author: Black :

text:
    Jack M. Franks, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 53685.
    Promulgated March 22, 1935.

      W. R. Arrington, Esq., for the petitioner.

      O. R. Marshall, Esq., for the respondent.

       SBC. 161. IMPOSITION OP TAX.
      (a) Application of Taso. — The taxes imposed by this title upon individuals shall apply to the income of estates or of any kind of property held in trust, including—
      *******
      (2) Income which is to be distributed currently by the fiduciary to the beneficiaries, and income collected by a guardian of an infant which is to be held or distributed as the court may direct:

      SEC. 162. NET INCOME.
      The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that—
      *******
      (b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to he distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. Any amount allowed as a deduction under this paragraph shall not be allowed as a deduction under subsection (c) of this section in the same or any succeeding taxable year.

   OPINION.

Black :

In this proceeding petitioner assails a deficiency in income tax in the amount of $889.79 determined by the respondent for the calendar year 1929. The sole issue presented for our decision is whether any portion of a fund set aside by a trustee in 1929 for payment of 1928 real estate taxes on trust properties constitutes income currently distributable and taxable to a beneficiary of the trust, where the trustee, who kept his books and filed his returns on the cash receipts and disbursements basis, did not pay these taxes in 1929 and did not distribute or credit any portion of the fund to the beneficiary.

The facts are stipulated and we adopt this stipulation as our findings of fact. For the purpose of this decision, the following brief statement will suffice.

Petitioner is a resident of Chicago, Illinois, and is one of the beneficiaries named in a trust created in the will of his father, who died in April 1928. Under the terms of this will and a trust agreement subsequently entered into by three beneficiaries named in. the will and the Chicago Title & Trust Co., as trustee, petitioner is entitled to receive a portion of the net income of the trust. The will authorizes four trustees named therein to “ determine the mode in which expenses are to be borne as between capital and income ”, “to pay off any and all encumbrances against the trust estate * * * as the same mature if, in the judgment of the trustees, it is advisable so to do ”, to “ incur and make whatever expenses and outlay they may deem necessary, prudent or expedient for the proper administration of their respective trusts ”, and “ to pay any taxes.” In the trust agreement the trustee, among other things, “ is authorized, empowered and directed to pay all taxes, assessments and other charges levied or imposed against said trust estate or any part thereof ”, and the agreement provides that all expenditures made or incurred by the trustee in administering the trust, including the payment of all taxes against the trust estate, shall be paid or allowed out of the income of the trust estate. The trust agreement also provides that the trustee shall from time to time, as and when received by it, distribute and pay over, in quarter-yearly installments as near as may be, all of the moneys payable to petitioner under the trust created for his benefit in the will of the decedent.

During the year 1929, the Chicago Title & Trust Co. (hereinafter referred to as the “ trustee ”), as trustee under the will and trust agreement, set aside out of the income received from the trust estate the sum of $30,366.59 as an estimated liability for real estate taxes of the trust for the year 1928. Under the law of Illinois these taxes became a lien against the property of the trust estate on April 1, 1928. Ordinarily tax bills are rendered in April of the following year and are payable on or before May 1 of the same year. Owing to a delay resulting from a reassessment of real estate for tax purposes ordered by the Cook County Board of Tax Assessors in 1928, the trustee received no bills for 1928 taxes on the property of the trust estate located in Cook County, Illinois, until after December 31, 1929. In 1930 the trustee paid $21,185.97 in cash to the County Collector of Cook County, Illinois, for real estate taxes of the trust for the year 1928.

Petitioner’s books of account are kept on the basis of cash receipts and disbursements and his individual income tax return for the calendar year 1929 was made on the same basis.

The books of account of the. trustee in respect to the trust here involved are kept on the basis of cash receipts and disbursements and the fiduciary return filed by the trustee for the year 1929 was made on the same basis, except that in computing the net income, the trustee set aside and deducted the sum of $30,366.59, representing the estimated liability of the trust for real estate taxes due to Cook County, Illinois, for the year 1928. After making this deduction, the net income shown on the fiduciary return was $33,852.94, and petitioner’s distributive share was $11,317.83.

On his individual return for 1929 petitioner reported $11,286.16 as his distributive share of the income of the trust, and $91.67 was returned as interest on tax-free covenant bonds upon which a tax was paid at source.

Upon examination of the books and records of the trustee for the purpose of verifying the fiduciary return of income, for 1929, respondent disallowed as a deduction the estimated liability of $30,-366.59 for real estate taxes of the trust for 1928, increased the amount of distributable income for 1929 by $30,366.59, and also increased petitioner’s distributable share by $13,068.09, which amount represents the proportionate part of $30,366.59 allocable to petitioner, measured by his share in the entire trust estate. The deficiency here, in dispute results from respondent’s action in increasing the income reported by petitioner by the amount of $13,068.09. No portion of this amount was either credited or physically distributed or paid to him by the trustee in the year 1929. The “ trustee ” has since refused to make actual distribution of this sum of $13,068.09 or any part thereof, although repeated demands therefor have been made by petitioner.

Petitioner contends that the fund reserved by the trustee out of the income of the trusts for the year 1929 for the payment of the 1928 real property taxes of the trust does not and could not conceivably constitute income taxable to him; that the trustee was specifically authorized by the trust instruments to pay all taxes levied against the trust properties and was given absolute discretion in charging such taxes against the income of the trust; that the trustee became personally liable May 1,1928, for the 1928 taxes and was under a specific duty to pay them; and that no portion of the fund deducted by the trustee from the 1929 trust income to pay these taxes is taxable to petitioner because (1) it was not received or credited to him in the year 1929, and (2) he had no right in the fund reserved and could not, even by court action, have compelled the trustee to distribute to him any portion of this fund.

Respondent contends that the amount of distributable income of the trust was properly increased by the, disallowance of a reserve for local taxes, where the boobs of the trust were kept on a cash receipts and disbursements basis.

The applicable provisions of the Revenue Act of 1928 are sections 161 (a) (2) and 162 (b). Under these provisions income is taxable to the beneficiary of a trust where by the terms of the trust instrument the fiduciary is “ under an absolute ob,ligation to pay, whether he had done so or not, and whether he has credited the payments to the beneficiary or not.” Commissioner v. Stearns, 65 Fed. (2d) 371; certiorari denied, 290 U. S. 670. One of the points relied on by the petitioner, that no portion of the amount which respondent added to the income from the trust reported in his return was paid or credited to him during 1929, is not therefore decisive of the issue here presented. The test of the taxability to the beneficiary in a distributable trust is not the receipt of income, but the present right to receive it. Freuler v. Helvering, 291 U. S. 35.

Respondent’s determination that petitioner’s distributable share of the income of the trust estate should be increased by his proportionate share of the amount withheld for taxes is based upon the fact that the trustee, being on the cash receipts and disbursements basis, was not entitled in its fiduciary return for 1929 to deduct the amount set aside in that year for the payment of 1928 taxes on the trust properties which were not actually paid until 1930. While respondent was justified in disallowing this deduction to the fiduciary (see Arthur T. Galt, 31 B. T. A. 930, and cases therein cited), it does not necessarily follow that the amount disallowed may be added to the distributable income of the beneficiaries. -We do not have the trust before us in this proceeding. The “ trust ” is a taxpayer within the meaning of Title I of the Revenue Act of 1928, Anderson v. Wilson, 289 U. S. 20, affirming 60 Fed. (2d) 52, and a separate taxable person from the beneficiary, Merchants Loan & Trust Co. v. Smietanka, 255 U. S. 509.

The deductions which a trustee may take in computing its taxable income are controlled by the applicable provisions of the revenue act. In determining the income currently distributable to beneficiaries of a trust, however, we must be guided by the terms of the trust instruments. Baltzell v. Mitchell, 3 Fed. (2d) 428, 430. If they gave petitioner a present right to receive in 1929 his proportionate share of the amount set aside for taxes and the trustee was under an absolute obligation to pay it to him, this share should be included in his taxable income, although. not actually distributed to him.

