Paine v. Commissioner

FRANK C. PAINE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Paine v. Commissioner

Docket No. 81606.

United States Board of Tax Appeals

37 B.T.A. 427; 1938 BTA LEXIS 1040;

February 25, 1938, Promulgated

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">*1040 Petitioner, a naval architect, invested $100,000 in stock in a boat company in order to secure employment as a designer of a boat to compete for the position of defender in the international yacht races between the United States and Great Britain in 1930. The investment was made in order to advertise and enhance his reputation as a naval architect. The boat designed by him having been unsuccessful, he made a bona fide sale of the stock for $10, and deducted the difference from gross income. Held, that the loss upon the sale of corporate stock did not constitute a loss incurred in trade or business, or in a transaction entered into for profit.

John W. Townsend, Esq., and Joseph Wiggin, Esq., for the petitioner.

Thomas F. Callahan, Esq., for the respondent.

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DISNEY

">*427 This proceeding involves income tax for the year 1930. The issue is as to whether the respondent erred in disallowing as a loss the deduction of the sum of $99,990 claimed by petitioner as either in a transaction incurred in trade or business, or entered into for profit. The Commissioner determined a deficiency in the amount of $12,389.46, which with interest of $4,265.37, ">*1041 was paid in December 1936, since the institution of this proceeding. The decision, therefore, will be either that there has been an overpayment, or a deficiency already collected, due to payment of the above amount.

FINDINGS OF FACT.

The petitioner, Frank C. Paine, has practiced as a naval architect continuously since 1922. During the year 1930 he was associated with a firm of naval architects, the firm name being Paine, Belknap & ">*428 Skene. That firm was organized in September 1929 to carry on, and in 1930 did carry on, a yacht designing and brokerage business. Petitioner's specialty is sailboats and his practice is the designing, drawing of construction plans, supervision of the construction, and supervision and adjustment of rigging. The general source of his income is investments.

Since 1922 the designing, construction of, and dealing in sailing vessels has been his principal occupation, taking 85 percent of his time over that period, and during that period 1 to 2 percent of his income has been earned as a yacht architect. In 1930 all of his time was spent in that occupation up to the middle of August, and during the remainder of the year 80 percent of his">*1042 time was so devoted. Since 1930, 90 percent of his time has been devoted to that business.

Prior to 1929 he had built from seven to ten boats, costing around $14,000 to $15,000, and had designed one boat, the Thebaud, 50 percent larger than the Yankee (hereinafter discussed). He has engaged in sailing racing boats seven or eight years since manhood, and four or five years as a boy. His father was interested in sailing racing boats.

Petitioner is also the owner of the controlling interest in George Lawley & Sons, Inc., a large yacht building plant, and his partnership does a brokerage business of buying and selling boats for others for a commission and buying and selling boats on its own account. George Lawley & Sons, Inc., constructed approximately $1,000,000 worth of sailing vessels in 1929, and later 11 boats from petitioner's designs, the gross contracts being about $150,000.

The partnership maintains a brokerage office, which at times has one to three men in it; also a designing office, in which petitioner's partners are located, and where he employs two or three draftsmen, according to the amount of business.

Petitioner advertised in yachting magazines">*1043 every month in 1930, an average of half a column, and to a relatively small amount from 1922 on. His personal name as a yachting architect was not up at his office. He ran an advertisement as naval architect and yacht broker.

Petitioner spent money advertising as a naval architect as follows:

1929 (last 4 months)	$138.55
1930	511.20

Petitioner had designed a number of very successful racing boats, but they were small and he had not been able to get enough national advertising. He thought that the America Cup challenge in 1930 would be an excellent opportunity to get his name before the public. He attempted to raise a syndicate to commission him to build a boat, but the majority of the people contacted did not think he had enough ">*429 experience to build such a large boat. He then subscribed $100,000 towards a syndicate to build a boat, provided he had complete charge of the designing, building, and construction. This was agreed on in August 1929, and in January 1930 the New England Boat Co., a corporation, was organized. Petitioner was one of the original subscribers, subscribing for 1,000 shares which cost him $100,000 paid in cash, of which $10,000">*1044 was advanced in 1929 and $90,000 in 1930. The corporation had an authorized capital stock of 5,000 shares without par value. There were on October 30, 1930, seventeen stockholders, petitioner holding the largest number of shares. Four other stockholders held 500 shares each. The corporation engaged in the business of constructing and sailing the yacht Yankee. The intent in forming the New England Boat Co. was to limit liability.

