Pacific Affiliate, Inc. v. Commissioner

Pacific Affiliate, Inc., a Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent

Pacific Affiliate, Inc. v. Commissioner

Docket No. 12836

United States Tax Court

18 T.C. 1175; 1952 U.S. Tax Ct. LEXIS 79;

September 30, 1952, Promulgated

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">*79 Decision will be entered under Rule 50.

1. Items includible in petitioner's borrowed invested capital, determined.

2. Status of certain securities held and sold by petitioner during taxable years, determined.

3. Period determined over which the premium paid for certain Federal Land Bank bonds purchased and sold in 1943 is amortizable.

4. Whether or not certain dividends received during taxable years are excluded from petitioner's excess profits net income, determined.

5. Contracts to purchase or to sell certain corporate securities when, as and if issued, held, properly recognizable as individual assets on a "gross basis" in computing the percentage of inadmissible to total assets under section 720, I. R. C.

George H. Koster, Esq., for the petitioner.

T. M. Mather, Esq., for the respondent.

Van Fossan, Judge. Murdock, J., dissenting. Turner, Harron, and Raum, JJ., agree with this dissent.

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VAN FOSSAN

">*1175 This case involves deficiencies in income tax and excess profits tax for the taxable year ended December 31, 1943, and a deficiency in excess profits tax for the taxable year ended December 31, 1944, as follows:

Year	Income tax	Excess profits tax
1943	$ 9,992.35	$ 169,500.52
1944		425,725.10

Petitioner paid the foregoing deficiencies after issuance of the deficiency notice, and here seeks refunds of the amounts so paid.

Several issues raised in the original petition have been abandoned, conceded, or adjusted by stipulation of the parties. Effect will be given to all such">*81 agreements in the computation under Rule 50. There remain for our consideration:

1. Whether the margin account liability to Bear, Stearns & Company is allowable as borrowed invested capital, within the meaning of section 719 of the Internal Revenue Code.

2. Whether certain Federal Land Bank bonds, purchased and sold in 1943, were held primarily for sale to customers in the ordinary course of petitioner's business and the loss claimed by the petitioner is deductible.

3. Whether certain debts incurred by petitioner in 1943 and 1944 are includible as part of invested capital, within the meaning of section 719 of the Internal Revenue Code.

4. Whether the Commissioner erred in disallowing as part of petitioner's invested capital for the years 1943 and 1944 the amount of ">*1176 $ 278,240.98 as capital paid in to petitioner by its sole stockholder in the year 1934.

5. Whether gains and losses from the sales of certain securities in 1943 and 1944 were from sales of capital assets, as claimed by petitioner, or from assets held primarily for sale to customers in the ordinary course of business.

6. Whether the petitioner sustained a short term capital loss on the sale of 20,000 shares of">*82 Chicago & North Western Railway System preferred stock.

7. Whether petitioner realized short term capital gain or ordinary income in 1944 upon the sale of 22,174 shares of Western Pacific Railway Company new preferred stock.

8. Whether certain dividends received by petitioner in 1943 and 1944 were received on capital assets and excludible from excess profits net income.

9. Whether petitioner realized long term capital gain or ordinary income upon the assignment or discount of its "when, as and if issued" contracts respecting Chicago & North Western Railway securities in 1944.

10. Whether the respondent erred in determining petitioner's inadmissible assets.

FINDINGS OF FACT.

The facts that were stipulated are so found and made a part hereof.

Petitioner is a California corporation with its principal office in San Francisco, California. It was originally incorporated under the name of Bankamerica Company. Subsequently, on April 20, 1945, petitioner duly changed its name to Pacific Affiliate, Inc. Petitioner keeps its books and files its tax returns on the accrual basis of accounting. The tax returns for the years here under review were filed with the collector of internal revenue">*83 for the first district of California, at San Francisco.

In his determination of deficiency for 1943, respondent included in petitioner's income as ordinary gross profit from sales, the amount of $ 455,505.46 which had been reported by petitioner as short term capital gains. Petitioner, on brief, now acquiesces in respondent's action except in so far as it pertains to $ 204,141.34 of such gains. Petitioner has also expressed on brief its acquiescence in respondent's action with respect to the following dividends received by it in 1943:

Electric Bond & Share Co. Pfd	338	$ 507.00
Electric Bond & Share Co. Pfd	470	587.50
Dewey & Almy Chemical Co	372	93.00
North American Co	10,000	2,975.00
North American Co	5,000	1,450.00
Tidewater Associated Oil Co	5,200	780.00
Tidewater Associated Oil Co	1,700	255.00
White Sewing Machine Corp., Pfd	310	155.00

">*1177 In addition to the foregoing stipulations, petitioner now concedes on brief that the profit derived from the sale in 1944 of certain Chicago, Rock Island & Pacific bonds in the amount of $ 226, and the loss sustained on the sale in 1944 of 2,000 Chicago, Milwaukee & St. Paul 5 per cent bonds in the amount of">*84 $ 5,693.75 are properly taxable as ordinary gain or loss rather than as long term capital gain or loss as reported.

In February 1943 the petitioner opened a margin account with Bear, Stearns & Company (hereinafter sometimes referred to as Bear, Stearns), New York, New York, a firm engaged in business as a broker and dealer in securities. Upon the opening of this account the petitioner executed several documents. One document was a "corporate account" agreement whereby the company notified Bear, Stearns of official authorization for the opening of the account. A second document was a certified copy of the resolution of petitioner's Board of Directors containing such authorization. A third document was a "customers' agreement" which read, in part, as follows:

Any transaction made for my/our account(s) is subject in all respects to all applicable State or Federal legislation, and the regulations thereunder, and to the constitution, rules, by-laws and customs of the Exchange on which executed, and of its clearing house or clearing association. Actual delivery of all securities and commodities bought or sold for my/our account(s) is contemplated, and I/we so understand and agree.

">*85 * * * *

[EDITOR'S NOTE: TEXT WITHIN THESE SYMBOLS [O> <O] IS OVERSTRUCK IN THE SOURCE.]

For the purpose of expressly giving the consents required by any applicable State or Federal Law or Regulations, I/we hereby consent that all securities and/or contracts for commodities now or hereafter carried in my/our account(s) or deposited to protect the same, may, without further notice to me/us, be [O> lent and <O]/[O> or <O] [sic] hypothecated by you, either separately or commingled with the securities and/or contracts of your other customers, either for the sum at any time due thereon from me/us to you, or for a greater sum, not in excess of the aggregate indebtedness to you of me/us and of such other customers whose securities and/or contracts are so pledged or hypothecated with mine/ours.

I/We hereby further consent that whenever my/our margin is deemed by you insufficient, or for any other like or unlike reason, any or all securities and/or commodities and/or contracts for purchase or sale of securities or commodities carried or borrowed for my/our account(s), may be sold or bought at public or private sale without demand for margin or additional margin and without notice of the">*86 time and place of the sale or purchase of said securities, commodities or contracts, and no specific demand or notice, if given by you, shall invalidate or affect this consent.

* * * *

During the years 1943 and 1944 petitioner purchased a considerable amount of securities from Bear, Stearns which securities were held by the latter in this margin account. The following are the month-end balances of such account, all figures representing amounts owing from ">*1178 petitioner to Bear, Stearns except those figures in parentheses which represent balances owing from Bear, Stearns to petitioner:

	1943	1944
January (31)	$ 132,809.12	$ 967,966.27
February	(18,434.16)	350,651.17
March	973,696.44	642,594.72
April	(572,036.32)	902,252.77
May	148,007.07	466,071.68
June	1,054,016.73	525,303.69
July	910,559.71	1,605,852.82
August	1,177,099.95	1,611,748.91
September	619,487.29	1,335,367.43
October	(83,045.48)	961,544.82
November	678,222.63	(457,062.65)
December	268,484.56	609,136.69

On April 2, 1943, the petitioner purchased certain Federal Land Bank 4 per cent 7-15-44-64 bonds of a par value of $ 4,810,000 at a cost of $ 5,014,672.15. The">*87 purchase price of the bonds was based upon a 0.65 per cent per annum net interest yield. Petitioner borrowed $ 5,014,000 from the Guaranty Trust Co. of New York at an interest rate of three-fourths per cent to pay on the purchase price, and the bonds were delivered to the lender to be held as collateral security for the loan. At the time this amount was so borrowed, petitioner executed a continuing loan agreement dated April 5, 1943, on a Guaranty Trust Co. printed form specifying the terms under which any extension or credit would be granted. Petitioner also executed a Guaranty Trust Co. printed form as of the same date which reads as follows:

New York, 4/5/43

GUARANTY TRUST COMPANY OF NEW YORK

Please loan the undersigned jointly and severally under the terms of agreement dated 4/5/1943 on file with you, $ 5,014,000, payable on on demand with interest at the rate of 3/4 per cent. per annum, payable monthly, secured by the following collateral:

$ 4,810,000. par value FEDERAL LAND BANK 4% BONDS DUE 7/15/64/44

BANKAMERICA COMPANY

/S/ Willard H. Livingstone

President

/S/ R. W. Wild

Vice President

When the loan was paid, the foregoing instrument was stamped">*88 as follows:

P A I D

NOV 24 1943

GUARANTY TRUST CO.

OF NEW YORK

">*1179 The bonds were acquired purely as a house investment account and not for the sale to customers in the ordinary course of petitioner's trade or business. At the time of such acquisition, petitioner agreed that if it subsequently offered the bonds for sale it would first offer them back to the vendor on the same basis on which they were purchased, that is, at a price based upon same 0.65 per cent per annum net interest yield.

When petitioner effected its purchase it was under the erroneous impression that the interest received from the bonds was tax exempt and the interest paid to carry them would be deductible for income tax purposes and that, accordingly, a profit would ensue. The sole reason for the purchase was the expectation of profit. Upon learning that such impression was erroneous and while the interest on the bonds was tax exempt, the interest paid to carry them was not deductible, petitioner made immediate arrangements to sell the bonds back pursuant to the foregoing agreement. The bonds were thus sold during the period from June 2, 1943, to November 23, 1943. The aggregate amount realized upon">*89 such sale was $ 4,925,231.70. The difference of $ 89,440.45 between the amount paid and the amount so received therefor was claimed as an ordinary loss in petitioner's return for 1943.

While petitioner held the above bonds it received interest totaling $ 107,657.80 which was reported in its return as tax exempt. It paid interest on the money borrowed to carry the bonds in the sum of $ 21,257.47. This amount was not claimed as a deduction.

The respondent has treated these bonds as capital assets, inadmissible in computing the excess profits tax credit, and has declined to allow the loan incurred to carry them as borrowed capital. He has computed amortization of the premium, has reduced the basis of the bonds for such amortization, and has spread it over the period from the date of purchase to the earliest call date.

Shortly prior to April 16, 1943, a business associate of petitioner, Blair Securities Company (hereinafter called Blair), suggested that petitioner make an original subscription for $ 20,000,000 of 2 per cent United States Treasury bonds which were about to be issued. On April 16, 1943, the petitioner made a subscription of $ 20,000,000 United States Treasury bonds, ">*90 1950-52, to the Federal Reserve Bank through the Bank of America N. T. & S. A. (hereinafter referred to as Bank of America). The Bank of America carried the obligation for this subscription from April 16 to April 19 making an interest charge of $ 1,630.50 therefor computed at the rate of 1 per cent. In the meantime Blair arranged for a loan from another source in the amount of $ 19,800,000 to carry the bonds at an interest rate of three-fourths per cent. This loan was made to petitioner on April 19 upon petitioner's execution and delivery to the lender of an instrument in the form of a request, which reads as follows:

">*1180 New York, April 19, 1943

GUARANTY TRUST COMPANY OF NEW YORK

Please loan the undersigned jointly and severally under the terms of agreement dated     on file with you, $ 19,000,000 payable on demand with interest at the rate of 3/4 per cent. per annum, payable monthly, secured by the following collateral:

BANKAMERICA COMPANY

/S/ Willard H. Livingstone

President

/S/ R. W. Wild

Vice President

On that date also petitioner paid to the lender $ 200,000 cash which it withdrew from its margin account at Bear, Stearns. On the same day ">*91 the lender paid the proceeds of the loan, together with the $ 200,000 cash payment, to the Federal Reserve Bank, and thereupon it received the foregoing United States Treasury bonds to be held as collateral security for the loan.

Between April 19, 1943, and May 14, 1943, the petitioner made sales of these bonds, finally disposing of the entire $ 20,000,000 thereof. It paid interest for this period in the amount of $ 9,225.47 which, together with that paid to the Bank of America for the above period from April 16 to April 19, made a total interest payment of $ 10,855.97. It collected interest income of $ 27,010.84 making a net amount of interest received over interest expense of $ 16,154.87, one-half of which, or $ 8,077.44, was paid by petitioner to Blair. Petitioner's letter dated May 20, 1943, transmitting its check to Blair read as follows:

We enclose our check payable to you for $ 8,077.44 which is one-half the net interest earned on the $ 20,000,000 U. S. Treasury 2% Bond account.

There is also enclosed an itemized statement of this account.

On its books petitioner maintained a special account with Blair for the above-mentioned transactions. In that account it made monthly">*92 charges for 50 per cent of the interest paid to the banks for carrying the bonds and every few days entries were made crediting to the accounts interest at the coupon rate which accrued on 50 per cent of the bonds. A summary of the entries is as follows:

Interest on one-half of the loan to carry the bonds -- charged
monthly	$ 5,427.98
Interest on one-half of the bonds credited to Blair Securities
every few days	13,505.42
Balance paid to Blair Securities Co	$ 8,077.44

Blair's acknowledgment dated May 26, 1943, read as follows:

This will acknowledge your letter of the 20th addressed to Mr. Wood, enclosing your check for

$ 8,077.44

representing one-half of the net interest earned on the

$ 20,000,00. principal amount -- U. S. TREASURY 2% bond Account.

We also acknowledge your itemized statement covering this account.

">*1181 The petitioner, in addition to realizing the net interest profit of $ 8,077.43, realized a profit from the sales of the bonds in the total amount of $ 41,875, which profit was reported by it as ordinary income resulting from the operation of its dealer business.