One of the duties imposed on the trustee under the provisions of the trust instrument was to pay to petitioner a certain portion of the net income of the trust. Another was to pay the taxes and encumbrances out of the trust income. In the instant proceeding, we are not prepared to say that the trustee did not exercise sound judgment by withholding from the distributable income of the beneficiaries in 1929 a reasonable amount to cover taxes which became a lien on the trust properties on April 1, 1928, and for the payment of which it became personally liable as the holder of the legal title on May 1 of that year. Cahill’s Revised Statutes of Illinois (1927 and 1929), ch. 120, par. 64; City of Bangor v. Pierce, 76 Atl. 945; 106 Me. 527. The Supreme Court of Minnesota in In re Harris' Will, 212 N. W. 182, had occasion to discuss the duty of a trustee under somewhat similar circumstances, and said:

It is for the trustee not only to see to the payment of the taxes and other maintenance charges, but also, where reasonably possible, to provide in advance for their payment and take such measures as will in any event save the property against the liens which are sure to result unless current payments are met. The rights of the beneficiaries are subordinate to such charges.

It is true that the trust instruments here in controversy directed the trustee “ to pay any taxes ” and did not expressly empower it to set aside funds for such payment. A trustee may, however, adopt such measures and do such acts as are implied in the general directions contained in the trust instruments and which are proper and reasonable means for making them effectual. The mandatory duty of a trustee to pay taxes in our opinion carries with it the implied power to set aside an amount sufficient to meet their payment under such circumstances as we have in the instant case. The only restriction placed on the trustee by the trust instruments here is that the taxes must be paid out of income, and there is nothing contained therein which prohibits the trustee from providing for such payment at a future time by setting aside out of current income that which the trustee properly regards as a charge against that income on account of taxes.

Assume the petitioner had instituted suit against the trustee for the sums deducted. What court would have compelled the trustee to distribute to the beneficiaries of the trust this money which had been segregated to assure payment of the taxes constituting a lien against the trust properties and constituting a personal liability of the trustee for which it was entitled, both under the language of the trust instruments and under the established principles of trust law, to be reimbursed out of the trust properties ?

It is our conclusion that the trustee acted within the authority conferred upon it by the trust instruments when it withheld from distribution to the beneficiaries of the trust in 1929 a reasonable amount of the trust income to meet a tax liability which had accrued against the trust properties, and that petitioner had no present right in that year as a beneficiary to receive any portion of the income so withheld. Cf. Mollie Netcher Newbury, 26 B. T. A. 101. Respondent erred in determining that a portion of this income was taxable to petitioner. Cf. Luke W. McCrory, Trustee, 25 B. T. A. 994; affd., McCrory v. Commissioner, 69 Fed. (2d) 688.

In the latter case the Board held that the trust required the trustee to distribute annually the income of the trust to the beneficiaries, except that which was required to pay certain “ burdens and obligations ” of the trust, among which were certain taxes to become due, but not then exactly ascertainable. In the taxable year which we had before us the trustee did not distribute the income, but went through the form of crediting some $550,290.40 on the books of the" trust to the beneficiaries. However, the facts surrounding this so-called crediting showed that the trustee had no intention of ever distributing to the beneficiaries the amounts which would be required to pay the taxes and that as to these amounts the beneficiaries could not compel distribution. On these facts we held that the trustee was taxable as fiduciary on the amounts of money set aside to pay the taxes (which were paid in the following year), $252,332.02, and that the remainder of the amounts credited to the beneficiaries not required to pay taxes was distributable to the beneficiaries, although not actually distributed to them in the taxable year, and therefore was not taxable to the fiduciary. Our decision was affirmed in McCrory V. Commissioner, supra.

As we have already pointed out, the trustee in the instant case set aside $30,366.59 of the trust income in 1929 to pay 1928 taxes which under ordinary conditions would have been due and payable in 1929. It did not credit any of the $30,366.59 to the beneficiaries.

The stipulation shows that these 1928 taxes were actually paid by the trustee in 1930 and that the amount paid was $21,185.97 instead of the $30,366.59 which had been estimated. Following McCrory v. Commissioner, supra, it might seem logical to tax petitioner with his proportionate part of the difference between $80,366.59 estimated and $21,185.97 actually paid in 1930. However, there is this difference between the facts present in the McGrory case and in the instant case. In the McGrory case the trustee, in form at least, credited the beneficiaries with all the net income of the trust, $550,290.40, and evidenced his full intention to distribute all of this to the beneficiaries except that which was required to pay the taxes. The evidence also shows that this difference between $550,290.40 credited and the amount of the taxes paid, $252,332.02, was in fact distributed to the beneficiaries in the two following years.

In the instant case it has been stipulated that: “ No portion of the said sum of $13,068.09 was either credited or physically distributed or paid to the petitioner in the year 1929 by the ‘ trustee.’ * * * The ‘ trustee ’ has since refused to make actual distribution of the said sum of $13,068.09 or any part thereof, although repeated demands therefor have been made by the beneficiaries of the trust.” These facts, it seems to us, make a distinction between those which existed in the McGrory case and the facts we have here, and we hold that none of the reserve set aside for taxes by the trustee in the taxable year before us was distributable income to petitioner.

Reviewed by the Board.

Decision will be entered for petitioner that there is no deficiency for the year 1929.


source: Caselaw Access Project

license: Public Domain

text:
    Franklin Title & Trust Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Ben Franklin Fire Insurance Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 51947, 60167, 67804, 67805.
    Promulgated March 28, 1935.

      Elwood Hamilton, Esq., for the petitioners.

      Ha/rold D. Thomas, Esq., for the respondent.
   OPINION.

MuRdock: The following table shows the deficiencies determined by the Commissioner:

The cases were consolidated. The facts of record were stipulated. There are in controversy three issues, all of which were raised by the petitioners.

One issue relates only to the year 1930. The Franklin Bond & Mortgage Co. owned all of the capital stock of the Ben Franklin Fire Insurance Co. A consolidated return was filed for the year 1930 by certain trustees for the Franklin Bond & Mortgage Co., the Ben Franklin Fire Insurance Co., and the Franklin Title & Trust Co. This return showed that the two latter companies had net income while the mortgage company had a loss. The Commissioner held that the insurance company was taxable separately. The parties are in agreement as to the amount of its taxable income. The record does not show that the Commissioner has not taxed this insurance company under section 204 of the Revenue Act of 1928 and the parties in their argument and presentation of the case seem to assume that he has taxed it under that section. It is only reasonable to believe that he has so taxed it. The mortgage company and the trust company were subject to tax under section 13 of that act. If the insurance company was subject to the tax imposed by section 204, it can not be included in the same consolidated return with the other corporations, which were subject to the tax imposed by section 13. See sec. 141(e). Cf. Fire Companies Building Corporation, 23 B. T. A. 550; affd., 54 Fed. (2d) 488; certiorari denied, 286 U. S. 546; Travelers Indemnity Co., 31 B. T. A. 507. The sole contention of the fire insurance company is that it was in fact not an insurance company taxable under section 204, but was merely an agent for an insurance company and subject to tax under section 13.

The stipulation shows that the Ben Franklin Fire Insurance Co. was organized to insure property against loss or damage from fire and certain other causes, as well as to act as agent for other insurance companies to reinsure its risks in other companies in whole or in part, to reinsure other companies and their risks in whole or in part, to do "things which are generally done by fire insurance companies organized under the provisions of the laws of the State of Kentucky, and to do anything needed in the general carrying on of the fire insurance business. The following is quoted from paragraph 13 of the stipulation:

* * * The Ben Franklin Fire Insurance Company issued fire insurance policies, all of which were reinsured by the Insurance Company of North America of Philadelphia, Pa., and its income consisted of commissions on said policies and interest on investments. [Italics supplied.]

