*110 Decision will be entered under Rule 50.
Petitioner, an Ohio building and loan corporation engaged principally in the business of making chattel loans, conducted its affairs on a cash basis for a fiscal year ending September 30. Prior to February 1, 1940, petitioner was exempt from taxation under section 101 (4), Internal Revenue Code. On that date it changed its methods of operation and thereafter it was not exempt from taxation. Petitioner filed an income tax return for the 12-month period ended September 30, 1940, reporting as taxable only a prorationed share of its net income for such period, in the belief that it was entitled to a partial tax exemption on the income received. It computed the tax under the rates imposed by the Revenue Act of 1938. Petitioner filed no excess profits tax return for the period in question or for any part of such period, in the belief that its tax year began prior to January 1, 1940. Respondent determined that its first taxable year was the period February 1 to September 30, 1940, a short taxable year beginning after December 31, 1939, and determined a deficiency in income tax by applying the rates imposed by the Second Revenue Act of 1940*111 to the stipulated net income for this period. He further determined that petitioner was subject to an excess profits tax and a 25 percent penalty for failure to file an excess profits tax return, and determined a deficiency accordingly. In computing the deficiency in excess profits tax respondent annualized the excess profits income and computed petitioner's excess profits credit under the invested capital method on the theory that petitioner was not in existence prior to January 1, 1940. It is stipulated that, in the event petitioner is subject to an excess profits tax, this method results in a lesser tax than if computed on the base period income tax method. By amended answer respondent claims an increased deficiency in excess profits tax on the contention that in determining such deficiency he erroneously included as borrowed capital in computing invested capital 50 percent of moneys deposited with petitioner for which petitioner had issued nonnegotiable certificates of deposit. Such funds were not subject to check and the certificates bore interest at the rate of 5 percent per annum. Held:
(1) Petitioner's first taxable year began February 1, 1940, and ended September*112 30, 1940. Its stipulated net income for such period is taxable under the Second Revenue Act of 1940 as received in a taxable year beginning after December 31, 1939. Royal Highlanders, 1 T.C. 184">1 T. C. 184.
(2) Respondent's action in annualizing the excess profits tax net income is approved. General Aniline & Film Corporation, 3 T.C. 1070">3 T. C. 1070.
(3) The stipulation that the invested capital method of computing excess profits credit results in a lesser tax than the computation on the base period income method renders immaterial in this proceeding a decision as to whether petitioner was in existence prior to January 1, 1940.
(4) The certificate of deposit issued by petitioner securing the deposits with it is a certificate of indebtedness and the moneys secured thereby were properly allowable in computing petitioner's borrowed capital for excess profits tax purposes.
(5) The 25 percent penalty for failure to file an excess profits tax return is properly imposed. Mere belief that a return was unnecessary is not reasonable cause. Burford Oil Co., 4 T. C. 613.
*544 This proceeding involves deficiencies in income tax and excess profits tax for a fiscal period ended September*114 30, 1940, in the following amounts:
| Income tax | $ 27,951.39 |
| Excess profits tax | 34,355.18 |
| 25% penalty | 8,588.80 |
There are several issues. They all stem from respondent's determination that petitioner's return for a period ending September 30, 1940, was for a taxable year beginning after December 31, 1939, and subject to the Second Revenue Act of 1940. Petitioner in filing its income tax return computed its tax under the Revenue Act of 1938.
Respondent also determined an overassessment in declared value excess profits tax in the sum of $ 334.40, which petitioner asks be refunded. Originally, respondent determined a deficiency in excess profits tax of $ 22,535.81 and assessed a penalty of 25 percent, or $ 5,633.95, for failure on the part of petitioner to file an excess profits tax return. By amended answer respondent claimed that he erroneously computed petitioner's excess profits tax credit in the notice of deficiency. In computing petitioner's invested capital for the purposes of excess profits tax credit, respondent included therein as borrowed capital 50 percent of moneys deposited with petitioner for which petitioner had issued certificates of deposit. He now claims*115 that that sum should be excluded in computing invested capital because it is not a debt evidenced by a "bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage or deed of trust." Sec. 719 (a) (1), Internal Revenue Code. The amended answer asked for increased deficiencies and penalties as hereinabove set out. In its reply to the amended answer petitioner denied that respondent erred in computing its credit in the manner set forth. The reply also requested relief under the pertinent provisions of section 722 of the Internal Revenue Code. Petitioner's claim for relief under section 722 has been dismissed for lack of jurisdiction.
