author: Leech:

text:
    Parke, Davis & Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 62717.
    Promulgated October 25, 1934.

      George M. Wolcott, Esq., and Robert N. Miller,- Esq., for the petitioner.

      Dean P. Kimball, Esq., for the respondent.
   opinion.

Leech:

The petitioner here seeks redetermination of a deficiency of $36,430 in income tax for 1929, arising from disallowance by respondent of a credit taken on account of income taxes of $70,123.64 paid for that year by petitioner to the Governments of Queensland and New South Wales, Australia. Eespondent, by his answer, raised an additional issue and asked a corresponding increase in the deficiency, alleging that a sum of $612,150 received by petitioner in the taxable year under a contract covering certain patent rights, and treated by it as a return of capital, was in fact taxable income.

The first issue is disposed of by stipulation, and effect will be given thereto under Kule 50. There remains for consideration only the issue involving the receipt of the sum of $612,150. The facts in respect of this issue are stipulated and the formal stipulation filed is incorporated herein by reference as our findings of fact.

Briefly stated, the facts are that petitioner is a Michigan corporation, engaged in the manufacture of pharmaceutical products. For some time prior to 1929 petitioner and Eli Lilly & Co. were the only large manufacturers of gelatin capsules in the United States. Several years prior to 1929 the Arthur Colton Co., a manufacturer of pharmaceutical machinery, developed an invention for the making and filling of gelatin capsules. This company manufactured several of these machines and installed them in its factory and began the manufacture and sale of capsules in competition with petitioner and Eli Lilly & Co. Finally this competition became so serious that petitioner in 1929 purchased from the Arthur Colton Co. its capsule-making machinery, its filling machines, patents and patent applications, and other properties used in its capsule business. The total consideration paid by petitioner was $1,480,000, of which amount $1,224,257.72 represented the consideration paid for the patents and patent applications.

Immediately upon the acquisition of this property by petitioner it entered into a contract with Eli Lilly & Co., reading as follows:

This Agreement made this 19th day of October, 1929, by and between Parke, Davis & Company, a corporation organized and existing under and by virtue of the laws of the State of Michigan with its principal office at Detroit, Michigan, hereinafter called Licensor and Eli Lilly & Company, a corporation organized and existing under and by virtue of the laws of the State of Indiana, with its principal office at Indianapolis, Indiana, hereinafter called Licensee.
WITNESSETH
Whereas: The Licensor has purchased the capsule business of the Arthur Colton Company, such purchase including all patents, patents applied for, drawings, blue prints, specifications and/or improvements of every kind or nature now existing or which may be made in the future covering machinery, appliances, apparatus and/or equipment of all kinds for the manufacture, finishing, sorting, counting, filling, sealing and/or boxing of capsules all of which is hereinafter referred to as “ Patents ”, and
Whereas : The Licensee is desirous of obtaining the exclusive right, license and privilege to make and to use such “ Patents”, and to sell and lease certain of same as hereinafter limited, and the Licensob is willing to grant such exclusive right, license, and privilege subject to the rights herein reserved.
Now, therefore, the said Licensob in consideration of the payments to be made as hereinafter mentioned, hereby sells and grants unto the said Licensee the exclusive right, license and privilege to manufacture and have manufactured for its exclusive use, and to use but not to sell, the inventions covered by said “ Patents ” except as in clause “ Third ” provided for the full term of each of same and for the additional term of any improvement on any thereof as hereinafter provided in clauses “ Fourth ” and “ Fifth ”, subject, however, to the following conditions, namely:
First: The Licensee shall pay to the Licensob for such exclusive right, license and privilege $164,287.50 at the date hereof and $149,287.50 on November 5, 1929, and $149,287.50 on December 5, 1929, and $149,287.50 on January 5, 1930, without interest.
Second: The Licensob reserves fully and without qualification of any kind or description the right and privilege to manufacture and to have manufactured for its exclusive use but not to sell the inventions covered by said patents; provided, however, that the Licensob shall not grant any other license to any other person, firm or corporation or sell or lease capsule filling and/or sealing machinery without the consent in writing of the Licensee.
Third: The Licensee shall not assign this license or any part thereof, or grant any license to any person, firm or corporation or sell or lease capsule filling and/or sealing machinery without the consent in writing of the Licensob. The Licensee shall not use said Patents otherwise than in accordance with this license.
Fourth: If at any time hereafter during the continuance of this license the Licensob shall make any further improvements in the inventions covered by said Patents, or the mode of using the same, or shall become the owner of any such improvements, then in every such case the Licensob shall forthwith communicate each such improvement to the Licensee and give it*full information respecting the mode of using the same, and such improvement shall fall within the terms of the license as though now existing, without further consideration.
Fifth: If at any time hereafter during the continuance of this license, the Licensee shall make any further improvements in the inventions covered by said patents or the mode of using the same, the Licensee shall forthwith give the Licensob full information respecting each such improvement or the mode of using the same, and the Licensob shall thereupon become the owner of such improvements as though the same were now known and included herein. To that end the Licensee will execute such assignments and other documents as may be necessary and proper in carrying out this agreement.
Sixth: In case said Patents shall be infringed, the Licensob shall take all necessary proceedings to enjoin such infringement, but the cost and expenses of such proceedings shall be paid equally by the Licensob and the Licensee, and if there be any recoveries from such proceedings such recoveries will be divided equally between the parties hereto, it being understood however that there is no obligation on the part of the Licensob to prosecute such proceedings beyond the point of endeavoring to enjoin any infringement.
Seventh: This agreement shall be binding upon the respective successors of the Licensob and the Licensee.

The sum of $612,150, to be paid by Eli Lilly & Co. under the above agreement, was duly paid and was treated by petitioner as a return of capital. The cost of the Colton patents and patent applications, set up on its' books at $1,224,257.72, was reduced by the amount of the payment received from Eli Lilly & Co. Petitioner has since that date taken credit for depreciation upon these patents and patent applications only in the reduced amount.

Since the execution of the contract in question petitioner has billed Eli Lilly & Co. for one half of all costs in respect of the perfecting of the patent applications and filing of additional applications for patent and the latter company has paid this proportion of such expenses.

Petitioner contends that the $612,150 it received in 1929 was in payment for one-half interest in the Colton patents' transferred to Eli Lilly & Co. and represented merely a return to it of. one half of the amount invested by it in such patent rights. Respondent’s contention is that the rights transferred to Eli Lilly & Co. amounted to merely a license to use -the patents. He insists that this result of the transaction between petitioner and Eli Lilly & Co. is shown by four conditions — (a) that while the right to make and to use the invention was transferred there was not included the right to sell the invention, (b) that improvements on the invention were to belong to petitioner, (c) that petitioner alone was given the right to sue for infringement, and (d) that' Eli Lilly & Co. did not receive the right to grant to others, by way of license, the right it received from petitioner.

If these four "conditions represented all of the rights granted or conditions imposed by the agreement, respondent’s theory would undoubtedly be well founded. The above statement of conditions, however, fails to include other and very material conditions of the agreement. It is true that a right to sell the invention or to grant to others a license was not transferred to Lilly, but petitioner by the agreement surrendered the right to exercise these privileges without Lilly’s consent, so that its rights in this respect were no greater than those of the latter. Upon execution of the agreement neither had the right to. sell or license without permission of the other. We do not agree with respondent’s statement that improvements on the invention were to belong-to petitioner. Under the agreement such improvements were to be subject to the same conditions as the Original patent rights and both parties were to bear equally their cost of development and.patent. It is true that petitioner retained the legal title to .the patents as well as any future improvements thereon and alone could sue for their infringement, but such suit was to be for the benefit of both, its cost to be borne equally by the two and any judgment secured for the infringement was the property of the two in equal proportions. ’ As a result of these conditions we can see no more than the retention by petitioner of the naked legal title in the interest and for the benefit of itself and Eli Lilly & Co. as the joint owners in equal proportions of the entire beneficial interest in the patents and improvements thereon.

We are familiar with the decisions cited by respondent holding that purported assignments of patent rights which failed to grant the right to the assignee to sell the patent or license its use were in themselves only licenses. Waterman v. Mackenzie, 138 U. S. 252; Gayler v. Wilder, 51 U. S. 476; Atwood Look Co. v. Yale & Towne Mfg. Co., 115 Fed. 332; Six Wheel Corporation v. Sterling Motor Trust Co., 50 Fed. (2d) 568; Oliver v. Rumford Chemical Works, 109 U. S. 75. The question presented in these cases was the right of the so-called assignee to maintain a suit,for infringement which right was denied because the right to 'sell the patents or license their use had been retained by the assignor.

In none of the cited cases did the court have the situation here existing. The questions there presented were entirely different from the one before us for decision. The right to maintain a suit at law is often controlled by the question of the possession of the naked legal title. Here we have a question of income tax liability where legal title is of little consequence and the inquiry is as to the ownership of the beneficial interest. We are not to determine whether petitioner or Eli Lilly & Co. could maintain a suit for infringement in its own name, but merely whether petitioner, under its contract with Eli Lilly & Co., divested itself irrevocably of certain capital investments in consideration of the payment made to it by the latter company. If this is the fact, then the transaction for income tax purposes is no more than a conversion of capital.

