author: Van Fossan:

text:
    Annie Stevens Woodruff, Petitioner, v. Commissioner of Internal Revenue, Respondent. Stevens Woodruff, Petitioner, v. Commissioner of Internal Revenue, Respondent. John Owen III, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 79784, 79785, 79786.
    Promulgated October 6, 1938.

      John M. Hudson, Esq., for the petitioners.

      W. H. Payne, Esq., for the respondent.
   OPINION.

Van Fossan:

These proceedings were brought to redetermine deficiencies for the year 1932, found by the respondent, as follows:

Annie Stevens Woodruff_$1,260. 95
Stevens Woodruff- 792.07
John Owen III_ 382.19

The sole question at issue is whether or not the petitioners sustained deductible losses in 1932 upon the dissolution of a limited partnership in which they had been special partners.

Under an ancillary issue, the right of the petitioner Annie Stevens Woodruff to a one-half interest in the share of her son, Stevens Wood-ruff, in the partnerships was conceded by the respondent.

The facts were stipulated substantially as follows:

The petitioners are individuals and reside in Detroit and Grosse Pointe, Michigan.

Under articles of agreement entered into as of June 15, 1929, there was organized under sections 9885 et seq. of the Compiled Laws of Michigan, 1929, a limited partnership under the name and style of “Crouse and Company,” hereinafter called the Old Co., with Charles B. Crouse and Harry W. Kerr as general partners and Stevens Woodruff and John Owen III as special partners. The partnership was organized for the purpose of conducting and carrying on a general stock and bond brokerage and underwriting business.

In accordance with the terms of the agreement, petitioners Stevens Woodruff and John Owen III, as special partners, contributed $50,000 each, in cash, to the partnership capital. The special partners were entitled to interest upon their respective contributions at the rate of 6 percent per annum and, in addition, 5 percent of the annual net earnings of the partnership after the payment of all expenses. Upon the termination of the partnership, the special partners were entitled, after the payment of all debts, to the return of their respective capital contributions before any distribution should be made to the general partners and, in the event the capital of the partnership at the date of termination should be less than the aggregate contribution of the special partners, they were entitled to their respective portions of the aggregate capital. The management and control of the business was in the hands of the general partners, and the petitioners, Stevens Woodruff and John Owen III, as special partners, had no voice and did not participate in the control and management of the affairs of the partnership. The Old Co. was to continue until June 15, 1934.

By an act of the Legislature of the State of Michigan, approved May 18,1931, being Act No. 110 of the Public Acts of Michigan for 1931 and known as the Uniform Limited Partnership Act, to authorize the Formation of Limited Partnerships and for other purposes, chapter 33 of B. S. 1846 was repealed except as to certain existing partnerships, and the provisions for the organization of limited partnerships were reenacted.

All partners, general and special, desired to take in Philip K. Watson as a general partner. They did not consider the move feasible under the provisions of the old statute governing limited partnerships. Through losses the capital of the Old Co. was reduced below.the aggregate contribution of the special partners. All partners of the Old Co. and also Philip K. Watson desired to take advantage of the provisions of the new statute. To accomplish that purpose and to permit the business and affairs of the Old Co. to be carried on without interruption and without unfavorable publicity, the “technical dissolution” of the Old Co. was effected.

In January 1932 the assets of the Old Co., shown in the following table, exclusive of good will, had a gross value of $18,939.31 and a net value of $17,073.06 (petitioners’ counsel at the hearing limited the amount of loss claimed to $80,000) :

Cash on hand_$1,137.53
Accounts receivable- 1,914.38
Stocks at market_ 2,900. 00
The beneficial interest in two memberships upon Detroit Stock
Exchange _ 7,000.00
Furniture and fixtures- 2,150.00
Prepaid Fidelity insurance- 958.28
Prepaid life insurance- 493.11
Commissions receivable- 650.00
Stamps _ 51.01
Cash surrender value of life insurance- 1,685.00
18,939.31
Less liabilities:
Insurance note-$986. 25
Fidelity insurance account- 600. 00
Accrued rent- 150.00
Accrued Stock'Exchange expense- 130.00
- 1,866.25
Net assets-17,073. 06

By agreement dated January 26, 1932, but effective as of January 15, 1982, the Old Co., by mutual agreement of all the partners, was dissolved and the affairs of the Old Co. were taken over by the New Co., hereinafter described, organized simultaneously with the dissolution of the Old Co., and notice of dissolution was duly given and published.

