*276 Decisions will be entered under Rule 50.
Amounts borrowed by petitioner, a corporation engaged in the general investment and finance business, and used to purchase United States Government bonds as bona fide business investments for profit constituted borrowed invested capital for excess profits tax purposes under sec. 719, I. R. C., and Regulations 112, sec. 35.719.1.
*192 These proceedings, consolidated for hearing, involve deficiences in excess profits taxes for the fiscal years ended November 30, 1944, 1945, and 1946, in the respective amounts of $ 30,818.67, in Docket No. 18058, and $ 46,314.07, and $ 2,738.24, in Docket No. 22202.
*193 Several adjustments were made in petitioner's income and excess profits tax returns for the years here involved which are not contested. The only question in issue is whether amounts borrowed by petitioner and used to purchase U. S. Government bonds constituted borrowed invested capital for excess profits tax purposes.
Some of the facts were stipulated and are so found. The stipulation filed is incorporated *277 herein by reference.
FINDINGS OF FACT.
The petitioner is a Washington corporation, organized in December, 1935, under the name "Securities Mortgage Company," with its principal office in Seattle, Washington. Its income and excess profits tax returns in each of the three taxable years here involved were filed in the name of Securities Mortgage Co. with the collector of internal revenue for the district of Washington. On October 21, 1947, the name of the corporation was changed to "Globe Mortgage Company," which is the name in which these proceedings were instituted.
Throughout the taxable years involved the petitioner had outstanding $ 200,000 par value capital stock, substantially all of which was owned by Charles F. Clise. Since 1942 the petitioner has owned 100 per cent of the capital stock of Northwestern Development Co., a Washington corporation engaged in developing a residential project in Tacoma, Washington. Since 1945 the petitioner has also owned 100 per cent of the capital stock of Rainier Properties, Inc., a Washington corporation not engaged in substantial business operations during the period here involved.
The petitioner is, and has always been, engaged in the general*278 investment and finance business. Its activities consist of:
(1) Acting as loan correspondent for numerous investors, primarily insurance companies, making loans upon both completed structures and uncompleted structures;
(2) Promoting and financing various types of construction and housing projects in the vicinity of Seattle;
(3) Investing in securities of commercial corporations in the vicinity of Seattle; and
(4) Investing in general marketable securities, including U. S. Government bonds.
In the course of its operations the petitioner borrowed heavily from banks in Seattle and nearby cities and in New York, usually borrowing large sums on short term or demand notes. The development and maintenance of large credit lines were essential to petitioner's business operations.
Governmental restrictions placed upon private building soon after the beginning of World War II brought about a general contraction of the private construction finance business. As petitioner transferred its construction mortgages to its principals upon completion of *194 construction, its lines of credit became available for operations in other fields, since it could no longer conduct equivalent operations*279 in the financing of private construction.
Charles F. Clise, petitioner's principal shareholder and officer, had been for several years interested in the market in Government bonds. After making an intensive study of conditions in the Government bond market and seeking the advice of investment experts with respect to bond investments, he concluded that the petitioner could make substantial profits by investing borrowed funds in Government bonds and realizing both interest and speculative profits on them. Also, it was to petitioner's interest to maintain the level of its borrowings from the banks in order to keep open its available credit lines with them. The banks with which petitioner dealt were at that time eager to make loans at attractive interest rates and were willing to lend 100 per cent of the value of petitioner's collateral for mortgage loans and 90 to 95 per cent of the value of petitioner's investments in U. S. Government bonds. Pursuant to this plan petitioner during the years 1944 to 1948, inclusive, procured the following loans to purchase U. S. Government securities, depositing the securities purchased, together with additional cash, with the banks for collateral: *280