In September 1943, the Treasury again issued bonds and again Blair and ">*93 petitioner agreed to a transaction similar to that of April 16 and 19, 1943, but this time the arrangement differed in that the agreement provided for the sharing of profits on the bonds. The petitioner made the subscription for $ 20,000,000 of bonds under date of September 15, 1943, through the Bank of America. It paid $ 200,000 cash and borrowed $ 19,800,000 from that bank on its promissory note. Blair paid $ 100,000 to the petitioner to be used in making the foregoing $ 200,000 cash payment. When petitioner received this $ 100,000 from Blair, it recorded the receipt on its books by crediting $ 100,000 to its Blair Securities Corporation (hereinafter called Blair Corp.) account. The item remained in this account until the petitioner repaid it on November 16, 1943. The bonds purchased, as herein described, were United States Treasury 2 per cent bonds 9/15-53-51.

On November 16, 1943, $ 10,000,000 of the par value of these bonds were sold to the Bank of America at a profit of $ 9,375. On the same day the petitioner authorized the bank to credit $ 100,000 of the proceeds of the sale to the account of Blair Corp. and on its books the petitioner charged the Blair Corp. account ">*94 with this amount, wiping out the $ 100,000 previously credited to the account. Interest earned on the $ 20,000,000 of bonds to this date was $ 68,131.80, and interest paid on the $ 19,800,000 at this date at 1 per cent per annum was $ 34,100.12, making a net interest return of $ 34,031.68. Petitioner wanted to close the joint account and to carry the remaining $ 10,000,000 of bonds free of its arrangement with Blair. It settled the joint account by paying Blair one-half of the net interest earned of $ 17,015.84 and also the entire profit on the sale of the $ 10,000,000 of bonds on November 16, or $ 9,375, making a total of $ 26,390.84. It sent its check for this amount to Blair on November 18, 1943. The Company's letter of transmittal read as follows:

We are pleased to enclose our check for $ 26,390.84, representing your share of the interest earned and profit in the $ 20,000,000. United States Treasury 2% Bonds Joint Account.

There is also enclosed an itemized statement of the Account.

On its books petitioner maintained a special account with Blair for the above-mentioned transactions. In that account it made monthly charges for 50 per cent of the interest paid to the banks">*95 for carrying the bonds, and every few days entries were made crediting to the account interest at the coupon rate which accrued on 50 per cent of the bonds.

">*1182 The acknowledgment from Blair, dated November 26, 1943, read as follows:

We acknowledge with thanks your letter of November 18 enclosing your check for

$ 26,390.84

representing our share of earned interest and profit on

$ 20,000,000. principal amount -- U. S. TREASURY 2s Due 9/15/53/51.

There is no writing about these transactions other than those above-mentioned. The officials of the two companies had telephone conversations almost every day, so whatever details had to be taken care of were arranged over the telephone, but there was no other agreement as to the general nature of the transaction than the agreement hereinabove mentioned. The taxpayer company sold $ 2,000,000 of the $ 10,000,000 remaining bonds to the Bank of America on November 17, 1943, at a profit of $ 2,187.50. It sold $ 2,000,000 of these bonds to J. C. Devine & Co. on November 17, 1943, at a profit of $ 2,500. It sold $ 1,000,000 of these bonds to J. C. Devine & Co. on November 18, 1943, at a profit of $ 1,250; and it sold $ 5,000,000 of these">*96 bonds to Bank of America on November 24, 1943, at a profit of $ 6,250. All of these profits were reported as ordinary income from the operation of the dealer business.

On April 27, 1944, petitioner purchased through Bear, Stearns $ 1,000,000 face value of American Telephone & Telegraph Company (hereinafter referred to as A. T. & T.) 3 per cent Conv. debenture bonds due September 1, 1956, for a cost of $ 1,170,000. Petitioner borrowed $ 1,050,000 from the Bank of America, with interest at 1 per cent per annum. This indebtedness was evidenced by a promissory note dated May 1, 1944, and subsequent renewal notes dated August 3, 1944, and November 1, 1944. The bonds were pledged with the bank as collateral security for the loan. This loan was repaid on various dates between November 1, 1944, and November 6, 1944. These bonds were brought to the attention of petitioner's management by an investment counselor. They were attractive to petitioner in that it only required a 10-point margin with a bank to carry the bonds at a 1 per cent per annum rate of interest, and the bonds carried a 3 per cent interest coupon. While investment of these bonds was under consideration petitioner's ">*97 tax counsel was consulted with regard to amortizing the bond premium out of earned income and the possible tax advantages incident thereto. After being advised that such method of amortization was doubtful, petitioner decided that the bonds were sufficiently attractive to proceed to purchase them regardless of any possible tax benefit to be derived. These bonds were not acquired or held for sale to customers and none were so sold.

">*1183 This petitioner corporation was organized under the laws of the State of California under the name of Bankamerica Company on October 31, 1930, to take over the assets and liabilities of two other companies, hereinafter referred to as the Transferor Companies.

Petitioner's capital stock consists of 500 shares of a par value of $ 1,000 per share. The permit to issue stock granted by the California Corporation Commissioner on November 7, 1930, prescribed that the stock was to be issued for cash at $ 2,500 per share. All of the stock was issued to Corporation of America, pursuant to that permit. Corporation of America was a wholly owned subsidiary of Transamerica Corporation and the above-mentioned Transferor Companies were wholly owned subsidiaries">*98 of other wholly owned subsidiaries of Transamerica Corporation. Corporation of America remained the owner of the Bankamerica Company stock until June 20, 1933, when it transferred the stock to Transamerica Corporation which owned it from then until 1937 when Transamerica Corporation disposed of it.

In the taking over of the assets of the Transferor Companies in December 1930, the price for some of those assets was immediately agreed upon by the parties to the transaction. As to the remainder of the assets, the price was to be settled by a committee of persons selected by the parties. This committee reached its decision in February 1931, fixing the price for the remaining assets. Included in such assets were certain stock exchange seats. These seats, and the prices which the transferor wanted for them, and the prices which the transferee was willing to pay, were:

Owned by transferor, National Bankitaly Co.:
San Francisco Stock and Curb -- Seller's price	$ 125,000
Buyer's price	31,250
Owned by transferor, America Investment Co.:
Los Angeles Stock and Curb -- Seller's price	$ 210,000
Buyer's price	15,000

The transferee gave credit in December 1930">*99 to the transferors for $ 46,250 for these seats, and the balance of the price was left to the committee for decision. The committee in its decision in February 1931 decided that Bankamerica Company, the transferee, should pay the prices asked by the transferors.

The selling price in December 1930 of the San Francisco stock and curb memberships of the character acquired from National Bankitaly Co. was approximately $ 31,250, and the selling price in December 1930 of the Los Angeles stock and curb membership of the character acquired from American Investment Co. was approximately $ 15,000.

In the latter part of 1931, Corporation of America took over from Bankamerica Company for $ 150,000, the San Francisco Stock and Curb Exchange seats acquired by Bankamerica Company from American ">*1184 Investment Company. Bankamerica Company retained the other seats until it disposed of them in 1943.

The cost of these retained seats to the Transferor Companies was $ 32,100 and from 1930 to 1943 this cost was reduced by liquidating distributions from the Exchanges amounting to $ 5,254.91. The Transferor Companies, the petitioner corporation, and Corporation of America were affiliated companies">*100 in 1930 and were included in the consolidated income tax return filed by Transamerica Corporation as parent for that year.

The proper basis for tax purposes of the stock exchange seats was the basis for these seats in the hands of the Transferor Companies. The Government has properly computed this basis to be $ 26,845.09, in computing the gain or loss on the seats when the petitioner sold them in 1943.

On February 10, 1931, the Board of Directors of the petitioner took action, as set forth in the following excerpt from the minutes of the meeting of the Board of Directors held on February 10, 1931:

The Chairman brought up for discussion the action taken by the Liquidating Committee of the Corporation of America with reference to the Stock Exchange seats formerly held by the American Investment Company and Securities Division, National Bankitaly Company in which the Liquidating Committee had reached a decision to transfer these seats to the Bankamerica Company at their book carrying values.

The Chairman stated that he believed the matter should be opened for reconsideration inasmuch as he had not been present at the Liquidating Committee's meeting and had not had an opportunity to ">*101 bring out certain phases of the matter which he felt should be taken into account. He made particular reference to National Bankitaly Company's associate membership in San Francisco which had originally cost $ 10,000 and been written down to nothing but had subsequently been written up to $ 125,000 at the time of transfer of this associate membership to the Securities Division, National Bankitaly Company's books. The associate memberships in San Francisco formerly owned by the American Investment Company were originally transferred to the company from the French American Corporation at $ 150,000. At the time of the formation of the Bankamerica Company these memberships had a market value of approximately $ 31,500. The full memberships on the Los Angeles Stock and Curb Exchanges formerly owned by the Merchants National Company were written up to $ 210,000 at the time they were transferred to the American Investment Company. At the time of formation of the Bankamerica Company these memberships were worth approximately $ 15,000.

The Chairman further stated that at the time of the formation of Bankamerica Company and the creation of liquidating accounts, it has been his recommendation">*102 that the memberships which the Bankamerica Company could use, namely the associate memberships in San Francisco held by the National Bankitaly Company and the full memberships in Los Angeles held by the American Investment Company be taken over at their then existing market values on the theory that these were the prices at which these seats could be acquired if the Bankamerica Company were permitted to buy them in the open market.

The Chairman stated that at the meeting of the Corporation of America Liquidating Committee on February 3, 1931, the argument had been advanced ">*1185 that Bankamerica Company should take these seats at the full carrying value in recognition of the fact that the seats carried with them the value of a going business developed by the predecessor companies.

The Chairman stated that this arrangement was equivalent to charging the Bankamerica Company with the inflated prices for these seats not only much higher than their current market values but also much above the prices originally paid for them and that furthermore, the arrangement did not take into consideration the fact that the associate memberships on the San Franchise [sic] Exchange formerly">*103 owned by the American Investment Company were of absolutely no value to the Bankamerica Company. In view of the latter fact he had already instructed the Accounting Department to place this item on the "C" Account at its carrying value of $ 150,000.

The Chairman also pointed out that in view of the decision already approved by the Board relative to the discontinuance of floor representation on the Los Angeles Exchange that the gross revenue derived from the Los Angeles seats would be cut approximately in half and in all probability these seats would cease to be a factor of any appreciable importance as far as net earnings were concerned. He suggested that some compromise price should be agreed upon taking the above factor into consideration.

On motion made by E. J. Nolan, seconded by L. P. Keplinger and carried, it was resolved that the Liquidating Committee of the Corporation of America be asked to reopen the subject of the transfer of Exchange seats to the Bankamerica Company and that R. W. Miller discuss the basis of price transfer at the next Liquidating Committee meeting.

In 1932, as of December 31, 1931, Transamerica Corporation effected a quasi reorganization by revaluing">*104 all of its assets and setting up reserves in the amount of the difference between the value of the assets as carried on the books and the appraised value of those assets. In the revaluation of assets, Transamerica Corporation set up a reserve of $ 278,240.98 which represented the difference between the value at which it carried its investment in the capital stock of the petitioner on its books and the appraised value of that investment. The journal entry made by Transamerica Corporation in setting up this reserve was as follows:

12/31/31 Dr. Paid-in Surplus	$ 269,256.98
	8,975.00
	$ 278,240.98
Cr. Reserve for fluctuation of Investments-Bankamerica Co		$ 278,240.98
To adjust carrying value of investments in controlled companies and banks to
net assets value as of Dec. 31, 1931.
(Explanatory data indicates that the reduction in asset value results from
stock exchange seats) --
Book value at 12/31/31		$ 322,990.98
Appraised value		44,750.00
Difference		$ 278,240.98

On September 29, 1933, the Board of Directors of the petitioner adopted a resolution as follows:

">*1186 The Chairman stated that inasmuch as Bankamerica Company">*105 was a wholly owned subsidiary of Transamerica Corporation, he deemed it desirable to reduce the balance due from Transamerica Corporation through inter-company account by crediting such account with the sum of $ 427,514.07, and charging this amount to paid-in surplus of Bankamerica Company. He then submitted to the meeting an exhibit of the proposed journal entry in this connection and stated it was desirable that the Board of Directors approve such entry. A copy of said exhibit is as follows:

EXHIBITJOURNAL ENTRY

September 29, 1933

	Debit	Credit
Paid-in Surplus Account	$ 427,514.07
Due from Transamerica Corporation		$ 427,514.07

After discussion of the proposed entry, on motion duly made and seconded, the following resolution was adopted:

RESOLVED, that the journal entry appearing in the Exhibit submitted to the meeting by the Chairman be, and hereby is, approved and that the proper officers of this corporation be, and they hereby are, authorized and directed to make, or cause to be made the said journal entry and such other entries incident thereto in the books of this corporation, as of September 29, 1933.

The journal entry which was made by Transamerica">*106 Corporation to reflect that transaction was as follows:

Inter-Company	Debit	Credit
Bankamerica Company	$ 427,514.07
Investment Bankamerica Company		$ 427,514.07
To credit Investment in Bankamerica Company with above
amount which represents the amount of Inter-company Account
due Bankamerica Company by Transamerica Corporation which
was forgiven by Bankamerica Company and charged to their
paid-in surplus in accordance with Resolution of the Board of
Directors of Bankamerica Company at a meeting held September
29, 1933.

