*844 Petitioners, as holders of certain "6% Convertible Obligations" of the Associated Gas & Electric Co., received in 1936 in payment of accrued interest 4 percent interest-bearing scrip, subordinated in principal to certain senior securities of the company. The scrip had a market value, established by numerous sales, of 35 cents for every dollar of face value. The petitioners were on the cash basis. Their agent, who prepared and filed their returns, failed to include this scrip in 1936 in petitioners' income tax returns on advice of counsel. Held, that the scrip constituted taxable income, and that it was realized by the petitioners in the year of receipt to the extent of its then fair market value; held, further, that the 5 percent negligence penalty should not be imposed for petitioners' failure to return the scrip as income in 1936.
*608 These five cases, consolidated for hearing, involve the same questions and come up on respondent's determination of deficiencies in income tax for the calendar year 1936, as follows:
| Petitioner | Docket No. | Deficiency | 5% penalty |
| Charlotte L. Andrews | 97628 | $3,197.83 | $159.89 |
| Bertha A. Rainey | 97629 | 3,330.15 | 166.51 |
| Mary A. Stoddard | 97630 | 1,615.56 | 80.78 |
| Belle Andrews | 97631 | 3,196.71 | 159.84 |
| Antoinette D. Andrews | 99353 | 72,964.56 | 3,648.23 |
*845 The questions are: (1) Whether certain scrip issued in 1936 by the Associated Gas & Electric Co. in payment of interest on its obligations held by petitioners constituted income received by them, on the cash basis, in that year to the extent of its fair market value, and (2), if this is so, what that fair market value was. Likewise dependent on an affirmative resolution of the first question is (3), whether petitioners incurred the 5 percent negligence penalty imposed by respondent under section 293(a), Revenue Act of 1936, for failure to return the scrip as income in the taxable year. The facts, in part stipulated, with documents attached (which are incorporated by reference here), are, in so far as pertinent to our decision, as follows:
FINDINGS OF FACT.
1. The petitioners kept their books and filed their income tax returns for the year 1936 on the cash basis. They filed their returns for the year 1936 in the office of the collector of internal revenue for the first district of New York. Four of the petitioners are sisters, the fifth, Antoinette D. Andrews, being a sister-in-law. Throughout 1936 they were owners of Associated Gas & Electric Co. "6% Convertible Obligations" *846 due March 1, 2002, in the following face amounts:
| Antoinette D. Andrews | $1,236,600 |
| Bertha A. Rainey | 120,000 |
| Mary A. Stoddard | 66,000 |
| Belle Andrews | 100,200 |
| Charlotte L. Andrews | 120,000 |
On September 22, October 20, and November 6, 1936, the Associated Gas & Electric Co., hereinafter called the company, by resolution issued to holders of its 6 percent convertible obligations due in the year 2002, including petitioners, scrip as follows:
| Scrip issued | ||||
| Oct. 1936 | Nov. 1936 | Dec. 1936 | Total | |
| Total issued | $1,482,542 | $4,475,761 | $4,481,458 | $10,439,761 |
| C. L. Andrews | 3,600 | 10,800 | 10,800 | 25,200 |
| B. A. Rainey | 3,600 | 10,800 | 10,800 | 25,200 |
| M. A. Stoddard | 1,980 | 5,940 | 5,940 | 13,860 |
| B. Andrews | 3,006 | 9,018 | 9,018 | 21,042 |
| A. D. Andrews | 37,098 | 111,294 | 111,294 | 259,686 |
| Total | 49,284 | 147,852 | 147,852 | 344,988 |
*609 The scrip, which was issued in payment of interest on the 6 percent convertible obligations, is identical except that the certificates bear different dates of issue, as above indicated, and the maturity dates are, respectively, October, November, and December 1941, the October scrip purporting to represent*847 interest from June 1, 1933, through November 30, 1933; the November scrip purporting to represent interest from December 1, 1933, through May 31, 1935; and the December scrip purporting to represent interest from June 1, 1935, through November 30, 1936.