The facts are found as stipulated. The facts we think material to a decision of the issues involved and other facts gathered from the pleadings are set out below.
*545 FINDINGS OF FACT.
Petitioner was incorporated December 5, 1892, under the building and loan association laws of the State of Ohio. Its principal office and place of business is at Columbus. Petitioner's principal source of income is from the making of chattel loans. Up to and including September 30, 1940, it carried on the business authorized under such laws*116 without change in the period under review except as hereafter noted. Since October 1, 1938, petitioner's books of account have been kept on a cash receipts and disbursements basis, its annual accounting period being from October 1 to September 30. On May 16, 1939, respondent reaffirmed prior rulings that petitioner was an exempt corporation under section 101 (4) of the Revenue Acts of 1936 and 1938 and ruled that petitioner need not file income tax returns.
Petitioner has been regularly inspected and supervised in the conduct of its business by the building and loan department of the State of Ohio. It filed its annual reports with the superintendent of the division of the building and loan associations, Department of Commerce of the State of Ohio, as provided by law. There has been no change in such inspection and supervision by the department with which its reports were filed.
As of February 1, 1940, petitioner called in all its outstanding stock and changed its method of operations. Prior to that date substantially all of its business was with borrowers who were shareholders. Thereafter, substantially all its business was with borrowers who were not shareholders. This change*117 in the method of doing business caused petitioner to lose its exempt status under the applicable revenue acts and the Internal Revenue Code.
Petitioner filed an income tax return for the 12 months ended September 30, 1940, reporting net income of $ 210,190.56 for that period. Petitioner determined the taxable portion of such income to be six-twelfths, or $ 105,095.28, erroneously believing that its transition from exempt to nonexempt status was effective April 1, 1940. It computed its tax under the Revenue Act of 1938. Petitioner's exempt status ended February 1, 1940.
Petitioner's net income for the 12 months ended September 30, 1940, was $ 215,683.13. Its net income for the 8 months from February 1 to September 30, 1940, was $ 192,534.45. In determining the deficiencies in income tax and excess profits tax respondent held that petitioner lost its exempt status as of February 1, 1940, and that its return for the succeeding 8 months ended September 30, 1940, was a return for a period less than 12 months which began after December 31, 1939. Accordingly, in computing the deficiency in income tax, respondent applied rates imposed by the Second Revenue Act of 1940. In determining*118 *546 the deficiency in excess profits tax respondent annualized the excess profits net income, pursuant to section 711 (a) (3) (A), Internal Revenue Code.
Under the provisions of its bylaws and rules and regulations as to deposits during the business year ended September 30, 1940, petitioner received deposits with respect to which it issued certificates of deposits. The average balance of the amount so deposited for the eight months ended September 30, 1940, amounted to $ 1,963,185.76. Petitioner's liability on such deposits was evidenced by certificates, the form of which was as follows:
CERTIFICATE OF DEPOSIT
[Face]
No. 2100
$
Columbus, Ohio, 194
This Certifies That has deposited in
THE ECONOMY SAVINGS & LOAN CO.
the sum of Dollars payable to on return of this certificate properly endorsed, subject to conditions printed on the back hereof, at any interest paying period hereafter, with interest at the rate of Five per cent (5%) per annum, payable semi-annually, if left six months and the same rate thereafter if left full six month periods. Any uncollected interest to bear interest at the same rate.
This certificate is non-negotiable and is accepted*119 subject to the bylaws of the Company and conditions on back hereof.
President, Vice Pres., Sec'y, Asst. Sec'y or Treas.
NOT SUBJECT TO CHECK
[Reverse]
CONDITIONS
1st. Certificates of Deposit, as a general rule, may be withdrawn at any time without notice; but to protect the interest of depositors, members and borrowers and to avoid the sacrifice of securities, thirty days notice of withdrawal may be required. Withdrawal notices of depositors and members will be filed in the order in which they are received and paid from the regular receipts of the Company in the order filed as fast as one-third of the regular receipts of the Company will pay them; but the Board of Directors may, at its discretion, use all the regular receipts of the Company to pay the withdrawals. As to interest rights, a notice to withdraw shall be deemed the same as an actual withdrawal.