The yacht Yankee was a sloop specifically constructed to be a contender for the defense of the America Cup in 1930. The idea of building the boat to defend the cup in the international races was petitioner's. Approximately $470,000 in New England Boat Co. stock was sold, including what petitioner purchased, and that amount of cash was put into the proposition. The approximate cost of constructing the Yankee was $400,000. Two hundred thousand dollars would cover a year's running expense, including alterations, of a boat of the character of the Yankee. Petitioner was given the commission to design the yacht and George Lawley & Sons, Inc., was the builder. Petitioner supervised the construction from start to finish and has supervised">*1045 and designed all changes made in the boat from time to time. His partnership of Paine, Belknap & Skene, under his supervision, made most of the detailed drawings of the Yankee, while he personally did all the designing of the outside lines. The rest of the drawings were done under his supervision. He never sailed or had charge of the sailing of the Yankee himself. He did not personally design any of the interior parts or decorations.

The boat was launched in May 1930. It was not selected to defend the America Cup. However, the yacht established the fastest record for the triangular course ever made by a 90-footer, until 1937, when that record was barely beaten. The boat was not selected because it was a heavy weather boat, and a light weather boat was required. The yacht again tried in 1934 and beat the new candidate for defense the first 17 races straight, but broke down once, lost three of the last four races, and finally was not selected. In 1935 the Yankee was taken to England, where she raced against the crack boats and won eight firsts out of 33 starts, while the crack English boat was able to win only one more. In 1936 she raced against the Rainbow,">*1046 which was the 1934 boat, and in their starts they each won an equal number against the other. In 1937 she was again put into the trial races, without success.

">*430 In 1930, after the failure of the Yankee to be selected as a cup defender, petitioner considered the New England Boat Co. as hopelessly insolvent, and sold his stock. He sold it for the reason that he did not believe the revenue officers would allow him a loss, unless he established it. He did not think they would let him write it off his books. In that year he had a conversation with his third cousin, James J. Minot, Jr., of the firm of Jackson & Curtis, investment bankers and stockbrokers. In that conversation petitioner told Minot that he wanted to sell 1,000 shares of New England Boat Co., and Minot told him that he would see that it was sold. Petitioner did not designate to Minot anyone who would buy the stock. Petitioner said to sell at any price at all; that he wanted to be sure to have a bona fide sale; that he thought the stock had little or no value, but that it might have certain slight conceivable value under certain conditions. Petitioner put in an order to sell, with a limit of $1 for">*1047 the lot, and actually and physically delivered the stock to Jackson & Curtis, stockbrokers, to sell and received a receipt dated December 2, 1930, therefor. The stock was sold on December 11, 1930, for $10, and he was notified on that date by the brokers. The expense of selling the stock was $48.50. It was purchased by James J. Minot, Jr., for Mrs. Miriam Minot, his wife. Minot saw to it that the stock was sold at auction, as petitioner had ordered, so as to make sure that petitioner would get the best price obtainable. Minot would have bid up to $101. There were other bidders. The certificates covering the 1,000 shares were surrendered and canceled and new certificates issued to Jackson & Curtis, and the stock was carried in the name of Jackson & Curtis as a matter of convenience, so that Minot would not have to bother Mrs. Minot to sign any blank powers of attorney. The stock was never changed into the name of James J. Minot or Mrs. Minot.

A liquidating dividend was paid by the New England Boat Co. in 1933, and as to the 1,000 shares formerly held by petitioner, was paid to Jackson & Curtis, in the sum of $510 and was credited to Mrs. Minot's account. No liquidating dividend">*1048 was ever paid directly to J. J. Minot or Mrs. J. J. Minot, or to anyone by the name of Minot.