| Date | Total | ||||
| Total cost | Amount | loan | Interest | interest | |
| Designation of issue 1 | of issue | borrowed | repaid | rate | paid |
| Per cent | |||||
| A | $ 502,374.57 | $ 490,000 | 2-10-44 | 3/4 | $ 1,439.37 |
| B | 500,586.12 | 490,000 | 2-10-44 | 3/4 | 1,061.67 |
| C | 503,750.00 | 450,000 | 7- 2-45 | 1 1/8 | |
| 475,000 | 1- 7-47 | 1 | 14,542.15 | ||
| D | 502,187.50 | 450,000 | 7- 2-45 | 1 | |
| 475,000 | 1-20-47 | 1 | 13,327.50 | ||
| E | 250,000.00 | 250,000 | 7- 1-46 | 7/8 | 4,399.70 |
| F | 1,023,125.00 | 900,000 | 3-12-47 | 1 | 17,625.00 |
| G | 207,715.24 | 180,000 | 7- 8-46 | 1 | |
| 140,000 | 8- 5-47 | 1 | |||
| 110,000 | 12-30-47 | 1 | |||
| 80,000 | 1-21-48 | 1 | |||
| 70,000 | 3-23-48 | 1 | 4,034.94 |
During the period from 1943 through 1948 the petitioner's purchases and sales of U. S. Government securities were as follows:
| Designation | Date of | ||
| of issue | bond | Purchase | Face |
| purchase | price | amount | |
| A | 9-22-43 | $ 502,374.57 | $ 500,000 |
| B | 10-29-43 | 500,586.12 | 500,000 |
| C | 1-24-44 | 503,750.00 | 500,000 |
| D | 3-11-44 | 502,187.50 | 500,000 |
| E | 6-26-44 | 250,000.00 | 250.000 |
| 6- 1-45 | |||
| F | 3-27-45 | 1,023,125.00 | 1,000,000 |
| G | 6-25-45 | 207,715.24 | 180,000 |
| Designation | |||
| of issue | Bond description | Date sold | Sale price |
| A | 7/8% certificates, due 4-1-44 | 2-10-44 | $ 501,872.80 |
| B | 7/8% certificates, due 4-1-44 | 2-10-44 | 501,872.80 |
| C | 2% bonds, due 9-15-52-50 | 1- 7-47 | 512,734.38 |
| D | 2% bonds, due 9-15-53-51 | 1-20-47 | 514,687.50 |
| E | 7/8% certificates, due 6-1-45 | 6- 1-45 | 250,000.00 |
| Replaced by 0.9%, due 7-1-46 | 7- 1-46 | ||
| F | 2 1/2% bonds, due 6-15-67-62 | 3-12-47 | 1,053,906.25 |
| G | 2 3/4% bonds, due 12-15-65-60 | 1 7- 8-46 | 1 46,775.03 |
| 1 8- 5-47 | 1 34,396.80 | ||
| 1 12-30-47 | 1 21,697.54 | ||
| 1 1-21-48 | 1 21,626.57 | ||
| 1 3-23-48 | 1 75,512.50 |
*195 The total amounts of interest received by petitioner on each of the bond issues and the total amounts of interest paid by petitioner on loans procured for the purchase of each issue, with the net gain on interest from each transaction, are summarized as follows:
| Total loan | Loan | Total bond | Bond | Net gain on | |
| Designation of issue | interest | interest | interest | interest | interest |
| paid | rate | received | rate | ||
| Per cent | Per cent | ||||
| A | $ 1,439.37 | 3/4 | $ 1,713.54 | 7/8 | $ 274.17 |
| B | 1,061.67 | 3/4 | 1,263.89 | 7/8 | 202.22 |
| C | 14,542.15 | 1 | 29,534.20 | 2 | 14,992.05 |
| D | 13,327.50 | 1 | 28,730.00 | 2 | 15,402.50 |
| E | 4,399.70 | 7/8 | 4,472.47 | 1 7/8 | 72.77 |
| F | 17,625.00 | 1 | 49,095.95 | 2 1/2 | 32,470.95 |
| G | 4,034.94 | 1 | 10,945.91 | 2 3/4 | 6,910.97 |
| Total | 70,325.63 |
Petitioner's net investments and holding periods for Government bonds, its gains on interest, profits or losses on bond sales, and total profits or losses on its bond investments were as follows:
| Designation of | Net investment | Holding period |
| issue | ||
| A | $ 12,374.57 | 141 days |
| B | 12,374.57 | 104 days |
| 53,750.00 | 1 yr. 159 days | |
| C | 28,750.00 | 1 yr. 189 days |
| 52,187.50 | 1 yr. 113 days | |
| D | 27,187.50 | 1 yr. 202 days |
| E | 2 yrs. 5 days | |
| F | 123,125.00 | 1 yr. 350 days |
| 27,715.24 | 1 yr. 13 days. | |
| 21,953.65 | 1 yr. 28 days. | |
| 17,972.00 | 147 days. | |
| 14,116.01 | 22 days. | |
| G | 12,828.69 | 61 days |
| Total |
| Designation of | Gain on | Profit or loss | Total profit |
| issue | interest | on sale | or loss |
| A | $ 274.17 | ($ 501.77) | ($ 227.60) |
| B | 202.22 | 1,286.68 | 1,488.90 |
| C | 14,992.05 | 8,984.38 | 23,976.43 |
| D | 15,402.50 | 12,500.00 | 27,902.50 |
| E | 72.77 | 72.77 | |