2nd. This certificate may be called in, paid and cancelled by the Company at any interest paying period by mailing notice prior thereto to the payee at the address given at the time of deposit.
Section 21 of the bylaws provides:
WITHDRAWAL OF DEPOSITS
Section 21. * * *
Upon receipt of such applications for withdrawal, *120 the Association shall number and file the same in the order received, and shall, within thirty days from the receipt of an application, either pay the holder the amount thereof in part or *547 in full as requested, in the order filed, or apply at least one-third of the cash receipts of the Association received thereafter, (after making provision for the payment of interest on deposits, borrowed money and taxes) from all sources except borrowed money and the proceeds from the sale of assets to the retirement of such applications in numerical order. Provided, however, that the Board of Directors shall have an absolute right to pay out of said one-third of said cash receipts or out of any other funds, in respect of any application, not exceeding one hundred dollars of any one account in any one month in any order; and provided further, that if any depositor applies for the withdrawal of more than one thousand dollars of any account or accounts, he shall not be paid in excess of one thousand dollars, in order when reached, subject to the foregoing provisions of this Section, and his application shall be charged with such amount and shall be renumbered and placed at the end of the*121 list of applications for withdrawal and, thereafter, upon again being reached shall be paid in like amount, but not exceeding the amount of his account; and until paid in full shall continue to be so paid, charged, re-numbered, and replaced at the end of the list until paid in full. * * *
In the event petitioner is subject to excess profits taxes, the tax computed by the use of invested capital credit under section 714 is less than that computed by the use of the base period income credit computed under section 713. Petitioner filed no excess profits tax return for the period ended September 30, 1940. Its officers believed that its taxable year began October 1, 1939, and that therefore no return was necessary. Petitioner's failure to file an excess profits tax return was not due to reasonable cause.
OPINION.
The underlying question is, When did petitioner's taxable year begin? If, as petitioner contends, its taxable year began October 1, 1939, petitioner is not subject to excess profits taxes or the income tax rates imposed by the Second Revenue Act of 1940, which applies only to taxable years beginning after December 31, 1939. Petitioner claims that the change in its business*122 activities whereby it lost its exempt status under the Revenue Act of 1938 did not change its accounting period. It contends that its taxable year is the full 12 months commencing October 1, 1939, and that, since the law requires the use of an annual accounting period, respondent's determination based on an 8-month accounting period violates this requirement, because it creates a hybrid entity, part taxable and part exempt. Petitioner further contends that in any event its taxable income for the 8-month period commencing February 1, 1940, should be determined by eliminating four-twelfths of its total income for the 12-month period October 1, 1939, to September 30, 1940, irrespective of when that income was received or when the expenses in connection therewith were incurred. Respondent claims that under our decision in Royal Highlanders, 1 T. C. 184; reversed on other grounds, 138 Fed. (2d) *548 240, petitioner was not a taxable entity until February 1, 1940. Respondent takes the position that petitioner's income and disbursements prior to that date are not his concern, because petitioner was exempt. Also that, since*123 petitioner is on a cash basis and lost its exemption as of that date, it is only the net income after that day which is subject to tax and is the basis of his determination. Respondent contends that petitioner's return for the period February 1 to September 30, 1940, was a return for less than 12 months, a return for a taxable year commencing after December 31, 1939, and therefore petitioner is subject to the income tax rates imposed by the Second Revenue Act of 1940 and subject to the excess profits taxes imposed by that act.
Petitioner challenges respondent's action in computing the income tax on its actual net income for the 8-month period. Petitioner is on the cash basis. Admittedly the income sought to be taxed by the respondent was received in the 8-month period. Petitioner has not shown that it is necessary to prorate the income for the 12-month period, and for that reason the cases relied on are distinguishable. Cf. Gage Coal Co., 2 T.C. 488">2 T. C. 488.
