Gussow, Kahn & Co.
Comm'r of Internal Revenue

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Tax Court of the United States.Oct 19, 1949
13 T.C. 580 (U.S.T.C. 1949)

Docket No. 16970.



Abraham Kraditor, Esq., for the petitioner. E. Randolph Dale, Esq., for the respondent.

Petitioner during 1943 and 1944 advanced to its wholly owned subsidiary a total of $11,334.43. These advances constituted the only capital of the subsidiary during the year involved and they represented an investment by petitioner in the unissued capital stock of the subsidiary. This investment became worthless during the taxable year when it was determined to liquidate the subsidiary, and it is therefore held that, with the exception of the advances made after the determination to liquidate the subsidiary, petitioner may deduct the advances involved under section 23(g)(4) of the Internal Revenue Code. Abraham Kraditor, Esq., for the petitioner. E. Randolph Dale, Esq., for the respondent.

The respondent determined deficiencies against the petitioner for the year 1944 as follows:

+-------------------------------------------+ ¦Income tax ¦$1,770.90¦ +---------------------------------+---------¦ ¦Declared value excess profits tax¦887.90 ¦ +---------------------------------+---------¦ ¦Excess profits tax ¦3,666.49 ¦ +-------------------------------------------+

One of the three adjustments made by respondent in petitioner's net income for 1944 is not contested. Only two issues, therefore, are raised by the pleadings: (1) Did petitioner sustain a deductible loss in 1943 and 1944 in an amount not exceeding $11,334.43 which was advanced by petitioner in 1944 to Tomorrow's Masterpieces, Inc., and not recovered? (2) Is the amount of $525.69 deductible by petitioner as traveling expenses for the year 1944 under section 23(a)(1), Internal Revenue Code?


Some of the facts are stipulated and they are so found.

The tax return for the year involved was filed with the collector of internal revenue for the third district of New York.

The petitioner is a corporation, duly organized and existing under and by virtue of the laws of the State of New York. Its principal office is in New York City. During 1943 petitioner with its own funds caused the organization of Tomorrow's Masterpieces, Inc., which was incorporated in the State of New York on May 12 of that year. The incorporators were Herbert Kaufman, Louis H. Kaufman, and Sara Kaye. The incorporators named acted as such merely as the agents of petitioner. At no time did any person or corporation other than petitioner have any financial interest in Tomorrow's Masterpieces, Inc. The president and treasurer of petitioner were also the president and treasurer of Tomorrow's Masterpieces, Inc. Neither corporation had any other officers. These officers were respectively Leonard Gussow and George N. Kahn.

At the time of its incorporation Tomorrow's Masterpieces did not issue any of its stock, nor has it issued any since that time. Petitioner has controlled the activities of Tomorrow's Masterpieces since it caused its organization as if the latter were the wholly owned subsidiary of petitioner.

Tomorrow's Masterpieces was created to popularize and sell works of contemporary American artists directly through the medium of department store displays and other accepted merchandising methods. It commenced operation during the spring and summer of 1943. A number of department stores throughout the country were invited to join in its program. Approximately 25 stores accepted, each store signing a one-year contract with Tomorrow's Masterpieces. Contracts with the department stores expired in August, September, October, November and December, 1944, and none of the contracts was renewed.

Tomorrow's Masterpieces had under contract between 700 and 850 artists, who were to supply it with paintings on a loan basis, which in turn were to be sent to the various contract stores for sale. The artist was to receive 60 per cent, the department store 30 per cent, and Tomorrow's Masterpieces 10 per cent of the selling price of each painting. Tomorrow's Masterpieces also received $525 from each department store in consideration for the right to exhibit and sell the paintings and for promotional services in connection therewith. Its only other income was from the sale of the photographic prints of works of art on exhibition.

In the contracts between Tomorrow's Masterpieces and the artists it was provided that the former was to insure each of the paintings and that the artists were to look solely to the insurance company for any loss or damage to any work of art loaned to Tomorrow's Masterpieces.

In January 1944 Tomorrow's Masterpieces received free valuable advertising for its program in Life Magazine. In July 1944 Tomorrow's Masterpieces sent letters with this magazine attached to approximately 2,500 department stores in various cities throughout the country. A follow up letter was mailed to these stores in August. Although a few stores showed some interest, no new contracts resulted from these efforts.

In October 1944 it became apparent that the approximately 25 stores which had previously signed contracts would not renew them. It was clear to the officers of Tomorrow's Masterpieces at the beginning of November 1944 that it was a financial failure and insolvent. At that time it was decided to liquidate that corporation. Steps were taken almost immediately to do so.