The fire insurance company argues that it was merely an agent, since it reinsured all of its risks; “it did not have to maintain a reserve ”; its income can not be computed under section 204; and its income can be fairly computed under section 13. The statement in the stipulation that the company issued fire insurance policies indicates quite clearly that it was an insurer and primarily liable on (he policies which it issued. It was not merely an agent for another company. Reinsurance and the payment of so-called commissions to the original insurer by the reinsurer is not unusual. There is no evidence that it was not required to maintain reserves. The argument that its income can not be computed under section 204 seems vacuous, since its income has been computed to the mutual satisfaction of the parties. Undoubtedly its income, like the income of any other corporation, could be fairly computed under section 13, but since it was an insurance company within the meaning of section 204, it is subject to tax under that section. Cf. National Capital Insurance Co. of the District of Columbia, 28 B. T. A. 1079. The Commissioner did not err in excluding from the consolidated return and taxing separately the income of the Ben Franklin Fire Insurance Co. for 1930.

Another issue is whether the Franklin Title & Trust Co. has a right to have its income tax liability for 1929 and 1930 computed upon the basis of a consolidated return in which it would be joined with the Franklin Bond & Mortgage Co. The income of the trust company would be offset by the losses of the mortgage company for these years. A corporation is defined in the revenue act to include an association, and some trusts have been held to be associations taxable as corporations. The petitioner contends that the trust created on February 1, 1925, is an association, is, therefore, a corporation within the meaning of the act, and is a “ parent corporation ” within the meaning of section 141(d). The Commissioner has held that the Franklin Title & Trust Co. was not entitled to join with any other corporation in filing a consolidated return for 1929 and 1930. He contends that the trust was not an association taxable as a corporation, therefore, it could not be the “parent corporation” and, consequently, there was no “ affiliated group.” A summary of the stipulated facts relating to this issue appears in the three paragraphs following this one.

A copy of the trust agreement is attached to the stipulation as Exhibit G. It is dated February 1, 1925. The subscribing stockholders of the Franklin Bond & Mortgage Co. (called the mortgage company) and of the Franklin Title & Trust Co. (called the trust company) stated that they were creating the trust estate for the purpose of securing closer cooperation between the mortgage company and the trust company, to further the best interests of the two companies and the stockholders therein. The subscribing stockholders were to assign whatever shares of stock they held in either or both of the companies to five named trustees, who were to hold and manage these shares as a common and indivisible trust fund for the purposes of and in accordance with the trusts provided in the instrument. When shares were thus assigned to the trustees, the latter were to issue to the assignor a “ Trustees Participation Certificate ” showing the number and kind of shares transferred to the trustees and the number of shares in the trust estate to which the assignor was entitled. The stockholders of the mortgage company were to receive two participation shares for every share of mortgage company stock assigned to the trustees. The stockholders of the trust company were to receive one participation share for each share of the trust company stock assigned to the trustees. The trustees were not to assume any liability as stockholders. The assignors were not to be relieved of liability as stockholders. The stockholders’ liability was to rest upon the participation certificate holders in the proportion which the share of each in the trust estate bore to the entire trust estate. The trustees could not sell or assign the shares which were assigned to them, except to a newly elected director of one or the other of the companies merely for the purpose of qualifying him during his directorship “ upon the request of the holders of Participation Certificates sufficient in amount to secure his election.” The trust was to continue until the death of the last survivor of the original subscribers and for 21 years thereafter, but it could be terminated on short notice by a vote of three fourths of the certificate holders. Three of the five trustees were designated by the mortgage company stockholders and two by the trust company stockholders. The following, in regard to appointment of trustees, is from paragraph II of the trust instrument:

•Those persons who shall at the time constitute the Stockholders of the Mortgage Company, may, at any time, by a writing signed by a majority of them and filed with the Trustees, remove any of the Trustees designated by the Mortgage Company Stockholders; in like manner, those persons who shall at the time constitute the Stockholders of the Trust Company, may, at any time, by a writing signed by a majority of them and filed with the Trustees, remove any of the Trustees designated by the Trust Company Stockholders; provided, however, that such power shall not be exercised within sixty days prior to the annual meetings of the Stockholders of the Mortgage Company and the Trust Company.
Upon the death, removal, resignation, or refusal to act of any Trustee, or if, from any cause, there should be a vacancy in the position of any Trustee, the Trustees shall immediately elect as a successor that person who shall be designated by a writing signed by a majority of those persons who shall at the time, constitute the Stockholders of the Mortgage Company or of the Trust Company, as the case may be, to the end that there shall always be three Trustees appointed on behalf of the Mortgage Company Stockholders, and two Trustees appointed on behalf of the Trust Company Stockholders.

Paragraph IY is entitled “Terms of Trust” and includes the following:

* * * They [the trustees] shall have the right and it shall be their duty, subject only to the limitations herein prescribed, to exercise, in the interest of the holders of Trustee’s Participation Certificates, all the powers of management and control over the Mortgage Company and the Trust Company incident to the ownership of the stock transferred to them hereunder. This shall include all corporate functions of shareholders, for any corporate purpose whatever, and shall especially authorize the Trustees to exercise all voting rights and rights of ownership over said stock in the election of directors, or in the discharge of any other corporate function.
Provided, however, that the owner of record on the books of the Trustees, of any Trustee’s Participation Certificate, shall have the right, by written directions to the Trustees, given at least five (6) days before the vote is to be cast, to instruct them how they shall vote, in corporate meetings of either the Mortgage Company or the Trust Company, such proportionate number of shares therein owned by the Trustees as the number of shares represented by the Certificate owned by such person may bear to the total number of shares represented by outstanding Trustee’s Participation Certificates.

Paragraph YII is as follows:

DISTRIBUTION OB' DIVIDENDS
The Trustees shall have the right to deposit with the Trust Company any dividends which they shall receive upon the stock of either or both of said institutions, with directions to the institution in which the deposit is made as to the distribution thereof among the holders of Trustees’ Participation Certificates. The making of such deposit and giving of such direction shall relieve the Trustees of all further responsibility for such dividends.

The par value of the capital stock outstanding during the years 1928, 1929, and 1930 was $400,000 for the mortgage company and $200,000 for the trust company. Over 95 percent of the stock of each company was assigned to the trustees and was held by them during 1928, 1929, and 1930. The trustees acted during these years in accordance with the trust agreement. “ The Trustees received income from dividends on stock of the two Companies held by them during each of the years here involved in the amount of $79,512.00, and disbursed the same to the holders of the Trustees Participation Certificates.”

The mortgage company and the trust company had filed a consolidated return for 1928. The trust company, the mortgage company, and the Ben Franklin Fire Insurance Co. filed a consolidated income tax return for 1929 on March 13,1930. The “ Trustees under agreement dated February 1, 1925” filed a consolidated return for themselves, the mortgage company, the trust company, and the Ben Franklin Fire Insurance Co. as an affiliated group for 1929 on or about June 4, 1931. The items of income and deductions disclosed by the two returns for 1929 were the same, except that in the second return the amount of $79,512 was reported as dividends received from the trust company and the mortgage company, and a deduction for the same amount was taken. The Commissioner held that the taxpayers did not constitute an affiliated group and refused to compute the tax on the basis of a consolidated return. He determined a deficiency in income taxes against the trust company for the year 1929. The “ Trustees under agreement dated February 1, 1925 ” on March 4, 1931, filed a consolidated income tax return for 1930 for themselves, the trust company, the mortgage company, and the insurance company as an affiliated group. The respondent held that the taxpayers did not constitute an affiliated group and refused to compute the tax on the basis of a consolidated return. He determined a deficiency in income tax against the trust company for 1930.