By articles of agreement entered into as of January 15,1932, a new partnership was organized in accordance with the new Uniform Limited Partnership Act under the name of “Crouse & Company,” hereinafter called the New Co., with Charles B. Crouse, Harry W. Kerr, and Philip K. Watson as general partners and Stevens Wood-ruff and John Owen III as limited partners.

In the agreement dissolving the Old Co. it was recited that the New Co. was to be organized with Stevens Woodruff and John Owen III as limited partners and that the New Co. was willing to accept as the capital contributions of the limited partners thereto all of the assets of the Old Co. to which the special partners, upon the termination of the Old Co., were entitled. It was further recited that all the parties desired to avoid the necessity of transferring the assets of the Old Co. to the special partners and thereafter having the special partners retransfer them to the New Co. It was thereupon agreed that the Old Co. was dissolved and all the net assets of the Old Co., exclusive of good will, were the property, share and share alike, of the special partners, Stevens Woodruff and John Owen III. The special partners, by the terms of the agreement, directed the Old Co. to convey and transfer all of its net assets, exclusive of good will, to the New Co. to represent the special partners’ contributions as limited partners of the New Co. to the partnership capital of that company. In accordance with that agreement the Old Co. transferred and conveyed all its net assets, exclusive of good will, to the New Co.

Under the articles of agreement, dated as of January 15, 1932, creating the New Co., it was recited that “all of the net assets are as a matter of law the property of the special partners of the Old Company” and that the Old Co. was transferring all such assets to the New Co. “as the nominee of the special partners of the Old Company * * *.” It was provided that the capital contributions of the limited partners, Stevens Woodruff and John Owen III, in cash and other assets, were shown in the schedule annexed to the agreement and that for the purposes of the agreement the limited partners should be regarded as having contributed to the capital, of the partnership the sum of $10,000 each. The agreement and schedule “B” annexed thereto also provide that the capital contributions of the general partners to the new partnership should be as follows:

Charles R. Crouse, $15, 000
Representing good will in the firm of Crouse & Company, a Limited Partnership, organized as of June 15, 1929;
Harry W. Kerr, 5,000
Representing good will in the firm of Crouse & Company, a Limited Partnership, organized as of June 15, 1929;
Philip K. Watson,
In cash 10, 000
30,000

Under the new agreement, the limited partners were entitled to interest at the rate of 6 percent on their respective capital contributions as agreed upon. In addition it was provided that the net profits, as therein defined, should be distributed to the limited partners as follows: 8 percent of the first $10,000 net profits, 12 percent of the second $10,000 net profits, and 16 percent of the balance of such net profits. All the remaining net profits were distributable to the general partners. The limited partners were prohibited from participating in the control or management of the partnership business and were not liable for any loss suffered by the partnership beyond their respective contributions, nor were they personally responsible for the debts or losses of the company.

Under the terms of the agreement, dated as of January 15, 1932, the new partnership was to continue to January 15, 1937. On or prior to that date, by mutual agreement of all the partners, general and limited, the partnership was continued under the existing articles of agreement for a period of six months, or until July 15, 1937.

In the notices of deficiency sent to the petitioners Stevens Wood-ruff and John Owen III appears the following statement:

Upon tlie dissolution of the old partnership on January "15, 1932, you received one-half of the assets based upon an appraisal and revaluation of the assets. On the same date, the new partnership was organized and the assets received from the old company were turned over to the new company for an interest in that business.

The petitioners contend, in the first instance, that they liquidated their interests in the Old Co. which cost them $100,000, for assets having a net value of $17,073.06 and that the difference between these figures represents their loss sustained by reason of the transaction. In the alternative, they argue that if such liquidation should be held not to result in a deductible loss, then upon the transfer of those assets to the New Co. for $20,000 they sustained a loss measured by the difference between the cost of the assets to them, or $100,000, and $20,000, the capital value of their limited partnership interests in the New Co.

The respondent’s position is that the petitioners sustained no deductible loss whatever, either through the liquidation of the Old Co. or upon the transfer of the physical assets of the Old Co. to the New Co. He urges that there was a “distribution in kind” of the assets, thereby bringing the cases within the prohibition found in article 604 of Regulations 77. He also asserts that the assets were not in reality received and transferred by the petitioners to the New Co. and argues that recitals to that effect were merely a “recognition” of their contractual rights. This, contention, it will be noted, is squarely at variance with his finding in the notices of deficiency wherein he held that they “received” the assets. Respondent does not question that the petitioners entered into the transaction for profit nor is any question raised as to the value of the assets.