Shortly thereafter and prior to December 31, 1944, Tomorrow's Masterpieces informed all of the department stores with which it had contracts to return the paintings then on exhibition as the venture was being liquidated. All of such paintings were returned and all of the contracts with the various department stores were terminated on or before December 31, 1944.

Tomorrow's Masterpieces returned to the artists all but 25 or 30 of the paintings on or before December 31, 1944. Those few could not be given back before that time because some of the artists were either in the armed services or could not be located.

Tomorrow's Masterpieces vacated its office on December 31, 1944. It paid its final electrical bill on December 29, 1944, and it paid its final telephone bill on January 31, 1945, the invoice for which showed that the service was discontinued on November 30, 1944.

At various times between May 12, 1943, and December 31, 1944, petitioner advanced directly to or on behalf of Tomorrow's Masterpieces the total sum of $11,334.43, as follows:

+------------------------------------------------------------------------+ ¦May 31, 1943 ¦$512.66 ¦Dec. 31, 1943 ¦$93.44 ¦Sept. 25, 1944¦$300.00 ¦ +--------------+--------+--------------+--------+--------------+---------¦ ¦June 30, 1943 ¦333.91 ¦Jan. 31, 1944 ¦190.16 ¦Sept. 29, 1944¦100.00 ¦ +--------------+--------+--------------+--------+--------------+---------¦ ¦July 31, 1943 ¦311.06 ¦Jan. 31, 1944 ¦300.00 ¦Oct. 20, 1944 ¦200.00 ¦ +--------------+--------+--------------+--------+--------------+---------¦ ¦Aug. 30, 1943 ¦233.46 ¦Feb. 29, 1944 ¦421.67 ¦Oct. 25, 1944 ¦600.00 ¦ +--------------+--------+--------------+--------+--------------+---------¦ ¦Aug. 31, 1943 ¦444.25 ¦Mar. 31, 1944 ¦28.56 ¦Oct. 31, 1944 ¦300.00 ¦ +--------------+--------+--------------+--------+--------------+---------¦ ¦Sept. 1, 1943 ¦100.00 ¦May 31, 1944 ¦2.53 ¦Oct. 31, 1944 ¦26.40 ¦ +--------------+--------+--------------+--------+--------------+---------¦ ¦Sept. 15, 1943¦1,000.00¦June 5, 1944 ¦1,000.00¦Nov. 22, 1944 ¦300.00 ¦ +--------------+--------+--------------+--------+--------------+---------¦ ¦Sept. 24, 1943¦1,000.00¦July 31, 1944 ¦3.50 ¦Dec. 8, 1944 ¦300.00 ¦ +--------------+--------+--------------+--------+--------------+---------¦ ¦Sept. 30, 1943¦1,083.67¦July 31, 1944 ¦200.00 ¦ ¦_ ¦ +--------------+--------+--------------+--------+--------------+---------¦ ¦Oct. 2, 1943 ¦1,000.00¦Aug. 1, 1944 ¦200.00 ¦Total ¦11,334.43¦ +--------------+--------+--------------+--------+--------------+---------¦ ¦Oct. 31, 1943 ¦84.30 ¦Aug. 21, 1944 ¦300.00 ¦ ¦ ¦ +--------------+--------+--------------+--------+--------------+---------¦ ¦Nov. 30, 1943 ¦164.86 ¦Sept. 15, 1944¦200.00 ¦ ¦ ¦ +------------------------------------------------------------------------+

No part of that amount has ever been returned to or recovered by petitioner. Petitioner also advanced $300 to Tomorrow's Masterpieces on January 12, 1945, and $500 on January 31, 1945. The advances made in 1945, together with $600 last advanced in 1944, were not made to continue the business of Tomorrow's Masterpieces, but for the purpose of paying part of its indebtedness incurred prior to November 1, 1944. They were made after it had become known to petitioner that Tomorrow's Masterpieces was insolvent and after it had ceased business because its business venture had proved a failure. On August 31, 1945, Tomorrow's Masterpieces returned to petitioner $600 of the 1945 advances.

All of these amounts were recorded on the books of petitioner as loans made to Tomorrow's Masterpieces and the latter organization entered the advances on its books as loans payable to petitioner.