The September 30, 1933, balance sheet of Bankamerica Company was as follows:

ASSETS
Cash in banks	$ 319.85
Owing from Transamerica General Holding Company	19,000.00
Securities owned	713,250.61
Accounts receivable:
Due from customers
Due from brokers	944.10
Due from Standard Telephone Bondholders Committee	618.24
Accrued interest and dividend	6,701.02
Syndicate advances:
Golden Gate Bridge & Highway District	9,150.00
Exchange memberships	322,761.21
Stationery and supplies	4,083.46
Revenue stamps	113,36
Deferred charges -- Bond premiums, Insurance,
subscriptions, etc	1,673.61
Suspense resources	409.31
	$ 1,079,024.77
LIABILITIES
Accounts payable:
Customers deposits for security purchases	$ 5,999.38
Due to brokers -- Stock undelivered	9,041.72
Due to clients -- Unexecuted orders	470.14
Notes payable to Bank of America N. T. & S. A.	430,000.00
Due on Golden Gate Bridge & Highway District Syndicate
Suspense liabilities	1,973.19
Capital stock and surplus:
Capital stock -- Authorized and issued, 500 shares of
$ 1,000 par value each	500,000.00
Paid-in surplus	76,249.67
Profit and Loss surplus	55,290.67
	$ 631,540.34
	$ 1,079,024.77

">*107 ">*1187

BANKAMERICA COMPANY
Paid-in Surplus
September 30, 1933
Balance, December 31, 1932	$ 503,763.74
Less -- Forgiveness of a portion of current account owing from
Transamerica Corporation	427,514.07
Balance, September 30, 1933	$ 76,249.67
* * * *
Profit and Loss Surplus Account
September 30, 1933
Balance, December 31, 1932	$ 42,648.25
Net profit for the nine months ending September 30, 1933	112,642.42
	$ 155,290.67
Less -- Dividend paid September 30, 1933	100,000.00
Balance, September 30, 1933	$ 55,290.67

In computing the invested capital of the petitioner, the respondent has eliminated the distribution of $ 427,514.07 from invested capital as a distribution not out of earnings and profits.

">*1188 On June 27, 1934, Transamerica Corporation "transferred" the reserve which it had set up as a revaluation reserve as hereinbefore stated, to the petitioner corporation by charging the reserve, and crediting its account with the petitioner, and the petitioner reflected the transaction on its books by charging the account due from Transamerica Corporation in the amount of $ 278,240.98 and crediting a reserve for revaluation">*108 of the stock exchange seats, which action was taken pursuant to action by the Board of Directors taken at a meeting held July 26, 1934, as indicated by the following excerpt from the minutes of that meeting:

The Chairman stated that Transamerica Corporation, the owner of all the issued and outstanding shares of the capital stock of Bankamerica Company, carries on its books a reserve of $ 278,240.98 for fluctuation of its investment in the stock of this corporation, the reserve having been provided for the purpose of reducing the carry value of this corporation's investment in stock exchange memberships, and that Transamerica Corporation now proposed that this reserve be transferred to this corporation. Thereupon, on motion duly made and seconded, the following resolution was adopted:

RESOLVED, that this corporation accept the transfer of $ 278,240.98 from Transamerica Corporation by charging said amount to the Current Account of said corporation and that said amount be held by this corporation for the purpose of reducing the investment in stock exchange seats from $ 322,261.21 to $ 44,020.23.

The journal entry made by Transamerica Corporation on June 27, 1934, reflects this as follows: ">*109

Reserve for Fluctuation of Investment in Bankamerica
Company	$ 278,240.98
Inter-Company
Inter-Continental Corporation		$ 130,784.40
Inter-Company
Bankamerica Company		147,456.58
To record transfer from Transamerica Corporation of "Reserve
Account" as above through current account which reserve
will be set up on the books of Bankamerica Company as
"Reserve for Investments" also to record settlement between
Inter-Continental Corporation and Bankamerica Company
through current account of each with Transamerica Corporation
for sale by Inter-Continental Corporation to Bankamerica
Company of
17,096 shares Distributors Group		$ 1.00
17,096 shares Group Assets Inc		130,783.40
		$ 130,784.40

During the taxable years under review, petitioner was engaged in business as a dealer in selling securities at retail and wholesale. Petitioner's operation was departmentalized. It consisted of, first, the business of dealing in Government bonds wherein such bonds were purchased from dealers and distributed to customers who were banks, ">*1189 insurance companies, and individuals; second, the business of">*110 retail distribution of securities purchased from dealers and others and then sold to the general public through a large sales organization maintained for that purpose; and, third, the business of buying securities for investment and speculation for petitioner's own account and risk. The securities handled in this latter category were purchased through dealers or brokers, held for investment or speculative profit, and then sold through dealers or brokers.

The Government bond operation was under the direct supervision of petitioner's president, who selected the particular securities to be carried. He negotiated both the purchases and the sales thereof. Profits from this operation were treated as ordinary income from sales of securities held for sale to customers in the ordinary course of petitioner's business.

The retail operation was extensive. Petitioner's retail organization was composed of about 60 men. It had 13 offices, 12 of which were in California and one in Nevada. The purchase of securities for retail distribution was also under the supervision of petitioner's president. When securities were purchased for such purposes, petitioner generally took immediate delivery ">*111 of them through its San Francisco and Los Angeles offices. At such time as the management decided to release them for sale at retail, the sales managers were notified accordingly. The time that elapsed between procurement of the securities and their release to the sales department depended largely upon the availability of the particular securities and petitioner's desire not to affect the growing market in that security in order to acquire them. On the average, such elapse of time was from a week to two weeks. Salesmen were paid a 40 per cent commission based upon the amount of spread between the price petitioner paid for the security on the professional market and the marked-up price which petitioner could charge a customer. Such commission was paid regardless of the cost of the security to petitioner or whether petitioner realized a gain or loss on the sale. The profits from this retail operation were treated as ordinary income from sales of securities held for sale to customers in the ordinary course of business.

The operation involving the purchase of securities for investment or speculation on petitioner's own account was very profitable. This operation was under the exclusive">*112 supervision of petitioner's president, who selected which securities were to be purchased and decided when they were to be sold. Most of the securities bought for petitioner's own account and risk were purchased from Bear, Stearns. When such securities were sold they were sold to or through Bear, Stearns. Since such securities were not sold through petitioner's ">*1190 salesmen, no commissions were ever paid to its salesmen upon their sale. Prior to the time when petitioner opened its margin account, in January 1943, with Bear, Stearns, these securities when purchased were usually held in a depository in New York with one of the correspondent banks. After the margin account was opened, these securities were, for the most part, held in that account. On occasion, securities purchased for investment or speculation purposes were withdrawn, transferred to retail and distributed to customers. There were instances when petitioner would purchase one block of securities for retail distribution and another block of similar securities to be held for investment or speculation on its own account and risk.

The petitioner, in the years 1943 and 1944, used its margin account with Bear, ">*113 Stearns for making purchases of securities. Certain bonds and shares of stock of various corporations so purchased were received by petitioner by actual delivery out of this margin account on numerous occasions in 1943. On December 27, 1943, St. Paul, Kansas City Short Line 4 1/2 -- 1941 registered bonds of a face value of $ 692,000 were drawn out of the margin account and on the same day replaced with $ 692,000 face value coupon bonds of the same issue. Registered bonds were not readily saleable.

No specific notation or identification as to the purpose for which securities were acquired was made on petitioner's books until late in 1943. All purchases of any particular security were posted to an investment ledger sheet for that security regardless of the purpose for which those purchases were made.

Beginning in October or November, 1943, petitioner, upon the advice of its tax counsel and its accountants, began to designate on its ledger accounts the term "House" which was intended to convey an identification that certain securities were held for investment or speculation and not for sale to customers. Some original ledger sheets were rewritten or the word "House" inserted thereon.

">*114 Beginning January 1943 and continuing throughout most of that year, petitioner dealt with customers at retail in Kansas City, Fort Scott & Memphis Rwy. 4 per cent 1936 bonds. As of May 1, 1943, petitioner did not own any such bonds in its margin account or otherwise. On May 3, 1943, petitioner purchased Kansas City, Fort Scott & Memphis 4s -- 1936 in the face amount of $ 500,000 from Bear, Stearns. These bonds were held in petitioner's margin account with Bear, Stearns. On various dates during June and July, 1943, petitioner made additional purchases of these bonds through its margin account in aggregate face amount of $ 55,000. These additional purchases were withdrawn from the margin account following their acquisition and sold to retail customers. As of July 31, 1943, petitioner had a balance of $ 500,000 face amount of such bonds in its margin ">*1191 account. This balance remained intact throughout the month of August. No purchases or sales were made through the account and no bonds of this issue were withdrawn therefrom during that month. On September 17, 1943, Kansas City, Fort Scott & Memphis bonds in face amount of $ 12,000 were withdrawn from the margin account">*115 to cover petitioner's sale of bonds in that face amount to a retail customer on September 16, 1943. Bonds in the face amount of those so withdrawn were delivered into the account on September 27, 1943. Thereafter, until November 16, 1943, $ 500,000 face amount of these bonds remained intact in petitioner's margin account. From November 16 through December 15, 1943, petitioner sold all of these bonds so held in its margin account. With exception of the foregoing withdrawals, all bonds of this issue that petitioner sold to its retail customers were acquired from sources or through brokers other than Bear, Stearns.

Milwaukee, Sparta & Northwestern Co. 1st 4 per cent bonds of a face value of $ 300,000 were purchased by petitioner during the period March 17 to March 24, 1942. Between April 27 and May 16, 1942, petitioner sold bonds out of the foregoing purchases of a face value of $ 29,000 to the public. The remaining $ 271,000 face value of such bonds was kept intact and sold to Bear, Stearns on January 18, 1943.

On November 5, 1941 and November 19, 1941, petitioner bought from Bear, Stearns bonds of Chicago, Milwaukee & St. Paul Rwy. 4 1/2 per cent 1989 Series C in aggregate face">*116 amount of $ 110,000. The bonds thus purchased were delivered to the National City Bank for petitioner's account, where they were held until sold on February 3, 1942. Profit from the sale thereof was reported as ordinary income. From May 7 through June 6, 1942, petitioner purchased such bonds from Bear, Stearns in a total face amount of $ 234,000 as follows:

May 7, 1942	$ 29,000
May 9, 1942	71,000
May 26, 1942	23,000
May 27, 1942	27,000
June 6, 1942	84,000

The bonds purchased on May 7 and 9, 1942, were delivered to Bank of America's New York correspondent on May 11, 1942. Those purchased on May 26 and 27, as well as those purchased on June 6, 1942, were also delivered to Bank of America's New York correspondent. These bonds were delivered out of the depository into petitioner's margin account with Bear, Stearns on January 26, 1943. Between October 8, 1942, and December 1, 1942, petitioner purchased additional bonds of this issue having an aggregate face value of $ 143,000. On January 9, 1943, petitioner sold $ 128,000 face amount of these bonds and on January 27, 1943, sold the remaining bonds of a face amount ">*1192 of $ 249,000. Both sales were made to ">*117 or through Bear, Stearns. There was no retail sale of these bonds at any time.

On its returns for the year 1943, petitioner reported long term capital gains resulting from the foregoing transactions, as follows:

Name of security	Gain reported
Kansas City, Fort Scott & Memphis Rwy. Co. Bonds	$ 28,296.10
Milwaukee, Sparta & Northwestern Co. Bonds	11,484.95
Chicago, Milwaukee & St. Paul Rwy. Co. Series C Bonds	23,150.73

As stated above, the parties have stipulated that the profit reported on the sale of Kansas City, Fort Scott & Memphis Rwy. Co. bonds in the amount of $ 28,296.10 is overstated by an amount of $ 10,000, which $ 10,000 should have been reported as interest income and is properly taxable as interest income.

Beginning in 1943, the petitioner entered into WAII (when, as and if issued) sell contracts for the new common stock of United Light & Rwys. Company (Maine) to its customers. United Light & Power Company (hereinafter called Power) owned all of the common stock of United Light & Rwys. Company (hereinafter called Railways). In 1941 the Securities & Exchange Commission ordered a liquidation of Power which comprehended that Railways' common stock be distributed">*118 to Power's preferred shareholders on a five for one basis. This distribution was begun in April 1945. The plan of reorganization which provided for the distribution, was approved in 1945. The common shares of Railways were dealt in on a when issued basis in 1943 and up to the exchange date in 1945. The petitioner had entered into WAII sell contracts of Railways in excess of its buy contracts of the same stock as set forth in the following table:

	Purchase	Sales	Oversold
1. 1943 Retail Account	76,655	123,669	47,014
2. 1943 "House Acct"	5,000		42,014
3. 1944 Retail Account	13,786	3,386	31,614
4. 1944 House Account	31,614

The 31,614 shares of Railways WAII purchase contracts, listed on line 4 in the preceding table, were contracted for on October 28, 1944, in the amount of 10,000, and on November 2, 1944, in the amount of 21,614.

On various dates in 1943 petitioner purchased 16,270 shares of Power 6 per cent preferred, and in that year sold 2,470 thereof. In its ledger accounts in which petitioner recorded its ownership of Power 6 per cent first preferred, and in its ledger accounts wherein was recorded its transactions with the public in Railways WAII contracts, ">*119 petitioner made notations to indicate that sales of Railways when issued securities under contracts with customers were covered by petitioner's ">*1193 ownership of Power preferred stock. These notations were dated July 31, 1943, and were to the effect that 9,300 shares of Power 6 per cent first preferred costing $ 471,596.49 were held against the sale of 46,500 Railways common shares WAII. In January 1944 petitioner purchased another 5,000 shares of Power preferred stock which it recorded on a separate ledger sheet marked "House No. 2 Acct." In February 1944, 1,200 additional shares of such stock were purchased. These latter acquisitions were recorded in a ledger account entitled "House Account No. I."

Between January 4 and November 4, 1944, petitioner sold all of such stock which had been owned by it after the beginning of the year and purchased by it during the year, namely, 20,000 shares. Its last three sales of such stock took place on October 28, 1944, November 1, 1944, and November 4, 1944. These sales aggregated 12,300 shares. Concurrently with the disposal of the remainder of such shares petitioner contracted for the purchase of WAII stock in Railways to cover the">*120 WAII stock which it had previously contracted to sell under the outstanding sell contracts with its customers.

Had the foregoing reorganization, which contemplated issuance of Railways common for Power preferred, been consummated while petitioner held the 20,000 shares of the latter stock, it could have turned in such shares, for which it would have received five times as many Railways common shares and distributed the same to its sell contracts.