In approaching the questions here involved and the possible application of respondent’s argument thereto, it is advisable to bear in mind that we are here dealing with special or limited partners. They made aggregate cash contributions of $100,000 to the old partnership. By the terms of their contract they were limited to 6 percent returns on their investment and a 5 percent share in net profits. Upon dissolution they were limited to a return of their investment and, if the assets were less than this amount, then to their respective portions of the aggregate capital on hand (excluding good will). On dissolution they received assets of an aggregate value of $17,073.06. These assets were, by agreement and solely for convenience, transferred directly by the old partnership to the new partnership as the nominee of the special partners. By contract it was agreed that such assets should be accepted by the new partnership as the contributions of tbe special partners at a value of $20,000. The rights of the special partners in the new partnership were limited to 6 percent on their investment, plus fixed percentages of the new profits, if any.

Bespondent based the notices of deficiency on the conclusion and alternatively contends that no loss is recognizable because of the prohibition contained in section 112 (b) (1) of the Bevenue Act of 1932. He states that “the exchange by Woodruff and Owen of their limited partnership interests in the Old Co. for limited partnership interests in the New Co. constituted an exchange of property” within the purview of that section. He predicates his argument on the assumption that there was a complete continuity and identity of assets and their ownership throughout the entire series of transactions.

We find the facts to be to the contrary. Subsection (b) is entitled “Exchanges solely in kind.” The petitioners acquired the ownership of certain specific assets through the dissolution of the Old Co. They then proceeded to exchange those assets for undivided interests in the New Co. — an entirely different kind of property. The “interest” of the petitioners in the Old Co. had been extinguished by its dissolution through the operation of the contract and therefore no longer existed as a comparable to an analogous interest which they may have acquired in the New Co.

The assets were owned outright by the petitioners, who were not engaged as individuals in the same business as Crouse & Co. Their contribution of those assets to the New Co. was in the same category as the payment of any money or other property valuable to its business.

The respondent stresses the fact that the assets of the Old Co. were transferred by that company directly to the New Co. and deduces therefrom that the assets never were received by the petitioners and, hence, not owned by them and exchanged by them for limited partnership interests in the New Co.

As above noted, this contention is contrary to his finding on which the notices of deficiency are based. The statement attached to the notices of deficiency recites that petitioners received the assets. Furthermore, the recitals in the agreement of January 15, 1932, were not only declarative of the rights of the petitioners to the physical assets of the Old Co. — they admitted the petitioners’ present ownership of such assets apon the dissolution of the Old Co. and recognized the proposed procedure of having them transferred directly to the new owners. By special direction of the petitioners, and for legitimate business reasons, the New Co. was substituted for themselves as transferee of the assets. To show the absolute ownership and right of possession of the petitioners, nothing further is needed than paragraph 2 of the covenants of the agreement of January 15, 1932, in which all the parties agreed that “all of the net assets of the Old Company, exclusive of good will, are the property, share and share alike, of the Special Partners.”

It is a legal principle, too familiar to require citation, that property may be transferred to a nominee of the contractual recipient in the process of fulfilling the terms of the contract. That procedure was adopted in these cases.

Respondent also contends that there was a distribution in kind of the assets of the old partnership and consequently the loss can not be allowed under article 604 of Regulations 77. Assuming respondent’s premise that there was a distribution in kind, we do not agree that the deduction of the loss suffered by the special partners is barred by the regulations. It is to be noted that the general tenor of the regulation is to recognize gains and losses on the dissolution of partnerships. It is the exceptional case rather than the rule where there will not be such recognition. If a real loss is sustained the regulation contemplates recognition. On the question of fact as to loss there can be no doubt. Petitioners had sustained actual losses. Moreover, article 604 deals with partnerships generally and does not purport to define the rights of special or limited partners. The interests of the petitioners were not those of general partners. They were in the nature of fixed or limited investments. They had no general participation in profits and losses. Their rights on dissolution were similarly limited by contract to the amount of their contribution. These rights are very different from the rights of general partners. We do not believe the present cases come within the prohibitive provision of the regulation. Rather, it fits the general concept that realized losses are deductible.