As to the balance of petitioner's argument, we think respondent must be sustained on authority of our decision in Royal Highlanders, supra. In that case the Royal Highlanders, *124 an insurance company, had been organized as a fraternal society operating under a lodge system and was therefore exempt from Federal income tax. Its accounting period was the calendar year. On May 4, 1937, it amended its charter so as to become a mutual legal reserve life insurance company, and it thereby became subject to tax. In reporting its income for 1937 it included only the income and deductions for the period May 4 to December 31. The Revenue Act of 1936 granted life insurance companies a deduction based upon a computation of reserve funds held at the beginning and end of each taxable year. The insurance company contended that the start of its tax year was May 4, 1937, the date it lost its exempt status, and that it was entitled to compute its reserves based upon its invested assets and reserves as of that date. The Commissioner contended, as petitioner does here, that the transition from the exempt to nonexempt status had no effect on the accounting period and that, since the reserves at the beginning of taxpayer's calendar year were zero, the only figure available for such computation was the reserves at the end of the calendar year. We ruled against the Commissioner*125 and sustained the insurance company's right to compute its reserves as of the day it lost its exempt status. We held that the return for the period May 4, 1937, to December 31, 1937, was for a taxable year and the only period in which petitioner was subject to tax. We said:
During the period January 1, 1937, to May 4, 1937, petitioner was an exempt corporation and was not required to make any return of its income for that *549 period. When it became a mutual legal reserve life insurance company on May 4, it lost its exempt status and, inasmuch as its books were kept on a calendar year basis, it was required to and did file a return for the period May 4 to December 31, 1937. * * *
* * * *
* * * Where no return was required for a portion of the year because petitioner was an exempt corporation, its taxable year, in our judgment, constituted the period covered by the return. The beginning of that year was May 4, 1937, and not January 1, 1937, as determined by the respondent. * * *
So here, when petitioner changed its methods of operation so that substantially all of its business was done with strangers instead of with member stockholders, as formerly, it lost its exempt status.
*126 We think that that case is clearly applicable here. There is nothing in that opinion to sustain petitioner's argument that the principles therein set down apply only to insurance companies. In the instant case petitioner became taxable on February 1, 1940. Its net income after that date was subject to tax. Under our decision in Royal Highlanders, supra, the succeeding eight months constituted a taxable year beginning after December 31, 1939. It follows that petitioner is subject to the income tax rates imposed by the Second Revenue Act of 1940 and the excess profits tax.
In view of our holding that petitioner is taxable under the Second Revenue Act of 1940 it becomes necessary to decide several alternative issues. Petitioner urges that respondent's action in annualizing its excess profits tax net income for the period from February 1 to September 30, 1940, results in a distortion of income, a fictitious net income which is greater than the actual income, and that the tax thereon is unconstitutional. Respondent relies on General Aniline & Film Corporation, 3 T.C. 1070">3 T. C. 1070, and Kamin Chevrolet Co., 3 T. C. 1076,*127 wherein we sustained the right of the respondent to annualize income for excess profits tax purposes pursuant to section 711 (a) (3) (A), Internal Revenue Code. The same argument as to unconstitutionality was made in General Aniline & Film Corporation, supra, and was rejected. It does not appear that petitioner comes within the exception (sec. 711 (a) (3) (B)) and, in any event, no effort has been made to secure the benefits of that section. Cf. Your Health Club, Inc., 4 T. C. 385. On the authority of General Aniline & Film Corporation, supra, respondent's action in computing petitioner's excess profits tax net income for the eight-month period ended September 30, 1940, on an annual basis is approved.
In computing petitioner's excess profits credit respondent ruled that petitioner was not in existence on January 1, 1940, and therefore its credit must be computed on an invested capital method pursuant to section 712 (a). The parties have stipulated that, if petitioner is subject to the excess profits tax, the credit computed under section 714 (the invested capital method) results in a lesser*128 tax. It appears that *550 petitioner is not contesting the correctness of respondent's determination on this point. It is, therefore, unnecessary to decide whether or not petitioner was in existence prior to January 1, 1940, for the purpose of computing its excess profits credit in this proceeding.
In his amended answer respondent asked for an increased deficiency in excess profits taxes and resulting increased penalty, claiming that he erred in computing petitioner's excess profits credit. He contends that in computing petitioner's borrowed capital he erroneously included as a part thereof 50 percent of moneys deposited with petitioner for which petitioner had issued certificates of deposit. The Internal Revenue Code defines borrowed invested capital as follows:
SEC. 719. BORROWED INVESTED CAPITAL.