Let us assume that by the present contract petitioner had sold for the entire cost to it not a half but its whole beneficial interest in the Colton patents, retaining the legal title for the benefit of its vendee, the latter to bring suits for infringement in petitioner’s name and bear all costs of such suits. It may well be that under the decisions cited the courts would'not recognize a suit brought by the vendee .in its own name, but in such case the conclusion would .surely follow that petitioner had sold at cost to it all for which such cost .had been expended and had derived no income thereby: Legal title alone, without beneficial ownership, and held for the interest of another, is without value. The value of the patents, for which petitioner paid $1,224,257.72, was represented by the beneficial ownership therein. Unquestionably, an equitable interest in patents is subject to transfer. Whiting v. Graves, 29 Fed. Cas. 1059; Am. Circular Loom Co. v. Wilson, 198 Mass. 189; 84 N. E. 133. When it sold one half of that interest to another, the amount received therefor was a return to that extent of its original capital outlay in the interest sold.

The fact that in the contract through which this result was reached the parties were termed “ Licensor ” and “ Licensee ” is of no consequence. A. B. Watson, 24 B. T. A. 466; affd., 62 Fed. (2d) 35; cf. Heryford v. Davis, 102 U. S. 235. The rights granted or surrendered determine the character of the instrument to have been an absolute conveyance of a one-half beneficial interest in the Colton patents for $612,150. We hold that only the excess of that amount over $612,128.86, petitioner’s stipulated basis for the interest conveyed to Eli Lilly & Co'., is taxable income to petitioner.

Included in the stipulation of facts was a statement of testimony which it was agreed would be given under oath by Horace W. Bige-low, general attorney for petitioner, if called upon to testify. Respondent stipulates that this would be the testimony given, but objects to the competency of such testimony upon the ground that it violates the rule prohibiting oral evidence to contradict the terms of a written instrument. The testimony in question is an explanation, by the witness, of the facts surrounding the execution of the instrument and the reasons for the adoption of the form of a license to cover the agreement instead of a formal assignment of conveyance of a one-half interest in the patents. We have considered carefully the question of the competency of this evidence and are of the opinion that it does not violate the parol evidence rule, but falls within the exception therefrom permitting the introduction of testimony to explain the nature of the transaction. As the Court said in Peugh v. Davis, 96 U. S. 332:

It is an established, doctrine that a court of equity will treat a deed, absolute in form, as a mortgage, when it is executed as security for a loan of money. That court looks beyond the terms of the instrument to the real transaction; and when that is shown to be one of security and not of sale, it will give effect to the actual contract of the parties. As the equity, upon which the court acts in such cases, arises from the real character of the transaction, any evidence, written or oral, tending to show this is admissible. The rule which excludes parol testimony to contradict or vary a written instrument has reference to the language used by the parties. That cannot be qualified or varied from its natural import, but must speak for itself. The rule does not forbid an inquiry into the object of the parties in executing and receiving the instrument. * * *

We may say, however, in conclusion that the same result would have been reached by us in the absence of this testimony solely upon the conditions of the contract between petitioner and Eli Lilly & Co.

Reviewed by the Board.

Judgment will he entered under Rule 50.

SteRNhageN and Adams concur in the result.


source: Caselaw Access Project

author: Smith: ÁRuNdbll,

license: Public Domain

text:
    Charles E. Van Vleck and Natalie J. Van Vleck, Petitioners, v. Commissioner of Internal Revenue, Respondent. Charles E. Van Vleck, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 70946, 70947.
    Promulgated October 25, 1934.

      George 8. Hills, Esq., for the petitioners.

      J. M. Leinenhugel, Esq., for the respondent.
   OPINION.

Smith:

These proceedings, consolidated for hearing, are for the redetermination of a deficiency in income tax for 1930 in the amount of $5,896.29. The question in issue is whether a statutory net loss incurred by an individual in his trade or business in 1929 can be taken as a deduction from the aggregate income of that individual and his wife reported on a joint return for the year 1930 where the individual had no separate income in 1930.

The facts have been stipulated as follows:

1. Charles E. Van Vleck filed a separate return for the calendar year 1929 and Natalie J. Van Vleck, his wife, filed a separate return for the calendar year 1929.
2. Charles E. Van Vleck and Ms wife, Natalie J. Van Vleck filed a joint return for the calendar year 1930 and paid a tax thereon of $12,164.93, one-half thereof being paid by each.
3. Charles E. Van Vleck was, during the calendar year 1929 and for several years prior and subsequent thereto, regularly engaged in the trade or business of a trader in securities and commodities.
4. During the calendar year 1929, Charles E. Van Vleck sustained a net loss of $58,165.37 in his said trade or business, of which
(a) $39,418.16 was taken as a deduction on the joint return of Charles E. Van Vleck and Natalie J. Van Vleck for the calendar year 1930, and
(b) $18,747.21 was not taken as a deduction on said joint return for the calendar year 1930.
5. The net income of Charles E. Van Vleck and Natalie J. Van Vleck for the calendar year 1930 was
(a) $123,781.48 without deduction of said 1929 net loss of Charles E. Van Vleck amounting to $58,165.37, or
(b) $65,616.11 after deducting said net loss, plus a capital net gain of $12,679.36.
6. An allocation of income and deductions between Charles E. Van Vleck and Natalie J. Van Vleck for the calendar year 1930, without taking into consideration the 1929 net loss of Charles B. Van Vleck of $58,165.37, is as follows:

The pertinent provisions of the Revenue Act of 1928 are as follows:

SEO. 51. individual RETURNS.
i\i * * iji * *
(b) Husband and wife. — If a husband and wife living together have an aggregate net income for the taxable year of $3,500 or over, or an aggregate gross income for such year of $5,000 or over—
(1) Each shall make such a return, or
■ (2) The income of each shall be included in a single joint return, in which case the tax shall be computed on the aggregate income.
SEC. 117. NET LOSSES.
(a) Definition of “net loss.” — As used in this section the term “net loss” means the excess of the deductions allowed by this title over the gross income, with the following exceptions and limitations:
■!■ V v i¡* .j* «,■ ij»
(6) Net loss not to produce net loss. — In computing the net loss for any taxable year a net loss for a prior year shall not be allowed as a deduction.
(b) Net loss as a deduction.- — If, for any taxable year, it appears upon the production of evidence satisfactory to the Commissioner that any taxpayer has sustained a net loss, the amount thereof shall be allowed as a deduction in computing the net income of the taxpayer for the succeeding taxable year (hereinafter in this section called “second year”), and if such net loss is in excess of such net income (computed without such deduction), the 'amount of such excess shall be allowed as a deduction in computing the net income for the next succeeding taxable year (hereinafter in this section called “third year”) ; the deduction in all cases to be made under regulations prescribed by the Commissioner with the approval of the Secretary.

Article 881 of Regulations 74, promulgated under the provisions of the Revenue Act of 1928, provides in part:

* * * Where the income of each is included in a single joint return, the tax is computed on the aggregate income and all deductions and credits to whioh either is entitled shall be taken from such aggregate income. * * * [Emphasis supplied.]

Article 652 of Regulations 74 provides in part:

* * * It should be noticed, however, that a net loss for a preceding year may not be considered in computing a net loss for a succeeding year.

Counsel for the petitioner cites Frank B. Gummey, 26 B. T. A. 894, and Joseph E. Oihlein, 30 B. T. A. 399, in support of the contention that all deductions to which either husband or wife filing a joint return is entitled may be deducted from their aggregate gross income, including the prior net losses of either husband or wife. The cases referred to merely hold that effect will be given to bona fide transactions between husband and wife for the purpose of determining their separate incomes; that for such purposes the husband and wife are each separate taxpayers; and that in filing a single joint return they lost no such rights, each remaining an individual and as such a taxpayer within the meaning of section 118 of the statute. In Frank B. Gummey, supra, we said:

Where husband and wife exercise the statutory right to file a single joint return, “the tax shall be computed on the aggregate income.” Sec. 51 (b), 1928 Act. * * * The term “ taxpayer ” means any person subject to a tax imposed by the act, and the term “ person ” includes an individual. Sec. 701 (a)(13) and (a)(1).
There is nothing in section 118 of the 1928 Act to the effect that the transactions of husband and wife who file a single joint return should be regarded as the dealings of the reporting spouse in the application of its provisions. Where a husband and wife exercise the statutory right to file a single joint return gross income and deductions are listed as though they belonged to the one making the return, but in reality they represent the combined receipts and deductions of each. To reach the aggregate net income, on which the tax is computed, consideration must be given to the transactions of each. In no other way can the combined taxable income be determined. The respondent has recognized this condition by the promulgation of regulations under section 51 of the 1928 Act providing that where husband and wife file a single joint return “ all deductions to which either is entitled shall be taken from such aggregate income.” * * *

Neither of the above cases involved the question of deducting the net loss of either husband or wife for a prior year. The above quoted language from the opinion in the Gvmmey case supports the respondent’s contention in these proceedings that the husband and wife, though filing a joint return for the taxable year, are nevertheless to be treated as separate individuals, and that each is the taxpayer referred to in section 117 (b) of the Revenue Act of 1928.