In Helvering v. Walbridge, 70 Fed. (2d) 683, the validity of this provision of article 604 was questioned, the court speaking through Learned Hand, J., characterizing the provision that no gain was realized until the property distributed was sold as “a provision of doubtful validity except perhaps in cases where the dividend did not itself have any ‘fair market value’.” We have no hesitation in saying that, were article 604 to be so construed as to bar the losses here claimed, the unreasonableness of the regulation and its consequent invalidity would be amply demonstrated. The losses are real. The amount is fixed. If the loss be denied at this time, it would seem beyond dispute that petitioners will never get the benefit of its deduction. By their contract the special partners have fixed the value of their contribution to the new partnership at $10,000 each. In the event of dissolution of that concern, by their contract their recovery would be limited to that amount and the fixed amount of the contribution would be the limit of any loss. That the respondent would permit them at that date to deduct the losses now in question is beyond the scope of imagination.

Petitioners at the hearing limited the amount claimed as losses to an aggregate of $80,000. The deduction by the petitioners of appropriate shares of this sum is approved.

Reviewed by the Board.

Decisions will be entered under Bule 50.

TueNer and Disney concur only in the result.

       Aet. 604. Readjustment of partnership interests. — Wñen a partner retires JErom a partnership, or it is dissolved, he realizes a gain or loss measured by the difference between the price received for his interest and the cost to him of his interest in the partnership, including in such cost the amount of his share in any undistributed partnership net income earned since he became a partner on which the income tax has been paid. However, if such interest in the partnership was acquired prior to March 1, 1913, both the cost as hereinbefore provided and the value of such interest as of such date, plus the amount of his share in any undistributed partnership net income earned since February 28, 1913, on which the income tax has been paid, shall be ascertained, and the gain derived or the loss sustained shall be computed as provided in article 561. If the partnership distributes its assets in hind and not in cash, the partner realizes no gain or loss until he disposes of the property received in liquidation. Whenever a new partner is admitted to a partnership, or any existing partnership is reorganized, the facts as to such change or reorganization should he fully set forth in the next return of income, in order that the Commissioner may determine whether any gain or loss has been realized by any partner.

       SEC. 112. RECOGNITION OE GAIN OR LOSS.
      (a) General Rdle. — upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.
      (b) Exchanges Solely in Kind.—
      (1) Peopeety held foe PEODUCTIVE use oe investment. — No gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale, nor stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest) is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment.


source: Caselaw Access Project

author: OppeR :

license: Public Domain

text:
    Sallie Cosby Wright, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88943.
    Promulgated October 7, 1938.

      O. H. Tufts, G. P. A., and F. G. Davidson, Jr., Esq., for the petitioner.

      John H. Pigg, Esq., for the respondent.
   OPINION.

OppeR :

The question on which the parties are at issue is whether that part of petitioner’s income which is the subject of the deficiency was an annuity or the income from a trust fund. The facts are peculiar. Petitioner, who had a qualified life interest in the trust left by decedent so long as she should occupy decedent’s homestead as her own home and had the right at any time to terminate the trust prior to her death, entered into an agreement with the remaindermen, the President and Fellows of Harvard College, to terminate the trust forthwith in consideration of the latter’s agreement to pay her during her lifetime two-thirds of the net income from the property so obtained. Respondent contends that the relationship thus created was in the nature of a trust and that the income received by petitioner as the beneficiary thereof is taxable to her under the trust provisions of the Eevenue Acts of 1932 and 1934. Petitioner takes the position that she purchased an annuity and that there is no deficiency, since she included in her income tax returns such amounts as the annuity provisions of the respective revenue acts required. Petitioner’s position is further, as stated in her brief, that “we maintain as an alternative proposition that if the ‘memorandum of agreement’, dated April 30, 1932, did not constitute the purchase of an annuity by the petitioner, then it created a trust for the benefit of the petitioner to the extent of two-thirds of the income therefrom.”