The contention of the trust company, on its point that it and the mortgage company belonged to an affiliated group during 1929 and 1930, and were entitled to join in a consolidated return for those years, falls completely if the trust created by the instrument dated February 1, 1925, was not an association taxable as a corporation. Not all trusts are to be treated as associations and taxed as corporations. See Supplement E, Revenue Act of 1928, where trusts are taxed as trusts. A trust taxable under the provisions of Supplement E certainly can not be the “parent corporation” of an affiliated group under section 141 (d). Cf. Roger Morris Realties, Inc., 27 B. T. A. 924. A number of cases have been cited by the trust company to show under what circumstances a trust is considered an association taxable as a corporation. It cites Hecht v. Malley, 265 U. S. 144, in which the Court said that where trustees do not merely collect funds and pay them over, “but are associated together in much the same manner as the directors in a corporation for the purpose of carrying on business enterprises, the trusts are to be deemed associations * * Other cases are cited in which the courts and the Board have attempted to state the test to be applied in determining whether a trust is or is not an association. The trust company argues that the trustees under this trust instrument were not merely acting as fiduciaries to collect dividends and disburse them among stockholders, but under quasi-corporate form and in the manner of a corporation were organized to carry on a business and were actually engaged in carrying on a business enterprise during the years here involved. Cf. Investment Trust of Mutual Investment Co., 27 B. T. A. 1322; affd., 71 Fed. (2d) 1009; art. 1314, Regulations 74. If this were true the trust would be an association under the decisions cited. It is true that the stockholders of the two separate companies threw their stockholdings into a common pool which formed the trust estate and were given participation certificates in the trust. In this respect the trust bore some resemblance to a corporation. Cf. Myers, Long & Co., 14 B. T. A. 460. However, there is little further similarity between the form of this trust and the form of a corporation or between the manner in which this trust functioned and the manner in which a corporation functions. Cf. Jackson-Wermich Trust, 24 B. T. A. 150.

There is a more important circumstance which alone is fatal to the contention of the trust company — this trust was not organized for the purpose of carrying on a business and, during the taxable years, it did not carry on a business, as distinguished from the normal activities of a mere fiduciary. See, for importance of “ business ” test, Twin Bell Oil Syndicate v. Helvering, 70 Fed. (2d) 402, affirming on this point 26 B. T. A. 172; Tyson v. Commissioner, 68 Fed. (2d) 584; certiorari denied, 292 U. S. 657; Monrovia Oil Co., 28 B. T. A. 335. The mortgage company had its own officers and its own board of directors. Thus equipped, it carried on its own business. The same is true of the trust company. The trustees did not “ carry on the business ” of either of these corporations in any sense of the words quoted. Their rights were derived from the stockholders and were no greater than the rights of stockholders. Indeed, they were not as great as the rights of stockholders, since the stockholders retained certain of their rights, including some relating to election of directors, allowed the trustees to exercise only a part of their rights, and even retained the power to recall some of the privileges thus granted. The trust company relies upon the provision of the trust instrument that the trustees, subject to certain limitations, shall have “ powers of management and control over the mortgage company and the trust company incident to the ownership of the stock transferred to them hereunder.” But a stockholder, as such, has no power to directly manage or control a corporation, and carries on no business. The same is true of these trustees. This trust is a limited voting trust. The trustees, with certain important exceptions, were permitted to vote the stock according to their own best judgment. They were to receive and disburse such dividends as were declared and paid by the two companies. The trustees were not carrying on a business in the sense necessary to constitute them an association taxable as a corporation. Cf. Hecht v. Malley, supra; Dunbar v. Commissioner, 65 Fed. (2d) 447. The trust was not a “ parent corporation ” and the trust company and the mortgage company did not belong to an affiliated group during 1929 and 1930.

The conclusion reached above from the reasoning employed makes it unnecessary to consider whether or not a trust taxable as an association could in any event be a parent corporation, whether or not this particular trust “ owns directly ” the stock of the mortgage company and the trust company as required by section 141 (d) (2), or whether there was an election to file a consolidated return for 1929.

The above decision of the second issue eliminates from the third issue all question of the right of the mortgage company to deduct commissions paid by it in 1929 and 1930 in connection with the sale of its bonds. It is not a petitioner here, and, since it is not entitled to join in a consolidated return with the trust company for those years, obviously its income and deductions can not affect the tax liability of the trust company. The third issue, thus narrowed, is divisible into two questions. One is whether the amount of commissions which the trust company paid to salesmen for selling the mortgage notes which it had secured from mortgagors was deductible in its entirety in the year in which the sales were made and the commissions paid, as the trust company contends, instead of being deductible pro rata over a five-year period as determined by the Commissioner. The other is whether the commissions paid by the mortgage company in 1928 in connection with the issuance of its own bonds are deductible in their entirety in that year instead of being deductible pro rata over a five-year period as determined by the Commissioner. The stipulated facts relating to the first question in this issue have been briefly summarized in the three paragraphs following this one.

The trust company during the years 1928,1929, and 1930 was regularly engaged in carrying on the business of making mortgage loans on real estate in Kentucky and Texas and selling the mortgage notes thus obtained. These loans were for terms ranging from 60 to 180 months and were evidenced by notes of the borrower and secured by mortgages of the borrower. Each loan called for payment of monthly installments by the borrower. Each mortgagor on Kentucky mortgages, at the time he gave the notes and mortgages, agreed by written contract to pay the trust company an amount equal to 1 percent per annum on the monthly balances due on the notes and mortgages. The total of the contract payments payable over the period for which the loan was made was set up on the books of the trust company as accrued income at the time the loan was made. The loans on property in Texas were payable in 63 months. At the time such a loan was made, the mortgagor agreed by written contract to pay the trust company an amount equal to 3 percent on the monthly balances. The total of these contract payments over the period for which the loan was made was set up on the books of the trust company as accrued income at the time each loan was made. The trust company collected from the mortgagor the principal, 6 percent interest, and the contract payments as they fell due, and redeemed at maturity the notes executed by the mortgagor. All of the mortgage notes received by the trust company in connection with the above loans were sold to the public, with the payment of principal and interest at 6 percent guaranteed by the trust company and the mortgage company. The money received from the sale of the notes was used to make new loans, which in turn were handled in the same way. The trust company kept its books on an accrual basis.

The trust company, in selling the notes which it obtained from mortgagors, paid commissions to various agents, some of whom were its employees. The net amount of these commissions in each year was as follows :

1928_$8,803.53
1929 _ 9, 796.00
1930_10,169.01

The amount thus paid in each year represented an ordinary and necessary expense of carrying on the business of the trust company. The trust company, in each of the respective years, claimed as a deduction the amount paid in that year as commissions. This was in accordance with its bookkeeping method. The Commissioner disallowed the deduction claimed for each year and allowed instead a lesser amount which he explained was amortization of cost of bond issue charged to income over the life of bonds.

The following table shows the amount of notes sold, the amount of loans made, the total gross income, and commissions earned on loans during the three taxable years here involved:

The trust company rightly contends that the amount which it paid in each year as commissions on the sale of mortgage notes was an ordinary and necessary expense paid during that taxable year in carrying on its business within the meaning of section 23 (a) of the Eevenue Act of 1928. Apparently the parties were under some misapprehension as to just what these commissions were paid for until they came to write the stipulation of facts. The allegations in the petitions describe the commissions as commissions on collateral trust bonds, and the explanations in the deficiency notices indicate that the Commissioner disallowed the deductions believing that they represented commissions paid upon the issuance by the trust company of its own collateral trust bonds. The parties have now stipulated that the commissions were on the sale of mortgage notes which the trust company had obtained from mortgagors; nevertheless, the respondent still contends that the trust company is not entitled to the deductions. He argues that he correctly spread the deduction for the commissions over a five-year period. He relies upon decisions of the Board, such as Bonded Mortgage Co. of Baltimore, 27 B. T. A. 965, and cases therein cited on the second point decided, which actually involved discount, commissions, or similar items paid by taxpayers in connection with the issuance of their own bonds. The Board held in those cases that the discount and commissions should be deducted ratably over the definite period of years during which the bonds would be outstanding, because the taxpayer would benefit from the expenditures during all of this period and should not be allowed to offset the expenditures against the income of the single year in which the bonds were issued. The facts in the present case are quite different and the cases cited are not in point. The trust company issued no bonds. It negotiated mortgage loans and, as promptly as possible, sold the mortgage notes which it had thus obtained. It properly accrued, at the time of making each loan, the commission which it was entitled to receive under its contract with the mortgagor, although it would actually receive those commissions over a period of years. Bonded Mortgage Co. of Baltimore, supra; affirmed on this point, 70 Fed. (2d) 341. The sale of the mortgage notes was unlike the issuance of bonds and there would be no reason to spread the commission paid in connection with the sale of the mortgage notes over any period of years. Furthermore, since the petitioner was regularly engaged in the business of making such loans and selling the notes, there is in section 23 (a) statutory authority for the deduction of the commissions in the year in which they were paid. Cf. Bonded Mortgage Co. of Baltimore v. Commissioner, 70 Fed. (2d) 341, reversing on this point Bonded Mortgage Co. of Baltimore, supra; United States v. Anderson, 269 U. S. 422; American National Co. v. United States, 274 U. S. 99; United States v. Mitchell, 271 U. S. 9.