| F | 32,470.95 | 30,781.25 | 63,252.20 |
| G | 6,910.97 | (7,706.80) | (795.83) |
| Total | 70,325.63 | 45,343.74 | 115,669.37 |
Prior to September 22, 1943, when petitioner made the first of the investments in U. S. Government bonds here involved, it had numerous*283 investments in corporate and governmental securities of various kinds. It had made substantial investments in corporate bonds and securities of corporations in the vicinity of Seattle and some modest investments in U. S. Government bonds soon after it was incorporated in 1935. The petitioner's officers had studied the Government bond market from an investor's standpoint as early as 1936. Other corporations in which Charles F. Clise was the principal stockholder made similar investments in Government securities both before and after those here involved.
Beginning in January, 1947, the petitioner began to liquidate its investments in Government bonds. All of the investments here involved were liquidated by March, 1948. Petitioner's reasons for disposing of its Government bonds were that it expected a decline in the *196 Government bond market, which could reduce petitioner's profits or result in losses, and it wanted to increase its investments in the more profitable mortgage-financing business, which was then expanding as a result of postwar building activity. Also, the banks were becoming less willing to lend to petitioner on the liberal interest rates formerly available. *284 Petitioner completed liquidation of its U. S. Government bond investments at a total net profit of $ 115,669.37.
The petitioner's officers were kept constantly informed of the tax consequences of the petitioner's financial activities. They were aware that the maintenance of a large average indebtedness to the banks would result in a substantial saving in excess profits tax by increasing the petitioner's invested capital credits for excess profits tax purposes. The petitioner did not make the investments in Government bonds here involved solely for tax avoidance purposes, but made them as bona fide business investments for profit.
In determining its invested capital for excess profits tax purposes for the years here involved, the petitioner included borrowed capital as follows:
| Item | 1944 | 1945 | 1946 |
| Equity invested capital | $ 383,092.19 | $ 439,529.50 | $ 524,942.95 |
| Total average borrowed capital | 2,699,460.58 | 3,703,936.88 | 2,710,062.39 |
| 50% of total average borrowed capital | 1,349,730.29 | 1,851,968.44 | 1,355,031.19 |
| Average borrowed capital for purchase | |||
| of U. S. bonds | 1,007,459.02 | 1,842,383.56 | 2,040,958.90 |
| 50% of average borrowed capital for | |||
| purchase of U. S. bonds | 503,729.51 | 921,191.78 | 1,020,479.44 |
*285 Respondent eliminated from petitioner's borrowed invested capital the 50 per cent of the average borrowed capital used for purchase of U. S. bonds which petitioner had included in its borrowed invested capital. Respondent also made some other minor adjustments to the returns, which petitioner has not contested.
OPINION.
Section 719 of the Internal Revenue Code provides with respect to borrowed invested capital for excess profits tax credit purposes as follows:
SEC. 719. BORROWED INVESTED CAPITAL.
(a) Borrowed Capital. -- The borrowed capital for any day of any taxable year shall be determined as of the beginning of such day and 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, * * *
* * * *
(b) Borrowed Invested Capital. -- The borrowed invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be an amount equal to 50 per centum of the borrowed capital for such day.
*197 In addition to restating the requirements of the statute, *286 respondent's Regulations 112, section 35.719-1, provides that: "In order for any indebtedness to be included in borrowed capital it must be bona fide. It must be one incurred for business reasons and not merely to increase the excess profits credit." We have previously upheld the validity of the cited portion of Regulations 112, section 35.719-1, in Hart-Bartlett-Sturtevant Grain Co., 12 T. C. 760, where we said: "It is entirely in accord with the spirit of the excess profits tax legislation."