The precedent most nearly in point seems to be Annie Louise Van Aken, 35 B. T. A. 151. In that proceeding the widow of decedent released to the owners of the remaining interest her dower right in decedent’s real property, in consideration of their agreement to pay her certain sums during her lifetime. We held that the widow was taxable as the beneficiary of a trust upon the payments received by her under the agreement. In Robert Roe Estate Co., 32 B. T. A. 903, the facts were somewhat similar. There we held that such payments were not properly deductible by the owners of the property in determining their net income but were capital items representing expenditures incurred in the acquisition of capital assets. At first glance the cases are not readily distinguishable, but the Van Alten case, supra, rests upon the doctrine that “a trust exists where the legal title is in one person and the equitable or beneficial interest in another.” (P. 159.) In characterizing the relationship created by the agreement between the widow and the owners of the property we said there, “all of these provisions * * * strongly support respondent’s contention that, under the agreement, petitioner transferred only the legal title to the trustee, reserving the beneficial interest in the property or right to receive the income for life.” (P. 158.) The Roe case is reconciled by reference to the language of the court which affirmed it on appeal, that there “ ‘the promise was not to pay her one-third of the profits in kind, to say nothing of giving her any right in the land itself; it was general and created a general obligation’”, as distinguished from the Van Alcen case where “the widow did not exchange her dower interest for the promise of the testamentary trustee to pay ‘an amount equal to’ one-half of the net operating income; she transferred the legal title on condition that the trustee should account for and pay over to her each month one-half of the net operating income derived from the dower lands.” (P. 160.) A reading of the entire opinion makes it clear that it was not any special form of words and particularly any such narrow distinction as that between the profits themselves and an amount equal to the profits which was regarded as justifying the Van Alcen decision, but rather an examination of the agreement as a whole and the conclusion that in the Van Alcen case the relationship was essentially fiduciary. Indeed, the opinion itself states that “it has been said many times that no particular form of words is required to create a trust.” (P. 159.)

In the Hoe case, supra, the question arose as to the income of the grantee, and the transaction is discussed from the standpoint of what it received, namely, an interest in real property which the widow had formerly owned for her life. Thus, the opinion states: “The annual payments to the widow were in fulfillment of the contractual obligation assumed by the petitioner and we consider them to be a part of the purchase price which the petitioner paid for the property which it acquired.” (P. 908.) Here, we think it impossible to say that the petitioner in any sense transferred property or an interest therein. Once petitioner terminated the trust any interest in the property obtained by the remaindermen was the result of the provisions of the will. The consideration to petitioner thus approximates payment for a service rendered, in the form of an agreement of the remaindermen to hold the property in trust for petitioner’s benefit.

But be that as it may, we regard the Van Alcen case as deciding that in such a case as this the relationship between the parties is to be viewed as a whole; and since there that relationship appeared to be essentially of a fiduciary nature, income received by the beneficiary was taxable to her. Our analysis of the arrangement here leads us to the same conclusion. We do not base this result on any single provision, but some of the terms of the agreement which we consider significant may be briefly mentioned. The remaindermen agree that they will “during the lifetime of” the petitioner “hold the principal as the ‘William J. and Georgiamia B. Wright Fund’ provided for in the said will, but invested separately.” They agree that they “will pay to the” petitioner “for and during her life a sum equivalent to two-thirds of the net income arising from the fund so held.” They undertake that “the principal shall be kept invested by” them. They reserve the privilege of investment “without obligation to observe the usual requirements for fiduciary investments.” They agree that if the real estate is sold the net proceeds of any such sale “shall be a part of the principal of said funds.” They provide for “making the ⅜ * * charges and expenses customarily charged to income”, and they agree that they will furnish “a quarterly statement of income account, and annually will render” to the petitioner “a statement of capital account and investments of the fund.” Such provisions, and the agreement as a whole, lead to our conclusion that petitioner was in effect the beneficiary of a trust, and taxable as such.

Petitioner cites the case of Continental Illinois Bank & Trust Co. v. Blair (1930), 45 Fed.- (2d) 345. As we view that decision, it is inconsistent with our determination in this proceeding. But we regard it as having in effect been overruled by the Supreme Court’s decision in Helvering v. Butterworth (1933), 290 U. S. 365, for the cases on which it is based were expressly disapproved in the Butterworth opinion. Michael Fay et al., Executors, 34 B. T. A. 662.

Since respondent now concedes that petitioner, being taxable as the beneficiary of a trust, is consequently entitled to deduction for dividends received by the trustee and included in the income paid to her, no issue remains on this question. With that exception respondent’s determination is sustained.

Decision will be entered under Bule 50.

       Sees. 161 (a) (2) and 162 (b).

       Sec. 22 (b) (2), Revenues Acts of 1932 and 1934.