The stipulated facts relating to the second question in the third issue are summarized in this paragraph. The mortgage company was incorporated in 1924 and was regularly engaged in carrying on the business of making mortgage loans on real estate. These loans were payable in 62 equal monthly installments and a final payment of the balance due on principal and interest, which was not always equal to the prior monthly payments. The loans were secured by mortgages and notes which bore interest at 6 percent. The notes were known as first lien notes. Each mortgagor, at the time he received a loan, also executed a subordinate lien note and thereby agreed to pay the mortgage company an amount equal to 3 percent per annum of the face value of the first lien notes. This amount was to be paid in 28 monthly payments during the first 28 months of the loan. The mortgage company kept its books and made its income tax reports on an accrual basis. It accrued as income at the time of making a loan the total amount of the subordinate lien note. The mortgage company deposited with a trustee United States bonds and treasury certificates, cash, and the first lien notes which it received on its mortgages guaranteed as to principal and interest by the Maryland Casualty Co. The mortgage company issued and sold to the public its 6 percent “ first mortgage collateral trust gold bonds ” which were guaranteed by the title company as to the payment of principal and interest and were secured by the collateral deposited with the trustee. These bonds “ were due at various times ranging from one to fifteen years ” and “ a fair average of the due date thereof is five years.” The mortgage company collected from the mortgagors the monthly payments to be made under the first lien notes and the subordinate lien notes. In case of default, the trustee could foreclose and apply the proceeds first to satisfy the first lien notes and next to satisfy the subordinate lien notes. The mortgage company had “ the right to make substitutions for the collateral originally assigned to and deposited with the trustee; to increase or decrease the amount of the collateral, and the amount of the Bonds outstanding at any time, provided always that the aggregate principal amount of Bonds outstanding shall not exceed the aggregate principal amount of collateral held by the trustee to secure the payment thereof.” The bonds were subject to redemption at any interest payment date at 101 and accrued interest. The mortgage company sold its bonds and the money received therefrom was used to make new loans which, in turn, were handled in the same way. In selling the bonds, it paid commissions to various agents, some of whom were its employees. The mortgage company paid annual premiums to the Maryland Casualty Co. for insuring the collateral trust bonds, trustees’ fees, and certain bondholders’ taxes, including the Federal income tax withheld at the source. The following table shows the amount of bonds sold, the amount of loans made, the total gross income, the commissions earned on loans, and the commissions paid in the sale of its bonds:

The Commissioner has computed the tax liability of the title company and the mortgage' company for 1928 on the basis of a consolidated return. The mortgage company reported a loss of $171,-871.34 on that return. The Commissioner added to income as shown on the return $521.79 representing the disallowance of a deduction for insurance premiums on officers’ lives, and $163,616.02 representing commissions on loans which he held represented income in the year the loans were made. The petitioner has not contested the Commissioner’s treatment of these two items. The Commissioner also disallowed a deduction of $80,227.89 because, as the cost of issuing bonds during the year, it represented a deferred charge to income over the life of the bonds, and allowed instead a deduction of one fifth of that amount as amortization of cost of bonds issued in 1928. He determined the net income of the mortgage company for 1928 to be $56,448.78. The entire deficiency in tax was allocated to the title company in accordance with an agreement between the two companies.

The commissions paid on the sale of the mortgage company’s bonds in 1928 could be properly accrued and accounted for in more than one way. True income could be clearly reflected by any one of several methods of accrual if that method were adhered to consistently. The Commissioner concedes that the item is deductible at some time, and the only question is whether the Commissioner’s action in spreading the expense over a five-year period and allowing the deduction of only one fifth in 1928 must be reversed and the entire amount allowed as a deduction in 1928. A taxpayer borrowing money by issuing its bonds only occasionally could clearly reflect its income only by prorating the expense of each issue over the life of the issue. Helvering v. Union Pacific Railroad Co., 293 U. S. 282; Chicago, Rode Island & Pacific Railway Co., 13 B. T. A. 988; affirmed on this point, 47 Fed. (2d) 990; certiorari denied, 284 U. S. 618; Kansas City Southern Railway Co., 22 B. T. A. 949, 966; affirmed and reversed on other points in 75 Fed. (2d) 786; Liberty Farms Co., 22 B. T. A. 1298. However, a taxpayer issuing its bonds frequently and regularly in the ordinary course of its business, provided its business is the making of mortgage loans having a life commensurate with the life of its bonds, could not only clearly reflect its income by prorating the expenses of each bond issue over the life of those particular bonds, but might also clearly reflect its income if it regularly and consistently treated the expense of issuing its bonds as an expense of the year in which the bonds were sold.

The revenue acts provided, as a general rule, that net income shall. be computed “ in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income.” Sec. 42, Revenue Act of 1928. A taxpayer which has chosen an accrual method of accounting must be allowed some latitude in the application of that method in accounting for its own particular business. The Board, like the courts, will not weigh to a nicety the relative merits of accounting systems. Brown v. Helvering, 291 U. S. 193. If a taxpayer has selected a method of accounting which clearly reflects the income of its business, and if it regularly employs that method, there is no justification for either the taxpayer or the Commissioner departing from that method in the computation of income tax, even though the departure may have some slight tendency to reflect income more clearly. Had the record disclosed more completely the details of the accounting method employed by the mortgage company and the details of the various bond issues which it made, decision could have been reached on more satisfactory grounds. However, the case must be decided upon the record as made, and that record is sufficient to swing the scales slightly in the petitioner’s favor.

The parties have stipulated that the mortgage company kept its books on an accrual basis. This must mean that it was regular and consistent in this respect. But we still do. not know exactly how it treated the commissions on the sale of its bonds, that is whether it accrued them and charged them all against income of the year 1928 or whether it accrued them and charged them off over some longer or different period. The commissions on mortgage loans were accrued as income at the time the loans were made. Yet they were not reported as income on the return for 1928. It is difficult to tell, under such circumstances, exactly what the taxpayer’s regular system of accounting was. However, we conclude from a consideration of the entire record that the mortgage company regularly accrued on its books the entire amount of commissions on the sale of its bonds at the time the bonds were sold and charged this item against income of that particular year, which income included the commissions accrued in that year on all mortgage loans made during the year. Such a method would clearly reflect the mortgage company’s income for 1928 and the Commissioner had no right to depart from it in determining the deficiency. His action in adding the commissions accrued to income for 1928 was correct, because in that respect he adjusted the return to correspond with the bookkeeping method.

The principal business of the mortgage company in 1928 was to borrow money on its bonds at some expense to itself and promptly to lend that money out on mortgage loans at a profit. In a sense it was dealing in money as a commodity. This process of borrowing and lending was a continuous one. Most of the money loaned was obtained from the sale of bonds. The average life of the bonds was substantially equivalent to the life of the mortgages, and the interest rate on each was the same. The amount borrowed within each year was only slightly less than the amount loaned during that year. It can not be said that the mortgage company’s bookkeeping method, in which both the commissions on bonds sold and the commissions on loans made were accrued as expense and income, respectively, at the time of the particular transactions, fails clearly to reflect the income of its business for Federal income tax purposes. The two kinds of commissions were sufficiently closely related in this particular business during that year to justify similar treatment on the books of account. It is immaterial here that they might be properly accounted for in other ways. The mortgage company treated them in this particular'way and the Commissioner had no right to change the method thus regularly employed.