We think that the provision of the Commissioner’s regulations that “ where the income of each is included in a single joint return, the tax is computed on the aggregate income and all deductions and credits to which either is entitled shall be taken from such aggregate income ”, is not to be construed as affecting the rule with respect to the bringing forward of net losses. The income tax law looks upon husband and wife as separate taxpayers. The net loss provisions of the statute relate only to the taxpayer sustaining the net loss. The provisions of section 117 (b) of the Revenue Act of 1928 providing for the net loss as a deduction from the gross income of a subsequent year permits the deduction only from the gross income of that taxpayer who sustained the net loss. The net loss may be deducted only from the taxpayer’s net income of the following years. This was made plain, by the Supreme Court in Woolford Realty Co. v. Rose, 286 U. S. 319. The facts there were that a corporation, the Piedmont Savings Co., had sustained net losses in 1925, 1926, and 1927. It became affiliated with the Woolford Realty Co., and the two corporations filed a consolidated return for 1927. In such return the Woolford Realty Co., which had a net income for 1927, sought to add to the net loss of the Piedmont Savings Co. for 1927 the net losses sustained by it in 1925 and 1926 for the purpose of reducing the consolidated net income for 1927. The Supreme Court held that this could not be done. It said: “ The tax for the year [1927] was nothing, and the losses of other years could not serve to make it less.” This is decisive of the point in issue.

It may also be noted that section 117 (a) (6) of the Revenue Act of 1928 specifically provides that “ in computing the net loss for any taxable year a net loss for a prior year shall not be allowed as a deduction.” This provision must be regarded as making emphatic the rule of law invoked by the Supreme Court in Woolford Realty Co. v. Rose, supra. The contention of the petitioner is therefore not sustained.

The contention of the petitioner in these proceedings finds support in the opinion of the Board in William H. Shelmerdine, 24 B. T. A. 833. The facts in that case are that for the years 1923 and 1924 husband and wife filed joint income tax returns and for 1925 separate returns. The husband had a net loss from the conduct of his business for 1923 in the amount of $94,045.61; the wife a net income of $10,120.40. The joint return for 1923 showed a net loss of $83,925.21. For 1924 the husband had a net income, before bringing forward any net loss for 1923, of $23,755.90 and the wife a net income of $46,947.19, or a joint net income of $70,703.09. For 1925 the husband, on a separate income tax return, had a large net income. The Board held that the husband was entitled to bring forward the portion of the net loss of 1923 ($83,925.21) not absorbed by the net income of the community for 1924 ($70,703.09), or $13,222.12. In the course of our opinion we stated:

* * * In the instant case, it has been stipulated that for the year 1924 the petitioner and his wife, Susannah B.. Shelmerdine, filed a single joint return and that the correct net income of petitioner and his wife for the year 1924, on the basis of a joint return (excluding any deduction for net loss for 1923) was $70,703.09. However, the statute gives petitioner the right to bring forward any net loss incurred in the prior year in his trade or business and use it as a deduction in determining petitioner’s net income for 1924. When effect is given to this statutory provision, it will be found that all of the $70,703.09 income of petitioner and his wife for 1924 is offset by the deduction and petitioner still has some of the net loss for 1923 which he may carry forward into 1925 and use as a deduction in determining his net income for 1925.

It will be noted from the above that we allowed the husband’s net loss for 1923 to be applied against the joint net income of husband and wife for 1924. We must regard this holding of the opinion as being definitely overruled by the Supreme Court in Woolford Realty Co. v. Rose, supra.

.Reviewed by the Board.

Judgment will be entered under Rule 50.

ÁRuNdbll,

dissenting: The premises upon which the majority holding is based are (1) that husband and wife are separate taxpayers, and (2) that the net loss provisions of the statute apply only to the individual taxpayer sustaining the loss. Upon these premises the conclusion is reached that a carried forward loss may be used as a deduction only by the individual taxpayer who sustained the loss.

Passing the first premise without comment, I think that the second is wrong. The statute provides that where husband and wife file a single joint return “ the tax shall be computed on the aggregate income.” The income described by the adjective “ aggregate ” is obviously net income, as it is net — as distinguished from gross— upon which tax is computed. In arriving at net income one of the allowable deductions is the net loss for the preceding year. The language of the statute is, “ the amount thereof [the net loss] shall be allowed as a deduction in computing the net income of the taxpayer.” In thus allowing a net loss as a deduction in computing net income the net loss is treated in the same manner as other deductions — expenses, bad debts, etc. — that is, as a deduction from gross income in order to determine net income. The same reasoning which would confine net losses to the individual sustaining them would require similar treatment of other deductions, and yet the other deductions have never been so restricted. As early as 1921, in O. D. 1005, C. B. 5, p. 196, it was held:

Where the net income of one spouse is in excess of $2,000 but the other has allowable deductions, which if applied against this net income will result in mating the figure representing the aggregate net income of both less than $2,000, no return need be filed.

If a net loss is so strictly individual and personal as the majority opinion holds, it would seem erroneous to reduce the net loss of one spouse to be carried over by the nontaxable income of the other, but such is the rule laid down in Samuel G. Adams, 19 B. T. A. 781. In that case we said in part:

* * * When a husband and wife elect to file a joint return in the name of the husband, they thereby adopt a method under which the only return submitted is this joint return, which is sworn to by the husband and the tax shown due thereon is assessed against him. In determining whether tax is due, all items of taxable income and allowable deductions o-f both parties are taken into consideration in the same manner as if a determination were being made with respect to one taxpayer. In other words, the two are treated as a unit for the purpose of determining taxable net income and we think a different course should not be pursued when we come to arrive at a “net loss” as applicable to the year for which the joint return was filed. To determine the “ net loss ” of an individual for 1921, it is necessary to take into consideration not only the items of gross income specified in the statute, but also nontaxable income received by such individual. And the same method' would obviously apply where a “ net loss ” is being determined on the basis of a joint return for one year which would be allowable as a deduction in computing net income on a joint return for the subsequent year. * * *

The majority opinion cites Woolford Realty Co. v. Rose, 286 U. S. 319. That case involved consolidated returns of corporations, which seem to me to be fundamentally different from joint returns of husband and wife. In a consolidated return the net income or loss of each corporation is separately computed and the net results are combined. No corporation in the initial computation can take advantage of an affilate’s income or losses. In the case of a joint return of husband and wife “ gross income and deductions are listed as though they belonged to the one making the return.” Frank B. Gummey, 26 B. T. A. 894; Samuel G. Adams, supra, O. D. 1005, supra; art. 381, Regulations 14. That is, all income and deductions in the first instance go into hotchpot and the net result determines whether any return need be filed, and, if so, the tax is calculated on that result — what the statute describes as “ aggregate income.”

Prior to the Revenue Act of 1928 the liability of affiliated corporations for tax was limited by statute, in the absence of an agreement among them, to the portion of the total tax determined on the basis of the net income assignable to each corporation. That rule was subsequently changed and the liability made several. See art. 15, Regulations 15. In the case of a joint return it seems never to have been questioned but that husband and wife were severally liable for the full amount of the tax. It was so ruled under the Revenue Act of 1918, see I. T. 1515, II-l C. B. p. 144, and no holding to the contrary has been brought to our attention.

Corporations filing consolidated or separate returns are bound to file in the same way for subsequent years except as they may obtain permission from the Commissioner to change. An election made by husband and wife does not bind them for any other year; they are entirely free to file either separate or joint returns for successive years without regard for the kind of return filed in any prior year, and without obtaining the consent of the Commissioner to change.

In the Woolford Realty Co. case it was pointed out as a practical consideration that the result of failing to confine a net loss to the corporation sustaining it would be “ that a prosperous corporation could buy the shares of one that had suffered losses and wipe out thereby its own liability for taxes.” It would require a most fertile imagination to suppose any such consideration applicable to husband and wife.

For these reasons I think the second premise of the majority opinion to be erroneous and the conclusion reached must fall with it.

Trammell, Matthews, Goodrich, and Leech agree with this dissent.


author: Morris:

text:
    Edgar N. Finn, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 71397.
    Promulgated October 25, 1934.

      H. Edward Slwlman, Esq., for the petitioner.

      Frank M. Thompson, Jr., Esq., for the respondent.
   OPINION.

Morris:

The respondent having determined a deficiency in income tax of $5,106.99 for the calendar year 1930, the petitioner brings this proceeding for the redetermination thereof, alleging error by reason of the failure of the respondent to exempt the sum of $59,030 from taxation, representing compensation received by the petitioner from the city of New York for his services as an expert appraiser.

The petitioner, an individual, a resident of the city of New York, is, and has been for 31 years, an expert real estate appraiser, and for approximately 23 years of that time he has been doing such work for the city of New York in condemnation proceedings instituted by its corporation counsel by virtue of its power of eminent domain. He has been employed in at least 100 of such proceedings — during the last nine of such years he has been “ continuously ” so engaged.