         Warner v. Walsh (3920), 15 Fed. (20) 307 ; United, States v. Bolster (1928), 20 Fed. (2d) 760; Allen v. Brandeis (1928), 29 Fed. (2d) 363.

       Revenue Acts oí 1932 and 1934, secs. 25 (a) (1) and 163 (b).


author: MuRdock :

text:
    Robert McCarthy Bullington and Bessie B. Bullington, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89806.
    Promulgated October 7, 1938.

      Abram P. Staples, Esq., for the petitioners.

      J. W. Smith, Esq., for the respondent.
   OPINION.

MuRdock :

The parties have stipulated that A. B. C. is an agency of the state. The petitioner was an officer of the state. He concedes that the conduct of the state stores and all activities incidental to the merchandising done by A. B. C. was a proprietary function rather than an essential governmental function. But he contends that all other functions of A. B. C. were essential governmental functions involving an exercise of the police power of the state, including not only important administrative powers but also judicial and legislative powers, the kind of powers which none but the sovereign state could exercise.

It is well settled, as the petitioner concedes, that the sale of liquor by a state is not the exercise of an essential governmental function and does not relieve the salaries of officers engaged in the work from Federal income tax. South Carolina v. United States, 199 U. S. 437; Ohio v. Helvering, 292 U. S. 360; Helvering v. Powers, 293 U. S. 214; Helvering v. Gerhardt, 304 U. S. 405. The liquor business conducted by A. B. C. was not merely incidental to its regulatory functions, as the petitioner contends. It was an important part of the work of A. B. C. It accounted for a large part of the personnel of the organization and for a large part of the revenue produced. It occupied a substantial part of the time of the board members. If those board members had been employed and paid separately for their work in connection with this proprietary business, their salaries would have been subject to income tax. Their compensation for that work can not escape tax merely because it is an undisclosed part of their total compensation for that work and also for other work in connection with an essential governmental function. The petitioner has not cited any authority to the contrary. The case of Powers v. Commissioner, 68 Fed. (2d) 634, cited by the petitioner, was reversed, 293 U. S. 214, supra.

The Supreme Court has repeatedly held, however, that those agencies through which the states immediately and directly exercise their sovereign powers are indispensable to the continued existence of the state and are of necessity immune from the taxing power of the Federal Government. Metcalf & Eddy v. Mitchell, 269 U. S. 514; Board of Trustees v. United States, 289 U. S. 48. Furthermore, the immunity seems to extend to the salaries of state officers engaged in the exercise of such essential governmental functions, even though a limitation may arise in the case of compensation of some others where no real direct burden is placed upon the state by the incidence of the tax. Collector v. Day, 11 Wall. 113; New York, ex rel. Rogers v. Graves, 299 U. S. 401; Bobbins v. Commissioners of Erie County, 41 U. S. 435; Helvering v. Gerhardt, supra. Cf. Willcuts v. Bunn, 282 U. S. 216. The exercise of the police power is an essential governmental function. Ambrosini v. United States, 187 U. S 1; Ohio v. Helvering, supra.

A. B. C. exercised an essential traditional governmental function in regulating and controlling the liquor business as carried on by others in the state. The salary received by the petitioner for his services in that connection is immune from Federal income tax.

Thus a part of the petitioner’s salary is subject to the tax, while the remainder is immune. It is important that a part be taxed and it is equally important that a part be left untaxed. The question is, How much is immune? The respondent in his brief concedes that an allocation would be proper, provided the evidence shows how much of the total compensation should be allocated for proprietary and how much for governmental services. It has been said that practical considerations are extremely important in the field of taxation and that the Board must make a reasonable determination where some approximation is necessary. Cohan v. Commissioner, 89 Fed. (2d) 540; Helvering v. Taylor, 293 TJ. S. 507. This seems to be such a case. The petitioner made the best approximation within his ability when he said that his time was divided upon about a four to one basis. One-fifth of his salary may therefore be included in his taxable income.

Reviewed by the Board.

Decision will be entered wnder Rule 50.

Disney concurs only in the result.

Arundell, Sternhagen, Smith, Black, Turner, and Opper, dissent.


author: Disney:

text:
    Portland Oil Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81705.
    Promulgated October 7, 1938.

      John T. Noonan, Esq., for the petitioner.

