The opinion of the court was delivered by: CLARY
Two suits were instituted by plaintiff, The First National Bank of Lansdale, as executor under the will of Irwin H. Pool, deceased, to recover an alleged overpayment of income taxes by plaintiff's decedent. The first case, Civil Action No. 13825, was brought against Francis R. Smith, Collector of Internal Revenue, in order to preserve plaintiff's right to a jury trial. The second case, Civil Action No. 13826, was brought against the United States of America. Since identical questions of law and fact were involved in each action, the two cases, by agreement of counsel, were consolidated for trial.
Beginning January 13, 1956, Civil Action No. 13825 was tried to a jury. It was stipulated that the testimony in the first action against Smith might be considered by the Court in deciding the second action against the United States. On January 17, 1956, after a special verdict by the jury in Civil Action No. 13825, the Court entered judgment in that case in favor of the plaintiff in the sum of $ 11,862.51, plus interest as allowed by law, and costs. On January 27, 1956, defendant filed a timely motion to vacate the judgment and to enter judgment for the defendant. Because of the identical factual situations involved, the Court heard argument at the same time on defendant's motion as well as on proposed findings of fact and conclusions of law in Civil Action No. 13826.
The principal question presented in each case is whether the deceased taxpayer, Irwin H. Pool, incurred a loss proximately related to his trade or business which could be deducted in 1945 under Sections 23(e)(1) and 23(k)(1) of the Internal Revenue Code of 1939, Title 26 U.S.C., and which could be carried forward to 1946 and 1947 under the net operating loss provisions of Section 122 of the Internal Revenue Code of 1939, Title 26 U.S.C., because he was unable to recover funds which he had furnished to a corporation of which he was a director, officer and shareholder.
The record discloses that until his death in 1948 the deceased taxpayer, Irwin, H. Pool, a lifelong resident of Lansdale, Pennsylvania, was engaged in the pants manufacturing business. Pool was also active in the social and religious life of his community. That he was a generous person with a high degree of civic consciousness and responsibility clearly appears from the evidence. As president of Pool & Sons, he devoted considerable time, effort and energy to the business. A man of financial substance, he was also active in organizing small local finance companies to improve credit conditions in small communities outside of the metropolitan area. Actually, he was a promoter of these credit facilities. The record indicates that from time to time he personally made loans to various individuals for educational purposes as well as for business, but the record does not support a finding that he was in the money lending business. Many of his loans were never repaid or such a small portion of a loan would be repaid that the conclusion is inescapable that his prime object was help to his fellow man rather than to profit by his money lending activities.
The controversy between the Commissioner of Internal Revenue and the taxpayer stems from Pool's activities with Motorfrigerator Company, a Lansdale enterprise. This company owned a vital patent in the field of air conditioning and refrigeration, granted in 1928 (U.S.Patent 1,673,082). Until this patent was issued, every mechanical refrigerator had to have what was known as a 'drip pan' under it. By use of this patent it was possible to avoid the use of a drip pan by internal absorption of moisture and it is now in use as standard equipment on every mechanical refrigerator and air conditioning unit in the United States. The company was not very successful in its manufacturing attempts and determined that it would retire from the manufacturing business. It attempted to make licensing arrangements with all mechanical refrigerator manufacturers, but it had no funds with which to operate. To police the industry for infringers, to start lawsuits for infringement, to make settlements with infringers, and to conclude licensing arrangements required substantial capital. Accordingly, the company approached three men of substance and asked them to contribute funds for the above stated purposes and to expend their services, time and financial assistance in behalf of the company in return for which they were to receive 25% of any profits made on the patent. These three gentlemen, Irwin H. Pool, James M. C. Speirs and D. M. Feldman, had very minor holdings in the stock of the company and never increased their holdings but, since the proposition advanced by the company appealed to them, they agreed to enter into the project. An Executive Committee composed of Pool, Speirs and Feldman was placed in charge of the company's activities on what was clearly a joint venture agreement. Operations started on the project in the year 1931. On December 12, 1933, the stockholders of the company at a special meeting unanimously adopted a resolution which ratified the arrangement with the Committee, which resolution read as follows:
'Whereas, the stockholders of the Motorfrigerator Company, are greatly indebted to the Committee appointed to handle the affairs of the Company with reference to litigation against General Motors Corporation and any other corporation, firm or individuals which may be infringing certain patents now owned by Motorfrigerator Corporation, in that the members of said Committee and other Directors named herein have advanced their personal funds and have given largely of their time and will, in the future, advance further personal funds for other litigation, in connection with infringements of patents held by said Motorfrigerator Corporation; Now, Therefore, be it resolved by the Stockholders of the Motorfrigerator Company that said Committee, consisting of J. M. C. Speirs, Irvin H. Pool and D. M. Feldman and the following Directors, LeRoy R. Wismer and the Estate of Henry L. S. Ruth, who have served on said Committee and/or have advanced their personal funds in connection with said litigation, shall receive for their services 25% of any actual recovery in connection with any litigation brought for infringement of any patents owned by said Motorfrigerator Company, after all charges and bills have been paid, and the Board of Directors is hereby authorized to so compensate the above mentioned Directors for their services.'