Bonded Mortgage Co. of Baltimore, 27 B. T. A. 965, did not present quite as strong a case for the petitioner as this one. Furthermore, our decision in that case has been reversed. Bonded Mortgage Co. of Baltimore v. Commissioner, 70 Fed. (2d) 341. Although the court was influenced by much the same considerations which influence us here, it may have been unduly impressed with the necessity of treating both sides of the ledger in the same way. In the absence of close relationship between borrowings and lend-ings, as for example in the case where bonds having a life of 15 years were issued and the money thus obtained was loaned on mortgages having a life of 3 years, we would be unable to agree that there would be any inconsistency in spreading the cost of the bonds and at the same time taking into income of each year the entire amount of commissions on loans made during that year. But here the expenses of issuing the bonds in 1928 were deductible in that year in their entirety as an ordinary and necessary expense of the mortgage company’s business under section 23 (a) of the Revenue Act of 1928.

Decision will Toe entered for the respondent in Doohet No. 67804, o/nd in the other three dochet numbers decisions will be entered wnder Rule SO.

       (d) Definition of “affiliated group”. — As used in this section an “affiliated group” means one or more chains of corporations connected through stock ownership with a common parent corporation if—
      (1) At least 95 per centum of the stock of each of the corporations (except the common parent corporation) is owned directly by one or more of the other corporations; and
      (2) The common parent corporation owns directly at least 95 per centum of the stock of at least one of the other corporations. * * *

       SEC. 23. deductions FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:
      (a) Empernes. — 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; * * *


author: Arundell: SterNhageN,

text:
    Dudley T. Humphrey, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 64376.
    Promulgated March 28, 1935.

      Alex M. Hamburg, Esq., for the petitioner.

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

Arundell:

This proceeding is to test the correctness of respondent’s determination of a deficiency in income tax in the amount of $12,749.93 for the calendar year 1929. The deficiency arises primarily from respondent’s action in determining the profits on the sale by petitioner of his interest in a partnership. Petitioner alleges as error the increase of his net income in the sum of $70,000, representing the face value of three nonnegotiable notes received in connection with the sale, and the failure of the respondent to tax the profit from the sale as a capital gain. The third error alleged is the inclusion in income of the sales price of certain American and Foreign Power stock without an allowance of petitioner’s cost. No evidence was offered on this third point, and as to it we must sustain the respondent.

In February 1926 the partnership of Waterman & Co. was formed, with offices at Albany, New York, and the partnership immediately entered into the business of buying and selling securities. Petitioner had approximately a one-ninth interest in the capital and the profits of the partnership. The other partners were W. Y. A. Waterman, S. E. Yail, and Alida L. Waterman, the latter being a limited partner.

On February 1,1929, an agreement was entered into between petitioner, as party of the first part, and W. Y. A. Waterman, S. E. Yail, and Alida L. Waterman, as parties of the second part, wherein it is recited that petitioner is withdrawing from the partnership, that his interest in the partnership on January 31, 1929, amounted to the sum of $142,626.99, that he transfers and assigns unto the parties of the second part “ all his right, title and interest in the aforesaid limited copartnership and in the good will thereof ” in consideration of $72,626.99 in cash and the balance:

* * * by notes of the parties of the second part, bearing date this first day of February, 1920, and maturing on the first day of February, 1930, bearing interest at five per cent per annum which notes shall be non-negotiable in form and to be executed for the following amounts by the following parties of the second part respectively, viz: a note for Fourteen thousand dollars ($14,000.) executed by William V. A. Waterman, a note for Twenty-eight thousand dollars ($28,000.) executed by Sheldon E. Vail, and a note for Twenty-eight thousand dollars ($28,000.) executed by Alida L. Waterman. The receipt of said cash and notes is hereby acknowledged by the party of the first part.

The agreement was carried out and petitioner received the cash and the three nonnegotiable promissory notes described in the agreement. These notes were duly paid on February 1, 1930, when they fell due, and petitioner included the sum received in his income tax return for 1930.

It is petitioner’s position that, being on the cash receipts and disbursements basis, the nonnegotiable notes should not be included in his income for the year 1929. The notes were unsecured and were received by petitioner as evidence of the indebtedness due him and not in satisfaction of this indebtedness. The testimony is that the notes had no fair market value. In John B. Atkins, 9 B. T. A. 140, we said: “ * * * in the case of one reporting income on the cash receipts and disbursements basis only cash or its equivalent constitutes income.” A mere promise to pay in the future which is not accepted in payment, but only as an evidence of indebtedness, is not ordinarily the equivalent of cash. Taxation, as the courts many times have said, is eminently practical; and in determining taxable income wre must view obligations for future payments from a practical point of view. As stated by Judge Learned Hand in Bedell v. Commissioner, 30 Fed. (2d) 622, 624:

If a company sells out its plant for a negotiable bond issue payable in the future, the profit may be determined by the present market value of the bond's. But if land or a chattel is sold, and title passes merely upon a promise to pay money at some future date, to speak of the promise as property exchanged for the title, appears to us a strained use of language when calculating profits under the income tax. * * * It is absurd to speak of a promise to pay a sum in the future as having a “ market value ”, fair or unfair. Such rights are sold, if at all only by seeking out a purchaser and higgling with him on the basis of the particular transaction.

In our opinion it was error to include the three nonnegotiable notes in petitioner’s income for the year 1929.

The next matter in issue is whether the gain realized in 1929 on the sale of petitioner’s interest in the partnership was capital gain or ordinary income. Petitioner’s view is that, having owned an interest in the partnership more than two years, it was a capital asset and the gain realized was a capital gain. Bespondent’s argument against this is based on the theory that a partner’s interest in the partnership consists of a joint ownership with the other partners of the partnership assets. The assets in this case consisted of securities held by the partnership primarily for sale; hence, respondent argues, they were not capital assets.

There are expressions in the cases to the effect that a partner “ is a joint owner of the firm assets ”, Harris v. Commissioner, 39 Fed. (2d) 546, affirming 11 B. T. A. 871; indeed, the New York statutes provide that: “ A partner is a co-owner with his partner of specific partnership property holding as a tenant in partnership.” These, however, are only general expressions and a further reading discloses that a partner’s rights in partnership property are severely limited. Under section 51 of the New York partnership law a partner “has an equal right with his partner to possess partnership property for partnership purposes; but he has no right to possess such property for any other purpose without the consent of his partners.” That section further provides:

A partner’s right in specific partnership property is not assignable except in connection with the assignment of the rights of all the partners in the same property.

Section 51 provides:

A partner’s interest in the partnership is his share of the profits and surplus and the same is personal property.

In Henry Wilson, 16 B. T. A. 1280, at page 1287, we said:

It is a well recognized principle that the title to partnership property is not in the individual members of the firm so that either may assign or transfer to another an undivided share in any specific articles, but it is in the firm as an entirety, subject to the right of the partners to have it applied to the payment of the debts of the firm and the equities of the partners.

In Helvering v. Walbridge, 70 Fed. (2d) 683, it is pointed out that even under the common law the portion of the property of which a partner was regarded as owner was nevertheless an asset of the firm; “he could not withdraw it; he had no effective power over it, and therefore no interest in it, save as it might figure in his share of the profits and surplus.” Further, “ * * * the legal interest of a partner as joint owner has long since lost most of its legal incidents.” See also Edward B. Archbald, 27 B. T. A. 837; affd., 70 Fed. (2d) 720. In Blodgett v. Silberman, 277 U. S. 1, a partner’s interest is described as follows:

A partner has a right equal to that of his partners to possess specific partnership property for partnership purposes, but not otherwise. His right in specific partnership property is not assignable, nor is it subject to attachment or execution upon a personal claim against him; upon his death the right to the specific property vests not in the partner’s personal representative but in the surviving partner; his right in specific property is not subject to dower, curtesy, or allowance to widows, heirs or next of kin.