In 1931 petitioner signed as a surety as to one-fourth of a note of $69,000 made by the New England Boat Co., to pay some indebtedness. In 1933 petitioner advanced to the New England Boat Co. $2,500, and received a stock certificate for 25 shares of stock in the New England Boat Co. The boat was turned over to him and others by reason of the assumption of the $69,000 note, and they later sold it to Gerard B. Lambert for $50,000. In 1933 he received a liquidating dividend on this 25 shares in the amount of $12.75, at the rate of 51 cents a share.

">*431 Petitioner subscribed for the $100,000 stock in the New England Boat Co. because he wanted to get his name before the public, to advertise himself and enhance his reputation as a designer of sailing yachts. He expected to get back between 25 and 50 cents on the dollar for his actual investment in the boat, not including any designer's commission received by him, and in addition, expected to get advertising out of his investment. He did not expect to make a profit on the sale of the stock and had no idea of receiving any dividends">*1049 as ordinarily termed, but did expect to receive a liquidating dividend. He expected to be out of pocket on the deal a maximum of $50,000 to a minimum of $25,000. He was willing to invest that amount in that form of advertising.

Petitioner's reputation as a designer and builder of sailing boats is excellent, and his name is very well known throughout the profession of yacht architecture. Some of the facts contributing to the building up of his reputation were the designing of the Yankee, the Thebaud, and the Highland Light, which holds the best sailing record to Bermuda from an American port. The Thebaud holds the record between Gloucester and Halifax.

Paine, Belknap & Skene on its partnership return of income for the year 1930 showed a gross profit of $24,822.16 from business or profession, and a net income of $23,711.49. About $17,000 of the income of the partnership was from work on the Yankee, and no other commission was paid to petitioner in connection with the designing of the Yankee. After 1930 Paine, Belknap & Skene had nothing but losses. The partnership return shows Frank C. Paine's distributive share of the partnership net income to be">*1050 $8,888.56. Petitioner reported a net income from business on his individual income tax return for 1930 in the amount of $1,365.88 (the gross income being $8,586.43), it being labeled as income from business or profession as naval architect. This included his full share of the partnership income. He alsio reported $35,618.93 profit from sale of real estate, stocks, bonds, etc., and $806,777.23 capital net gain from the sale of assets held more than two years.

The New England Boat Co. filed income tax returns for the years 1930 to 1933, inclusive. The 1930 return shows a gross income of $675.57, while net income in 1931 was $36.54, in 1932 nothing, in 1933 $131.20 from refund of tax.

The sale by petitioner of the stock in the New England Boat Co. was bona fide.

OPINION.

DISNEY: The question as to the bona fides of the sale should first be considerd. There is conflict of evidence in this regard. Respondent stresses the facts that the sale was made by petitioner's ">*432 third cousin, a member of a firm of stockbrokers, that although the stock was sold for $10, the expenses of the sale were $48.50; that the stock was purchased by this third cousin (for his wife) ">*1051 and that later, in 1933, the petitioner purchased more stock in the New England Boat Co., buying 25 shares at $100 per share, and that the purchaser in 1933 received $510 as a liquidating dividend. These circumstances do cast doubt upon the bona fides of the sale. Nevertheless, we believe that the petitioner has shown such bona fides. The stock did not again vest in petitioner. The sale to the wife of a distant relative obviously does not negative bona fides. Although less was received from the stock than the expenses of the sale, yet the sale was at public auction, and the petitioner might have received more than the expenses of sale. The acquisition of stock later in 1933 is shown to have been in effect an advancement of money for expenses, rather than a real sale of stock, this being done by the petitioner and others interested in the success of the Yankee. The stock sold in 1930 passed completely out of the ownership of the petitioner. We are of the opinion and hold that the sale was bona fide.

Is petitioner entitled to a loss upon the sale of the stock either as a loss incurred in trade or business, or as one taken upon a transaction entered into for profit? He">*1052 does not contend that the matter be considered an ordinary and necessary business expense as such. The statute relied upon, section 23(e)(1) and (2) of the Revenue Act of 1928, ^{1938 BTA LEXIS 1040">*1053 with the New England Boat Co., though the company itself was engaged in sport. The question just here is as to the nature of petitioner's individual activity in the matter, as to whether to him it was a transaction entered into for profit. He concedes and testified that he did not expect to make a profit from the sale of the stock of the New England Boat Co.; that he 37 B.T.A. 427">*433 did not expect any ordinary dividends, though he did expect liquidating dividends; that he expected to take a loss of from $25,000 to $50,000 on the deal; and that he was willing to invest that amount in that form of advertising.}