The petitioner’s duties — he having first been employed by the corporation counsel upon a specific assignment, which he performed under the direction of said corporation counsel — covered appraisals in connection with various types of improvements; subways, school sites, playgrounds, street openings, water supply, and properties of any character acquired by the city of New York for public use. Having been so employed, the petitioner is supplied with a blueprint of the property to be acquired and each and every one of the properties covered thereby is personally examined and valued. He is also required to make examinations of the properties from time to time in order to keep informed of the various changes that may take place from the institution of a proceeding until such proceeding is finally disposed of by the court before which such matter is brought. A complete record is made of the appraisal and delivered to the corporation counsel at various stages of the proceeding, together with a complete record from the register’s office of every real estate transaction within a radius of five blocks in either direction of the properties to be acquired for a certain period. During the various stages of the condemnation proceedings, consuming from several months to several years, there are constant and frequent conferences with the assistant corporation counsel in charge of the particular proceeding. The proceeding is then set for trial in the county where the property is located. During the trial he is required to be in attendance throughout the entire period that he may advise the corporation counsel from time to time on different phases of the transaction from an expert’s point of view. He, himself, is called to testify on each appraisal and is required to submit himself to cross-examination by the claimants in the matter.

Although the corporation counsel prescribed the duties to be performed by the petitioner, no one had jurisdiction over the actual work to be accomplished.

His fees for such work were upon a per diem basis. A particular proceeding having been concluded by judicial disposition, a bill was rendered to the corporation counsel showing the number of days engaged thereon, the character of the work performed, such as conferences, views, valuations, examinations, investigations, etc., which was passed upon by the corporation counsel and returned to the comptroller for payment in due course. Payment, however, was not always prompt. For instance, the income which the petitioner reported in 1930 was in payment for services extending over approximately six years from 1925 to 1930. This delay is occasioned by reason of the fact that in some instances the court delays the signing of the final decree or, as is very often the case, there are objections to the award, thereby delaying consummation of the proceeding.

He took no oath of office. His employment was under oral agreement with the corporation counsel but was for no specified period of time, the period being governed by the circumstances of each particular proceeding. Though he could have accepted other appraisal employment if the period of his engagements with the city of New York had lapsed for sufficient space of time — there being no prohibition against so doing — he regarded it as unethical to do so while continuously engaged for the city.

He maintained his own office, though he had the privilege of desk space in the corporation counsel’s office. He employed, at his own expense, one assistant who assisted with investigations and the laying out of maps and the performance of other duties which he did not have time to do personally.

He prepared and filed his income tax return upon the basis of cash receipts and disbursements.

He received $59,030 from the city of New York in 1930 for the services rendered in said condemnation proceedings, which he claims was exempt from taxation by reason of having been paid to him as an employee of a political subdivision of the State of New York.

The respondent has included the aforesaid amount in the petitioner’s taxable income for said year on the ground that he was an agent of the court required to render a specific service needed in connection with condemnation proceedings ” and was therefore “ not an officer or employee of the City of New York,” and for the further reason that such services were not continuous but occasional and temporary.

Article 643 of Regulations 74, promulgated under the Revenue Act of 1928, provides as follows:

Abt. 643. Compensation of State officers and employees. — Compensation paid to its officers and employees by a State or political subdivision thereof for services rendered in connection with the exercise of an essential governmental function of the State or political subdivision, including fees received by notaries public commissioned by States, is not taxable. Compensation received for services rendered to a State or political subdivision thereof is included in gross income unless (a) the person receives such compensation as an officer or employee of a State or political subdivision, and (b) the services are rendered in connection with the exercise of an essential governmental function. The commissions of receivers appointed by State courts are subject to tax for 1928 and subsequent taxable years.
An officer is a person who occupies a position in the service of the State or political subdivision, the tenure of which is continuous and not temporary and the duties of which are established by law or regulations and not by agreement. An employee is one whose duties consist in the rendition of prescribed services and not the accomplishment of specific objects, and whose services are continuous, not occasional or temporary. * * *

The petitioner’s counsel has asked the Board to take judicial notice of the Greater Charter of the City of New York as amended, and, particularly, certain chapters thereof relating to the opening of streets, the acquisition of lands for public use, contracts and local improvements, the duties of the borough president regarding such improvements, powers of local courts concerning local improvements, the authority of the board of estimate and apportionment to change the map or plan of the city for laying out new streets, bridges, and tunnels, etc., the power of department of water supply and the board of estimate and apportionment to select a department of water supply, the duty of the corporation counsel to take proper steps for the condemnation of land for the supplying of water, the creation of the office of said counsel empowering him to appoint assistants, clerks, subordinates, requisite to the discharge of the business of that department to prosecute and defend matters appertaining to such condemnation proceedings.

In order to obviate a detailed and unnecessary discussion of the foregoing provisions, to which our attention has been directed, we are willing to concede, for the purposes of this proceeding, the power of eminent domain vested in the city of New York and its right thereunder to condemn land for public use; the creation of the office of corporation counsel and his power and duty to proceed in behalf of the city in such condemnation proceedings and, furthermore, his right to employ necessary assistants, .including appraisers.

We are of the opinion that the petitioner was neither an “ officer ” nor an “ employee ” within the meaning of the decided cases, of which there are many. Nor do we deem it necessary to enter into a discussion of such cases, for the reason that we are convinced after a review of the facts and application of the well established principles laid down therein that the petitioner was merely an independent contractor. Metcalf & Eddy v. Mitchell, 269 U. S. 514; Frank H. Mesce, 64 Ct. Cls. 481; certiorari denied, 278 U. S. 612.

The petitioner had practiced his profession for a period of about 31 years, about 14 of which he was occasionally, and about 9 of which he was “ continuously ”, engaged by the city of New York. He maintained independent office quarters and employed an assistant to aid him in his practice, both of which were at his expense. He took no oath of office, and, notwithstanding the argument of the petitioner’s counsel to the contrary, he was free to accept other concurrent employment, but did not do so, as he explained, for ethical reasons. A more cogent reason, however, would seem to be that he was kept sufficiently busy upon work assigned to him by the corporation counsel; had he not been, the witness testified, he would have been at liberty to accept other employment. While he testified that he had been continuously employed by the city for a period of nine years, the record shows that each appraisal was a separate project, hence a separate contract of employment. Therefore, we do not construe this testimony to mean — because of the constant and repeated demands for his services over that period of time — that he has been continuously employed within the meaning of the decided cases. He was not appointed for any definite period of time, for, as he testified, no one knew how long any particular proceeding would take. While he was subject to call from the office of the corporation counsel in matters pertaining to his employment as an expert appraiser, the record does not show that he was required to devote his entire time in the service of the city, irrespective of whether there was appraisal work to be done or not. He was paid on a per diem basis for services actually rendered upon appraisal work and matters incident thereto. If there were no appraisals requiring his time, he was free to do as he pleased therewith, without prejudice to his position.

The record shows, and of which we are satisfied, that after the petitioner was appointed to a specific project, furnished with a blueprint and given instructions as to what was to be accomplished in a given proceeding, he was absolutely free to use his own judgment and discretion in the performance of his assignment, provided, of course, that such assignment was executed according to the best standards of his profession.

In addition to the foregoing factors, and in conclusion, it is noteworthy that the petitioner was not compensated for his services at regular intervals of time as in the case of an ordinary employee. As his work was completed, a bill was rendered showing the number of days engaged and character of the work performed, which was subject to approval or disapproval by the corporation counsel. At the conclusion of proceedings, which lasted from several months to several years, the bill as rendered and approved was paid by the comptroller. For instance, the income in controversy was received in 1930 in payment for services rendered over a period of approximately six years.

Judgment will be entered for the respondent.


author: Adams :

text:
    Miles Realty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 51394.
    Promulgated October 25, 1934.

      Geo. ¡S. Atkinson, Esq., and PL. V. Robertson, O. P. A., for the petitioner.

      P. A. Bayer, Esq., and R. P. Hertzog, Esq., for the respondent.
   OPINION.

Adams :

This case involves deficiencies in income tax for the calendar years 1926 and 1927 in the amounts of $570.28 and $6,440.13, respectively. The material facts have been stipulated in writing and are adopted by reference as our findings. So much thereof as may be necessary will be referred to in this opinion, together with other findings we may make.

The petitioner during the taxable years and prior thereto was a corporation organized and existing under the laws of the State of Texas and was engaged in the business of promoting, subdividing, and selling real estate in or adjacent to Amarillo, Texas. The lots were usually sold on the installment basis under contracts which contained the following provision:

If said purchaser shall fail to make any of the payments of principal or interest as herein provided; or shall perform or allow to be performed, any breach of the restrictions hereinafter contained, he agrees to give immediate possession of said property; and all amounts paid by said purchaser together with all improvements on said land, shall be retained by the seller as liquidated damages, and this contract shall thereafter be null and void and of no further effect without any act on the part of the seller.

During the years 1926 and 1927 the petitioner sold a large number of lots on the installment plan, and, in accordance with a provision of the contracts which required payment of 50 percent of the purchase price before the purchaser was entitled to a deed, no conveyances of title were made.