      B. P. Uerbzog, Esq., for the respondent.
   OPINION.

Disney:

In order to dispose of the questions here presented, it is necessary first to determine whether the obligation of the Continental Oil Co. to pay $1,650,000, which was exchanged for corporate stock and securities of the petitioner, was an installment obligation under section 44 of the Eevenue Act of 1928. Petitioner argues that it was not, that tbe sale of oil leases in 1929 by the Bu-Vi-Bar Petroleum Corporation was a transaction of sale fully taxable in that year, that the contract had a fair market value at that time of its principal amount, that full profit was recognized upon the sale in 1929, and that therefore the basis of the contract to taxpayer was the principal amount of the contract when acquired in 1929 by the Bu-Vi-Bar Petroleum Corporation.

Assuming, without deciding, that the contract with Continental Oil Co. (providing for no initial payments in 1929 — and none being made in that year) would not be the basis of an installment obligation if completed in 1929, but would give petitioner a basis of the fair market value of the contract at that time, we must nevertheless decide which is the taxable year when the contract is completed, for if therein there are partial payments, the statute is obviously satisfied. The contract with the Continental Oil Co. was in consideration of payment and performance of certain “covenants and agreements to be kept and performed” by the parties, including payment of taxes, delivery of abstracts of title disclosing merchantable title free of liens and encumbrances, examination of such abstracts and correction or perfection within a reasonable time of defects found, payment of expenses of development and operation to January 1, 1930, including cost of certain tested items of equipment, and adjustment of inventory of personal property. The contract further provided for delivery of assignments to a named trustee, to be held until completion of payment and only then delivered. The stipulation recites that the assignments were delivered to the Continental Oil Co. on December 17, 1929, and Buell testified that they were so delivered. Obviously, such a delivery prior to payment would have been contrary to the contract. It seems probable that the intent of the stipulation and testimony was that delivery was to the trustee in accordance with the contract; however, it is possible that the statements are literally correct, and we will so assume and find. Such delivery of assignments of itself, however, does not show a completed transaction in 1929 between the contracting parties. The other conditions above described may or may not have been completed in that year. Moreover, Buell specifically testified that the contract was effective as of January 1, 1930, that Bu-Vi-Bar operated the property until January 1, and turned the property over as of 7 a. m., January 1, had physical control until that time, that the operation continued until then under the contract, and that they delivered possession on January 1. Considering these facts, the treatment of the obligation by Bu-Vi-Bar as an installment matter, and the burden upon petitioner to demonstrate that the transaction was completed in 1929, we are unable so to find. Lucas v. North Texas Lumber Co., 281 U. S. 11; and. Helen Beatrice (Duveen) Crocker et al., Executors, 28 B. T. A. 132, 141.

Moreover, sections 113 (a) (7) and 113 (a) (8) of the Kevenue Act of 1928, if applicable at all, provide that the basis (of the obligation from the Continental Oil Co.) “shall be the same as it would be in the hands of the transferor * * *” (increased or decreased as hereinafter discussed). The Bu-Vi-Bar Petroleum Corporation, the original owner of the obligation, had an election as to whether to return it for tax purposes as an installment obligation. It so elected and returned the obligation on an installment basis and paid taxes accordingly. It does not appear that it ever amended such return or asked a basis dilferent than under the installment obligation theory. The law as to installment obligation gave the Bu-Vi-Bar Petroleum Corporation a certain basis. Under the above language of section 113 (a) (7) and (8) of the statute, the basis provided by the installment obligation is the basis of the petitioner. Wot-hers, Inc., 26 B. T. A. 322. We therefore conclude, both upon the factual showing made and the application of the statute, that it has not been shown that the obligation of the Continental Oil Co. was taxable in the year 1929, and conclude that it was an installment obligation as reported by Bu-Vi-Bar in 1930.

Is the petitioner, then, entitled, for income tax purposes, to a “stepped-up” basis for an installment obligation acquired by it in return for its stock and bonds in a nontaxable exchange? The factual situation may be epitomized as follows: A corporation owned an installment obligation upon which it had reported and paid income tax upon installments received during one year. The two sole stockholders of the corporation furnished, one to his wife, and the other to his wife and daughter, as gifts, money with which to purchase stock and securities in a new corporation (the petitioner). Pursuant to a plan primarily to minimize income taxes upon the receipt of the balance of the installment obligation, the first corporation exchanged the installment obligation to the new corporation for slightly less than 80 percent of its stock and securities (bonds) about three weeks after the wives and daughter had purchased, with the money furnished them, all (except qualifying shares) of the then authorized stock, which was slightly more than 20 percent of the stock and securities of the new corporation, after increase of capital stock and amount of securities. The stock and bonds acquired by the old corporation and the wives and daughter, were substantially in proportion to the property transferred (including the cash contributed by the two wives and the daughter). The old corporation was then dissolved and the stock and bonds received by it from the new corporation distributed in liquidation to the two stockholders of the old corporation. Both the old corporation and its stockholders reported no income therefrom, and none was asserted by respondent.