As of March 27 and 28, 1944, petitioner purchased a total of 2,000 shares of Rustless Iron & Steel Company stock. This stock was purchased for petitioner's own account and risk and not for resale to its customers. All transactions therein were recorded on petitioner's books in an account titled "House Investment Account." When the stock was acquired it was delivered to Bear, Stearns to be held in petitioner's margin account until it was sold on October 3, 1944. From such sale petitioner sustained a loss of $ 5,106.90. Petitioner received dividends amounting to $ 600 on this stock during 1944.

Petitioner reported its gains and losses from the foregoing transactions as long term capital gain or loss in the following amounts, respectively: ">*121

		Gain or loss
Name of security -- Stocks	Shares	reported
United Light & Power Pfd	13,700	$ 147,316.28
United Light & Power Pfd	1,300	5,934.74
United Light & Power Pfd	5,000	14,468.37
Rustless Iron & Steel Co	2,000	(5,106.90)

Petitioner reported short term capital gain for the year 1943 in the amount of $ 455,505.46. Of such sum, $ 204,141.34 represented the ">*1194 aggregate profit, respectively derived from transactions involving the following securities:

Shares or		Gain or
face	Name of security	(loss)
value
1,000 sh.	United Light and Power Co. pfd. stock	$ 297.39
500 M	Kansas City, Fort Scott & Memphis Railway Co., bonds	14,375.00
100 M	Chicago & North Western Railroad Co., 4% -- 1987 bonds	4,750.00
220 M	Chicago & North Western Railroad Co., 4 3/4% -- 1987
	bonds	7,040.00
233 M	Chicago & North Western Railroad Co., 4 3/4% -- 1987
	bonds	5,227.22
300 M	Chicago & North Western Railroad Co., 5% -- 1987 bonds	20,750.00
319 M	Chicago & North Western Railroad Co., 5% -- 1987 bonds	10,367.50
231 M	Chicago & North Western Railroad Co., 5% -- 1987 bonds	5,612.44
200 M	Colorado & Southern Railway Co. bonds	4,250.00
375 M	Missouri Pacific Railroad Co. bonds	17,604.07
500 M	Western Pacific bonds	33,492.85
1,600 sh.	American Power & Light, pfd. stock	8,078.77
5,986 sh.	Commonwealth & Southern Corp. pfd. stock	21,860.57
6,200 sh.	Consolidated Natural Gas Co. stock (short sale)	28,502.85
1,000 sh.	Midland United Co., pfd. stock	2,202.92
7,363 sh.	Pacific Mutual Life Ins. Co. stock	10,645.75
3,800 sh.	United Corp. pfd. stock	9,084.01
	Total	$ 204,141.34

">*122 The 1,000 shares of Power preferred stock were purchased from Bear, Stearns between May 26, 1943 and November 8, 1943. These shares were held in petitioner's margin account from their respective dates of purchase until sold on December 7, 8, and 9, 1943, to Bear, Stearns.

As heretofore noted, the above $ 500,000 of Kansas City, Fort Scott & Memphis 4 per cent 1936 bonds were acquired on March 13, 1943, and sold on April 30, 1943. They were bought from and sold to Bear, Stearns, and were carried in petitioner's margin account from the time of purchase until the time of sale.

The different issues of Chicago & North Western Railroad Company (hereinafter called Chicago & North Western) bonds were purchased from and sold to Bear, Stearns during the first 4 months of 1943. In each instance such bonds were held in petitioner's margin account with Bear, Stearns from their date of acquisition until their date of sale.

Petitioner purchased the above $ 200,000 of bonds of the Colorado & Southern Railway Company (hereinafter called Colorado & Southern) on July 6, 1943, from Bear, Stearns through petitioner's margin account. The bonds were held therein until they were withdrawn on July 28, ">*123 1943, following their retirement by the obligor on July 26, 1943.

The above listed bonds of the MissouriPacific Railway Company (hereinafter called Missouri Pacific) were acquired from Bear, Stearns on August 14, 1943, and sold to Bear, Stearns during the period August 17 to September 25, 1943. These bonds were held in petitioner's margin account from the time of purchase until the time of sale.

">*1195 Petitioner purchased the $ 500,000 of Western Pacific bonds from Bear, Stearns on September 2, 1943. They were thereafter held in petitioner's margin account until sold to Bear, Stearns on October 6, 1943.

The 1,600 shares of American Power & Light preferred were purchased through Bear, Stearns for petitioner's margin account on July 1, 2, and 7, 1943. These shares were held therein and sold therefrom through Bear, Stearns on July 6 and 9, 1943.

During June, July, and August, 1943, petitioner acquired an aggregate of 6,000 shares of Commonwealth & Southern preferred stock through its margin account with Bear, Stearns. Fourteen of such shares were delivered into the possession of the petitioner on June 13, 1943. The other 5,986 shares were sold through the margin account during">*124 July, August, and September, 1943. A resume of the trading in these shares is as follows:

Margin Account of Petitioner with Bear, Stearns & Co. for
Commonwealth & Southern Preferred
				Month end
			Possession	balance of
	Shares	Shares	of shares	shares held
Date	bought	sold	received by	in margin
			petitioner	account
June 4, 1943	1,000
June 17, 1943	1,000
June 29, 1943	1,000
June 30, 1943				3,000
July 12, 1943		1,000
July 13, 1943			14
July 20, 1943		1,986
July 28, 1943	1,000
July 31, 1943				1,000
Aug. 2, 1943	1,000
Aug. 11, 1943	1,000
Aug. 31, 1943		200		2,800
Sept. 1, 1943		200
Sept. 15, 1943		700
Sept. 17, 1943		800
Sept. 18, 1943		1,000
Sept. 20, 1943		100
Sept. 30, 1943				0

During the period from October 14 to October 16, 1943, petitioner sold short 6,200 shares of stock WAII of Consolidated Natural Gas Co. (hereinafter referred to as Consolidated). These short sales were effected through Bear, Stearns and were covered by later purchases of a like number of such shares WAII through Bear, Stearns from November 23, 1944 to December 3, 1944.

From November 22, 1943, to December 1, 1943, petitioner">*125 purchased 4,000 preferred stock shares of Midland United Company (hereinafter called Midland). These shares were bought from Bear, Stearns and retained in petitioner's margin account with that firm until subsequently sold. Petitioner sold 1,000 of the shares to Bear, Stearns on December 22, 1943. The remaining 3,000 were sold to Bear, Stearns on January 5, 1944.

">*1196 On January 7, 1943, petitioner purchased 500 shares of stock of Pacific Mutual Life Insurance Co. (hereinafter called Pacific Mutual) from Akin-Lambert & Co. (hereinafter called Akin-Lambert). On the same date, petitioner resold the 500 shares to Akin-Lambert. Thereafter, on February 13, 1943, petitioner purchased 7,863 shares of such stock from Akin-Lambert. Of these shares so acquired, 1,000 shares were transferred to retail and sold to a customer on February 20, 1943. On the latter date, also, petitioner sold 2,000 such shares to Akin-Lambert. At various times thereafter, through March 10, 1943, petitioner sold an aggregate of 4,863 shares to Akin-Lambert. Aside from the above retail sale of 1,000 shares of Pacific Mutual stock, there were two other such sales within the period January 7 to March 10, ">*126 1943, during which time petitioner was dealing with Akin-Lambert in Pacific Mutual shares. These retail transactions involved the purchase of 30 such shares from a retail customer on or about February 26, 1943, and the sale thereof on or about the same dates to another retail customer, and the purchase of 20 such shares from an individual on March 1, 1943, followed by a sale thereof on the same date to Akin-Lambert.

On six occasions during January 1943, petitioner purchased an aggregate of 360 shares of United Corp. (hereinafter called United) prefered stock. Such shares were acquired from Adolph Lewisohn & Sons, and sold to retail customers on the same dates. On June 4 and 8, 1943, petitioner purchased a total of 4,000 shares of United's preferred stock from Bear, Stearns through its margin account. On June 21, 1943, two hundred of the shares so purchased were transferred to retail distribution for the sale thereof to a customer on that date. Petitioner withdrew the 200 shares so transferred and sold from its margin account on July 6, 1943. The remaining 3,800 shares were retained in the margin account until sold to Bear, Stearns on or about July 1, 2, and 6, 1943.

During the">*127 taxable year 1944, petitioner derived an aggregate of $ 184,374.45 from sales of certain securities which had been held for less than 6 months. The securities involved had, in most instances, been acquired through or from Bear, Stearns by way of petitioner's margin account and held therein without withdrawal or transfer to retail distribution until sold to or through Bear, Stearns. On one occasion, rights to acquire United Airlines preferred stock were purchased through Bear, Stearns and upon the acquisition of the stock, petitioner delivered same into its margin account to be held until subsequently sold. Two of the stocks in question had been held as collateral by the Bank of America, one such issue having been acquired from a source other than Bear, Stearns. Both were apparently sold through Bear, Stearns. Another sale involved bonds of Western ">*1197 Pacific in the face amount of $ 300,000. These bonds were purchased through Bear, Stearns on a WAII basis. After issuance, the bonds were sold for petitioner's own account and risk. The securities involved in 13 transactions, together with the profit or loss, respectively, derived therefrom, were as follows:

No. of
shares or	Name of security	Gain or (loss)
face
value
4,500 sh.	Allis-Chalmers Mfg. Co. pfd. stock	$ 15,962.50
17,400	Electric Bond & Share pfd. stock	4,724.50
3,595	North American Co. pfd. stock	3,188.13
500 M	St. Louis, San Francisco Railroad Co., bonds	20,799.62
250 M	St. Louis, San Francisco Railroad Co., bonds	1,700.00
200 M	St. Louis, San Francisco Railroad Co., bonds	5,490.00
27 M	St. Louis, San Francisco Railroad Co., bonds	(983.75)
500 M	St. Paul, Kansas City Shortline bonds	22,250.00
135 M	Denver & Rio Grande Railroad bonds	5,439.65
1,119 M	Seaboard Airline Railroad bonds	88,975.00
67 M	do	6,448.75
20,000 sh.	Chicago & North Western Railroad Co. pfd. stock	(170,843.81)
22,174	Western Pacific Railroad Co. pfd. stock	120,862.74

">*128 Between April 5 and April 11, 1944, petitioner acquired 4,500 shares of Allis-Chalmers Mfg. Co. (hereinafter called Allis-Chalmers), 4 per cent conv. pfd. stock WAII through Bear, Stearns. After this stock "went regular" ^{1952 U.S. Tax Ct. LEXIS 79">*129 its Bear, Stearns margin account. On February 9 and March 6, 1944, petitioner recorded a transfer of 100 and 2,500 shares, respectively, to its retail account. At various times between February 9 and March 15, 1944, petitioner sold a total of 2,425 such shares to retail customers. During the period March 8 to March 27, 1944, petitioner withdrew and Bear, Stearns delivered 2,425 shares out of the margin account. From June 20 to 26, 1944, petitioner sold 17,275 shares through its margin account. One sale of 175 shares thus made on June 26, 1944, was directly to a retail customer. The 300 shares remaining in the margin account were withdrawn on July 5, 1944, to be later sold at retail.}

18 T.C. 1175">*1198 Petitioner purchased 5,000 shares of North American Co. stock from Bear, Stearns through its margin account on or about November 26, 1943. On January 4, 1944, petitioner transferred on its ledger account 1,500 of the shares thus purchased to retail. Thereafter, on January 24, 1944, 95 such shares were transferred back to petitioner's house investment account. During the period January 17 to January 29, 1944, 2,125 of the shares were delivered to petitioner out of the margin account. ">*130 The disposition of 920 such shares was as follows:

January 15 -- 100 shares sold to Bacon & Co.

January 22 -- 100 shares sold to Brush Slocumb & Co.

January 22 -- 420 shares transferred to Los Angeles

January 22 -- 300 shares sold to Davis, Skaggs & Co.

On January 24, 1944, 2,675 shares were sold to Bear, Stearns. The remaining 200 shares were withdrawn and delivered to petitioner on March 9, 1944.

As of December 31, 1943, petitioner had in its margin account a balance of $ 500,000 face value of 4 per cent 1950 bonds of the St. Louis & San Francisco Railroad Co. (hereinafter called St. Louis & San Francisco). The bonds had been purchased through that account during that month. During January 1944 the $ 500,000 face amount of such bonds was sold through the margin account. Petitioner purchased an additional $ 250,000 face value of these bonds through its margin account on February 16, 1944. On March 17 and 20, 1944, petitioner acquired through Bear, Stearns $ 100,000 of such bonds other than through its margin account, which bonds it delivered into the margin account on March 27, 1944. There was no further activity in this security until $ 200,000 face value thereof was">*131 sold to Bear, Stearns on July 19, 1944. In its ledger account petitioner transferred $ 8,000 and $ 115,000 face value of these bonds to a retail account on July 24 and August 1, 1944, respectively. The $ 150,000 of bonds remaining in the margin account on July 31, 1944, were withdrawn and delivered to petitioner on August 18, 1944, $ 27,000 thereof having been sold to Blythe & Co. of San Francisco on August 15, 1944, and $ 123,000 thereof having been previously transferred to retail distribution, as above noted. Thereafter, on December 5, 1944, petitioner again purchased $ 250,000 face value of St. Louis & San Francisco 4 per cent 1950 bonds through its margin account. These bonds were sold through the account on December 15, 1944.

On December 20, 1943, petitioner bought 4 1/2 per cent 1941 bonds of St. Paul, Kansas City Shortline (hereinafter called Shortline) in face amount of $ 1,000,000 through its margin account with Bear, Stearns. This purchase was recorded on petitioner's ledger in an account entitled "House Investment Acct." Thereafter, on December 31, 1943, January 5 and 8, 1944, $ 500,000 of such bonds were transferred from petitioner's house investment account to its">*132 retail account. The $ 500,000 ">*1199 block remaining in the former account was sold through the margin account on January 19, 1944.