In the case just cited the partnership interest before the Court was that of a general partner in a limited partnership, and such was the interest of this petitioner in Waterman & Co. The Court in that case concluded that “ the interest of the partner was the right to receive a sum of money equal to his share of the net value of the partnership after a settlement, and this right to his share is a debt owing to him, a chose in action, and an intangible.”

Now, applying the above holdings to the present case, it would appear that what petitioner sold to his partners was an intangible consisting of his right to a share in the net value of the partnership after settlement of its affairs. He had no interest in the assets of the partnership as such; consequently, what he sold was not a portion of or an interest in the partnership securities. His interest in the partnership was separate and distinct from his coownership of the partnership assets and the length of time of his ownership of the partnership interest is not measurable by the period of time that the partnership had owned the securities on hand at the time he sold his interest. He had owned his interest more than two years and in our opinion it constituted a capital asset in his hands.

Reviewed by the Board.

Decision will be entered under Buie 50.

SterNhageN,

dissenting: I find it impossible to adopt the view that an amount received by an individual from his erstwhile partners in consideration for his retirement from the partnership and for his interest therein includes a “ gain from the sale or exchange of capital assets ”, as required by the Revenue Act of 1928, section 101 (c) (1), such “ capital assets ” being defined in subdivision (8) as “ property held by the taxpayer for more than two years.” I agree that the nonnegotiable notes do not involve income for 1929, and I agree that the partner may not be regarded as selling the specific assets of the partnership and that the duration of his property holding is not to be taken as that of the partnership’s holding, although it is interesting that the $142,626.99 which he was to receive upon retirement was, as shown by the evidence, computed entirely upon the market value of the assets on the date of retirement. But it seems to me an empty formula of words that an interest in a partnership is itself property and that to end it for cash is there! ore a sale of property, irrespective of its relation to the partnership assets. Surely if one, say a lawyer, has been a member of a service partnership for 10 years and quits for a cash consideration, the transaction would hardly be called per se a sale or exchange of property held more than two years. Yet this seems to me to decide as much. That “ sale or exchange ” is not to be loosely applied is indicated by John H. Watson, Jr., 27 B. T. A. 468, and Arthur E. Braun, Trustee, 29 B. T. A. 1161, 1177, in which the amount received upon the termination of an obligation was held not derived from a sale or exchange of the obligation. Likewise the amount received upon the termination of a partnership should, in my opinion, also be excluded unless there is evidence of a sale or exchange.

McMahoN agrees with this dissent.


author: Seawell :

text:
    J. Paul Blundon, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 74546.
    Promulgated March 28, 1935.

      Meredith M. Davibin, Esq., for the petitioner.

      Philip M. Ciarle, Esq., and Stanley B. Pierson, Esq., for the respondent.
   OPINION.

Seawell :

The petitioner claims that the income he received from the cities of Huntington and Charleston is exempt from taxation on the ground that it represents compensation paid to him as an employee of the municipalities in connection with the exercise of an essential governmental function. The respondent’s contention is that the petitioner was an independent contractor.

In Metcalf & Eddy v. Mitchell, 269 U. S. 514, the taxpayers, consulting engineers, were employed by states and subdivisions thereof to give advice respecting proposed water supply and sewage disposal systems. They took no oath of office and were free to accept other concurrent employment; their employment was not of a continuous or permanent nature. In holding that Metcalf and Eddy were independent contractors, not employees, the Court said:

* * * The record does not reveal to what extent, if at all, their services were subject to the direction or control of the public boards or officers engaging them. In each instance the performance of their contract involved the use of judgment and discretion on their part and they were required to use their best professional skill to bring about the desired result. This permitted to them liberty of action which excludes the idea that control or right of control by the employed which characterizes the relation of employer and employee and differentiates the employee or servant from the independent contractor. * * *

The petitioner cites Burnet v. Livezey, 48 Fed. (2d) 159, as a case having facts differing from those here only in the professions of the taxpayers. There are other, and distinguishing, facts. Livezey gave the work for which he was engaged preference over his private law practice; he was not employed for a specific case and his salary was for a specified amount a year and not, as here, regulated by the amount of work he did.

The case of Underwood v. Commissioner, 56 Fed. (2d) 67, decided by the same Circuit Court of Appeals, contains facts similar to those here. In that case Underwood, an architect, was employed by the State of North Carolina to devote all of his time to public construction work, and as compensation for his services received amounts based upon the cost of the projects. He maintained an office force to assist him carry out his duties and paid his business expenses out of the compensation he received from the state. In holding that Underwood was not an employee of the state, but an independent contractor, the court pointed out that his services were not different from those ordinarily performed by an architect and engineer, and that while he complied with directions of the joint building committee of the state as to the kind of construction to undertake, he brought about desired results by his own methods.

We do not think the respondent committed error in holding that the petitioner was an independent contractor and that the compensation he received from the cities of Huntington and Charleston was not immune from income tax. Metcalf & Eddy v. Mitchell, supra; Underwood v. Commissioner, supra; John Reid, Jr., 28 B. T. A. 1217; Edward M. Lynch, 30 B. T. A. 727; Commissioner v. Modjeski, 75 Fed. (2d) 468.

In support of his second allegation of error the petitioner alleged in his petition that in connection with a sale of certain stock in 1929 at a profit, the amount of which he reported as taxable income in 1929, he agreed to pay to the purchaser the amount of any liabilities of the corporation not shown on its balance sheet, and that in 1931 he paid the sum of $102.5,4 on account of such obligation. These allegations of fact were denied by the respondent in his answer. At the field hearing counsel for the petitioner offered in evidence the revenue agent’s report on the petitioner’s income tax liability for 1931 “ merely to show the incident action by the Revenue Office pertaining to the Bureau’s 60-day letter.” After counsel for the respondent admitted that the report formed the basis for the deficiency notice, the parties agreed to the introduction of the report “ solely as showing the basis used by the Commissioner in determining the deficiency here at issue.” Nothing further was offered by either party on the question.

In addition to the facts alleged in the petition, the revenue agent’s report contains statements that the petitioner sold the stock for cash and a note, that the petitioner received payment of the note in 1931 and that the petitioner paid his liability by accepting from the purchaser of the stock an amount $702.54 less than the principal sum of the note, plus interest. On brief counsel for the petitioner asks us to find as to the issue facts based altogether on statements appearing in the revenue agent’s report. The respondent, on the other hand, requests us to sustain his disallowance of the claimed loss deduction because of the petitioner’s failure to prove any facts on the issue.

This difference of opinion as to the probative value of the revenue agent’s report came to light during our consideration of the proceeding after its submission. We thereupon issued and entered an order to the effect that in the event the parties could not agree upon the facts relating to the issue the proceeding would be restored to the calendar to allow the introduction of evidence on the question. The parties were unable to reach an agreement as to the facts. At the further hearing had for the purpose of establishing the facts of the question, neither party offered any evidence on the issue, counsel for the petitioner stating that the amount of tax involved did not justify incurring the expense of producing a witness to testify to the facts.

The respondent’s finding that no loss was sustained in the taxable year is presumed to be correct and the burden of proving error is on the petitioner. Burnet v. Houston, 283 U. S. 223; Welch v. Helvering, 290 U. S. 111.

Reports of revenue agents are not competent proof of the facts stated therein in the absence of an agreement to that effect. Hunter Coal Co., 2 B. T. A. 828; Georgiana McFetridge, 9 B. T. A. 759. Here tbe report is in the record merely for the purpose of showing the basis for the respondent’s determination, not as proof of the facts appearing in the document. There being nothing in evidence from which any facts can be found on the issue, there is no alternative but to sustain the respondent.