Respondent concedes that the borrowings in question were evidenced by notes and did constitute indebtedness of the petitioner, thus meeting the requirements of the letter of the statute. The real question at issue, then, is whether the indebtedness qualifies as borrowed invested capital within the intent of the statute and regulations. Player Realty Co., 9 T. C. 215; Hart-Bartlett-Sturtevant Grain Co., supra.
Respondent argues that this case is controlled by our decision in Hart-Bartlett-Sturtevant Grain Co., supra, in which we held that the taxpayer's borrowings to *287 purchase U. S. Government securities during war loan drives did not constitute borrowed invested capital for excess profits tax purposes within the meaning of section 719 of the Internal Revenue Code and Regulations 112, section 35.719-1. In that case the taxpayer, a corporation engaged in the grain business, borrowed large sums to purchase U. S. Government bonds during war loan drives, paying the same interest on the borrowed money that it received from the bonds. It sold out all the securities and retired the notes for the loans after the close of the fiscal year, when the excess profits tax was no longer in effect and the tax benefits of a large amount of borrowed invested capital could no longer be obtained. The taxpayer did not contend that the transactions were entered into for profit, but contended only that it obtained good will by participating in war loan drives in communities where it had grain elevators. This Court concluded that the facts did not support a view that the borrowings were a proper measure by which the amounts of profits which were excessive could be judged, since the funds were not borrowed for business reasons and were not subject to business risks.
*288 The facts of that case are clearly distinguishable from the facts in this case. Here, the taxpayer was engaged in a general mortgage and investment business and was accustomed to borrowing large sums from the banks to finance its business investments. When as a result of wartime building restrictions, petitioner became unable to obtain sufficient mortgage loan investments, it used its available credit to borrow for investments in U. S. Government securities. The petitioner had for several years made investments in corporate and Government securities and its officers were familiar with the market in such securities. We conclude from all the facts that the petitioner borrowed the sums here in question and used them to purchase Government *198 securities in the normal course of its business as bona fide business transactions, subjecting the borrowed capital to business risks for profit. The petitioner did not sell out the securities and pay the loans they secured until an anticipated decline in the Government securities market threatened to reduce the profits on its investments. Although the fact that petitioner did realize a substantial profit on the investments does not *289 in itself determine whether the investments were bona fide transactions in connection with petitioner's business, it does indicate that petitioner's officers were justified in their expectations of profits from the transactions. The further fact that petitioner did not sell out the securities and repay the loans until in some cases, long after the excess profits tax was no longer effective 1 further evidences the bona fide business nature of the transactions.
The fundamental purpose of the legislation defining invested capital for excess profits tax purposes was to establish a measure by which the amount of profits which were "excess" could be judged. The capital funds of the business, including borrowed capital, which were placed at the risk of the business are entitled to an adequate*290 return. West Construction Co., 7 T. C. 974; Hart-Bartlett-Sturtevant Grain Co., supra.
Petitioner's officers were kept informed of the tax consequences of their business activities and were aware that the transactions here in question would result in substantial tax benefits. However, the tax saving incident to the transactions does not negative the petitioner's motive in entering the transactions to make a profit. The petitioner is not required to transact business by other means to avoid saving taxes. Gregory v. Helvering, 293 U.S. 465">293 U.S. 465; Commissioner v. Kolb, 100 Fed. (2d) 920.
We conclude that the borrowings here in question were for business reasons and that the amounts borrowed are includible in petitioner's borrowed invested capital under section 719 of the Internal Revenue Code.
Decisions will be entered under Rule 50.
Footnotes
1. Arbitrary designations made aphabetically in chronological order for clarity only.↩
1. Portions of issue sold at various dates.↩
1. Original certificates due June 1, 1945. Replaced by 0.9% certificates due July 1, 1946.↩
1. The excess profits tax was repealed by the Revenue Act of 1945, effective with respect to taxable years beginning after December 31, 1945. Petitioner's investments in Government securities were finally liquidated March 23, 1948.↩