Petition for Review of Order of United States Board of Tax Appeals.
Before ALSCHULER, EVANS, and SPARKS, Circuit Judges.
Pursuant to sections 1001-1003 of the Revenue Act of 1926, c. 27, 44 Stat. 9, 109, 110 (26 USCA §§ 1224 and note, 1225, 1226), petitioner seeks to review an order of the Board of Tax Appeals. The order redetermined deficiences in petitioner's income taxes for the years 1920 and 1921, aggregating $202,526.50, which includes a fraud penalty of $67,508.84.
In 1917, H. W. Dubiske & Co., hereinafter referred to as Dubiske & Co., was incorporated by the efforts of petitioner. The authorized capital stock was $100,000, of which petitioner owned more than ninety per cent., and he was president and general manager. The business of the company was that of marketing industrial stocks at retail upon time payment plan, and it grew rapidly to quite large proportions, and its activities extended over many states. The sale methods employed by Dubiske & Co. were very expensive, and in some instances ran as high as $33.87 on each share of stock of the par value of $50. Among the stock issues sold by Dubiske & Co. were those of Metropolitan 5 to 50c Stores, Inc., which is referred to hereinafter as Metropolitan Company; Stevens-Duryea, Inc., and Dayton Rubber & Manufacturing Company, referred to hereinafter as Dayton Company.
In extending its activities, Dubiske & Co. encountered statutory restrictions in many of the states, which limited the maximum commission allowable to selling agents to 15 per cent. of the fair value of the stock. Accordingly, in July, 1919, said company's method of operation and system of accounting was modified in order to circumvent the effect of the statutes of those states which limited the commission.
Prior to the adoption of the modification, Dubiske & Co. purchased none of the stock, of the issuing companies, but it sold the stock, both preferred and common, on a straight commission of 15 per cent., which was deducted and retained by Dubiske & Co. at the times of the sales, and one share of the preferred stock was sold with each share of the common stock.
Under the modified plan, the preferred stock was disposed of in the same manner as before, but the entire issue of the common stock was purchased outright by Dubiske & Co., and it was to be paid for by Dubiske & Co. only when and as it was sold to its customers and paid for by them. Before any stock of an issue was sold. Dubiske & Co. estimated the additional and contingent expenses in selling and making distribution of the particular issue. This estimate included commissions and compensation of petitioner and several other principal officers, outside brokers, expense of banquets, and all other miscellaneous items of expense which would or might arise.In recording such purchase of common stock the cost thereof was shown, not at the amount which Dubiske & Co. had agreed to pay the previous owners, but at an amount sufficient to cover the original cost plus the estimated additional expense. For this total amount a series of notes were executed by Dubiske & Co. to itself and were termed "escrow notes," but they bore no serial numbers, and were in no manner identified with any particular stock issue. They matured at various times ranging from thirty days to six months, and were indorsed by Dubiske & Co., and, upon failure to pay at maturity, they were renewed.
Such notes were recorded on the books of the company as the cost of such common stock and as the balancing liability therefor. They were not then delivered, but were held by Dubiske & Co. in its safety deposit box, to which petitioner at all times had access, and he was in sole charge and control of their delivery and payment. Said notes were to be delivered and paid only when and as the stock was sold and payment therefor was received by Dubiske & Co., and after 85 per cent. of the collections on preferred stock were accounted for to the issuing corporation. By this method the amount of unpaid notes in the deposit box should have always corresponded to the estimated cost of the unsold stock. If a portion of a particular stock remained unsold after the time limit in the contract had expired, an equivalent amount of notes recorded as the cost thereof was canceled.
After adoption of such accounting procedure in July, 1919, commissions and compensation of petitioner and several other principal officers and outside brokers and miscellaneous items of expense were not reflected upon the books directly as such disbursements, as before, but, being included in the predetermined cost of common stock, when such items became due a sufficient amount of said notes, for that purpose, were turned over to petitioner or his associates, and such person receiving the same would ordinarily deposit them for collection in his own bank and as a credit to his own account. If the obligation represented by such note or notes was owing to some person or persons other than petitioner or his associate, the person who had deposited the note or notes to his own credit would give his personal check to the party to whom this obligation was owing. In other words, all of the "escrow notes" which were paid by the company were cleared through petitioner or his associates, and a large part of all of them were cleared through petitioner, and the books of Dubiske & Co. showed such disbursements as payment of cost of escrow notes, and not as distribution expense. It was out of the preparation and use of said "escrow notes" and the clearance of a large part of their proceeds through petitioner that the present controversy arose.
Petitioner has assigned error against the following rulings of the Board of Tax Appeals:
(1) That $350,000 withdrawn by petitioner in 1920, as proceeds of "escrow notes," most of which was disbursed as loans to Metropolitan Company, was income to petitioner.
(2) That $25,000 withdrawn by petitioner in 1920, and $75,000 in 1921, as proceeds of "escrow notes" and disbursed as loans to Stevens-Duryea, Inc., were income to petitioner.
(3) That out of "escrow note" proceeds withdrawn by petitioner in 1920 and disbursed to Hoyt and Little, petitioner realized income in the amount of $18,665.13.
(4) That for the year 1920, an item of $17,120 should be added to income of petitioner as profit on stock ...