item on the reports made in the first quarterly months of the year, but the other securities were more of an item on the weekly report. The annual report, consisting of 16 pages, gave the individual return from each individual investment. It took up three solid pages for real estate, and the rest represented matters concerning petitioner's securities.
Most*954 of Gustav Zimmerman's time was taken up with real estate matters, and sitting on the board of control. He kept the books, including accounts of the various securities, interest and dividends therefrom, rentals received, etc., although he generally prepared petitioner's Federal and state income tax returns, with the help of the attorneys. Approximately two-thirds of the time of Gustav Zimmerman and William S. Whitehead in 1932 and 1933 was taken up with real estate matters, and the other one-third with all other interest and dividends. Martin J. Dietz was in charge of real estate during 1932 and 1933, and had nothing to do with any other business. Bessenbeck was combined office boy, stenographer, and general clerk and assistant. His efforts involved both real estate and securities matters. In Paris, D. P. Cousteau's duties were to check off the accounts the New York office sent him in the weekly statements, and to act as stenographer to the petitioner. He attended to all of petitioner's correspondence in Paris upon receipt of accounts and letters from the New York office, replied, and took the petitioner's dictation, and took care of posting of mail and sending of cablegrams*955 and radiograms to the New York office. The letters were in connection with investments in stocks and bonds and securities as well as real estate. He kept "close tabs" on the New York office. The petitioner did the same. Petitioner's affairs have been managed in the same manner since 1889.
Duplicates of the records kept in the New York office were during the taxable years kept in France, consisting of cash book, registry of dividends and interest, and account books as to real estate. On two different occasions a duplication of the books of the New York office were sent to the petitioner in Paris. In the taxable years the extent of the petitioner's activities in the corporate enterprises in which his money was invested was to receive reports and keep track *1011 of the dividends and interest he received as an investor in the stock. In the early days he was on the board of managers of the Delaware, Lackawanna & Western Railroad Co., but not during the taxable years. The stock in the various corporations owned by petitioner was solely in his name, and he did not appoint anyone to vote for him. In his 1932 income tax return petitioner designated his business occupation*956 or profession as that of renting real estate; in 1933 he made no designation. As to both years, no income was reported under the caption "Income from business or profession." With the exception of one small item in each year ($356.42 for 1932; $1,250 for 1933), all income was reported under the four heads: interest on bank deposits, notes, etc.; interest on tax-free covenant bonds; rents and royalties; and dividends from domestic corporations. The total gross income reported for 1932 was $380,394.06, net income, $247,392.63; for 1933, total income, $344,625.04, net income, $248,746.63. Income reported from rents and royalties for 1932 was $209,597.26; for 1933, $173,622.81.
If it were not for petitioner's securities and other investments, the office could have been run with decidedly less help. A bookkeeper and stenographer might have been dispensed with. A real estate man and a bookkeeper were necessary. On account of the petitioner's investments, a bookkeeper and an office boy at least were needed. Gustav Zimmerman and Bessenbeck might, under such circumstances, be dispensed with.
In 1931 petitioner settled with the Commissioner of Internal Revenue a matter pending before*957 the Board of Tax Appeals in which he was represented by attorneys. The case involved income tax for the year 1921, in which petitioner sold bonds in the amount of $4,576,500, and a deficiency of $80,887.52, arising from holdings of securities. In 1932 petitioner paid for such services $3,000 and $189.02 for incidental expenses connected therewith. The Commissioner also had a claim for income tax against the petitioner for 1929, involving a deficiency of $18,391.14, arising from condemnation of real estate, and in 1932 petition was filed with the Board of Tax Appeals for review of the deficiency determined. Petitioner paid for these services in 1933, in the sum of $2,500. Of the $2,500 item, $2,000 fairly represented the 1929 income tax controversy before the Board of Tax Appeals.
Depreciation was sustained on the Paris office in the amount of $600 for each of the taxable years.
OPINION.
DISNEY: Petitioner contends that the burden of proof is upon the respondent upon the ground that respondent, by calculating allowable *1012 deductions upon the proportion of tax-exempt income to gross income, and by reference to tax-exempt income as not giving rise to deductions, *958 had taken the position of allowing the entire deductions as being paid or incurred in trade or business, but of then disallowing them in part upon the theory, not now pressed, that tax-exempt income may not give rise to business deductions. In the deficiency letter for 1933 (though not in that for 1932), the Commissioner stated that petitioner was not engaged in trade or business within the meaning of section 23(a) of the act (quoting the section); petitioner affirmatively alleged error of the respondent, "particularly by disallowing deductions * * * to the extent of * * * a part of the expenses paid by petitioner for legal and office expenses * * * in the conduct of his business." Respondent does not seek increased deficiency, but, on the contrary, seeks to disallow as deductions less than the amount disallowed in deficiency notices, and did not ask affirmative relief. The stipulations of fact, contrary to petitioner's argument on brief, state that respondent disallowed certain amounts of petitioner's claim for deduction of ordinary and necessary expense. Under these circumstances, it may well be doubted whether the burden of proof shifted to respondent, but we find it unnecessary*959 to decide that question. We assume, without deciding, that the burden of proof was upon respondent, and base our opinion upon the facts adduced and the law applicable.