Through its margin account, petitioner purchased $ 250,000 face value bonds of the Denver & Rio Grande Railroad (hereinafter called Denver & Rio Grande) on February 23, 1944. Record of the purchase was made on petitioner's books in its house investment account. By entries therein on February 28, 1944, and July 24, 1944, $ 100,000 and $ 15,000 of the bonds were respectively transferred to petitioner's retail account. Between February 28, 1944, and July 19, 1944, petitioner sold an aggregate of $ 115,000 face value of the bonds to its retail customers. During the period April 10, 1944, to July 27, 1944, $ 115,000 of these bonds was withdrawn from petitioner's margin account to cover such retail sales. The bonds remaining in the margin account in face amount of $ 135,000 were sold through that account on July 27, 1944.

In September and October, 1944, petitioner purchased bonds of Seaboard Airline Railroad (hereinafter called Seaboard) 6 per cent due 1945 of a face value of $ 1,119,000. The purchases were made through Bear, Stearns, $ 112,000 thereof">*133 having been bought through petitioner's margin account. The $ 112,000 face amount of such bonds so purchased was withdrawn from the margin account during October 1944 and, together with the others that had been acquired, were placed with the Guaranty Trust Co. of New York as collateral for a loan. This entire block of bonds was sold on December 13 and 14, 1944. All transactions with respect thereto were recorded in a house investment account on petitioner's ledger. On October 17, 1944, petitioner purchased Seaboard 6 per cent bonds of a face value of $ 67,000, which bonds were sold on December 18, 1944. The acquisition and disposal of this $ 67,000 block of bonds were recorded in a ledger account captioned "House Account Margin C/D." All of the foregoing bonds were acquired and sold through Bear, Stearns. None of the bonds thus acquired passed through petitioner's margin account except those in the face amount of $ 112,000, as pointed out above.

Prior to May 9, 1944, the petitioner had entered into a number of contracts with Bear, Stearns to purchase Chicago & North Western new preferred stock, when, as, and if issued under a proposed reorganization plan of that company. Petitioner">*134 had also entered into a number of contracts with its customers to sell Chicago & North Western new preferred stock when, as, and if issued. On May 8, 1944, it had outstanding contracts to purchase 5,275 shares in excess of the contracts to sell. The price to be paid for these 5,275 shares under these contracts was $ 279,847.56.

">*1200 The petitioner entered into contracts on the dates hereinafter set forth with Bear, Stearns to purchase shares of Chicago & North Western stock, when, as and if issued, as follows:

May 9, 1944	1,700 shares at price of $ 93,921.19
May 13, 1944	800 shares at price of $ 44,000.00
May 18, 1944	2,225 shares at price of $ 122,963.73
July 19, 1944	9,200 shares at price of $ 590,933.33

The entry tickets covering these purchase contracts and entries in petitioner's ledger account incident thereto show them to have been acquired and held for house account purposes.

This stock was issued by Chicago & North Western on July 21, 1944, and settlement or payment on the contracts was required by July 24, 1944. Petitioner received delivery of the above 19,200 shares of new prefered stock, making payment therefor on or about July 24, 1944, and then">*135 delivered these shares, together with an additional 800 shares which petitioner purchased on July 24, 1944, at a cost of $ 51,428 through Bear, Stearns, to hold in the margin account. Petitioner then closed out its ledger account which was captioned "Chicago, North Western Pfd. WAII" on its books, and opened a new account captioned "Chicago North Western Pfd. House Account" in which the new stock was recorded.

Some time prior to May 8, 1944, petitioner received information through its New York correspondent to the effect that there was to be a $ 15 dividend paid on the new Chicago & North Western preferred. In July 1944, Chicago & North Western declared a dividend of $ 15 per share on the new preferred stock payable September 1, 1944, to stockholders of record as of August 11, 1944. On September 1, 1944, petitioner received a dividend of $ 300,000 on its 20,000 shares of preferred stock.

Commencing October 14, 1944, and throughout the period up to November 29, 1944, petitioner sold these shares of stock through Bear, Stearns. From such sales petitioner realized $ 1,012,250 which was $ 170,843.81 less than cost. This latter amount petitioner reported as a short term capital loss">*136 on its tax return.

The above-mentioned contracts for 5,275 shares held on May 8, 1944, and remaining contracts acquired up to and including July 19, 1944, amounting to 13,925 shares, were acquired at times while the petitioner was dealing with the public in WAII contracts of Chicago & North Western preferred.

On November 4, 1944, petitioner had outstanding purchase contracts for the purchase from Bear, Stearns of 26,358 shares of new preferred stock of Western Pacific when, as and if issued, under a proposed reorganization plan of that company. On the same date it had outstanding also sales contracts for the sale to Bear, Stearns of 9,774 ">*1201 shares of such stock when, as, and if issued. Petitioner also had outstanding sales contracts for the sale to its customers of 16,584 shares of such stock when, as, and if issued.

From November 14, 1944, to December 15, 1944, petitioner made contracts with Bear, Stearns to purchase from them an additional 12,400 shares of such stock when, as, and if issued at a price of $ 902,693.70. On December 16 and December 19, 1944, petitioner contracted with Bear, Stearns to sell to them 12,400 shares of the stock when, as, and if issued, at a">*137 price of $ 954,800.

On December 29, 1944, when the new stock was issued by Western Pacific petitioner received 38,928 shares on its purchase contracts with Bear, Stearns. It delivered 16,754 shares to customers under its sales contracts with them and it delivered 22,174 shares to Bear, Stearns pursuant to its sales contracts with them. These latter sales contracts included those for the 12,400 shares made on December 16 and December 19.

When the new stock was issued by Western Pacific and delivered, the petitioner closed its account captioned "Western Pacific Pfd. WAII-Retail Account" into a new account captioned "Western Pacific Pfd.-Retail Account" and it closed its account captioned "Western Pacific Pfd., when, as, and if Issued-House Account" into a new account called "Western Pacific Pfd. House Account." After the petitioner received the stock and made delivery to its customers and had received payment therefor, it closed out its retail account showing a profit on these retail sales in the amount of $ 43,815.22. When it made deliveries and settled with Bear, Stearns, its "House Account" was closed out disclosing a profit of $ 120,862.74. This latter amount petitioner reported">*138 as a short term capital gain on its tax return for 1944.

The difference between the profit of $ 52,106.30 realized upon the sale of 12,400 shares, and the amount of $ 120,862.74 reported a short term capital gain on petitioner's tax return for the year 1944, is the difference between the price at which petitioner had contracted to purchase 9,774 shares from Bear, Stearns and the price at which petitioner had contracted to sell 9,774 shares to Bear, Stearns under contracts, all of which were made prior to November 1, 1944.

On its corporate income and declared value excess-profits tax return (Form 1120) for 1943, petitioner reported dividends received of $ 39,179.80. On its excess profits tax return (Form 1121) for that year, petitioner reported $ 15,760.50 as dividends received, exclusive of dividends received from foreign personal holding companies and dividends received on stock held primarily for sale to customers. Of this latter amount so reported, $ 8,958 was received by petitioner in 1943 as dividends on 2,986 shares of the above-mentioned Commonwealth & Southern Corp. Pfd. stock.

">*1202 Petitioner reported $ 363,557.30 as dividends received in its income and declared value">*139 excess-profits tax return (Form 1120) for 1944. On its excess profits tax return (Form 1121) for that year, petitioner reported $ 355,106 as dividends received, exclusive of dividends received from foreign personal holding companies and dividends received on stock held primarily for sale to customers. This latter amount included $ 302,606 in dividends received, as heretofore noted, on the following securities:

	Shares	Value
Allis-Chalmers Mfg. Co. Pfd	3,400	$ 2,006
Chicago & North Western Ry Co. 5 per cent Pfd	20,000	300,000
Rustless Iron & Steel Co	2,000	600

Beginning in 1942 and 1943, the petitioner, in the course of its regular business in dealing with its customers, entered into numerous contracts for the sale to them of new securities of the Chicago & North Western Railway Company when, as, and if issued, pursuant to the proposed reorganization. On or about the same dates, petitioner entered into contracts with Bear, Stearns and other New York security dealers to purchase from them new securities of Chicago & North Western Railway Company when, as, and if issued. During 1942 and 1943 the petitioner made no segregation on its accounting records to show for">*140 what purposes such contracts were acquired, that is, whether they were to be held for investment or to be utilized ultimately for retail transactions. The quantity of securities for which contracts to purchase had been entered into, was recorded in the "Purchase" column of the petitioner's ledger sheet for these "WAII" items and the contract price was recorded in the "Amount-Purchases" or debit column thereof. The quantity of securities for which contracts to sell were entered into with customers, was recorded on the same ledger sheet in the "Sales" column and the amount of the contract price was recorded thereon in the "Amount-Sales" or credit column. The selling price under the contracts with customers was usually in excess of the purchase price under the contracts made with Bear, Stearns on or about the same day, and the difference was recorded on the ledger sheets as a deferred profit. The quantity of securities for which contracts to purchase were entered into was approximately equal to the quantity which petitioner had contracted to sell to its customers. On December 31, 1943, the quantity of new bonds and preferred stock of Chicago & North Western which petitioner had ">*141 contracted to purchase when, as and if issued, exactly equalled the quantity which petitioner had contracted to sell when, as and if issued. On the same date, the quantity of the new common stock shares which petitioner had contracted to purchase when, as, and if issued, was 41,995 shares, and the quantity which petitioner had contracted to sell when, as, and if issued, was 37,924 shares.

">*1203 Petitioner's position in these WAII contracts on April 30, 1944, was as follows:

	Purchase
Description	contracts	Amount
Common stock	86,550	$ 1,891,131.99
Preferred stock	57,857	2,305,912.96
4 1/2's of 1999	3,431 M	1,809,803.75

Description	Sell contracts	Amount	Profit
Common stock	86,050	$ 1,990,249.41	$ 111,021.97
Preferred stock	52,582	2,126,421.57	93,488.89
4 1/2's of 1999	3,173 M	1,712,543.25	80,389.50

Between April 29, 1944, and May 18, 1944, the petitioner assigned to Bear, Stearns certain of its WAII contracts for the purchase of new securities of Chicago & North Western for a consideration of 95 per cent of the difference between the price at which petitioner had to purchase such securities and the prevailing market price at which contracts">*142 to sell were being made at the time of the assignment. The assignments of contracts for the purchase of the new preferred stock of Chicago & North Western were recorded on petitioner's books as assignments of property held for house investment account. The entry tickets in connection therewith show these assignments as relating to "House investment account purchase contract." Similar accounts were maintained for the common stock and for 4 1/2%-99 bonds WAII and the entries in all accounts were of the same nature to record the similar transactions in the contracts involving the respective securities.

The gain realized on the sale of these contracts was reported by petitioner on its 1944 returns as a long term capital gain. Concurrently with the assignments, petitioner entered into contracts with Bear, Stearns for the purchase of the same quantity of new securities WAII as the quantity which it had assigned, as follows:

New common stock	1,700 shares
New preferred stock	17,300 shares
New bonds	$ 1,119,000 face

These new contracts were set up in a ledger sheet entitled "To cover short sales" and the entries indicated that they were for securities intended to be used for">*143 retail WAII. When the reorganization plan became effective, petitioner took delivery of securities covered by such contracts. It then delivered the securities to its customers pursuant to the contracts it had with them -- thereby fulfilling its obligations thereunder.

">*1204 OPINION.

The parties have, by stipulation, made certain concessions and have eliminated various items from controversy. These concessions and stipulations will be reflected in a recomputation under Rule 50. The ten questions remaining will be considered in the sequence set out in the preface to the Findings of Fact.

We first consider whether the petitioner's margin account liability to Bear, Stearns is allowable as borrowed invested capital within the meaning the section 719, Internal Revenue Code. ^{1952 U.S. Tax Ct. LEXIS 79">*144 During the years under review, petitioner maintained a margin account through which it purchased a large quantity of securities. These securities were held in this account to secure the payment of the balance due therein. Petitioner claimed its indebtedness on this margin account as "borrowed capital." Respondent disallowed the inclusion of such amount within petitioner's "borrowed capital" and here argues that such indebtedness was not evidenced by one of the seven types of instruments specifically called for in the statute. Petitioner, on the other hand, contends that in margin account transactions the relationship between customer (here petitioner) and broker (here Bear, Stearns) is that of pledgor-pledgee; that a margin account arrangement is a pledge of securities with the broker to secure loans made by the broker to the customer; and that such an arrangement as is here in question, as evidenced by the documents executed incident thereto, in law, constitutes a mortgage for borrowed capital purposes.}

Petitioner cites, and relies upon, Brewster Shirt Corporation v. Commissioner, 159 F.2d 227, reversing our Memorandum Opinion. In that proceeding">*145 Brewster, in order to acquire necessary operating capital, entered into a written agreement in which it agreed to assign, as collateral security, its accounts receivable to a factor. The factor agreed to advance 90 per cent of the face value of the accounts and to pay the balance, less a stipulated charge of three-fourths of 1 per cent per month upon payment of the accounts assigned. Brewster agreed to repurchase at face value those accounts not paid at maturity, and otherwise assumed all credit risks incident to the accounts. The Court of Appeals held that the instrument, pursuant to which amounts were advanced to Brewster, constituted in law a mortgage and that the amounts so advanced were allowable as borrowed invested capital.

18 T.C. 1175">*1205 The Brewster case is, we believe, distinguishable from the one before us and is inapplicable here. In the instant proceeding the basic agreement, as witnessed by the documents in evidence, pursuant to which the petitioner's margin account was established and maintained, was of the sort commonly found in the investment brokerage business. As we read it, it did nothing more than establish a certain line of credit to petitioner for the purchase">*146 in the financial market of securities which were to be held as collateral against default in payment of the full purchase price. There was no actual assignment of specific securities to secure the repayment of any fixed sum to be advanced. In fact, the record discloses no advance of moneys actually received by petitioner. We cannot say that the instruments involved legally constituted a mortgage within the meaning of section 719, supra. Cf. Consolidated Goldacres Co. v. Commissioner, 165 F.2d 542, affirming 8 T.C. 87, certiorari denied 334 U.S. 820">334 U.S. 820; Bernard Realty Co. v. United States, 188 F.2d 861; Pendleton & Arto, Inc., 8 T.C. 1302. If our judgment, that the situation here involved is distinguishable from that present in Brewster, be ill founded, then with all respect for the distinguished court that reversed our holding in the Brewster case, we adhere to the rationale of our opinion therein.