It is stipulated that, other than the amounts advanced to it by petitioner, ‘no capital of any kind was obtained by Tomorrow's Masterpieces, Inc.‘

The balance sheet of Tomorrow's Masterpieces for the year ended December 31, 1944, was as follows:

+---------------------------------------------------+ ¦ASSETS ¦ +---------------------------------------------------¦ ¦Cash ¦$464.97¦ +-------------------------------------------+-------¦ ¦Furniture and fixtures (after depreciation)¦63.95 ¦ +-------------------------------------------+-------¦ ¦Total assets ¦528.92 ¦ +-------------------------------------------+-------¦ ¦ ¦ ¦ +---------------------------------------------------+

LIABILITIES AND DEFICIT Accounts and loans payable $12,514.09 Deficit (11,985.17) Total liabilities and deficit 528.92

Explanation of Accounts and Loans Payable Taxes payable $128.16 Payable to artists *1,051.50 Loans payable to Gussow, Kahn & Co 11,334.43 Total 12,514.09

Tomorrow's Masterpieces was affiliated with petitioner during the year involved, for the purpose of section 23(g) of the code, if (A) at least 95 per cent of each class of the former's stock was owned directly by the petitioner, (B) more than 90 per cent of its income was from sources other than those set forth in section 23(g)(4)(B), which is quoted in the margin, and (C) the petitioner was a domestic corporation.

We are convinced that the petitioner held securities within the meaning of section 23(g) of the code. The term ‘securities‘ is defined by section 23(g)(3) as ‘(A) shares of stock in a corporation, and (B) rights to subscribe for or to receive such shares.‘ Although Tomorrow's Masterpieces has never issued any of its capital stock, petitioner had the legal right to direct the issuance to itself of all of the authorized capital stock of Tomorrow's Masterpieces and, in legal effect, therefore, petitioner directly owned in 1944 100 per cent of its stock. Petitioner's advancements to Tomorrow's Masterpieces constituted the only capital which the latter had and the record clearly establishes that no one else was entitled to any of the share of the unissued stock. Petitioner had the sole proprietary interest in Tomorrow's Masterpieces and had complete control of its activities. The advances by petitioner were accordingly capital contributions to Tomorrow's Masterpieces in proportion to its ownership of the rights to the latter's capital stock. Edward G. Janeway, 2 T.C. 197; affd., 147 Fed.(2d) 602.

There is some evidence that might be said to militate against such conclusion; that is, the advances in question were recorded on the books of petitioner as loans to Tomorrow's Masterpieces and such advances were recorded on the books of the latter as loans payable to the petitioner. Book entries, however, are evidentiary merely and not conclusive. The decision must rest upon the actual facts. Doyle v. Mitchell Bros. Co., 247 U.S. 179; Woods Lumber Co., 44 B.T.A. 88, 92; North American Coal Corporation, 32 B.T.A. 535, 542. An examination of all the facts convinces us that the advances were not loans, but were petitioner's investment in the capital stock of Tomorrow's Masterpieces.

It is stipulated that 100 per cent of the income of Tomorrow's Masterpieces was from sources other than those listed in section 23(g)(4)(B) of the code, and that petitioner is a domestic corporation. See section 23(g)(4)(C). We hold, therefore, that Tomorrow's Masterpieces was an affiliated corporation of petitioner during the year involved within the meaning of section 23(g)(4) of the code.

The gist of respondent's argument on the point that the ‘investment‘ represented by the advances of petitioner was not shown to be or to have become worthless in 1944, is that the solvency of Tomorrow's Masterpieces was dependent from the beginning on advances by petitioner and that so long as such advances were continued it can not be held that Tomorrow's Masterpieces was insolvent. Petitioner made advances to Tomorrow's Masterpieces on November 22 and December 8, 1944, of $300 each, and on January 12 and 31, 1945, petitioner advanced to Tomorrow's Masterpieces $300 and $500, respectively. Petitioner's advances having continued beyond the year 1944, respondent contends that the loss, if any, which petitioner sustained did not occur in 1944. In other words, respondent contends that, so long as petitioner continued to advance funds to Tomorrow's Masterpieces, the latter was a going concern and its business venture had prospects of potential success.

The above stated contention is negatived by the evidence, which clearly demonstrates the utter failure of the venture as of the beginning of November 1944. At that time there was no hope of recovering the investment of petitioner, and that was the identifiable event which determined the worthlessness of the securities. As said by the United States Court of Appeals for the Second Circuit in Deloss v. Commissioner, 28 Fed.(2d) 803, 804: ‘So far as human foresight could go, the shares were worthless, and the petitioner might have deducted the loss.‘

We also believe the language of the United States Court of Appeals for the Fourth Circuit in Forbes v. Commissioner, 62 Fed.(2d) 571, 574, is appropriate here:

We are not dealing with a case where there was hope that a business although involved might be saved and value in the stock established. Hope had been abandoned and liquidation had been ordered.

See also Smith v. Helvering, 141 Fed.(2d) 529. So we believe in the instant proceeding that petitioner was justified in determining that its investment in Tomorrow's Masterpieces was worthless in 1944, and we so hold.