Petitioner’s books and its income tax returns were kept and made on the installment sales basis. A number of the purchasers of lots defaulted in payments during 1926 and others during the year 1927. No affirmative action of any kind was taken by the petitioner during either of those years to forfeit the payments made' prior to the defaults, nor to cancel the installment contracts either by the board of directors, or otherwise. No entries were made on the books declaring or indicating a cancellation and forfeiture, nor were any steps taken to repossess the property.

The lots were sold by two real estate agencies, which also looked after and made collections of the installment payments, reporting the results from time to time to the petitioner.

It was the policy and practice of petitioner not to declare forfeitures and cancellation of contracts until it was convinced or notified that purchasers did not intend to perform and complete their contracts. Until such time it and its agents frequently made efforts to collect past due installments.

In 1928 the petitioner took over from the real estate agents all contracts and pass books and undertook the collections itself. After an examination of these and the accounts and further attempts at collections, in all cases where it appeared certain that no more payments would be made, forfeitures and cancellations were entered on petitioner’s books.

It is the contention of the respondent that whenever a default in payment occurred eo instanti, the contract by its terms became null and void and payments theretofore made became the property of petitioner and income to it in the year when the default occurred without any action whatever on the part of petitioner or any other person. In conformity therewith, respondent added to petitioner’s income for 1926 the sum of $1,231.99, and for 1927 the sum of $6,443.09. It is the position of the petitioner that the profits from these forfeitures and cancellations were income to it in 1928 when they were declared and its returns were made accordingly. It seems to us that the petitioner is correct. In Inland, Finance Co., 23 B. T. A. 199, we had before us the case of a corporation which sold its capital stock on an installment plan contract, which provided that if the purchaser failed to pay any of the installments and the default should continue for 30 days, the company could at its option terminate the agreement and all rights of the subscriber thereunder and hold all sums paid thereunder as liquidated damages.

A number of subscribers defaulted in payments and at meetings of the stockholders of the corporation resolutions were adopted canceling the defaulted contracts. It appeared from the evidence that any holder of these stock subscription agreements who desired to pay up the back payments due on his contract at the time it was canceled was allowed to do so, and no other method of attempting to cancel the contracts on account of defaults in payment was ever taken, except the resolutions of the stockholders. Under these circumstances, we held that the forfeited payments were not income to the taxpayer.

That case was affirmed in Commissioner v. Inland Finance Co., 63 Fed. (2d) 886, where the court said:

The Commissioner contends that, after corporate action had been taten canceling the subscription agreements, the amounts forfeited thereunder became the absolute property of the taxpayer, without qualification or condition, that is, not subject to reinstatement, and that therefore the forfeited payments were income. Although the subscription agreements contained no provision for reinstatement after cancellation, the evidence, as we have just seen, discloses that the agreements were subject to reinstatement at any time at the option of the subscriber, and that some of the agreements were reinstated. For these latter, the Commissioner made proper allowance in computing the asserted tax. In any event, we are of opinion that the Board correctly determined that the forfeited payments did not constitute “ income ” as the term has been defined, namely, gain derived from capital or labor, or from both combined. Eisner v. Macomber, 252 U. S. 189, 207.

While that case relates to a capital stock transaction, the principle relative to the cancellation and forfeiture under the subscription agreements applies equally here, viz., that the forfeiture is not com-píete while the purchaser has the right to reinstate. In the instant case it is clear that petitioner’s vendees had the right to reinstate during the taxable years and were urged to do so.

It has been often written and decided that forfeitures are not favored in the law. Forfeiture clauses such as the one involved here are exclusively for the benefit of the vendor and he may enforce it or not as he chooses. We think the general rules are stated correctly in the following quotations from 66 Corpus Juris:

Sec. 357. As a general rule, the contract provision giving the vendor the option to forfeit and terminate the contract on default by the vendee is a provision made for the benefit of the vendor, not for the benefit of the vendee, and the vendor may exercise the privilege or not as he sees fit. Likewise, where the contract provides that on default by the purchaser the contract shall be void, the contract is void only at the election of the vendor.
Sec. 358. Ordinarily, if the vendor desires to rescind or forfeit a contract of sale and payments thereunder for default in performance, notice of his intention must be given.
Sec. 359. Whether time is or is not of the essence of the contract, if the vendor has waived strict compliance with the terms of the contract as regards time of payment, he cannot thereafter rescind or forfeit the contract without giving notice of his intention to do so.

It seems to us that under the facts of this case, the contracts were voidable only and that as petitioner not only took no steps to enforce the forfeiture, but after default endeavored to make further collections, forfeitures did not occur until 1928, when the contracts were formally canceled on the books. It follows that the action of respondent was erroneous. Certain adjustments will be required under the stipulation of facts, and for that reason,

Decision will he entered under Rule 50.


author: Goodrich: Arundell, Matthews:

text:
    James Turner, Henry Elwyn Worcester and Central Hanover Bank and Trust Company (Formerly Central Union Trust Company of New York), as Executors of the Last Will and Testament of James Newbegin Jarvie, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 58971.
    Promulgated October 30, 1934.

      John M. Perry, Esq., Harold A. Donegon, Esq., John, W. Drye, Jr., Esq., and Lester L. Oolbert, Esq., for the petitioners.

      Eugene Smith, Esq., for the respondent.
   OPINION.

Goodrich:

Respondent determined a deficiency of $22,513.37 in estate tax against the estate of James Newbegin Jarvie, who died on June 21, 1929, a resident of Montclair, New Jersey. Petitioners, who are the duly qualified executors of the will of said decedent, contend that the deficiency is not owing and that the estate tax liability is already overpaid. The controversy concerns the computation of decedent’s net estate and petitioners allege two errors in respondent’s finding of that amount. They contend, first, that respondent should have deducted from gross estate as a claim against it $627,310.23, being the balance owing at the time of his death upon a charitable pledge made by decedent which petitioners subsequently paid. They contend, next, that respondent erroneously computed the amount of the residuary estate passing to charity, by deducting from the gross estate as charges against it the sum of decedent’s unpaid pledges to charity and the value of an annuity bequeathed to his sister. As to the first issue petitioners concede that respondent properly disallowed the deduction of seven unpaid pledges, totaling $14,949.98, and respondent admits error in failing- to deduct one such pledge of $10,000.

The facts are not in dispute and as our findings of fact we adopt the stipulation of the parties.

The respective concessions leave for our decision under the first issue the deductibility of only one item. Early in 1925, by written commitment, Jarvie made a pledge to the International Committee of the Young Men’s Christian Association, which it is stipulated was a corporation of a class described in section 303 (a) (3) of the Revenue Act of 1926, increasing the amount thereof from time to time to a total of $1,000,000. The committee had acquired a plot of ground in the city of Jerusalem; Jarvie undertook to supply the funds for the erection of an elaborate building on it. The committee agreed to make efforts to secure an endowment, the income from which was to be applied to the upkeep and maintenance of the building and for local and national work of the organization and later, when Jarvie increased his subscription, pledged itself to use its best endeavors to increase the endowment. It agreed also to proceed with the drawing of plans and the letting of contracts for the erection of the building and, upon its completion, to assume its control and maintenance and use it for Y. M. C. A. purposes. The provisions of the agreements were carried out; the building was completed and, since its dedication in April 1933, has been maintained and operated by the committee for the general purposes of the Association. Prior to his death, Jarvie made payments on his pledge totaling $372,689.77, leaving a balance owing of $627,310.23, which was a valid, legal and enforceable debt or obligation of his estate, and which was paid in full by petitioners in 1930. Respondent refused to allow that payment as a deduction from decedent’s gross estate. Whether he was correct in so refusing is the only dispute remaining under the first issue.

Respecting the second issue, it appears that by his will Jarvie bequeathed his entire residuary estate to the Jar vie Commonweal Fund, which is a charitable, exempt corporation under the provisions of section 303 (a) (3) of the Revenue Act of 1926'. He also left to his sister an annuity which, at the date of his death, was of a value of $74,287.87, and was a charge upon his estate. In determining the amount of the residuary estate passing to charity, respondent deducted from the gross estate the total of the pledges remaining unpaid at decedent’s death, and also the value of the annuity. Petitioners contend this action was erroneous.

We sustain respondent’s disallowance of the deduction of the amount of the unpaid pledge to the International Committee. Section 303 (a) (1) of the Revenue Act of 1926, as amended by the Revenue Act of 1928, allows a deduction from the value of the gross estate in determining the net estate subject to tax, of claims against the estate to the extent they were “ incurred or contracted bona fide and for an adequate and full consideration in money or money’s worth.” There is no question but that this pledge was contracted in good faith and was a valid and enforceable claim against the estate; the question is whether it was contracted upon such a consideration as the statute requires. Upon the evidence before us it seems clear that it was not so contracted; that such a consideration was lacking. We are shown only that Jarvie desired the building in Jerusalem to be erected, and that he undertook to supply funds for that purpose. He made a gift, apparently motivated solely by his own desires and generosity. His pledge was not made in consideration of the pledges of others, which we held sufficient to satisfy the statutory requirement in our decision in Jeftha H. Wade, Jr., et al., Executors, 21 B. T. A. 339, upon which petitioners rely, and that fact serves to distinguish this proceeding from the Wade case. See Esther Jackson Porter et al., Executors, 23 B. T. A. 1016.