We hold, therefore, that respondent did not err in his determination that petitioner's margin account liability did">*147 not represent "borrowed capital" within the intendment of section 719, supra.

The next issue involves the question of whether certain Federal Land Bank bonds, purchased and sold by petitioner in 1943, were capital assets or were held primarily for sale to customers in the ordinary course of petitioner's business.

Petitioner's president, during the period here involved, testified that these Federal Land Bank 4 per cent bonds were purchased purely for petitioner's house investment account. Having considered his testimony in the light of the other evidence of record, we have come to the conclusion, and found as a fact, that the bonds were not acquired for resale to petitioner's customers in the ordinary course of its trade or business. Consequently, we hold that the bonds represented capital assets to petitioner from the sale of which it sustained a capital loss in the amount of $ 89,440.45.

Having determined that the bonds represented capital assets to petitioner, two additional questions arise, first, whether the money borrowed to carry them represented borrowed capital, and, second, the method to be employed in computing the amortization of the bond premium paid by petitioner. ">*148 As to the first, whether the amount borrowed to carry these bonds is includible in petitioner's borrowed capital within the purview of section 719, it is to be noted that the ">*1206 purchase price of the bonds in question was based upon a .65 per cent interest basis yield. When petitioner effected their purchase, it borrowed substantially all of the purchase price at an interest rate of .75 per cent. Respondent has declined to include the amount so borrowed within petitioner's "borrowed capital." He argues in support that since the interest yield of the bonds was less than the amount actually paid to carry them, they were not acquired with any prospect of profit; that clearly no business purpose could have been served thereby; and that the transaction comes within the regulations disallowing the inclusion of an indebtedness incurred merely to increase excess profits credit.

Hart-Bartlett-Sturtevant Grain Co. v. Commissioner, 182 F.2d 153, affirming 12 T.C. 760, cited by respondent, is inapposite here. In that case, the taxpayer purchased bonds merely to create good will in the communities in which it did business. ">*149 It had no intent to profit otherwise.

Here, at the time the bonds were acquired, petitioner's management entertained the mistaken belief that the interest received from the bonds would be tax exempt and the interest paid to carry them would be deductible, and that, accordingly, a profit would ensue. There is substantial evidence to the effect that this hope of profit was the only motivating factor in petitioner's action in entering into the transaction. As soon as petitioner learned of its mistake, it forthwith took steps culminating in the sale of the bonds. There is no evidence of record which tends to show that the purchase of these bonds was motivated by petitioner's desire to increase its excess profits credit. We are of the opinion that there was a business purpose served by petitioner's acquisition of these bonds and in the indebtedness incurred to carry them. See Mahoney Motor Co. v. Commissioner, 192 F.2d 508, reversing 15 T.C. 118.

Respondent suggests, on brief, that it is extremely doubtful whether the form of petitioner's obligation to carry the bonds meets the requirements of a note, mortgage, or other">*150 form of indebtedness specified in section 719.

On April 5, 1943, petitioner executed a continuing loan agreement pursuant to which on the same date it executed a printed form requesting a loan of "* * * $ 5,014,000, payable on demand with interest at the rate of 3/4 per cent per annum, payable monthly * * *." When this latter instrument is considered, together with the continuing loan agreement, we think that it legally constitutes a fixed obligation to pay a sum certain on demand at a fixed rate of interest, and hence, was a de facto note. We, therefore, hold that the amount so borrowed represents "borrowed capital" within the meaning of section 719, and respondent erred in not so including it.

">*1207 We turn to a consideration of the proper period over which the bond premium should be amortized.

In determining the deficiency here involved, the respondent reduced the cost of the bonds by amortization computed and applied pursuant to section 125, Internal Revenue Code, the pertinent portions of which appear in the margin. ^{1952 U.S. Tax Ct. LEXIS 79">*151 thereof. Petitioner argues that it has the right to select the period over which the amortization is spread by electing to use either any call date or the maturity date; that as soon as it was called upon to do so it expressed its election to have the bond premium amortized over a period extending from the purchase date to the maturity date thereof; that the respondent is without authority under the law to substitute his selection therefor; and that, therefore, respondent erred in so computing and applying the amortization to the earliest call date. We disagree.}

">*152

Section 125, supra, provides for the amortization of bond premiums by the obligee. It is mandatory with respect to purely tax exempt 18 T.C. 1175">*1208 bonds. See Report No. 1631, Senate Finance Committee, 77th Cong., 2d Sess., p. 92. The amortizable bond premiums of the taxable year is the amount of the bond premium attributable to such year. Section 125 (b) (2). In the case of tax exempt bonds no deduction for the amortizable premium is allowable. Section 125 (a) (2).

The legislative history of section 125 clearly shows that the total premium is to be amortized over a period extending down to the earliest call date rather than down to the maturity date. In this connection, Report No. 1631, supra, at page 94, reads, in part, as follows:

The fact that a bond is callable * * * does not of itself prevent the application of this section. In the case of a callable bond, the earliest call date will, for the purposes of this section, be considered as the maturity date. Hence, the total premium is required to be spread over the period from the date as of which the basis of the bond is established down to the earliest call date, rather than down to the maturity date. * * *

See">*153 also Regs. 111, sec. 29.125-5. In view of the foregoing, we must sustain respondent in his determination of the bond premium amortization and the period over which such amortization should be spread.

The next issue involves the amounts borrowed by petitioner to finance its April 16, 1943, and September 15, 1943, subscriptions for certain United States Treasury bonds, and the amount which petitioner borrowed for its purchase in 1944 of A. T. & T. convertible debenture bonds. With respect to the indebtednesses incurred in connection with both purchases of United States Treasury bonds the specific question is whether the full amounts of such loans are includible in petitioner's borrowed capital rather than 50 per cent thereof as determined by respondent. As for the amount borrowed to purchase the A. T. & T. bonds, the issue is whether or not any of that indebtedness is so includible. In both instances the pertinent portion of the Code is section 719.

In or about April 1943, petitioner and its business associate, Blair, entered into an arrangement whereby petitioner would borrow funds to carry the purchase in its own name of $ 20,000,000 worth of United States Treasury bonds. On ">*154 April 19, 1943, petitioner borrowed $ 19,800,000 of the necessary funds from Guaranty Trust Co. of New York at an interest rate of three-fourths per cent, and the bonds thus purchased were pledged as collateral therefor. On its books petitioner maintained a special account with Blair wherein it was charged 50 per cent of the interest paid to carry the bonds and credited the interest accruing on 50 per cent of the bonds. The net amount was subsequently paid to Blair.

In September 1943 petitioner again entered into a similar arrangement with Blair pursuant to which petitioner borrowed an additional $ 19,800,000 from the Bank of America to finance the purchase in its own name of more United States Treasury bonds in the net amount of ">*1209 $ 20,000,000. This time the arrangement with Blair differed from the earlier one in that it contemplated a sharing of the profits on the bonds as well as a sharing of the interest accruing thereon. In all other respects the transaction was similar to the preceding one. A bond account was kept on petitioner's books and 50 per cent of the net amount derived therefrom paid to Blair.

Respondent has allowed 50 per cent of the indebtedness so incurred">*155 by petitioner as borrowed invested capital until November 16, 1943, and 100 per cent thereafter. He argues, on brief, that "* * * Where monies are borrowed in a joint venture or enterprise the borrower is not entitled to include in invested capital borrowing in excess of his interest in the venture." On the record, we believe respondent made a correct determination. Albeit petitioner made the purchase of bonds in its own name, the arrangement supporting the purchase and the manner in which petitioner handled the transaction on its books, convince us that Blair was more than a passive recipient of the benefits of the deal, and, had occasion arisen to present the question, Blair would have been held to account for a 50 per cent responsibility in the loans and purchases, not only in the profits. Since each case turns on the particular facts appearing, and since no two cases present identical facts, we get little help from the cited cases. We sustain respondent's action in respect to this item.

We turn now to the question involving petitioner's purchase in 1944 of certain A. T. & T. 3 per cent convertible debentures and the money borrowed to carry them.

These bonds were bought by ">*156 petitioner in the face amount of $ 1,000,000. The purchase price paid therefor was $ 1,170,000. Petitioner borrowed $ 1,050,000 thereof at an interest rate of 1 per cent per annum.

Respondent determined that the indebtedness so incurred was not includible in petitioner's borrowed invested capital for the reason that the primary purpose thereof was one of tax avoidance. He advances no argument on brief to support such determination.

While the evidence tends to show that petitioner's management was aware of possible tax advantages flowing from the transaction in the form of the amortization of the bond premium out of earned income, it also shows that this consideration was secondary to petitioner's decision to enter into the transaction with the bona fide business purpose of realizing the profit which it subsequently derived. In our opinion, therefore, respondent erred in his disallowance of the amount in question as a part of petitioner's borrowed invested capital for 1944, and we so hold.

The next issue is whether respondent erred in disallowing as part of petitioner's equity invested capital for the years 1943 and 1944 the amount of $ 278,240.98.

">*1210 Petitioner was organized">*157 in 1930 as the wholly owned subsidiary of Corporation of America, a wholly owned subsidiary of Transamerica Corporation. It was so organized to take over the assets and liabilities of two other corporations, the capital stock of which was also wholly owned by Transamerica. Upon its organization, petitioner's capital stock, consisting of 500 shares at a par value of $ 1,000 per share, was issued for cash at $ 2,500 per share, or a total of $ 1,250,000. Shortly thereafter, the Liquidating Committee of the Corporation of America caused petitioner to take over certain assets of the two Transferor Companies, namely, seats on the San Francisco and Los Angeles Stock Exchanges at an aggregate price of $ 335,000. The market value of these memberships at the time they were thus taken over totaled approximately $ 46,500. In a later quasi reorganization Transamerica revalued its assets. During this revaluation of assets, Transamerica set up a reserve of $ 278,240.98, representing the difference between the value ascribed to its investment in petitioner's capital stock and the appraised value of that investment. This reserve was subsequently credited to petitioner's account.

In computing">*158 its invested capital, petitioner has treated the $ 1,250,000 cash received upon issuance of its stock as equity invested capital and added thereto the $ 278,240.98 subsequently so credited to it by Transamerica. Respondent, on the other hand, has determined that the amount of $ 1,250,000 paid in by Transamerica for petitioner's stock at the time of its formation, in effect, included the stock exchange memberships taken in at the stated value of $ 335,000; that after various adjustments, this stated value was $ 278,240.98 in excess of the bases to the transferors; that this excess represents an abatement of the original sum paid in or a distribution to the parent corporation within the meaning of section 718 (b) and (c), Internal Revenue Code; ^{18 T.C. 1175">*1211 $ 278,240.98 was, in effect, a capital contribution to petitioner to reimburse it for the excessive amount at which the stock exchange memberships were taken in. Accordingly, respondent has computed petitioner's paid-in capital to be $ 1,250,000. He now points out on brief that certain clerical errors were made in petitioner's favor with respect to the computation of the amount">*159 by which the stated value of the above stock exchange memberships exceeded their bases to the transferors. However, respondent makes no affirmative claim for the sum so erroneously omitted from his original notice of deficiency and we will proceed without further references to it.}

">*160 At the time petitioner took over the seats in question, it gave credit to transferors in the sum of $ 46,250, which amount represented the market value of those assets. The balance of the price was left to the decision of a committee selected by the parties which shortly thereafter decided that petitioner should take in these memberships at a stated value aggregating $ 335,000. The committee rendering this decision was denominated the Liquidating Committee of the Corporation of America and was apparently formed incident to the plan whereby petitioner was organized to take over the assets and liabilities of the transferors. In any event, its activities in connection with petitioner's organization may be regarded as an integral part of the plan therefor inasmuch as they occurred approximately contemporaneously therewith. Moreover, since the parties to the transaction were all members of the affiliated group controlled by Transamerica, the committee which was selected by them was effectively under the domination of that parent corporation and reflected its decisions.

The additional charge to petitioner for these exchange memberships, pursuant to the committee's action, actually resulted">*161 in Transamerica's being credited back with a portion of the amount which it simultaneously therewith had paid in to petitioner's capital. It makes no difference whether we consider this transaction as an abatement of such an amount or as a distribution under section 718, supra. The fact is that petitioner's authorized capital was, from its beginning, diminished by the difference between the amount which was charged for the memberships and the market value thereof. This interpretation of the transactions surrounding petitioner's organization is lent credence by Transamerica's subsequent actions in first creating a reserve for revaluation of the seats and then later actually crediting petitioner with the amount thereof. Respondent is, therefore, affirmed as to this issue.

The next issue is whether certain securities sold by petitioner in each of the taxable years were capital assets. The securities thus sold had been held by petitioner for varying periods of time -- some for more than six months, others for less than six months. Petitioner reported ">*1212 the results of all such sales as capital gains or losses. It here argues that the securities involved were held by">*162 it in its capacity as trader for its own account and risk. Respondent has determined that the securities disposed of by petitioner were not capital assets within the definition of section 117 (a), I. R. C., ^{1952 U.S. Tax Ct. LEXIS 79">*163 This Court has consistently recognized the fact that a taxpayer, such as petitioner herein, may trade in securities on its own account and risk at the same time it is a dealer with respect to similar securities held for sale to customers. E. Everett Van Tuyl, 12 T.C. 900; Carl Marks & Co., 12 T.C. 1196; Stern Bros. & Co., 16 T.C. 295; and George R. Kemon, 16 T.C. 1026. As to those held for investment or speculation on its own account, the taxpayer is not a dealer and is not entitled to compute income on the inventory method. Such securities properly constitute capital assets. E. Everett Van Tuyl, supra;Stern Bros. & Co., supra;George R. Kemon, supra.On the other hand, those acquired and held primarily for sale to customers in the ordinary course of business are specifically excluded from "capital assets" by the statutory definition thereof. However, securities originally acquired and held for either purpose may be freely appropriated to the other purpose at the discretion">*164 of the taxpayer exercised in good faith. Carl Marks & Co., supra.Therefore, the ultimate question to be resolved is the purpose for which a particular security is held at the time of its sale. Such question is essentially one of fact. Stern Bros. & Co., supra.}

In determining whether a particular security was or was not thus held for sale to customers in the ordinary course of business, the most crucial factor to consider is the phrase "to customers." George R. Kemon, supra.Securities sold on an exchange are not considered as having been sold to "customers." Thomas E. Wood, 16 T.C. 213. For that reason, a stock speculator trading on his own account is not considered to have customers. George R. Kemon, supra.In this connection, we said in the Kemon case:

* * * Those who sell "to customers" are comparable to a merchant in that they purchase their stock in trade, in this case securities, with the expectation 18 T.C. 1175">*1213 of reselling at a profit, not because of a rise in value during the interval of time between purchase and">*165 resale but merely because they have or hope to find a market of buyers who will purchase from them at a price in excess of their cost. This excess or mark-up represents remuneration for their labors as a middle man bringing together buyer and seller, and performing the usual services of retailer or wholesaler of goods. Cf. Schafer v. Helvering, supra; Securities-Allied Corp. v. Commissioner, 95 F.2d 384, certiorari denied, 305 U.S. 617">305 U.S. 617, affirming 36 B. T. A. 168; Commissioner v. Charavay, 79 F.2d 406, affirming 29 B. T. A. 1255. Such sellers are known as "dealers."

