November 13, 1924.
Caldwell Raymond [ J.H. Caldwell and Charles C. Marshall of counsel], for the petitioner.
Carl Sherman, Attorney-General [ William D. Morrow of counsel], for the respondents.
Charles F. Roe, in making his income tax return for the year 1920, deducted from the gross income the sum of $110,800, which he claimed was a loss sustained during the taxable year. The Tax Commission refused to allow the deduction and assessed the tax, which was paid under protest. An application made for a recomputation and resettlement of the tax has been denied. The matter is presented here upon stipulated facts, in which reference is made to Unangst v. Roe ( 107 Misc. Rep. 516), we assume for the purpose of a more complete statement. Mr. Roe, it is conceded, had been for many years a margin customer of the stock brokerage firm of Van Schaick Co., and on August 30, 1911, had an account with them, on which he owed $259,098.78, the firm holding securities in a large amount (the amount not stated) as collateral. Roe had given authority to the firm to pledge these securities for the general loans of the firm at the banks. On August 30, 1911, in response to Roe's order, the firm sold enough of his securities in his margin account to pay all of his indebtedness to the firm. There remained in the firm's hands a large amount of these securities and, after the payment of his indebtedness, these belonged to Roe, free and clear of any claim on the part of the firm. These securities thus became his absolute property and subject to his order, except that they were pledged as collateral for firm notes. Also within a month prior to September 12, 1911, Roe had voluntarily delivered to the firm other securities (the amount not stated), not as additional collateral to his margin account, but for the sole purpose of enabling the firm to use them as collateral for its own purposes. These latter we shall call his loaned securities and the former his margin securities. On September 12, 1911, the firm made a general assignment for the benefit of creditors. At that time the Roe securities, both those from the margin account and those loaned, were pledged, together with securities belonging to other customers of the firm, in banks as collateral for firm loans. Directly after the assignment the banks resorted to the collateral to obtain payment for their loans. On demand of Roe upon the banks, in which such collateral was pledged, they first sold the collateral of the other customers and resorted to the collateral belonging to Roe only so far as required to satisfy any deficiency after the collateral of others had been exhausted; and the bank, after its note had been so paid, delivered to Roe all collateral pledged and not sold. The other customers, all of whose collateral had thus been sold, brought actions against Roe to compel him to bear his share of the indebtedness for which his collateral had been pledged with theirs, claiming that he was a cosurety with them. In these actions judgments were recovered against Roe and paid by him in February, 1920. It is the amount of these judgments he would have deducted from his gross income for the year 1920.
Before the Tax Commission the taxpayer claimed the deduction as a loss sustained by him in the taxable year 1920 and not compensated for by insurance or otherwise, incurred in a transaction entered into for profit, though not connected with his trade or business; that is under the provisions (in the words substantially) of section 360, subdivision 5, of the Tax Law (added by Laws of 1919, chap. 627, as amd. by Laws of 1920, chap. 693). The State Tax Commission disallowed this deduction because "the liability existed prior to January 1, 1919."
The petitioner now claims also that the loss is deductible under subdivision 7 of section 360 of the Tax Law (as added by Laws of 1919, chap. 627), which allows deductions for "Debts ascertained to be worthless and charged off within the taxable year." Any loss here is not a debt "ascertained to be worthless" in 1920. The only debt covered by this subdivision would be one due Roe. The only debt due Roe disclosed here is the indebtedness or obligation of Van Schaick Co. on account of the securities belonging to Roe, which it held at the time it made its assignment. The firm was obligated to return to him these securities. The firm was adjudged bankrupt under a petition in involuntary bankruptcy filed November 17, 1911. This obligation to return the securities was ascertained to be worthless long before 1920. The deduction claimed here is in no wise connected with any loss resulting from that obligation.
We then turn to the claim made for this deduction under
subdivision 5, supra; and the questions are (1) whether or not Roe or his estate, in 1920, sustained a loss; and (2) if so, was it sustained in a transaction entered into for profit?