(a) Borrowed Capital. -- The borrowed capital for any day of any taxable year * * * shall be the sum of the following:
(1) The amount of the outstanding indebtedness (not including interest) of the taxpayer which is evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust, plus,
* * * *
Regulations 112, section 35.719-1*129 (d), in describing the term "certificate of indebtedness," reads in part as follows:
The term "certificate of indebtedness" includes only instruments having the general character of investment securities issued by a corporation as distinguishable from instruments evidencing debts arising in ordinary transactions between individuals. Borrowed capital does not include indebtedness incurred by a bank arising out of the receipt of a deposit and evidenced, for example, by a certificate of deposit, a passbook, a cashier's check, or a certified check.
Respondent argues that petitioner was really in the banking business and therefore the money deposited with it as evidenced by the certificates, hereinabove referred to, must be excluded in computing petitioner's borrowed capital. Respondent claims that these certificates fall squarely within the definition set forth in the regulations excluding indebtedness incurred by a bank and that, in any event, they are not instruments having the general character of investment securities. Petitioner denies that it is in the banking business and says that the burden is on respondent to show that he erred in his original notice of deficiency. The term*130 "certificate of indebtedness" is not new. It appeared in earlier revenue acts, dealing, for example, with dividends paid credit and capital losses, and it appears in the present excess profits tax law creating a credit for debt retirement. The application of the term to any particular instrument has resulted in much litigation, none of which is helpful in determining whether or not the particular instrument here involved comes within section 719. We have heretofore held that sections 718 and 719, defining invested capital, must be given a strict construction. See Journal Publishing Co., 3 T. C. 518, and Flint Nortown Theatre Co., 4 T.C. 536">4 T. C. 536. Are the funds *551 deposited with petitioner under the circumstances hereinabove set forth invested in petitioner's business? Does this certificate have the general character of investment securities? We think these questions must be answered in the affirmative. The money so advanced to petitioner was used in its business for the making of chattel loans. There is no question here, or at least it has not been argued, that the money so received had no business purpose or*131 that the transactions were not bona fide in every respect. The certificate states upon its face that it is not subject to check. It is not negotiable. There are definite limitations on the right of a depositor to withdraw the funds deposited pursuant to its terms. Respondent's suggestion that petitioner was really in the banking business and that the funds evidenced by the certificates herein involved are analogous to the deposits of a bank is not borne out by the evidence. The distinction between ordinary bank deposits and the deposits such as these was recognized in Stoddard v. Miami Savings & Loan Co., 63 Fed. (2d) 851. In that case the Miami Savings & Loan Co. issued certificates covering deposits received, which deposits were made subject to the bylaws of the association. The bylaws provided that applications for withdrawal of such deposits, should be filed in the order in which they were received and paid out of receipts. The association had organized a Christmas savings club, which provided for a return of a fixed amount at the close of the year if certain payments were made throughout the year. The plaintiff, a certificate holder, *132 had served notice of withdrawal and then brought suit to enjoin the association from paying out funds to the Christmas club members before making payment to her. The Circuit Court of Appeals affirmed the District Court's action dismissing the complaint. The Circuit Court pointed out that, while both the members of the Christmas club and the certificate holders were creditors of the association, nevertheless the rights grew out of different contractual obligations and that the contractual limitation to pay certificate holders out of receipts was a different obligation than that created by the Christmas club memberships. The Circuit Court held that the right to demand payment from cash on hand and from receipts was a definite limitation on the certificate holder's rights and that there was no such limitation on the members of the Christmas club, and it pointed out that:
* * * The distinction is that the demand of the appellant is not yet due, at least in the sense that an action might be maintained upon it. Her money was in effect invested in the business of the association. On the other hand, the demands of members of the Christmas Club are now past due, and the deposits of*133 such members are much more clearly analogous to loans to the association than are the deposits of appellant. It may be conceded that both created a debtor and creditor relationship, but the right of the appellant to claim repayment is specifically conditioned upon the association having cash on hand to meet such *552 requirement, while the contracts of members of the Christmas Club, with equal precision, fixed a definite date of maturity. These demands have thus become debts of the association in which the appellant has invested her money. [Italics supplied.]