The decision in Glaser v. Commissioner, 69 Fed. (2d) 254 (affirming 27 B. T. A. 313), is controlling. There the court, after discussing the decision of the Court of Appeals of the Sixth Circuit in Latty v. Commissioner, 62 Fed. (2d) 952, and the decision of the Court of Appeals of the Second Circuit in the Porter case in connection with its consideration of the statutory provisions here involved, said:

It is the clear understanding in both circuits that Sec. 303 (a) (1) does not justify making deduction from the gross estate in the case like the one presented here, where there was not a business transaction on the part of the decedent, or a contract intended to augment his estate or to grant him some right or privilege he did not possess before, or to discharge him from any existing obligation but only a contemplated bounty was involved.

Whether the court’s interpretation of the phrase “ for an adequate and full consideration in money or money’s worth ” necessarily narrows our understanding of it as expressed in the Wade decision, we need not here decide, for it is apparent that petitioners’ contention must fail under either decision.

As their second contention petitioners urge that if the unpaid pledges (including those amounting to $14,949.98) are not deductible as claims against the estate, respondent should not be permitted to deduct them from gross estate in determining the residuary estate under section 303 (a) (3) and so reduce the amount deductible as a bequest to charity under section 303 (a) (3). They make the same contention respecting the value of the annuity. They claim the rule to be that the full amount of a charitable bequest should be deducted from gross estate, irrespective of the fact that the beneficiary may ultimately receive less than the amount bequeathed.

Assuming, arguendo, that to be so, we see no error in respondent’s action here. The residuary estate was bequeathed to charity; its amount must be determined. So far as appears from this record, respondent, in determining the residuary estate, reduced the gross estate by all specific bequests, enforceable claims against it, and other proper charges upon it. Petitioners complain of no such deductions except the unpaid pledges and the annuity value. Yet it is stipulated that these pledges were valid and enforceable claims against the estate. That we hold them not deductible as claims against the estate because not incurred upon such a consideration as the statute requires is immaterial. Whether deductible or not under the taxing statute, they were debts of the estate and had to be paid, and their payment in fact reduced the residuary estate. It is likewise stipulated that the annuity was a charge upon the estate. The amount necessary to discharge that annuity (the calculation of which is. not in dispute) also served to diminish the remainder, or residue of the estate, and respondent was right in deducting it; William Nelson Cromwell et al., Executors, 24 B. T. A. 461. In other words, before the residuary estate could be ascertained, these charges had to be met or provided for from the gross estate. What was left made up the residuary estate. The amount of it, respondent properly determined, and that he properly allowed the deduction of that amount as a bequest to charity is not disputed.

Reviewed by the Board.

Judgment will Be entered under Bule BO.

TRAmmell and Turner dissent.

Arundell,

dissenting: The majority holding — while technically abiding by the literal words of the statute — allows technicalities to obscure the “ beneficent purpose of Congress ” (Lederer v. Stockton, 260 U. S. 3) which has been manifested in all revenue acts in allowing deductions for gifts to> and exemption from tax of income of charitable corporations. In the case cited the Supreme Court did not allow the technical formality of a trust to stand in the way of exemption of income which the trustee should have collected but which he allowed a charitable corporation to retain and use. In Trinidad v. Sagrada Orden de Predicadores, 263 U. S. 578, the Court took into consideration “ the benefit which the public derives from corporate activities of the class named.” This was evidently the view of the Circuit Court of Appeals for the Second Circuit in Porter v. Commissioner, 60 Fed. (2d) 673, where, upon arriving at the conclusion that the recipient of a promised gift was an educational institution, deduction was allowed to the executors for the amount paid in fulfillment of the decedent’s promise.

Following the examples of these cases, I think that a proper consideration for the purpose of Congress at least permits — if it does not require — the deduction here claimed.

Matthews:

I agree with the foregoing dissent, but am of the opinion that the term “ transfers ” in section 303 (a) (3) is sufficiently broad to cover the payment by the executors of the balance of the amount promised by decedent in his lifetime to the Y. M. C. A.

Smith concurs.

       Modified 60 Fed. (2d) 673; affirmed on another issue, 288 U. S. 436.

       Affirming 23 B. T. A. 1250.

       Cf. Frances Planner McIlhenny et al., Executors, 22 B. T. A. 1093; Georgianna M. Romberger et al., Executors, 21 B. T. A. 193.

       Petitioners rely upon John Aspinwall Sadden, Jr., et al., Executors, 10 B. T. A. 741. But this case related to the diminution of charitable bequests by the amount of inheritance taxes.

        Mechanics Bank of New Haven et al., Executors, 20 B. T. A. 1033.

       “ Residue ” is that which remains of something after talcing away some part of it. It means, in the absence of language showing a contrary intention, the estate remaining after payment of charges, debts and particular legacies; and no residue exists until such burdens have been paid. 40 Cyc. 1570; Wetmore v. St. Luke’s Hospital, 9 N. Y. S. 753; In re Hamlin. 172 N. Y. S. 787.


author: Smith : Mtjedock,

text:
    Hummel-Ross Fibre Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 59865.
    Promulgated October 30, 1934.

      J. G. Bohannan, Esq., and G. M. Scott, O. P. A., for tRe petitioner.

      S. B. Anderson, Esq., for the respondent.
   OPINION.

Smith :

In this proceeding only the deficiencies for 1927 and 1928 are before us, but the true tax liability for 1927 depends upon the amount of a statutory net loss sustained in 1926, which the petitioner is entitled to carry forward in the computation of its taxable income for 1927. Accordingly, it is necessary to pass upon certain deductions from petitioner’s income in 1926, which have been disallowed by the respondent. As authorized by section 274 (g) of the Revenue Act of 1926, we therefore determine the ratable annual deductions representing amortization of the discount on the bond issues to which the petitioner was entitled in that year, as a condition precedent to redetermination of the deficiency for 1927.

The petitioner contends that the value of its common stock delivered to the First Wisconsin Co. and to its shareholders in connection with its refinancing operations should be regarded as the cost of selling its first and second mortgage bond issues, and seeks to deduct such alleged costs ratably over the terms of the respective issues. The repondent has based his determination on his finding that in each instance the bonds were sold at par for cash. In his brief he argues that even if it is not true, each transaction was a mixed sale of bonds and stock and there is no evidence of record upon which any allocation of receipts from the sale of the two different types of securities can be made.

The law is well established that a corporation which keeps its books of account and makes its income tax returns on the accrual basis is entitled to deduct from the gross income of each year a pro rata part of the expenses incurred and discount allowed upon the sale of bonds. Chicago, Rock Island & Pacific Railway Co., 13 B. T. A. 988; Liberty Farms Co., 22 B. T. A. 1298; East Ninth Euclid Co., 26 B. T. A. 32; Pictorial Review Co., 26 B. T. A. 472; Western Maryland Railway Co. v. United States, 33 Fed. (2d) 695.

The real question before us is the amount of the discount at which the petitioner’s first mortgage bonds were sold in 1925. The respondent, on the one hand, contends that they were not sold at a discount, but were sold at par, and that the shares of stock of the petitioner were issued without any cash consideration. The petitioner, on the other hand, contends that the fair market value of the shares of its capital stock on September 1, 1925, was $100 per share and that therefore the discount at which the $1,000,000 5-year 7 percent first mortgage bonds were sold was $250,000 and the discount at which the $698,850 second mortgage bonds were sold was $139,770. Substantially all of the evidence submitted by the petitioner is directed to the fair market value of its shares on September 1,1925. No evidence was submitted with respect to the amount of cash realized by the petitioner from the sale of its bonds alone.

The contention of the respondent that the bonds were sold at par cannot be sustained. The evidence conclusively shows that the petitioner was unsuccessful in its efforts to sell its bonds at par. The First Wisconsin Co. was willing to underwrite the issue only upon condition that the petitioner rid itself of its floating indebtedness and issue to it certain shares of stock which it could sell to its customers in connection with the sale of the bonds.

In this connection the president of the First Wisconsin Co. testified:

The common stock that we received of the corporation [petitioner] we sold in units to the bondholders, and six or eight months later we were able to sell some oí the bonds, the tail end of the issue, without the stock. It was not a part of our plan, but it happened that eight months later we were able to sell the bonds without the common stock.

The position of the petitioner is that its shares of common stock were sold at par. The corollary of this is that the first mortgage bonds were sold at $75. There is nothing in the evidence that warrants such a contention. The first mortgage bonds in the amount of $1,000,000 were secured by property that had cost the petitioner $3,000,000, bore 7 percent interest, and matured in 1930. We reject the contention that $750,000 of the cash received should be allocated to the $1,000,000 bonds and $250,000 to the $250,000 par value of stock issued.

From a consideration of all of the evidence, we reach the conclusion that the first mortgage bonds were sold for $900,000, or at a total discount of $100,000, and that the common stock issued in connection therewith was sold at $40 per share. Upon this basis the petitioner is entitled to the amortization of the discount of $100,000 over the life of the first mortgage bonds.