Contrasted to "dealers" are those sellers of securities who perform no such merchandising functions and whose status as to the source of supply is not significantly different from that of those to whom they sell. That is, the securities are as easily accessible to one as the other and the seller performs no services that need be compensated for by a mark-up of the price of the securities he sells. The sellers depend upon such circumstances as a rise in value or ">*166 an advantageous purchase to enable them to sell at a price in excess of cost. Such sellers are known as "traders."

The record in the instant proceeding discloses that during the taxable years petitioner engaged in extensive trading on its own account and risk aside from its regular "dealer" business. Often such trading was in securities similar to those which petitioner was at the same time, as a dealer, selling to its customers; and during the greater part of 1943 petitioner made no segregation or identification on its general ledger accounts as to the purpose for which a particular security was held. No such identification or segregation was begun and effected until October or November, 1943. While such lack of identification and segregation is of some significance and may not be totally disregarded, we by no means feel that it decisively indicates that petitioner engaged in no trading activities on its own account or that all of the securities acquired by it, and here in dispute, were devoted to petitioner's retail or wholesale "dealer" business. Most of the securities here in question and which petitioner claims were held for trading and speculation on its own account, were">*167 acquired through the margin account which petitioner established with Bear, Stearns. Such securities were generally held in that account until later sold through it. Prior to the establishment of the account, in January 1943, the securities involved in petitioner's trading activities were, for the most part, purchased from or through Bear, Stearns, held in a New York depository, and then sold to or through Bear, Stearns. On a number of occasions during 1943 and 1944, various securities held in petitioner's margin account were transferred and withdrawn to be used for retail distribution. There were a few instances when securities acquired through other means were deposited in the account. There were even times when a particular block of securities would be withdrawn, presumably to be used for retail distribution, only to be redeposited in the margin account. We do not agree with respondent's contention that such withdrawals and deposits conclusively show that ">*1214 all of the securities in question were held by petitioner, as a dealer, for sale to customers in the ordinary course of its business and, therefore, includible in petitioner's inventory. To the contrary, the ">*168 evidence, as a whole, is quite convincing that the primary purpose for the establishment and maintenance of the margin account was its use in conjunction with petitioner's trading activities aside from its dealer business. Further, we are satisfied that such securities as were purchased through the account, held or deposited therein, were held in petitioner's capacity as a trader on its own account until they were later either sold in that capacity or appropriated to retail distribution and sale.

In its income tax return for 1943, petitioner reported long term capital gains derived from the sales of certain blocks of bonds of Kansas City, Fort Scott & Memphis Railway, Milwaukee, Sparta & Northwestern Railway, and Chicago, Milwaukee & St. Paul Railway Co. We have found that the $ 500,000 Kansas City, Fort Scott & Memphis bonds here in dispute were acquired through the margin account on May 3, 1943; that this block was held intact in the margin account until September 17, 1943, when $ 12,000 thereof was withdrawn to cover an earlier sale to retail of such bonds in that amount; and that bonds in the face amount of those so withdrawn were delivered into the margin account on September">*169 27, 1943, where they were held together with the remaining $ 488,000 thereof until sold during November and December, 1943. We hold that $ 488,000 face amount of the bonds in dispute was held for investment and speculation on petitioner's own account and, therefore, constituted capital assets from the date of purchase, May 3, 1943, until the respective dates of sale in November and December, 1943. As for the $ 12,000 block deposited in the margin account to replace the bonds in that amount earlier withdrawn and appropriated to retail distribution, we hold that the bonds included in such block represented capital assets from and after September 27, 1943.

The $ 271,000 block of Milwaukee, Sparta & Northwestern bonds in dispute was originally acquired as a part of a $ 300,000 block of such bonds purchased in March 1942. An aggregate of $ 29,000 of the block originally acquired was sold to the public. No segregation or identification was made on petitioner's books as to the purpose for which such bonds were bought and held. We note, also, that the bonds in question were sold to Bear, Stearns prior to the time the margin account was opened, and there is no evidence of their having">*170 been otherwise physically segregated. While the record made might possibly warrant the assumption that such bonds were sold for petitioner's own separate trading account, there is no evidence of record to show on what date the bonds were definitely appropriated to such ">*1215 purposes. Consequently, for want of such evidence, we sustain respondent's determination that these bonds were held for sale to petitioner's customers in the ordinary course of its business.

The disputed bonds of Chicago, Milwaukee & St. Paul, in an aggregate face amount of $ 377,000, were purchased by petitioner at various times in 1942, and $ 234,000 thereof was held in a New York depository until their delivery in petitioner's margin account in January 1943. No part of this $ 377,000 block of bonds was ever sold to retail and the entire block was sold to or through Bear, Stearns in January 1943. On the record made, we hold that the bonds, comprising the block here in dispute, were acquired, held and sold in conjunction with petitioner's trading activities on its own account and represented capital assets to petitioner from their respective dates of purchase.

For 1944 petitioner reported as long term">*171 capital gains the profits derived from transactions involving sales aggregating 20,000 shares of United Electric & Power preferred stock. We have made detailed findings as to the purposes for which this stock was acquired and held until subsequently sold. The evidence shows that 9,300 of such shares were at one time appropriated and held to cover contracts for the sales of 46,500 shares of United Light and Railways common, when, as, and if issued to petitioner's retail customers, and that for aught there is in the record, the 9,300 shares were so held until the date of their sale to Bear, Stearns. There is no evidence of a change in the purposes for which the shares were held prior to such date. Consequently, respondent's action is approved in so far as it relates to 9,300 shares of the 20,000 shares in dispute. With respect to the remaining 10,700 shares, the evidence preponderates in favor of petitioner's position that the shares were acquired, held, and sold for petitioner's investment and speculation purposes on its own account. Respondent erred in his determination with regard thereto, and we so hold.

Also, in its 1944 return, petitioner reported the loss sustained on the">*172 sale of 2,000 shares of Rustless Iron & Steel Company stock as a long term capital loss. We have found as a fact, and here hold, that such shares were acquired for petitioner's own account and risk and not for resale to its customers. These shares, therefore, represented capital assets to petitioner, and respondent's determination to the contrary is reversed.

We turn now to those transactions during the taxable years involving the sales of securities which had been held for less than six months. There were 17 such transactions during 1943. We have found as a fact that those disposed of in 12 of the transactions had, in each instance, been acquired through petitioner's margin account and ">*1216 held therein from their respective dates of acquisition, without transfer to or withdrawal for retail distribution, until sold therefrom to or through Bear, Stearns. We here hold that the securities involved in these 12 transactions were purchased, held, and sold by petitioner in pursuit of its individual trading and speculating activities, and, therefore, constituted capital assets to petitioner from the time they were respectively acquired until their respective dates of sale. The">*173 remaining five transactions in controversy included the sales of certain securities of the Colorado & Southern, Commonwealth & Southern, Consolidated Natural Gas, WAII, Pacific Mutual, and United.

We have found as a fact that the Colorado & Southern bonds were acquired through petitioner's margin account and held therein until after their retirement by the obligor. We here hold that such bonds represented capital assets to petitioner, having been purchased, and, at all times material, held by petitioner for its investment or speculation in its individual capacity as a trader.

The 6,000 shares of Commonwealth & Southern stock in question were purchased through petitioner's margin account. Thereafter, 14 such shares were withdrawn and delivered into petitioner's possession, apparently for retail distribution. The remaining 5,986 shares were retained in petitioner's margin account until the time of sale. On the basis of the evidence adduced relative thereto, we hold that the 5,986 shares in dispute were at no time held by petitioner, in its capacity as dealer, for sale to customers in the ordinary course of business but were bought, held and sold incident to petitioner's trading ">*174 on its own account and risk. They constituted capital assets from the date of acquisition to the date of sale.

The 6,200 shares of Consolidated stock involved herein were acquired through Bear, Stearns, by petitioner on a when, as, and if issued basis to cover its prior short sales thereof in that amount and on such basis. The evidence shows little else. In respect to these items, we are of the opinion petitioner has not successfully carried its burden of proof. We accordingly hold for respondent.

Petitioner's transactions in the Pacific Mutual stock shares were with Akin-Lambert & Co., presumably another stockbroker. During the period in question petitioner purchased an aggregate of 8,363 such shares from Akin-Lambert and sold 7,363 shares thereof to Akin-Lambert. The other 1,000 shares were transferred and sold to a retail customer. The evidence here is insufficient to enable us to determine, with assurance, the character of the transaction. Wherefore, petitioner, which had the burden of proof, must bear the onus of a failure of proof. Respondent is affirmed.

With respect to the United preferred stock disposed of by petitioner in 1943, we have found as a fact that petitioner">*175 acquired 4,000 such ">*1217 shares through its margin account and that 3,800 thereof were carried in that account until sold therefrom to Bear, Stearns, 200 such shares having been appropriated and withdrawn for retail distribution. We here hold that the sale of the 3,800 shares in controversy resulted in short term capital gain derived from petitioner's trading activities on its own account and risk.

In 1944 petitioner entered into a number of transactions wherein it sold certain securities which had been held by it for less than six months. Such securities had, in most instances, been purchased for petitioner's margin account and held therein intact until sold. There were, however, those instances where the securities sold were the remainder of a larger block which had been so acquired and portions of which had been transferred and withdrawn for retail distribution. There was also one transaction entailing the sale of certain bonds that had been purchased on a when, as, and if issued basis and held until after the issuance thereof. Moreover, some of the securities in question were held in a bank as collateral. Certain of the transactions, which are here the subject of controversy, ">*176 culminated in the sale of 4,500 shares, 17,400 shares and 3,595 shares of Allis-Chalmers, Electric Bond & Share, and North American, respectively. Excepting these latter transactions and those involving the securities of Chicago & North Western and Western Pacific, both of which have been presented and considered as separate issues herein, it is our conclusion that none of the securities involved therein were property held by petitioner primarily for sale to customers in the ordinary course of its business. Rather, they were acquired for petitioner's speculation purposes on its own account and were thus capital assets. Regarding the securities of Allis-Chalmers, Electric Bond & Share, and North American that were sold, our conclusion is the same only with respect to 4,400 shares, 17,100 shares, and 2,675 shares thereof, respectively.

The next issue is whether 20,000 shares of Chicago & North Western preferred stock sold by petitioner subsequent to October 14, 1944, represented capital assets to petitioner. Respondent has determined that the entire 20,000 shares represented stock in trade to petitioner available for sale to customers in the ordinary course of its business.

As noted">*177 above, whether the status of a particular security held by an investment broker is that of stock in trade, held primarily for sale to customers in the ordinary course of business, is purely a question of fact. Those pertinent to this issue have been set forth in our findings of fact. As to the 14,725 shares purchased WAII subsequent to May 8, 1944, the evidence clearly shows that they were acquired and held by petitioner as a trader for investment or speculation. The record is specific that petitioner's acquisition of such shares was part of a plan ">*1218 to accumulate a sizeable block thereof in anticipation of a proposed dividend. With regard to the remaining 5,275 shares, the contracts under which they were acquired may well have been purchased for petitioner's retail business, the record not showing otherwise. However, upon issuance of the stock, on July 21, 1944, these shares were placed, together with the foregoing 14,725 shares, in an account where they were held for the same purposes pursuant to the above-described plan for accumulation until later sold. The appropriation of these shares to such ends indicates a definite change of petitioner's intentions with respect">*178 thereto and effects a transmutation of the shares from whatever their earlier nature may have been to property held for investment or speculation purposes on petitioner's own account. See Stern Bros. & Co., supra.

We hold, therefore, that the shares in question constituted capital assets to petitioner from and after July 21, 1944.

The next question presented is whether petitioner's sale in 1944 of 22,174 shares of Western Pacific preferred stock, pursuant to its earlier WAII sell contracts, resulted in short term capital gain, as reported by petitioner, or in ordinary income, as determined by respondent.

Prior to the time the transaction at issue took place, petitioner had contracted to purchase 38,928 shares of Western Pacific Pfd. stock WAII. It had contracted to sell a total of 16,754 such WAII shares to its customers and an aggregate of 22,174 such WAII shares to Bear, Stearns. We are here concerned with the sale made pursuant to petitioner's contracts with Bear, Stearns. These contracts included those for the sale of 9,774 shares, which contracts were executed prior to November 1, 1944, and those entered into after November 1, 1944, for the ">*179 sale of 12,400 shares. The sales contracts were covered by similar purchase contracts with Bear, Stearns, executed before and after November 1, 1944, respectively. Such purchase contracts were, at all times material, in excess of petitioner's sell contracts with its customers. It is our conclusion that both blocks represented capital assets to petitioner at the time of their acquisition and sale. Accordingly, we so hold.