We do not pass on the question of whether or not petitioner is in the banking business. We think that is immaterial to the precise question presented. We merely hold that the certificate of deposit issued by petitioner is a certificate of indebtedness, an instrument having the general character of an investment security, and thus is within the meaning of section 719. It follows that the moneys secured by these certificates were properly includible in computing petitioner's capital for the purposes of excess profits tax credit.
The final issue is whether respondent properly imposed the 25 percent penalty for*134 failure on the part of petitioner to file an excess profits tax return for the period under discussion. So far as the evidence before us reveals, petitioner still has not filed such return. The sole defense urged is that petitioner's officers believed that its tax year began in 1939 and, therefore, no return was required. There is no evidence on this important question. While the Second Revenue Act of 1940, requiring an excess profits tax return, became effective on October 8, 1940, the regulations extended the time for filing such return to March 15, 1941, regardless of when the taxable year ended. Thus, petitioner had over five months after the law became effective within which to take steps to protect itself from the imposition of this penalty. The Commissioner's assessment of the penalty for failure to file a return is not to be taken lightly. To escape the penalty petitioner must affirmatively show that its failure to file the required return was due to reasonable cause. In the case before us that has not been done. The mere belief that a return is unnecessary is not such reasonable cause. See Burford Oil Co., 4 T. C. 614, and O'Sullivan Rubber Co. v. Commissioner, 120 Fed. (2d) 845.*135
Decision will be entered under Rule 50.
Smith, J., dissenting: I dissent from the conclusion of my brethren that the petitioner is liable to a 25 percent penalty for failure to file an excess profits tax return for its fiscal year ended September 30, 1940. Such penalty is imposed by section 291 of the Internal Revenue Code. It is imposed in case of a failure to make and file a return "unless it is shown that such failure is due to reasonable cause and not due to willful neglect." The petitioner did not file an excess profits tax return because it "believed that its tax year began in 1939 and therefore no return was required." The majority opinion states *553 that "There is no evidence on this important question," that is, as to the reason for not filing an excess profits tax return. It appears to me, however, that it is immaterial that the petitioner did not furnish evidence upon the question. Where the facts show that the petitioner had a reasonable cause for failure to file a return, no additional evidence is necessary.
It is also stated in the majority opinion: "The Commissioner's assessment of the penalty for failure to file a return is not to be taken lightly." *136 I do not think that the respondent's imposition of the penalty should carry any weight with us. The Tax Court is not expected to rubber-stamp the Commissioner's determinations. We are to pass upon issues presented for our determination upon the evidence and in accordance with the law and justice.
The penalty for delinquency is in truth and fact purely a penalty. The fact that it is to be collected as a part of the tax is of no significance so far as the present issue is concerned. The imposition of the penalty is not a revenue measure. It is merely for the purpose of insuring collection of the tax imposed.
In Spies v. United States, 317 U.S. 492">317 U.S. 492, the taxpayer had not filed a required tax return. He had been convicted of attempting to defeat and evade income tax in violation of section 145 (b) of the Revenue Act of 1936. Passing upon the question as to whether he was correctly convicted, the Supreme Court covered the whole field of penalties imposed by the revenue acts, including the delinquency penalty. The Court stated:
Sanctions to insure payment of the tax are even more varied to meet the variety of causes of default. It is the right *137 as well as the interest of the taxpayer to limit his admission of liability to the amount he actually owes. But the law is complicated, accounting treatment of various items raises problems of great complexity, and innocent errors are numerous, as appear from the number who make overpayments. It is not the purpose of the law to penalize frank difference of opinion or innocent errors made despite the exercise of reasonable care. Such errors are corrected by the assessment of the deficiency of tax and its collection with interest for the delay. * * * [Emphasis supplied.]
Just what constitutes a reasonable cause for failure to file a return, in the absence of willful neglect (there is no suggestion made that the petitioner willfully neglected to file a return), is such a cause as appeals to a businessman, a man of the street, or a juror. It seems to me that the petitioner had a reasonable cause for failing to file an excess profits tax return for the taxable year. If the contention made by the petitioner in this case, which I believe was a reasonable contention, had been sustained, there would be no question of the 25 percent penalty in this case. It acted as a reasonable man*138 would act. We, likewise, considering whether there was a reasonable cause for *554 failure to file a return, should act as a reasonable person would act and not mulct the petitioner to the extent of approximately $ 8,000 for making an innocent error.