Upon the same basis, namely, that the shares of stock issued in connection with the second mortgage bonds were sold at $40 per share, the total discount at which the $698,850 par value of second mortgage bonds were sold was $55,908. The petitioner is entitled to amortize such discount over the life of the second mortgage bonds.

At the hearing counsel for respondent admitted error in the computation of petitioner’s deductible allowances for depreciation in 1926, in the amount of $38,859.54, which he now concedes should be added to petitioner’s allowable deductions for that year, and that the effect of such inclusion is to increase any statutory net loss sustained in 1926 in the amount of $16,597.65. He also admits that “ in the event an additional deduction was allowed for 1926 of the bond discount, of course, the net loss would be increased by whatever amount the petitioner is entitled to.” The effect of these admissions will be taken into account in the recomputation under Rule 50.

Reviewed by the Board.

Judgment will be entered wnder Rule 50.

Mtjedock,

dissenting: I think the determination of the Commissioner that the bonds were sold at par and nothing was received for the stock should be approved because the petitioner has failed to introduce evidence from which the Board can determine how much was paid for the' bonds and how much was paid for the stock. Where a guess is the only alternative to an affirmance of the Commissioner’s determination, the determination should be approved.

       Sec. 274. (g). The Board in redetermining a deficiency in respect of any taxable year shall consider such facts with relation to the taxes for other taxable years as may be necessary correctly to redetermine the amount of such deficiency, but in so doing shall have no jurisdiction to determine whether or not the tax for any other taxable year has been overpaid or underpaid.


author: Smith :

text:
    Moxa Building Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 53024.
    Promulgated October 30, 1934.

      Spotswood D. Bowers, Esq., for the petitioner.

      Frank M. Thompson, Esq., for the respondent.
   opinion.

Smith :

This is a proceeding for the redetermination of a deficiency in income tax for 1926 of $14,007.34. The question in issue is the right of th© petitioner to deduct from its gross income $102,000 representing amounts paid to certain individuals who had financed the operations of the petitioner. Petitioner claims the deduction either as interest paid upon loans or as ordinary and necessary expenses in carrying on its business.

The petitioner was incorporated prior to April 9, 1926. It had a capital stock, divided into 20 shares, 19 of which were owned by Robert B. Bowler and one by his secretary, Mary A. Pappert. Bowler was treasurer and secretary of the corporation.

Bowler was an investor in New York real estate. Over a period of about 10 years he had organized many corporations similar to the petitioner and had always made it a point of having several such corporations organized and ready to take title to a parcel of property whenever a favorable opportunity to invest therein was presented. As a rule each corporation was availed of for only a single business venture. The petitioner never engaged in any other venture than the one described below.

In April 1926 Bowler learned that the assets of the Manhattan Brass Co. were for sale by the trustees in liquidation of that company and that about $125,000 would be required to finance the deal. He also learned that there were two other persons contemplating the purchase of the property and that if he were to acquire it at the price asked he would have to act quickly. He did not at the time have the requisite amount of cash on hand to finance the deal. On numerous other occasions he had associated with him certain individuals who had advanced money for the financing of such deals and who had been permitted to participate in the profits arising therefrom.

When he learned of the opportunity above referred to he communicated with one Charles E. Pettinos and asked him if he would be interested in the proposition and if he could furnish sufficient money to finance it. Pettinos stated that he did not have the funds on hand, but would see if he could get a friend or two to come in with him. He and a friend, one Franklin Remington, and Bowler met the next morning and, after examining the property, decided to buy it. Bowler told them, “ I will give you 100 per cent profit in the deal, and after 100 per cent — if we make more than 100 per cent — I will get the balance.” They had no idea how much would be made out of it.

The property to be purchased consisted of real estate, buildings, Liberty bonds, cash in bank, and accounts receivable and stock on hand. The accounts receivable stood at $106,000 or $108,000. The other assets included $40,000 Liberty bonds and $23,000 in bank.

A down payment of $10,000 had to be made at once. Bowler advanced $10,000 to the Tocabo Investing Co., which made the down payment of $10,000 and took title to all the assets acquired, other than the real estate. The real estate was taken in the name of the Bullfrog Building Co. Both of the last named companies were similar in character to the petitioner. Under the agreement, or agreements, with the trustees the balance of the purchase price ($115,000) did not have to be paid prior to June 10, 1926, provided the purchasers would secure the vendors by the deposit of sufficient collateral with the Equitable Trust Co. Pettinos, Remington, and Bowler deposited as collateral with the Equitable Trust Co. securities having a fair market value at the time of approximately $180,000. Pettinos and Remington each deposited collateral of a fair market value of approximately $80,000 and Bowler collateral of a value of from $20,000 to $24,000.

On or about April 9, 1926, the petitioner purchased from the Tocabo Investing Co. the assets which it had acquired from the trustees in liquidation of the Manhattan Brass Co. for a consideration of $110,000. Immediately thereafter it began the liquidation1 of the assets thus acquired. It withdrew from the. bank a part of the $23,000 on deposit, sold the Liberty bonds, and collected the accounts receivable as fast as possible. Within two or three weeks it had succeeded in selling the machinery acquired for $51,000 cash. All the amounts thus received were paid over to the Equitable Trust Co. Prior to May 19, 1926, the Equitable Trust Co. had paid the balance of the purchase price to the trustees in liquidation. Thereupon the Equitable Trust Co. returned to Pettinos, Remington, and Bowler all the securities which they had deposited with it as collateral.

On May 19,1926, a resolution was passed by the petitioner’s directors, reading as follows:

Inasmuch as the company has collected from accounts receivable and from the sale of various assets acquired from the Manhattan Brass Company contract, such as Liberty Bonds, machinery, and so forth, in excess of $160,000, and has paid to the trustees in liquidation of the Manhattan Brass Company, $150,000, thus making it unnecessary to call on the underwriters of the series A notes issue, authorized at the meeting of the Board of Directors held April 9, 1926, for any sum whatsoever, resolved
That the company issue no series A notes and reimburse the Tocabo Investing Company, Inc., in cash for $10,000 initially paid by said Tocabo Investing Company, Inc., to the trustees in liquidation of the Manhattan Brass Company, and
Further resolved that the company issue the series B notes authorized in the resolution of April 9th, being several series B notes, May 1, 1926.

The above resolution was passed after agreement between Pettinos, Remington, and Bowler that the action would be satisfactory to them. Pursuant to the resolution series B notes dated May 1, 1926, were issued and delivered. There were eight series B notes issued, one for $50,000 due January 30,1929, to Charles E. Pettinos, one for the same amount due on the same date to Franklin Remington, and the remaining six aggregating $50,000 due on the same date to Robert B. Bowler.

After the trustees in liquidation had been paid the purchase price for the assets, the remainder of the money collected by the petitioner was used in part payment of the series B notes. Pettinos, Remington, and Bowler received payments upon such notes in 1926 as follows:

In its income tax return for 1926 the petitioner deducted from gross income $102,000 representing the amounts paid on the series B notes. This amount was disallowed by the respondent in the determination of the deficiency.

We do not think that the contention of the petitioner that the $102,000 in question may be deducted from gross income as interest on indebtedness can be sustained. The series B notes were not given to liquidate an interest charge. The agreement which the petitioner made with Pettinos, Remington, and Bowler was that they should receive the profits of the business up to $150,000; in fact, any profits distributable beyond that amount were to go to Bowler in part payment for services performed. The payments on the notes represented distributions of profits.

The principal contention of the petitioner is that the $102,000 is deductible from gross income under section 284 (a) (1) of the Revenue Act of 1926, which permits the deduction from gross income of “ all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered.” In connection therewith it calls attention to article 101 of Regulations 69, which, so far as material, provides as follows:

Business expenses. — Business expenses deductible from gross income include the ordinary and, necessary expenditures directly connected with or pertaining to the taxpayer's trade or business, * * * Among tlie items included in business expenses are management expenses, commisisons, '* * * A taxpayer is entitled to deduct the necessary expenses paid in carrying on his business from Ms gross income. * * * [Italics ours.]

We are of opinion that this claim of the petitioner rests upon no firmer ground than the first contention adverted to. What constitutes ordinary and necessary expenses deductible from gross income may be affected by time, place, and circumstance. Cf. Welch v. Helvering, 290 U. S. 111. We have been unable to find any case in which the Board or the courts have held that a distribution to stockholders or to others of the entire profits of a corporation constitute ordinary and necessary expenses deductible from gross income. In the proceeding at bar all of the profits were thus to be distributed. The share of the profits payable to Bowler was in part compensation for services. The record does not show what, if any, salary Bowler was to receive from tire corporation or did receive from it in 1926. We can not determine therefore whether the amount paid to him in the redemption of his series B notes, in addition to his regular salary, if any, constituted reasonable compensation for personal services actually rendered.

The claim of the petitioner, however, rests upon the broader ground that the entire amount paid to Pettinos, Remington, and Bowler in 1926 represents ordinary and necessary expenses because the business was hazardous and the amounts paid were not in excess of the amounts that would have been paid for a loan of money by a money lender. We have carefully considered this argument, but are not persuaded by it. The contract made by the petitioner with the three individuals named was that if they would put up the money to finance the deal all the profits would be paid to them. From their standpoint the transaction was a joint venture. The distribution of the profits in the amount of $102,000 in 1926 did not constitute the payment of ordinary and necessary expenses of the petitioner.

