Before FRANK and MEDINA, Circuit Judges, and BRENNAN, District Judge.
Whether or not the loss incurred in the posting of U. S. Government bonds as security for the performance of a contract is a capital loss or a business expense is the question posed on this appeal.
A background of essential facts were submitted by stipulation to the Tax Court. The Bagley & Sewall Co. (hereinafter referred to as the taxpayer), is a New York corporation engaged in the manufacture and sale of paper making machinery. In 1946 the taxpayer entered into a contract with a corporation acting in behalf of the Government of Finland for the manufacture and delivery of two paper making machines at a cost of approximately $1,800,000. Payments were to be made periodically during the progress of manufacture. The Government of Finland required that U.S. 21/2% Government bonds be deposited with a New York financial institution as security for the performance of the contract and in accordance with an agreement which provided for the return of the bonds to Bagley & Sewall upon receipt of the last payment due under the contract. The above provisions were incorporated in and made a part of the contract. The taxpayer did not have or own the required bonds and in order to carry out the provisions of the contract, U.S. Government bonds in a total face value of $800,000 were purchased by the taxpayer with moneys borrowed for that purpose and same were deposited as required by the contract, the total cost of same being $820,062.50. The interest earned upon the bonds during the period that they were held in escrow was reported as income received by the taxpayer. In accordance with the terms of the contract, the bonds were released in two lots, one of $400,000 face value on Sept. 7, 1948 and one of $400,000 face value on Sept. 22, 1948. The bonds were sold by the taxpayer in each instance a few days after their release resulting in a loss of approximately $15,000 which the taxpayer claimed, in its tax return for 1948, as an ordinary and necessary business expense. During the period that the bonds were held in escrow and until they were sold, they were carried in the general ledger of the taxpayer in an account entitled "U. S. Gov't. Bonds" and on its balance sheet of Dec. 31, 1946 and Dec. 31, 1947, the bonds were shown under the caption "U. S. Gov't. Bonds".
Upon re-audit, the Commissioner of Internal Revenue determined a deficiency in the taxpayer's 1948 return on the ground that the above loss was a capital loss under Section 117(a) (1) of the Internal Revenue Code of 1939, 26 U.S.C.A. The matter came on before the Tax Court and after making minor adjustments, which are not here in dispute, the Tax Court found in effect in accordance with the claim of the taxpayer that the sale of the bonds was of assets held for sale in the ordinary course of petitioner's business and the loss was deductible as an ordinary and reasonable business expense.
The findings made are substantially as outlined above with the following additions * * * that the taxpayer was not in the business of buying and selling securities, that its available cash reserve was necessary for working capital, that it is clear that no investment in U.S. bonds was intended by the petitioner, they were acquired solely to carry out a condition imposed by the contract. It was concluded that the purchase and sale of these bonds was merely an incident in the carrying on by the petitioner of its regular business of manufacturing and selling paper making machines. The Tax Court relied upon the decisions in Western Wine & Liquor Co., 18 T.C. 1090 and Charles A. Clark, 19 T.C. 48 and distinguished the case of Exposition Souvenir Corp. v. Commissioner, 2 Cir., 163 F.2d 283. This appeal followed.
Concisely stated, the contention by the Commissioner is that the bonds constituted capital assets, as the term is defined in Section 117(a) (1) of the Internal Revenue Code and that the loss sustained upon their sale is to be treated as a capital loss to the extent of offsetting capital gains, none of which are reported by the taxpayer and therefore the whole item is subject to elimination.
The taxpayer's contention is to the effect that the whole transaction is merely an incident required and made necessary in the performance of a contract undertaken in the regular course of the taxpayer's business and is deductible from gross income in its entirety by reason of the provision of Section 23(a) (1) (A) of the Internal Revenue Code of 1939.
The difficulty with the Commissioner's contention is that in effect he urges that the bond transaction should be considered independently of the contract of which it is a definite part. This circuit in Helvering v. New Haven & S.L.R. Co., 121 F.2d 985, at page 988 has held that a contract may not be thus atomized.
In Exposition Souvenir Corp. v. Commissioner, 2 Cir., 163 F.2d 283, the taxpayer was required to make an investment, related to, but not a part of the concession contract. This is not the situation here. The contract represents a complete business transaction, security of performance alone, not investment was required. The cost of procuring that security cannot be distinguished from ordinary premium expense of a surety company bond which is a usual item of contractor's costs. The Exposition case may be further distinguished by the fact that the debentures were treated as investments in the taxpayer's books and tax returns and in that case the Tax Court made a finding that the debentures were not held for sale in the ordinary course of business. There is no such treatment of this transaction in this taxpayer's tax return and no such finding. It is implicit that the Tax Court found that the bonds here were held for sale to purchasers as soon as released from escrow and available for sale. In the Exposition case, an investment was intended and the taxpayer relied upon the motive for the investment for relief. Here there is a clear finding that no investment was intended. The Taxpayer's lack of surplus capital, the interest return of the bonds, the interest obligation of the loan and the almost immediate sale of the bonds when available make such a finding imperative. The finding here in this respect is similar to that made in Gilbert v. Commissioner, 1 Cir., 56 F.2d 361.
In brief, it is urged that the all inclusive language of Section 117 requires that, since the bonds are "property", they must be treated as capital assets unless exempted by the specific language of the Section. The argument carries with it the necessary conclusion that the circumstances of the transaction, its factual background, the necessities of the business involved and the intentions of taxpayer are of no importance except in determining whether the bonds are exempted under the Section. We are not persuaded that Section 23 is so completely subordinate to Section 117 and we find no authority which goes so far.
"Whether an expenditure is directly related to a business and whether it is ordinary and necessary are doubtless pure questions of fact in most instances". Commissioner of Internal Revenue v. Heininger, 320 U.S. 467, at page 475, 64 S. Ct. 249, at page 254, 88 L. Ed. 171. The purchase of stock in order to terminate an agency contract was held to be business expense. Helvering v. Community Bond & Mortgage Corporation, 2 Cir., 74 F.2d 727. The purchase of stock in a non-profit corporation to aid business was held to be a business expense. Commissioner of Internal Revenue v. The Hub, 4 Cir., 68 F.2d 349. The purchase of stock of a liquor corporation in order to purchase liquor therefrom was held to be business expense. Hogg v. Allen, D.C., 105 F.Supp. 12, affirmed, Edwards v. Hogg, 5 Cir., 214 F.2d 640, 644. We find similar holdings by the Tax Court especially the two cases relied upon by that Court and referred to above. The above authorities are cited here not to show that we necessarily agree with the conclusions therein but as an indication that business expense, Section 23, has been many times determined by business necessity without a specific consideration of Section 117.
An appreciation of the particular situation, Welch v. Helvering, 290 U.S. 111, at page 116, 54 S. Ct. 8, 78 L. Ed. 212, to which is applied the pertinent sections of the law according to common understanding and experience, Helvering v. Horst, 311 U.S. 112, 61 S. Ct. 144, 85 L. Ed. 75, is the measure of the law's requirement.
We find no comparable authority wherein a contract is dissected and its separate parts are subjected to application of particular sections of the Revenue Law. The Tax Court was right in refusing to wrench this transaction from its setting and its finding and conclusion is amply supported by ...