Respondent admits that the real estate activities of petitioner from his New York office constituted trade or business. The question before us, whether activity in investments constitutes trade or business within section 23(a) of the Revenue Act of 1932, has been variously answered under various circumstances, and of course is to be viewed in the light of the facts involved in each proceeding. Both petitioner and respondent cite cases which tend to support their respective contentions. We shall not attempt to review in detail all of the various situations involved in those cases. Petitioner most particularly, perhaps, points out our decision in ; ; and , reversing . Reliance is placed also upon *960 . Respondent, on the other hand, relies heavily upon , affirming ; , and other cases.
In , it was said:
* * * A party may have investments in corporate stock, have no particular occupation, and live on the return of his investments. That would not *1013 constitute business under the statute in question. He may, however, take such an active part in the management of the enterprise in which he has investments as to amount to the carrying on of a business. * * *
In , a rule is laid down as follows:
* * * A person of property, who devotes his time to the active management of it and also to active participation in the management of the companies in which his property is invested, and who maintains an office for that purpose where he spends a substantial part of his time, is carrying on business within the meaning of this statute. *961 * * * The line comes between those who take the position of passive investors, doing only what is necessary from an investment point of view, and those who associate themselves actively in the enterprises in which they are financially interested and devote a substantial part of their time to that work as a matter of business. The maintenance of an office for this purpose, though not conclusive, is significant. * * *
The mere fact that investments produce income is not decisive. , states:
* * * If we were to agree with the argument of the petitioner's counsel that the real test of deductibility is whether the expense was an ordinary and necessary one in obtaining income, we would take what might be supported as a fair one. If Congress had intended to allow deductions on that basis, however, it would have been too simple and easy to have said so to make it reasonable to believe that such was intended by the language which plainly limited expenses deductible to those incurred ordinarily and necessarily in carrying on a trade or business. * * *
We must therefore decide petitioner's position as to whether he was "doing*962 only what is necessary from an investment point of view", or whether, on the contrary, he was among "those who associate themselves actively in the enterprises in which they are financially interested and devote a substantial part of their time to that work as a matter of business." Weighing the petitioner in these balances, we find that the petitioner has not been in the United States since 1921, and a fair interpretation of the following testimony seems to remove petitioner from the company of those who participate actively in the management or control of investments. We quote:
Q. Does Mr. Higgins devote any time to the business of the corporations in which he owns stocks or is he merely an investor in those stocks?
A. In the early days he was on the Board of Managers of the Delaware, Lackawanna and Western Railroad Company.
Q. I am speaking now of the years 1932 and 1933.A. He was not in the country in 1931, 1932 or 1933. The last time he was here was 1921.
Q. Then would your answer be that he did not devote any time to the business of the corporations in which he owned stock?
A. May I ask a question? Do you mean to imply he didn't watch any financial*963 statements of the company?
Q. No, in the affairs of the corporation itself - A. That he was right present?*1014 Q. Taking an active part in the affairs or was he merely an investor in the stock?
A. Oh, he was an investor in the stock then.Q. In other words, would you say that the extent of Mr. Higgins' activities in the corporate enterprises in which his money is invested is to receive reports and keep track of the dividends and interest he receives?
A. Yes.In , it is said: "Most men who have capital change their investments, and may speculate all the time; we should hardly call this a business, though the line is undoubtedly hard to draw." Therein, as herein, the fact of real estate business was relied upon as proof that there was a single business, including real estate, negotiable securities, etc., and that therefore the party was in business as to the securities. That interpretation of the statute was rejected. It is true that the statute there considered was section 204(a) of the Revenue Act of 1918 as to "business regularly carried on", yet the emphasis is placed by the court not*964 upon the lack of regularity, but upon the lack of essential business nature of the transactions.
In , we were affirmed in holding that a taxpayer deriving income from investments and securities is not entitled to deductions as business expenses, office rent, services of a bookkeeper, and fees as custodian and for collection of income, charged by a trust company. The same elements, in effect, enter into this proceeding, for the petitioner here desires to deduct rent and salaries of bookkeeper and other employees, and purchased his securities through a trust company. The court was of the opinion that in order to secure business deductions it would not be enough "to secure or attempt to secure income or capital stability by conversions of bonds into stock or vice versa, or by otherwise safeguarding the taxpayer's investments", and, after referring to , to the effect that to do only what is necessary from an investment point of view is insufficient to amount to engaging in business, states:
* * * The activities of the taxpayer's brother as to her investments and the employment for personal*965 convenience of a bookkeeper to record financial transactions, or of a bank to cut and collect coupons, did not, in our opinion, amount to the carrying on of a business. If so, every owner of property can obtain an income tax deduction of whatever sums he may expend to save the trouble of personal attention to his affairs. . (C.C.A. 7). There is no reason to suppose that the employment of a bookkeeper to keep accounts, or of a bank to make income collections, is more than a personal, as opposed to a business, expense.