The taking of a loss does not negative the idea of a profit transaction; but the expectation of profit must be present. . In the face of the positive evidence of petitioner himself that he expected to take a loss of a minimum of $25,000, there is no room for a conclusion that there was any expectation of profit. Using the words "any transaction entered into for rofit" in their usual and generic sense (">*1054 : ), they force the conclusion, when applied to petitioner's testimony, that the transaction here was not entered into for profit. It will not do to say that in some indirect manner it was hoped that this transaction, though in itself expected to be a loss, would ultimately benefit the petitioner by way of enhanced reputation. Practical considerations of taxes require that direct effects be considered here.

We hold that the transaction here does not fall under the category of transactions entered into for profit. Even if hope of ultimate benefit by enhancement of reputation were considered as making the transaction one entered into for profit, petitioner here has not shown loss, for, since the profit was not expected directly in the New England Boat Co. stock, it necessarily must have been expected, if at all, in the benefit to business by enhancement of reputation - and the record plainly proves such enhancement of reputation, instead of loss in that respect.

The same considerations largely dispose of petitioner's second contention, that there">*1055 was loss "incurred in trade or business." If we assume for a moment that the transaction was within petitioner's trade or business, it must be because of including within that term a transaction in indirect advertising for the ultimate benefit of the trade or business, for petitioner was not in the business of purchase and sale of corporate stocks. The same logic which prompts a contention that cost of such advertising to enhance reputation is a part of the business dictates that favorable result from such advertising means, to some extent at least, gain, and not loss, in business. Petitioner on brief argues there is here considered "a business promotional plan, somewhat in the nature of advertising." Since the record shows to an indefinite, but at least considerable degree, actual enhancement of reputation, it can not be said that such business promotional plan, in the nature of advertising, has resulted in a loss to petitioner. Petitioner may have realized enhanced reputation of value more than the investment or loss in stock.

">*434 We think the very difficulty of evaluating profit or loss in such an intangible as necessarily enters into consideration here indicates well">*1056 that such advertising expense is to be dealt with as business expense or capital expenditure, and not as a transaction entered into for profit or in trade or business. We have held that in case of extraordinary expenditure for advertising, resulting in benefit to a business in the year of expenditure as well as subsequent years, such expenditure is properly to be regarded as capital investment as to the future years and in part as current operating expense properly chargeable against current income, and that proper allocation must be shown by the petitioner. ; ; affd., ; . Petitioner presents no such allocation here, and, as above seen, he does not ask that the matter be treated as one of business expense. In , the Supreme Court affirmed the ) and the ">*1057 , which sustained the Commissioner's ruling that payments made by an individual of debts of a bankrupt corporation with which he had been associated, in order to reestablish his relations with customers and to solidify his credit and standing, were not deductible as ordinary and necessary expenses and were "rather in the nature of capital expenditures, an outlay for the development of reputation and good will." The Supreme Court said: "Reputation and learning are akin to capital assets, like the good will of an old partnership." We hold that petitioner has not shown loss incurred in trade or business.

We find a deficiency in the amount determined by the respondent, which deficiency has been paid.

Reviewed by the Board.

Decision will be entered for the respondent.

MURDOCK

MURDOCK, concurring: I think that Paine entered into the transaction for profit. The profit which he expected was to come from enhanced reputation in his business as a naval architect rather than from dividends or increased value of the stock. However, the record does not show that loss resulted from the expenditure, viewed as that kind of a transaction. ">*1058

VAN FOSSAN

VAN FOSSAN, dissenting: On the facts found I am unable to follow the logic of the opinion of the Board that denies the deduction. It seems to me such a result can be reached only by a confusion of terms and a misapplication of definitions. I think petitioner is entitled to prevail.

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Footnotes

• 1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.

  In computing net income there shall be allowed as deductions:

  (e) Losses by individuals. - In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise -

  (1) if incurred in trade or business; or

  (2) if incurred in any transaction entered into for profit though not connected with the trade or business. ↩