The next issue relates to certain dividends that petitioner received during the taxable years on its holdings of 2,986 shares of Commonwealth & Southern stock, 3,400 shares of Allis-Chalmers stock, 20,000 shares of Chicago & North Western 5 per cent Pfd. stock, and 2,000 shares of Rustless Iron & Steel stock. The specific question is whether or not the securities involved represented capital assets to petitioner on the dates such dividends were respectively declared and received. If so, the amount of the dividends so received thereon is not includible in petitioner's excess profits net income pursuant to section 711 (a)">*1219 (2), I. R. C. ^{1952 U.S. Tax Ct. LEXIS 79">*180 in the affirmative and hold that the securities in dispute, namely, 2,986 shares of Commonwealth & Southern stock, 3,400 shares of Allis-Chalmers stock, 20,000 shares Chicago & North Western 5 per cent Pfd. stock, and 2,000 share of Rustless Iron & Steel stock, constituted capital assets to this petitioner on the critical dates involved.}

">*181 The next issue is whether petitioner's assignments in 1944 of certain contracts for the purchase of new securities of Chicago & North Western WAII resulted in long term capital gain, as reported by petitioner.

The facts pertinent to this issue are briefly these: During 1942 and 1943, petitioner entered into contracts with its customers to sell them various new securities of Chicago & North Western WAII. These sell contracts were usually covered by purchase contracts made with Bear, Stearns on or about the same dates. On December 31, 1943, the quantity of new bonds and preferred stock which petitioner had contracted to sell WAII exactly equalled the quantity it had contracted to purchase WAII. With reference to the new common stock, petitioner had such contracts for the purchase of 49,995 shares and for the sales of 37,924 shares. Between April 29 and May 18, 1944, petitioner assigned certain of the purchase contracts for each type to Bear, Stearns. Contemporaneous with such assignments, petitioner entered into contracts with Bear, Stearns for the purchase of the same quantity of new securities which it had so assigned. The assignments were recorded on petitioner's books as being">*182 of property having been held for house investment account, while the securities in the same quantity repurchased concurrently therewith were set up "To cover short sales."

Petitioner's position that the contracts so assigned were property held for its own investment or speculation purposes separate and apart from its dealer business, is based primarily upon the testimony of its president during the period involved. This testimony was to the effect that beginning in late 1943, petitioner segregated the contracts and securities and identified them as to the purposes for which 18 T.C. 1175">*1220 they were held. However, the documentary evidence relative to the Chicago & North Western Pfd. stock WAII, while strongly indicating that such securities were originally acquired and held to cover petitioner's sales contracts with its customers, fails to show that any segregation or appropriation to other purposes was made prior to the time each individual assignment was effected and recorded. Moreover, petitioner's actions prior to and during the period of transactions here constitute better evidence of its purposes than does testimony based upon memory and hindsight. In this connection, it is of">*183 significance to note that no other securities of the type were acquired to cover petitioner's sales to its customers until the time of the assignments in controversy. Further, simultaneously therewith, petitioner entered into contracts with its assignee for the purchase of the same quantity of new securities WAII as the quantity which it had assigned. Such transactions enabled petitioner to derive a substantial profit on which it would be taxed at capital gains rates and at the same time contract to repurchase the identical securities to cover its customer commitments with any loss subsequently sustained thereon being deductible. Under such circumstances, we are of the opinion that the Commissioner was justified in disregarding the transaction, Higgins v. Smith308 U.S. 473">308 U.S. 473, and in determining that the amounts in controversy are taxable as ordinary income. Cf. Stewart Silk Corporation, 9 T.C. 174.

Inasmuch as the parties have stipulated that the accounts and entries with respect to the Chicago & North Western bonds WAII and common stock WAII, also here involved, were of the same nature, what we have said above ">*184 is equally applicable to the transactions involving those securities.

It is our conclusion that respondent did not err in his determination with respect thereto, and we so hold.

There remains for our consideration the question of admissible and inadmissible assets for computing petitioner's excess profits credit under the invested capital method. The pertinent portion of the statute involved is section 720, I. R. C.^{1952 U.S. Tax Ct. LEXIS 79">*185 18 T.C. 1175">*1221 The parties are in agreement that such corporate stocks as we have herein held to represent capital assets and the tax exempt bonds involved, constitute inadmissible assets. They are in disagreement as to the proper treatment to be accorded the various contracts to purchase and to sell certain securities when, as, and if issued.}

Petitioner cites and relies upon I. T. 3721, 1945 C. B. 164, to support its contention that the contracts to buy securities WAII constitute items of property separate and apart from the contracts to sell securities WAII, and that, therefore, its assets must include not only the investment in the purchase contracts but also the gross amounts receivable under the sales contracts. Respondent presents no argument as to the applicability or inapplicability of the cited ruling. He takes the position that such contracts have no cost until the liability to perform comes into force; that having no cost, the contracts cannot increase the total of admissible assets; and that, furthermore, the contracts to buy were, in the main, a hedge against the contracts to sell and offset each other.

Thus, the question here resolves itself">*186 into whether the contracts, as assets, are to be recognized as individual items of property, or "gross basis," rather than on an "offset" or "net basis" in which the total of contracts to buy and contracts to sell are set off against each other and the net result of all items is utilized.

The ruling cited and relied upon by petitioner provides, in part:

The usual situation in which trading in securities on a "when issued" basis takes place is one in which there is submitted a plan of reorganization of a corporation providing for the issuance, in exchange for its outstanding securities, of securities of a new corporation or of new securities of the reorganized old corporation. Before such a plan of reorganization actually becomes effective the approval of the interested security holders must be obtained or the plan must be approved by regulatory bodies or the courts. There is often litigation as a result of which the plan of reorganization may be abandoned or approved in a modified form. The time elapsing between the submission of the plan and the actual exchange of old securities for new securities under the plan, or the plan as modified, may be as much as several years. After">*187 the submission of the plan of reorganization, trading may be commenced in the new securities which are to be issued under the plan of reorganization. Inasmuch as these new securities are not in existence, and will never come into existence if the plan of reorganization is not carried out, the trading is on the basis of "when, as, and if issued," commonly called "when issued." The trading is carried on by the execution of contracts for the purchase and sale of the new securities "when issued" at specified prices.

">*1222 Continuing, the ruling sets out several specific examples in which it is held that when a taxpayer, who does not own old stock of a particular corporation, enters into a contract to buy or sell the new securities of that corporation when, as, and if issued," * * * acquires the right to purchase (or to sell) that stock when it is issued * * *" and that "* * * the right so acquired constitutes a 'capital asset' as that term is defined in section 117 (a) (1) of the Code * * *." Further, when such taxpayer "* * * enters into a 'when issued' buy or sell contract and some time thereafter enters into a 'when issued' sell or buy contract at a different price with the">*188 result that, provided the reorganization is consummated, he is assured of a profit from the combination of the two contracts * * *, the contract to buy and the contract to sell are to be treated as entirely separate capital assets." Moreover, it is ruled that while a "when issued" contract to buy or to sell may have cost the taxpayer nothing in cash at the time it was executed, nevertheless, such taxpayer had obligated himself to carry out the contract pursuant to its terms, and this obligation should be treated as part of the contract's basis in the taxpayer's hands in determining his gain or loss on its disposition.

I. T. 3721, supra, is an interpretation of section 117, I. R. C., and involves the question of whether "when issued" contracts are capital assets within the meaning of that section, and, if so, the proper treatment thereof for Federal tax purposes. Hence, the conclusions expressed therein are restricted "* * * to transactions entered into by investors and traders in securities but are not applicable to transactions entered into by dealers in securities where such transactions constitute a part of the business of dealers in securities." ^{1952 U.S. Tax Ct. LEXIS 79">*189 as to the status of the contracts in dispute, i. e., whether or not they are capital assets. However, the rationale of the foregoing ruling would appear applicable to the instant situation in so far as it relates to the treatment of such contracts as separate items of property and as to the tax bases to be used therefor. Such application devitalizes the position taken by respondent.}

Therefore, we hold that the contracts in controversy are to be recognized as individual assets, i. e., on a "gross basis" rather than on a "net basis" in computing the percentage of inadmissible to total assets under section 720, supra. Cf. Modesto Dry Yard, Inc., 14 T.C. 374.

Decision will be entered under Rule 50.

MURDOCK

Murdock, J., dissenting: I do not ">*190 agree that the money borrowed to purchase the Federal Land Bank bonds represented borrowed capital. 18 T.C. 1175">*1223 The taxpayer purchased those bonds knowing that it would sustain an income loss because it borrowed money to buy the bonds at an interest rate higher than that paid by the bonds. The only advantage which it expected was a tax advantage in that it thought, mistakenly, that the interest on the bonds would be tax exempt and it would be allowed a deduction for the interest on the money borrowed. This point should be decided against the petitioner on the authority of Hart-Bartlett-Sturtevant Grain Co., 12 T.C. 760, affd. 182 F.2d 153, which can not be distinguished satisfactorily.

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Footnotes

• 1. As used herein, the term "went regular" refers to the time as of which the plan contemplating the issuance of the security in question became effective, such security was issued, and became deliverable.↩

• 2. 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, plus,

  * * * *

  (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.↩

• 3. SEC. 125. AMORTIZABLE BOND PREMIUM.

  (a) General Rule. -- In the case of any bond, as defined in subsection (d), the following rules shall apply to the amortizable bond premium (determined under subsection (b)) on the bond for any taxable year beginning after December 31, 1941:

  * * * *

  (2) Interest wholly tax-exempt. -- In the case of any bond the interest on which is excludible from gross income, no deduction shall be allowed for the amortizable bond premium for the taxable year.

  * * * *

  (b) Amortizable Bond Premium. --

  (1) Amount of bond premium. -- For the purposes of paragraph (2), the amount of bond premium, in the case of the holder of any bond, shall be determined with reference to the amount of the basis (for determining loss on sale or exchange) of such bond, and with reference to the amount payable on maturity or on earlier call date, with adjustments proper to reflect unamortized bond premium with respect to the bond, for the period prior to the date as of which subsection (a) becomes applicable with respect to the taxpayer with respect to such bond. In no case shall the amount of bond premium on a convertible bond include any amount attributable to the conversion features of the bond.

  (2) Amount amortizable. -- The amortizable bond premium of the taxable year shall be the amount of the bond premium attributable to such year.

  (3) Method of determination. -- The determinations required under paragraphs (1) and (2) shall be made --

  (A) in accordance with the method of amortizing bond premium regularly employed by the holder of the bond, if such method is reasonable.

  (B) in all other cases, in accordance with regulations prescribing reasonable methods of amortizing bond premium, prescribed by the Commissioner with the approval of the Secretary.

  * * * *

  (d) Definition of Bond. -- As used in this section, the term "bond" means any bond, debenture, note, or certificate or other evidence of indebtedness, issued by any corporation and bearing interest (including any like obligation issued by a government or political subdivision thereof), with interest coupons or in registered form, but does not include any such obligation which constitutes stock in trade of the taxpayer or any such obligation of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or any such obligation held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.

  * * * *↩

• 4. SEC. 718. EQUITY INVESTED CAPITAL.

  * * * *

  (b) Reduction in Equity Invested Capital. -- The amount by which the equity invested capital for any day shall be reduced as provided in subsection (a) shall be the sum of the following amounts --

  (1) Distributions in previous years. -- Distributions made prior to such taxable year which were not out of accumulated earnings and profits;

  (2) Distributions during the year. -- Distributions previously made during such taxable year which are not out of the earnings and profits of such taxable year;

  * * * *

  (c) Rules for Application of Subsections (a) and (b). -- For the purposes of subsections (a) and (b). --

  (1) Distributions to shareholders. -- The term "distribution" means a distribution by a corporation to its shareholders, and the term "distribution in stock" means a distribution by a corporation in its stock or rights to acquire its stock. To the extent that a distribution in stock is not considered a distribution of earnings and profits it shall not be considered a distribution. A distribution in stock shall not be regarded as money or property paid in for stock, or as paid-in surplus, or as a contribution to capital.

  * * * *↩

• 5. SEC. 117. CAPITAL GAINS AND LOSSES.

  (a) Definitions. -- As used in this chapter --

  (1) Capital assets. -- The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include --

  (A) stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;

  * * * *↩

• 6. SEC. 711. EXCESS PROFITS NET INCOME.

  (a) Taxable Years Beginning After December 31, 1939. -- The excess profits net income for any taxable year beginning after December 31, 1939, shall be the normal-tax net income, as defined in section 13 (a) (2), for such year except that the following adjustments shall be made:

  * * * *

  (2) Excess profits credit computed under invested capital credit. -- If the excess profits credit is computed under section 714, the adjustments shall be as follows:

  (A) Dividends Received. -- The credit for dividends received shall apply, without limitation, to all dividends on stock of all corporations, except that no credit for dividends received shall be allowed with respect to dividends (actual or constructive) on stock of foreign personal holding companies or dividends on stock which is not a capital asset.

  * * * *↩

• 7. SEC. 720. ADMISSIBLE AND INADMISSIBLE ASSETS.

  (a) Definitions. -- For the purposes of this subchapter --

  (1) The term "inadmissible assets" means --

  (A) Stock in corporations except stock in a foreign personal-holding company, and except stock which is not a capital asset; and

  (B) Except as provided in subsection (d), obligations described in section 22 (b) (4) any part of the interest from which is excludible from gross income or allowable as a credit against net income.

  (2) The term "admissible assets" means all assets other than inadmissible assets.

  (b) Ratio of Inadmissibles to Total Assets. -- The amount by which the average invested capital for any taxable year shall be reduced as provided in section 715 shall be an amount which is the same percentage of such average invested capital as the percentage which the total of the inadmissible assets is of the total of admissible and inadmissible assets. For such purposes, the amount attributable to each asset held at any time during such taxable year shall be determined by ascertaining the adjusted basis thereof (or, in the case of money, the amount thereof) for each day of such taxable year so held and adding such daily amounts. The determination of such daily amounts shall be made under regulations prescribed by the Commissioner with the approval of the Secretary. The adjusted basis shall be the adjusted basis for determining loss upon sale or exchange as determined under section 113.↩

• 8. By special letter ruling dated August 18, 1950, I. T. 3721↩ was held to apply to a corporate dealer in securities where such contracts are acquired for investment purposes and not in conjunction with its business as a dealer in securities.