Nothing further appears in the instant proceeding. The petitioner, as in , employed others, largely to carry on his real estate business, as to which deductions are admitted by the respondent as allowable, and in a lesser degree simply to "keep *1015 accounts", to receive for deposit, keep records of, and report to him upon investments which he made from a foreign country through the United States Trust Co. of New York, in securities obviously selected for their attributes as investments and not primarily from the angle of profit and loss in dealing actively*966 therein. There was no contention that he was a dealer in securities. To allow the deductions claimed in the present proceeding and to disallow them as was done in , would be to make a distinction between the small investor and one investing like the petitioner upon a very large scale, for the nature of the expenses disallowed by the Commissioner obviously is the same in both cases. We can not make distinction merely because of the extent of investments or of expenses commensurate therewith.
Considering this proceeding upon the facts involved, different as it is in many respects from cases cited by both petitioner and respondent, we conclude that the activities of the petitioner did not constitute the carrying on of a trade or business within the purview of section 23(a) of the Revenue Act of 1932. We hold therefore that the petitioner is not entitled to deduct expense incurred on account of investments in securities, stocks, and bonds. We do not think that those cases wherein expenses have been allowed are on their facts determinative of the situation herein involved.
*967 Petitioner contends that to disallow deduction of expenses incurred as to tax-exempt securities would be unconstitutional. We merely point out that he also relies upon , to demonstrate that there is no distinction between tax-exempt and other securities as to deduction of business expenses. We think there is none, and therefore no violation of constitutional principles in disallowance of deduction of expenses on a common basis as to both tax-exempt and nonexempt securities.
Respondent argues particularly that, as to the expenses of petitioner's office in Paris, the maintenance of an office there was unnecessary and personal to the petitioner, and therefore the expense connected therewith was not deductible. We are not willing to say that one conducting a business may not set up additional office facilities, and incur additional expense, when residing elsewhere than at the place of his principal business. We think it is within taxpayer's discretion as to what offices he maintains. The Paris office was a mere adjunct to that maintained in New York, and the division of effort and expense between investments and*968 real estate business is logically upon the same basis. We therefore, considering the expense thereof ordinary and necessary business expense, allow deduction thereof upon the same basis as that of the New York office.
It seems necessary, in order definitely to dispose of this matter, to itemize the various deductions claimed, as treated by us in accordance *1016 with our conclusions above expressed: Of salary claims, since the evidence indicates that two-thirds of the office time and effort was devoted to real estate, we allow as deductions two-thirds of all salaries of the New York office, except that of Martin J. Dietz, all of whose time was devoted to real estate, and deduction of whose full salary is therefore approved. The Paris office being merely ancillary to that in New York, and logically upon the same basis, two-thirds of the salary of D. P. Cousteau is allowed as deduction. The strictly office expense in New York, denominated rent, stationery, radiograms, postage, petty cash, newspapers, and miscellaneous, are allowed as deductions to the extent of two-thirds thereof. As to legal expenses: For the year 1932, the item of $3,000, and disbursements of $189.02*969 in connection therewith arose from investment matters, and deduction is therefore disallowed. The items of $12,000 and disbursements of $100.69 connected therewith (and of $13,000 and $692.30 connected disbursements for 1933) are for business matters, as admitted by respondent, and deductions are therefore allowed. The item of $1,000 and $11.50 disbursements in connection therewith, arose from Federal and state income tax returns, and, in accord with our conclusion as to division between investment matters and real estate business, two-thirds thereof is allowed as deduction. The $1,500 item is agreed to be for advice as to investment in stocks and is disallowed under our conclusions above. The item of $2,500 for services with $113.03 disbursements, for the year 1932, and of $1,000 with $127.75 disbursements for the year 1933, are stipulated to be personal matters, and deduction thereof is therefore disallowed. The item of $2,500 with $10 disbursements connected therewith, for 1933, is shown to have arisen from real estate matters, condemnation of New York real estate, as to $2,000 thereof, and $2,000 is therefore allowed in full as a deduction; the remaining $500 being allowed*970 as a deduction as to two-thirds thereof, the same appearing to be for income tax matters in general. Deduction of the item of $1,000 for advice as to investments is disallowed. As to the Paris office expense, two-thirds thereof is allowed as deduction, and the item of $600 for depreciation is allowed in full for each year, under section 23(k) of the Revenue Act as property used in trade or business. It was so used. There seems no contention as to these Paris office items, except as to whether they are ordinary and necessary expense of trade or business. An erroneous overstatement of deduction in the amount of $969.21 is stipulated, as is a refund of $26.14, and respondent does not oppose an item of $90.71 for depreciation on the New York office furniture. These items will therefore be reflected accordingly in the deficiency.
Decision will be entered under Rule 50.