What were the relations between Roe and the firm? In the beginning Roe entered into a "transaction" with the firm as one of its margin customers. This was a transaction entered into for profit. But, on August 30, 1911, when the firm, at Roe's order, sold sufficient of his collateral to pay his entire indebtedness, his account as customer of the firm was closed. So far as the firm was concerned Roe then became the absolute owner of all of the remaining margin securities; he was also, so far as this record shows, the owner of the loaned securities. Thereafter he was not a margin customer of the firm and it was no longer contemplated that securities were to be bought or sold by the firm for him; but his securities were left with the firm and he stood thereafter simply as its creditor. No claim for a deduction is made here on the ground that he had lost in the purchase or sale of securities in his margin account. It is not clear that the leaving of his margin collateral with the firm, after his margin account had been closed, was incidental to this first transaction. When he made his demand for the return of his securities, it was not a peremptory demand, not one intended to "embarrass" the firm, but rather to procure from the firm as quickly as possible his securities. It is very plain that Roe was more than ordinarily interested in this firm. He was willing to risk all his securities for the benefit of the firm and open discrimination in his favor in the sale of collateral was rendered to him. The voluntary delivery of securities to the firm was not a transaction entered into for profit. Apparently no terms or conditions were attached to the loaning of these securities. How or when they were to be returned or paid for we do not know. We are not informed even that he was to receive interest during the period of the loan. If then we now concede, without so deciding, that the leaving of the margin securities was incidental to and a part of his margin transaction, we think it cannot be said that his voluntary loan of securities was for the purpose of protecting his own interests, or was incidental to his margin transaction. The State Tax Commission was not informed what the amount of these loaned securities was; and, if it be held that a loss in connection with the margin securities might be one sustained in 1920 in a transaction entered into for profit, the Commission had no means of determining the amount of that loss to be deducted. Such a deductible loss by Roe would depend upon the ratio between the amount of his collateral pledged and that of the other customers for a loan, and further on the proportion of his margin collateral to his loaned collateral. The Tax Commission had no means of telling what part of Roe's securities, among the collateral for a loan, was made up of the margin securities; so it could not determine what part of any loss sustained would be deductible. It was for the taxpayer to establish his right to a deduction and the amount thereof. He failed in this proof. But further, if any so-called loss, disclosed in this record, could be considered as a loss in his margin transaction, it would be a loss sustained by the sale of his collateral; but no such loss was sustained; his collateral was not sold. His so-called loss was sustained in a separate transaction, namely, his wrongful act in procuring discrimination in the sale of collateral favorable to himself. This was a scheme to avoid a loss, but not a transaction entered into for profit within the meaning of the statute, the effect of which we will now consider.
While Roe, after his debt was paid, owned the remaining securities absolutely and the firm had no further claim upon them, they and the loaned securities were still, by Roe's consent, subject to the lien of the banks, to which they had been pledged with the consent of Roe. After the firm made its assignment, had Roe not sought to secure an unfair advantage over other customers, whose collateral was pledged with his, his loss would have been suffered and its amount determined when the collateral was sold to pay the secured notes, namely, some years before 1920. When he did secure this unfair advantage, through favor of the banks and the firm, the collateral of the others was exhausted; he took the entire surplus collateral. The others bore what should have been his loss and the only loss he could have sustained which could be deductible in an income tax return. In effect he then took property which belonged to others; the court in the Unangst Case ( supra) so determined. That property was never rightfully a part of his estate; his apparent estate included assets not his. When he paid the judgments he simply returned to the plaintiffs in 1920 that which he had wrongfully taken from them in 1911. In paying these judgments his estate was not depleted and he suffered no loss thereby. In this sense the ruling of the State Tax Commission was right.
We conclude, therefore, that there was no loss sustained by Roe or his estate in 1920, in a transaction entered into for profit.
Roe having died his executors have been substituted.
The determination of the State Tax Commission should be confirmed, with costs.
Determination unanimously confirmed, with fifty dollars costs and disbursements.