The scrip in question bore interest, payable semiannually, at the rate of 4 percent per annum, whenever the board of directors should declare available net income for the purpose and was to be cumulative. Its principal and accumulated interest were subordinated in payment to senior securities of the company. 2
*848 *610 The 6 percent convertible obligations by their terms contemplated the payment of interest in securities of the Associated Gas & Electric Co. and provided expressly that all interest paid in securities should be deemed paid to the extent of the amount or value of such securities as determined by the board of directors. The scrip was issued by the Associated Gas & Electric Co. in payment of interest obligations. The 6 percent convertible obligations provided that unpaid interest thereon should accumulate without interest. They contained, among others, certain provisions which are set out in the margin. 3
*849 The full amount of the "Senior Indebtedness" referred to in the scrip certificate of the Associated Gas & Electric Co., though large, could not be accurately determined in 1936 as of that date, nor could estimates be fairly made as to what that indebtedness would be in 1941, the year in which the scrip certificates became due, because of the contingent nature of certain of the liabilities of the company. Although the company was in serious financial difficulties in 1936, an involuntary petition having been filed against it for a reorganization under section 77B of the Bankruptcy Act, and although the reports of the company and of its subsidiaries for 1934 showed a deficit, those for 1935 and 1936 showed increasing profits for the system and indicated a trend which, if it continued, would restore the sound position of both the company and system. In 1936 there existed a substantial equity for the stockholders, as shown by the report of the company for that year.
2. The scrip certificates were never traded in or quoted on any exchange but all transactions therein during the year 1936 were over the counter. Approximately 90 percent of all the known transactions in them were made*850 through four New York City brokers or traders. Three of the four were G. A. Saxton & Co. Inc., 70 Pine Street, New York City, S. A. O'Brien & Co., and Howard & Robbins. The face value of scrip outstanding in October 1936, was $1,482,542; in November $5,958,303; and in December $10,439,761. From October 12 to December 31, 1936, S. A. O'Brien & Co. made purchases of such scrip in the face amount of $356,024.76 at prices ranging from 40 to *611 52 percent of face value, the average being 42.40 percent. Additional purchases of the scrip in the face amount of $610,030.59 at prices ranging from 28 to 54 percent of face value, were made from January 1 to September 30, 1937. Approximately 60 percent of all transactions in this scrip were made through S. A. O'Brien & Co. From October 19 to December 31, 1936, G. A. Saxton & Co. Inc., made purchases of such scrip in the face amount of approximately $47,000 at prices ranging from 38 to 52 percent of face value. The transactions made by Howard & Robbins were approximately the same in volume and amount as those made by G. A. Saxton & Co. Inc. Other sales of such scrip by other firms took place, but there is no evidence in the record*851 as to volume or prices.
The market for this scrip was somewhat limited and if petitioners, upon receipt thereof, had placed all of it on the market for immediate sale it would have resulted in a substantial reduction of the price at which it could be sold. If, however, it had been marketed intelligently over a reasonable period of time, the reduction of price would not have been substantial.
The fair market value of the scrip when received by the petitioners was 35 cents for every dollar of face value.
3. The receipt of this scrip was not reported by petitioners in their income tax returns for the taxable year 1936 or any return for any subsequent year. The Associated Gas & Electric Co., in compliance with
Aquila W. Sweeney kept the books and record of petitioners and had done so continuously since 1911. He acted as a business adviser and handled all financial affairs, whether personal or otherewise, for petitioners, including maintenance of the records and preparation of the income*852 tax returns of petitioners for the years 1933 and 1936. He maintained for this purpose an office at 2034 Grand Central Station, New York City, and employed two assistants there.
Petitioners were in 1933 the owners of certain amounts of similar 6 percent convertible obligations of the Associated Gas & Electric Co. due in the year 2002, and in 1933 received scrip certificates, similar in form, and perhaps identical, with those received in 1936, for interest due on the obligations. Sweeney discussed the receipt of the scrip in 1933 with the attorney for petitioner, Alexander S. Andrews, who, without specific authority from petitioners, went to the offices of the Associated, gas & Electric Co. and protested against the issuance of the scrip in lieu of payment of the interest in cash. Andrews received no satisfaction from the company but was told to see one Aaronson about the matter. Aaronson was then absent from the *612 city. Andrews called later to inquire if Aaronson was back but made no further attempt to see him. The scrip was never returned to the company but was retained by the petitioners. Suit was not instituted against the company by the petitioners for its failure*853 to make the interest payments in cash, nor was any other action taken against the company in the matter.