In Traylor Engineering & Mfg. Co. v. Lederer, 271 Fed. 399; cer-tiorari denied, 257 U. S. 638, the Circuit Court of Appeals for the Third Circuit had before it a case somewhat similar to the present one. In that case it appeared that two individuals had “grub-staked ” a corporation in obtaining certain contract's for the manufacture of munitions. In consideration of such “ grubstaking ” the corporation agreed that certain profits arising from the contracts should be paid to the individuals who had advanced money in securing the contracts. The court held that the profits thus paid were not a legal deduction from gross income in determining the profits of the business subject to the munitions manufacturers’ tax. In our opinion the principle applied by that court is equally applicable to the proceeding at bar.

In support of its contention petitioner cites Wiggin Terminals v. United States (C. C. A., 1st Cir.), 36 Fed. (2d) 893. In that case plaintiff agreed to pay a 100 percent bonus for the loan of $50,000, which loan was to bear interest at 6 percent per annum. The court held that the amount paid to the lender was a legal deduction from gross income. It does not appear, however, from the opinion of the court in that case that the amount was in any sense a distribution of profits of the corporation. Petitioner also cites Jones Syndicate v. Commissioner (C. C. A., 7th Cir.), 23 Fed. (2d) 833. The question there was whether so-called dividends on preferred stock could be deducted by the syndicate as interest upon a loan. The court he! d in the circumstances of the case that the amount was deductible as interest. We think that that proceeding is distinguishable from the present one on its facts.

Reviewed by the Board.

Judgment will be entered for the respondent.


author: Smith:

text:
    Lido Building Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 53385.
    Promulgated October 30, 1934.

      Spotswood D. Bowers, Esq., for the petitioner.

      Frank M. Thompson, Esq., for the respondent.
   OPINION.

Smith:

This is a proceeding for the redetermination of a deficiency in income tax for 1927 in the amount of $5,465.70. The petition alleges that the respondent erred in the determination of the deficiency—

(a) * * * in ruling and deciding that there was a gain on the sale of lease of $43,937.16.
(b) * * * in ruling and deciding that the matter of the Lee Bros. Inc. lease was a corporate transaction, and in refusing to recognize the assignment of three-fifths of the corporation’s right, title and interest in the lease to Robert B. Bowler, which transfer was made for a valuable consideration and with the consent of all the stockholders.

The Caraboa Building Co. entered into an agreement with Lee Brothers, Inc., on March 20, 1925, to purchase the building located at 103 East 125th Street, New York City, for $1,007,500. The Caraboa Building Co. paid $100,000 as a deposit on May 1, 1925. In the agreement the seller agreed to turn over to the buyer, or a corporation to be named by it, the lease on the above building. The petitioner was the corporation named by the Caraboa Building Co. to receive the lease, for which the petitioner paid the Caraboa Building Co. $100,000 on May 1, 1925.

The option to purchase the building expired on May 1, 1926, and the Caraboa Building Co. did not exercise it. Lee Brothers, Inc., brought suit against the Caraboa Building Co. and the petitioner to cancel the lease. Pending the outcome of the litigation the court appointed a receiver to operate the demised premises.

The leasehold acquired at a cost of $100,000 was substantially the only asset held by the petitioner. Its only stockholders were Robert B. Bowler, Charles E. Pettinos, and Ms wife, Joy C. Pettinos. Bowler owned 20 shares of the stock and Pettinos and his wife each owned 10 shares. They continued its only stockholders during the year 1927. The company had no assets with which to defend the suit which had been brought against it, and it was estimated that the cost of such defense would be between $15,000 and $20,000. Pettinos and his wife were unwilling to advance funds to the petitioner to enable it to carry on the litigation.

Thereupon Bowler offered to finance the litigation on the basis that if successful he should receive three fifths of the net proceeds and petitioner two fifths thereof. This proposition was agreed to by Pettinos and his wife and a resolution was duly passed by the corporation on January 3, 1926, and signed not only by Bowler as secretary, but also by one Miss Tappert and by A. Stewart, who was a director and represented the Pettinos interests. That resolution read as follows:

Inasmuch as the company has no assets with which to carry on the litigation with Lee Brothers, defending its title to the lease on the Lee Building, and inasmuch as Robert B. Bowler has agreed to make himself responsible for all expenses in connection with the said litigation,
Resolved that the Company assign to said Robert B. Bowler, at such a time and in such a manner as he may desire, its right, title and interest to the lease in said Lee Building. The said Robert B. Bowler, agreeing to carry on the litigation at his own expense, and in the event that said litigation is successful for this company, or the settlement of said litigation is made, the said Robert B. Bowler agrees to account to this Company for two-fifths of any of the net proceeds derived either from said litigation by settlement or for the sale of said lease or for two-fifths of the net income derived from said lease during the balance of its term.

Although the resolution contemplated an assignment of the lease to Bowler, no such assignment was ever made. The litigation was conducted in the name of the petitioner corporation. It was decided by the lower court in favor of the petitioner. Thereupon, Lee Brothers, Inc., took an appeal to the appellate division and pending such appeal the case was settled by Lee Brothers, Inc., paying to the petitioner $155,000 in consideration of the surrender of the lease and in full settlement of the case. Of this amount $100,000 was payable to the petitioner in 1921, $25,000 on January 1, 1928, and $30,000 on July 2, 1928. Of the $100,000 received by the petitioner on July 1, 1927, $60,000 was immediately thereafter paid to Bowler, and $33,000, remainder of $93,000 representing 60 percent of the total amount received by the petitioner from Lee Brothers, Inc., was paid to Bowler in 1928, less certain expenses of litigation which, in the first instance, were paid by the petitioner and charged against Bowler’s share of the proceeds ($93,000).

Petitioner’s income tax return for 1927 showed a net loss of $3,450.51. The respondent added thereto a profit upon the sale of the lease of $43,937.16, resulting in a net income of $40,486.65, on which the deficiency of $5,465.70 has been determined. The profit of $43,937.16 was computed by the respondent as follows:

Total amount received from litigation_$155,000.00
Cost-$100, 000. 00
Less payment of- 3,000.00
- 97,000.00
58,000.00
Less expenses:
3, 000.00 Purchase of Oaraboa contract.
9, 650, 00 Legal expenses paid_
457. 55 Stenographer’s, etc_
955. 29 Lido liabilities not yet paid_
-- 14, 062. 84
Net profit- 43, 937.16

The issues in this proceeding are not sharply drawn. The deficiency notice upon which the petition is predicated includes as a part thereof the report of the audit made by a revenue agent, from which it appears that he treated as a nullity the agreement between the corporation and Bowler by which the corporation agreed to pay Bowler 60 percent of the proceeds of the litigation less the costs thereof. The revenue agent stated: “ The transfer by part of the directors to another director of corporate property is without authority. An income arising therefrom is income to the corporation and not income of the individual director to whom assigned.”

The real question in issue appears to be whether the petitioner had any taxable income for the year 1927. Counsel for the petitioner submits that if the $60,000 paid to Bowler by the petitioner in 1927 is a legal deduction from its gross income, the petitioner had no net income for that year.

We are of the opinion that the contract made between the petitioner and Bowler was a valid one. See Goss & Co. v. Goss, 132 N. Y. S. 76; First National Bank v. Commercial Traveler's Association, 108 App. Div. 78; affd., 185 N. Y. 575; H. R Bennington & Son Pulp & Paper Co. v. Caswell, 126 App. Div. 142. The petitioner was not in the possession of funds with which to carry on the litigation and the stockholders, other than Bowler, were unwilling to advance any funds to the corporation with which to do so. Bowler undertook personally to advance such funds and he made all necessary arrangements with his attorney for doing so.

The petitioner does not make it plain whether it is claiming that the amounts paid to Bowler pursuant to its contract with him constitute additional cost of the lease which was surrendered in 1927, or an ordinary expense of carrying on its operations in 1927. We think it was the former. In Murphy Oil Co., 15 B. T. A. 1195: affirmed upon this point in Murphy Oil Co. v. Burnet, 55 Fed. (2d) 17, we stated:

* * * We have repeatedly held that the cost of defending title, whether in the form of legal fees or compromise payments, is a capital expenditure representing additional cost of the property. Lincoln L. McCandless, 5 B. T, A. 1114; Gopher Granite Co., 5 B. T. A. 1216; Seletha O. Thompson, 9 B. T. A. 1342; Frederick McLean Bugher [9 B. T. A. 1155], supra; North American Oil Consolidated, 12 B. T. A. 68; Phoenix Development Co., 13 B. T. A. 414.

But whether the amount paid to Bowler be regarded as additional cost of the lease or as an ordinary and necessary expense of operation, the result must be the same in the determination of the issue in this proceeding; for the petitioner surrendered whatever rights it had in the lease to Lee Brothers, Inc., in 1927. The cost of the lease to the petitioner was in excess of the $155,000 received on the settlement of the litigation. It is apparent that the petitioner had no profit from the sale thereof.

Reviewed by the Board.

Judgment of no deficiency will be entered.