Petitioner is not entitled, however, to deduct the entire amount of $11,334.43 as claimed. The stipulation shows that petitioner advanced to Tomorrow's Masterpieces after the first part of November, when it was determined it would be liquidated, the amount of $600. It has not been shown that there was any obligation to make such payment. We do not believe that a taxpayer should be permitted to deduct a loss for advances made to its wholly owned subsidiary after it is decided, as it was here, that such subsidiary will be liquidated. Such advances could not and were not intended to rehabilitate the venture and restore its prospect of success.

We therefore conclude that, except for the $600 advanced after November 1, 1944, petitioner may deduct the advances involved from its gross income for its taxable year 1944. In other words, it may deduct by reason of such advances the amount of $10,734.43.

Petitioner raised by its pleadings a question concerning the deductibility of $525.69 for traveling expenses for the year 1944. However, it did not present any evidence with respect to this issue at the hearing, nor refer to it on brief. We therefore shall consider it abandoned.

Reviewed by the Court.

Decision will be entered under Rule 50.

* * *

* * *

MURDOCK, J., dissenting: The prevailing opinion allows deductions for capital losses, representing all advances made by the petitioner to its wholly owned subsidiary except those made after the determination to liquidate the subsidiary. The advances were all of the same class and made for the same purpose. They should all be allowed as deductions, regardless of whether made before or after the determination to liquidate. The petitioner obviously made those after the determination to liquidate in order to bail itself out of the situation into which it had already gotten and to which it was committed. Cf. Daniel Gimbel, 36 B.T.A. 539; Shiman v. Commissioner, 60 Fed.(2d) 65. The affairs of the subsidiary had to be wound up, and the amounts of $300 paid on November 22 and $300 on December 8, 1944, were paid during the taxable year for that purpose. That money was just as necessary and was just as lost as a part of the cost of the capital asset as the money previously advanced. The point is that the petitioner had to go on paying for this ‘asset‘ even after it had become worthless. George H. Stanton, 36 B.T.A. 112; C. H. White, 15 B.T.A. 1375, 1386-1387.

BLACK AND OPPER, JJ., agree with this dissent.

FN* Amount due to artists for sales of their paintings by various department stores.

On June 15, 1945, Tomorrow's Masterpieces received the amount of $743.60 from the insurance company for claims for pictures damaged or lost in 1944. This amount was owed to artists whose pictures had been either damaged or lost. During the first two weeks of 1945 Tomorrow's Masterpieces retained two employees for the purpose of attending to details concerned with liquidating the business.

In his statement attached to the notice of deficiency, respondent stated, under ‘Explanation of Adjustments,‘ as follows:

(a) It is held that the sum of $11,334.43 claimed as a bad debt deduction in your 1944 return representing advances made to Tomorrow's Masterpieces, Inc., does not constitute an allowable deduction within the purview of the Internal Revenue Code.

(b) Deduction claimed for traveling expense to the extent of $525.69 has been disallowed for lack of substantiation.

Petitioner's investment of $10,734.43 in Tomorrow's Masterpieces, Inc., became worthless in early November 1944.


HILL, Judge:

Respondent agrees that petitioner advanced the sum of $11,334.43 to Tomorrow's Masterpieces at various times during 1943 and 1944 and that petitioner has incurred a loss of that amount. He contends, however, that such loss is not deductible in the taxable year 1944 because, first, it is not a bad debt pursuant to section 23(k) of the Internal Revenue Code; second, it did not represent an investment in worthless stock within the purview of section 23(g)(4) of the Internal Revenue Code; and, third, ‘the investment of petitioner in Tomorrow's Masterpieces has not been shown to be worthless in 1944.‘

We believe that the amount of $11,334.43 involved, less the advances made on November 22, 1944, and December 8, 1944, or the amount of $600, is deductible by petitioner from its income for the year involved under section 23(g)(4) of the Internal Revenue Code. The record shows, as required by that section, (a) that Tomorrow's Masterpieces was an affiliated corporation of petitioner, and (b) that its securities became worthless during the taxable year 1944.

SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(g) CAPITAL LOSSES. . . .(1) LIMITATIONS.— Losses from sales or exchanges of capital assets shall be allowed only to the extent provided in section 117.(4) STOCK IN AFFILIATED CORPORATION.— For the purposes of paragraph (2) stock in a corporation affiliated with the taxpayer shall not be deemed a capital asset. For the purposes of this paragraph a corporation shall be deemed to be affiliated with the taxpayer only if:(A) at least 95 per centum of each class of its stock is owned directly by the taxpayer; and(B) more than 90 per centum of the aggregate of its gross incomes for all taxable years has been from sources other than royalties, rents (except rents derived from rental of properties to employees of the company in the ordinary course of its operating business), dividends, interest (except interest received on deferred purchase price of operating assets sold), annuities, or gains from sales or exchanges of stocks and securities; and(C) the taxpayer is a domestic corporation.

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