The receipt of the scrip certificates in 1933 by the petitioners was reported on their income tax returns for that year. Teh receipt of the scrip was treated as income on the books of petitioners, which were kept by Sweeney, and it was carried to the profit and loss account at the face amount. It was reported as income, however, at 10 percent of face value, a figure fixed by Sweeney which had no definite relation to market value but was arbitrarily arrived at so as to show the return of a nominal amount and nothing more. No statement of protest was made on or accompanied the returns which showed the receipt of scrip in 1933, nor was any claim for refund ever filed for the tax paid on the receipt of the scrip in 1933. Sweeney was in doubt whether to return the scrip as income in 1933 and consulted petitioners' attorney, Andrews, who advised him that the receipt of the scrip in 1933 was not taxable, but Sweeney nevertheless reported it. The receipt of scrip in 1936 was treated by Sweeney in the same manner on the books of the petitioners as the receipt of scrip in 1933, but*854 he did not return it in any amount as income for the later year.
Sweeney kept abreast of the rulings of the Bureau of Internal Revenue and was familiar with the regulations and the tax service. No developments, cases, or rulings came to his attention in the period between the preparation of the 1933 returns and the preparation of the 1936 returns which caused him to change his treatment of the scrip for income tax purposes. He was familiar in 1936 with the position taken by the Bureau of Internal Revenue, that scrip received as a dividend is taxable at its fair market value, but with regard to the scrip issued to petitioners in payment of interest on petitioers' Convertible Obligations" he was again informed by petitioners' attorney, with whom he consulted, that it was not income to petitioners and should not be included in petitioners' income tax returns.
Petitioners were not guilty of negligence in failing to include in their income tax returns for the year 1936 the receipt of this scrip.
OPINION.
KERN: 1. Petitioners were the owners of certain "6% Convertible Obligations" of the Associated Gas & Electric Co. It is stipulated by the parties that the terms of these*855 obligations contained "provision for payment of interest by action of the Board of Directors regardless of the existence * * * [of any conditions attached to the payment *613 of interest], in which case payment may be made in cash and/or 'securities' as defined in Board resolution and such payment shall be deemed to the amount of the value of said securities as fixed in such resolution." The phrase "conditions attached to the payment of interest" evidently refers to a provision that interest on such obligations shall be payable without action of the board of directors if dividends shall have been paid on the corresponding preferred stock into which these obligations were convertible. On September 22, 1936, the board of directors of the company adopted a resolution to the effect that "this Board * * * does hereby declare and direct the payment of * * * interest for the period beginning June 1, 1933 and ending November 30, 1933 on the 6% convertible obligations * * * and does hereby determine that such interest shall be paid in obligations of this Company maturing October 1, 1941 to be designated 'Scrip Certificates for Interest on Convertible Obligations'"; that these Scrip*856 Certificates should bear interest at the rate of 4% payable out of "Available Net income" but payable as to principal and accumlated interest at maturity without regard to "available net income" but subordinated to the senior indebtedness of the company; and that "the interest hereby declared on the Convertible Obligations * * * shall be charged against Capital Surplus of the Company." Similar resolutions were adopted with regard to the payment of interest on the convertible obligations for the period December 1, 1933, to May 31, 1935, and for the period June 1, 1935, to November 30, 1936, these resolutions being adopted under date of October 16, and November 6, 1936, respectively. Pursuant to these resolutions scrip of the company was issued and distributed to the petitioners herein, who received and retained it. The scrip was readily transferable; there was an active market for it immediately upon its issue, the sales being "over the counter" transactions; and it had a market value during the taxable year of 35 cents on each dollar of its face value.
Under these facts the first question posed herein is whether petitioners, on a cash basis, received taxable income during the*857 year 1936 by reason of their receipt of this scrip, to the extent of its fair market value.