Decision will ~be entered for the respondent.


text:
    Algernon S. Schafer, Petitioner, v. Commissioner of Internal Revenue, Respondent. Edward Schafer, Petitioner, v. Commissioner of Internal Revenue, Respondent. Leonard Schafer, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 72370, 72373, 72374.
    Promulgated March 28, 1935.

      Eugene Untermyer, Esq., for the petitioner.

      B. IF. Wilson, Esq., for the respondent.
   OPINION.

Leech: The respondent has determined that, as to the securities carried in the so-called “ Error Account ”, the Schafer Bros, partnership was not, during 1929, a “ dealer in securities ” within the meaning of article 105, Regulations 74, promulgated by the explicit authority of section 22 (c) of the Revenue Act of 1928, and was not entitled, under that statute and regulation, to inventory, at market, its securities carried in that account in computing its income tax for that year. The first issue here involves only the question of whether, upon this record, that determination shall be reversed.

That regulation has been approved as a reasonable application of the statute. Northeastern Surety Co., 29 B. T. A. 297; Oil Shares, Inc., 29 B. T. A. 664. Since respondent’s disputed determination was the result of the exercise of an administrative discretion definitely committed to him by statute, difficult as it may be to evaluate presumptions for practical comparison, petitioners’ burden in overcoming that determination is undoubtedly heavier than that of overthrowing the general presumption of correctness arising upon all determinations of tax liability by respondent. Alfred E. Hamill, 30 B. T. A. 955; Albert Fried, 31 B. T. A. 638; Frederic H. Brendle, 31 B. T. A. 1188.

There can be no doubt that an individual, partnership, or corporation may engage, at the same time, in more than one distinct branch of business activities, and that one of those may be that of “ dealer in securities.” Cf. Harriman National Bank v. Commissioner, 43 Fed. (2d) 950. These separate activities may even all have to do with the purchase and sale of securities, but not all be those of a “ dealer in securities.” James B. Lowell, 30 B. T. A. 1297; Northeastern Surety Co., supra; Frederic H. Brendle, supra. However, the purpose of the statute and the quoted regulation was to provide a means for the correct reflection of income resulting from a definitely limited character of business. Obviously, this purpose would not be furthered by permitting the use of this privileged method of tax computation to income from business activities which are not within the controlling regulation in question. The fact that a taxpayer may be a statutory dealer in securities as to some of its activities, does not, alone, entitle him to return income from its other and different activities, computed by that privileged method.

This record does not disclose that the activities of the Schafer Bros, firm, reflected in the “ Error Account ”, were essential to its business as a “ dealer in securities.” The ratio of those activities to the entire partnership business is not shown. However, it does appear that those activities were quite substantial. Certainly, at least, in such circumstances, the partnership is entitled to inventory only those securities purchased in its business or branch of business of dealing in securities as defined by the regulation. That regulation, itself, provides for such a segregation and different treatment for tax purposes of the income from separate branches of a business. Cf. Harriman National Bank v. Commissioner, supra.

The testimony in these proceedings is very clear and positive as to the purpose and character of the transactions covering the securities carried in the “ Error Account.” • During the year 1929, the partnership purchased those securities through orders executed by Leonard Schafer, or other brokers on any exchange on which the desired securities were listed. If the market price went up, those securities were sold through the execution of orders given to Leonard Schafer or other brokers. The identity of the purchasers of such securities was not known to the members of the partnership. The purchase and sale of securities in the “ Error Account ” had no relation to the partnership’s customers’ accounts or connection with the execution of orders given by its regular customers. They were purchased solely in expectation of a rise in the market, for the partnership’s own account for resale, to any buyer, at a profit.

The meaning of “ dealer in securities ”, as defined in the controlling regulation, has been considered many times by the courts, and this Board. It is limited to one who, as a merchant, buys and sells securities for customers for the profit thereon.

It is unnecessary here to attempt an abstract description of what this definition includes, since it is clear that the transactions of the partnership, recorded in the “ Error Account ”, were not within its boundaries.

Thus, except for customers in the sense that any speculator must have someone to whom he sells, which is not sufficient to bring the partnership within the regulation, it is not shown that as to the securities carried in the “ Error Account ”, the partnership had customers — an essential requisite of the controlling definition. Albert Friedl, supra. The stocks in dispute were purchased for the firm’s own account solely in expectation of a rise in the market, for sale to anyone at a profit, “ as distinguished from a purchase to create a stock of securities to take care of future buying orders in excess of selling orders.” Frederic H. Brendle, supra. So far as this record discloses, as to this branch of the partnership business, it was apparently a speculator and not a “ dealer ” within the regulation. Adirondack Securities Corporation, 23 B. T. A. 61; Oil Shares, Inc., supra.

It is contended for petitioners further that, inasmuch as the partnership has followed the practice of inventorying its securities at market in determining its income, since 1925, it should be permitted, as a matter of course, to follow the same practice for the year 1929, here involved. Important as is the evidence of such prior practice of the partnership (Alfred. E. Hamill, supra), it cannot be and is not controlling here, since we are concerned directly with only the year 1929. Even if the relevant facts pertaining to the securities carried in the “ Error Account ” in those prior years were similar to the facts appearing here as to 1929, and the respondent approved the partnership’s return of income therefrom as a “ dealer in securities ”, that approval certainly does not constitute more than a determination for those earlier years. It does not foreclose a change in such determination as to 1929. To do so would permit the perpetuation of an error, a result not only repugnant to common sense, but certainly not within the clear intent of the statute. Cf. Smith Paper Co., 31 B. T. A. 28; W. C. Mitchell Co., 27 B. T. A. 645.

Petitioners argue also that the partnership used the inventory method in reporting income for 1929. There was oral testimony to that effect. But the partnership return for that year, admitted in evidence as such, without objection, does not corroborate that contention. Nothing appears in that return after the titles “ Inventory at beginning of year ” and “ Less inventory at end of year.” Nor does the record disclose that either in that return or attached thereto was there a description of the method or basis upon which the questioned accounts of the partnership were kept. This is also fatal to the inventory privilege for the partnership. William W. Vaughan, 31 B. T. A. 548.

In any event, petitioners have not sustained their burden of establishing error in respondent’s determination that the partnership of Schafer Bros, was not a “ dealer in securities ” in reference to the “ Error Account ” within the meaning of the regulation. Nor have they shown its compliance with the conditions, provided in that regulation, precedent to the right to inventory securities carried in that account in determining income for the year 1929.

As to the second issue, involving the deductibility of certain alleged bad debts, the facts are insufficient to support a reasonable determination that the debts actually became worthless during 1929. The record indicates that the debts became worthless at the time the loans were made. Their deduction in computing taxable income for 1929 was properly denied. Eckert v. Burnet, 283 U. S. 140; Avery v. Commissioner, 22 Fed. (2d) 6; Paul Pryibil, 31 B. T. A. 164; J. Edgar Davidson et al., Executors, 26 B. T. A. 754.

The respondent’s determination is approved.

Reviewed by the Board.

Decision will be entered for resfondent.

       Akt. 105. Inventories by dealers m securities. — A dealer in securities, who in his books of account regularly inventories unsold securities on hand either—

        (а) At cost;
      (б) At cost or market, whichever is lower; or
      (c) At market value,
      may make his return upon the basis upon which his accounts are kept; provided that a description of the method employed shall be included in or attached to the return, that all the securities must be inventoried by the same method, and that such method must be adhered to in subsequent years, unless another be authorized by the Commissioner. Eor the purpose of this rule a dealer in securities is a merchant of securities, whether an individual, partnership, or corporation, with an established place of business, regularly engaged in the purchase of securities and their resale to customers; that is, one who as a merchant buys securities and sells them to customers with a view to the gains and profits that may be derived therefrom. If such business is simply a branch of the activities carried on by such person, the securities inventoried as here provided may include only those held) for purposes of resale and not for investment. Taxpayers who buy and sell or hold securities for investment or speculation and not in the course of an established business, and officers of corporations and members of partnerships who in their individual capacities buy and sell securities, are not dealers in securities within the meaning of this rule.

         (e) Inventories. — Whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.