While five persons were named in the resolution, only Pool, Speirs and Feldman functioned as active members of the Committee.
The evidence clearly shows that the Committee's activities consumed a substantial portion of Pool's time from 1931 to 1945. The Committee met at least once a week for several hours on Fridays and many Sundays. As treasurer of the Committee, Pool was entrusted with the responsibility for disbursements, receipts and keeping the financial records. From his personal funds between 1931 and through 1944 Pool advanced to the company $ 55,385. Similar advances were made by Speirs and Feldman; Pool, however, being the largest contributor. In 1940 General Motors offered Motorfrigerator Company, through the Committee, the sum of $ 750,000 for the purchase of the patent. Since it was a unique patent, the Committee felt that the offer was inadequate and that a higher price should be obtained for it. Among those with which license agreements were concluded were General Electric Company, Chrysler Corporation, Carrier Corporation, Westinghouse Electric, General Motors, York Ice Machine, Certified Products Corporation and others. The Committee employed a patent attorney and a qualified investigator with sufficient technical knowledge to represent the company before the Patent Office in Washington and in litigation.
The Internal Revenue Commissioner in refusing to allow the deduction of the loss of $ 55,385 took the position that the loss was not incurred in trade or business; that with respect to his activities in connection with Motorfrigerator, Pool was not in an individual business but was really acting for the corporation as an officer and agent of the corporation; that the advances were actually loans by him to the corporation; that the loans became worthless in some year and that this resulted in the creation of a bad debt.
The Commissioner also took the position that at best this venture could be called only a transaction entered into for profit and that the rule covering deductions for nonbusiness debts, 26 U.S.C. 1 23(k)(4) applied, which provides that such losses should be considered as 'a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months', a situation without the provisions of the carry-back sections of the Internal Revenue Code. Further, the Commissioner ruled that the loss was incurred in a year other than the year 1945, as claimed by plaintiff.
It would unduly prolong this opinion if the Court were to review in detail the testimony of all of the witnesses in the case. Mr. Feldman, one of the Committee of Motorfrigerator Company, testified in full detail as to the operations of the Committee. LeRoy R. Wismer, factory superintendent and former secretary of Motorfrigerator Company, testified as to the corporate documents. Hiram K. Gottshall, accountant associated with Charles S. Rockey & Company, certified public accountants and Pool's accounting advisor for many years, testified as to the activities of Pool with Motorfrigerator Company, as did his private secretary of many years, Mrs. S. Alice Horner. Briefly, the record discloses that Pool made the stipulated advances, that he devoted considerable of his time, effort and energy to Motorfrigerator Company, and that his activities in connection with it were with the idea and expectation of making a profit. The patent was scheduled to expire in 1945 and the last transaction in connection with the patent, as shown on the books of the company, also occurred in 1945. The question, therefore, as to when the loss was incurred became peculiarly one of fact to be determined by the jury under appropriate instructions by the trial Judge. Extensive requests for charge were filed by each counsel and, it being a tax case and rather technical, it was decided that special interrogatories should be submitted to the jury. Five proposed interrogatories were submitted by respective counsel and the form thereof approved by the Court. The questions propounded by the Court to the jury, as approved, and the answers thereto are as follows:
Q. '1. In what year was the loss on the advances of Irwin H. Pool to the ...