Our answer is in the affirmative. This scrip was not issued to petitioners merely to evidence or renew an existing interest obligation, but was issued in payment and satisfaction of this obligation pursuant to the provisions of the "6% Convertible Obligations" which they held and the resolutions of the board of directors of the company authorizing its issue. It was received and retained as such by petitioners regardless of their dissatisfaction with this medium of payment. The scrip had an established market value of its own and there was active trading in it. Under these facts the receipt by petitioners *614 of this scrip constituted the payment to them of interest by property having a market value and to the extent of this value they received income. See arts. 22(a)-1, 22(a)-3, and 115-10, Regulations 94;
In so far as these factual elements are lacking in the cases cited by petitioners, they are inapplicable to the question here presented. Cf. *858
2. We come, then, to the question of the scrip's value. We have found as a fact that the scrip when received by the petitioners in 1936 had a fair market value of 35 cents for every dollar of its face value. It was never quoted on the exchanges, but was sold actively and in considerable amounts over the counter by New York brokers. We need not enter here upon a detailed consideration of the contingencies of payment of the scrip, since it had an established market value. As the Circuit Court of Appeals for the Second Circuit said in
All this is well understook, and for this reason the price at which shares are sold is ordinarily the best test of their value. It is quite true that, even in wide markets where there are many buyers and sellers, these often do not know the more important facts about the company, and their consensus of opinion is not necessarily a proper measure of value, if by that be meant a truly informed judgment; nevertheless, sales are usually the most reliable evidence, and in any case they should weigh heavily. We cannot therefore*859 say that, in the case at bar, the Board were bound to prefer the calculations of experts, drawn from the books, to sales even of such small blocks as forty shares or less; or to quotations of brokers who dealt in the shares.
Petitioners object to a finding of value on these sales because of the contention that the sale of large blocks of the scrip at one time would depress the market to the point of extinction.
The one expert witness who testified on this subject was a broker. He stated that if the holdings of petitioners in this scrip had been placed upon the market it would have resulted in a substantial reduction in the price at which they could have been sold. On crossexamination he was asked as to the effect on the Market if petitioners' scrip had been sold over a long period of time. His answer was as follows:
A. Well, no doubt that if they had given me a period of two years I might have been able to liquidate thier entire holdings, but the very fact that that block of scrip never come into the market and, as we would say, it was tied off the market, it did not interfere with what constituted the*860 ordinary flow of scrip coming in or going out of the market, but with that additional scrip coming in the market, it is impossible for me to answer what the price would have been.
*615 In view of the fact that one brokerage firm sold $966,055.35 face amount of this scrip in the period of October 13, 1936, to September 30, 1937, that this amount was approximately 60 percent of all the scrip sold, and that the total of such scrip outstanding was only $10,439,761, we must conclude that the market for the scrip was active and capable of absorbing petitioners' holdings if sold intelligently over a reasonable period of time. While the sales were made for the most part in small lots, the volume of total sales and the activity of the market were such as to demand that great consideration be paid to the market prices as evidence of fair market value.
However, in the light of the testimony of this witness we must also conclude that the absorption by the market of petitioners' scrip would result in some reduction of the price thereof if the sales were to take place within a reasonable period. Therefore, instead of taking the average price at which the scrip was sold by this brokerage*861 firm during 1936 (approximately 42) as the sole factor determining the amount of market value, we have considered all the factors presented by the evidence and have determined that the market value of petitioners' scrip was 35. See
3. The only remaining question is whether petitioners, on the well established principle of agency, qui facit per alium facit per se, are liable for the negligence penalty by reason of the failure of their bookkeeper, Sweeney, who prepared their income tax returns, to return their scrip in 1936 as income.
The respondent grounds his case on the fact that Sweeney, in 1933, against the advice of petitioners' counsel, treated the scrip received by them in 1933 (and not here in question) as income at its face amount on his books and carried it to the profit and loss account, and at the same time returned it as income at 10 percent of its face value. This seems to have been an arbitrary amount fixed by Sweeney, so as to disclose*862 the scrip's receipt without conceding that it had any real value. No protest was made by the petitioners about the scrip being treated as income in 1933 and no claim of refund was filed for that year. At the hearing Sweeney professed to be familiar with the Treasury rulings in regard to scrip which was issued in payment of dividends but denied knowledge of any ruling in regard to scrip issued in payment of interest. In 1936 Sweeney treated it as income on his books but not on the returns made out for petitioners. He did so in the latter year on the advice of counsel. Respondent points to these facts as establishing negligence on the part of petitioners.
*616 We do not agree with respondent's contention. There is no question as to Sweeney's honesty of doubt with regard to the taxability of this scrip. It was and is a matter of a controversial nature and Sweeney was not negligent in consulting with petitioners' attorney with regard to it and following his advice. The failure to report this scrip as income in the taxable year was due to an honest misunderstanding of law and not to negligence.
Therefore, no penalty attaches.
Decision will be entered under Rule*863 50.
Footnotes
1. Proceedings of the following petitioners are consolidated herewith: Bertha A. Rainey; Mary A. Stoddard; Belle Andrews; Antoinette D. Andrews. ↩
2. The reverse side of the scrip bore this statement as to subordination:
"This Certificate shall be subordinate, both as to principal and interest, to the following (hereinafter called 'Senior Indebtedness'), namely: all indebtedness of the Company now or hereafter issued and outstanding, except (1) the 5%, 5 1/2%, 6 1/2%, and 7% Convertible Obligations. Series A, and 6% Convertible Obligations, Series A and Series B, and (2) indebtedness or obligations convertible at the option of the Company into stock of the Company of any class or subordinated by their terms to other indebtedness or obligations of the Company; and to that end it is hereby provided and agreed by each and every holder hereof as follows:
"(a) In the event that on any interest payment date the Company shall not have paid or provided for the payment of all interest due and payable on or before such interest payment date on all Senior Indebtedness, then and in such event any interest otherwise by the terms hereof payable on such date shall not then become payable, anything herein to the contrary notwithstanding, but shall cumulate (without interest) and shall become payable on the first interest payment date thereafter on which all interest due and payable on or before such date on all Senior Indebtedness shall have been paid or provided for.
(b) The principal of this Certificate shall be payable, at maturity, (i) only if and when the Company shall have paid or provided for the payment of all Senior Indebtedness that shall then be due and payable and (ii), if at the time this Certificate shall become payable the Company shall be bankrupt or insolvent or in liquidation, then only if and to the extent that there shall be assets of the Company remaining after all Senior Indebtedness (whether or not then due and payable) shall have been paid or provided for. If in any of the events specified in clause (ii) of this subdivision (b) the amount of such remaining assets shall be less than the aggregate principal amount of all of the Certificates of this issue then outstanding and of any other obligations of the Company of equal rank therewith then outstanding, then the registered owner of each Certificate of this issue then payable shall be entitled to receive only such proportion of the amount of such excess as the principal amount of Certificates of this issue held by him shall bear to the total principal amount of all of the Certificates of this issue and of all other obligations of equal rank therewith then outstanding. Upon any payment of the principal of any of the Certificates of this issue, accrued and unpaid interest thereon to the date of such payment of principal shall also then be due and payable, but subject to the same conditions as are applicable to the payment of principal." ↩
3. * * * Any unpaid interest thereon shall accumulate (without interest) and, if not previously paid, shall become due and payable whenever the principal of this obligation shall become due and payable, either on maturity, redemption or otherwise, and subject to the same conditions, or if this obligation shall be converted by the Company into said conversion stock as permitted by the terms hereof, upon the effective date of such conversion. Any interest required to be paid hereon on any interest payment date without action of the Board of Directors, may, in the discretion of the Board of Directors, be paid in the same medium (cash and/or securities, as defined in the resolutions hereinafter mentioned and subject to the conditions therein stated) as that in which the dividends on said conversion stock were paid in the quarterly period immediately preceding such interest payment date, and any interest directed to be paid by the Board of Directors may be paid in its discretion in such medium (cash and/or securities as defined in said resolutions and subject to the conditions therein stated) as the Board of Directors may determine, and all interest paid in securities shall be deemed paid to the extent of the amount or value, as determined by the board of Directors in accordance with the provisions of said resolutions, of such securities. ↩