Although earlier contending that the stock and securities purchased by the wives and daughter with cash furnished by the husbands, tb.6 stockholders of the old corporation, were controlled by the husbands, the respondent apparently has abandoned that theory, and there seems no issue now between the parties in that regard. At any rate, in view of the conclusion reached by us, it is immaterial whether there was such control. We assume the reality and validity of the gifts to the wives and daughter.

The questions then arising are: (1) Whether the acquisition of stock and securities in the new corporation for cash by the wives and daughter, and by exchange of the installment obligation of the old corporation, constitute a single transaction so that more than 80 per cent control of the property remained in the transferors under section 113 (a) (7) of the Kevenue Act of 1928 and whether under section 113 (a) (8), together with section 112 (b) (5) of the same act, the new corporation was controlled by the transferors, so that the basis of the property, the installment obligation, would be the same in the hands of the new corporation as in the hands of the old; and (2) whether in case of such control by the transferors, the fact that the property transferred was an installment obligation gives it an increased base under section 44 (d) of the Revenue Act of 1928.

That the transfers herein involved were in connection with a reorganization can hardly be doubted. Both the old corporation and its stockholders and the respondent treated the matters as constituting reorganization, with no recognition of gain or loss. The old corporation was merged in the new, its sole and only property passing to the new corporation. The “Plan of reorganization”, approved and adopted by both corporations, expressly provided that Bu-Vi-Bar “merge and consolidate” with petitioner by transferring to petitioner its sole asset, the Continental Oil Co. contract. A similar situation was treated as reorganization in Bickford's, Inc. v. Helvering, 98 Fed. (2d) 568, and section 113 (a) (7) of the Kevenue Act of 1928 applied. The cash with which the wives of the two stockholders and the daughter acquired stock and bonds in the new corporation constituted property within the purview of section 113 (a) (7). Halliburton v. Commissioner, 78 Fed. (2d) 265; and Claude Neon Lights, Inc., 35 B. T. A. 424-. Therefore, although the daughter and the two wives had acquired slightly more than 20 percent of the bonds and stock of the new corporation, property was conveyed by the transferors as a whole, including Bu-Vi-Bar Petroleum Corporation, for more than 80 percent control of the new corporation. Is the acquisition of stock and securities in the new corporation by the old corporation, the wives and daughter, to be considered a single transaction? The question as to whether the transfers constitute one transaction is one of fact. Helvering v. Ward, 79 Fed. (2d) 381; Commissioner v. Harris, 92 Fed. (2d) 374. That the avoidance of taxes was the prime object of the whole transaction, and gifts to wives and daughter and reorganization of business secondary, appears throughout the record. The attorney for Buell and Herndon told them that the gifts must be more than 20 percent. They had to give more than 20 percent. “The problem of taxation” is the first element mentioned by Buell when asked about his first consultation of counsel and the purpose thereof. Herndon, one of the husbands, testified: “Well, the plan is exactly what has been done. * * * Yes, the plan was exactly what was done.” Again, he testified that the attorney presented a plan or procedure which was essentially the plan that has since been carried out, a plan that there would be a stepped-up value of the Continental Oil Co. contract, and the Portland Oil Co. would not pay tax on that money.

Moreover, to fail to see that there was a mutual understanding and agreement between the two husbands, sole stockholders of, and acting for, the old corporation, and their wives and the daughter would be to close our eyes to actualities, and to resign our function as examiners of fact. Although each party would not, in terms, state that there was agreement, such agreement nevertheless plainly appears. Buell testified that the wives and daughter were to purchase the securities (of petitioner) if they saw fit, and that “we had reason to believe they would”; that the plan as worked out by the attorney contemplated all of those things (referring specifically to the gifts to wives and daughter, formation of petitioner, purchase of securities by wives and daughter, and turning over of the Continental Oil Co. contract to petitioner); asked if his wife and daughter agreed to use the money given for purchase of stock and bonds of petitioner, he “wouldn’t say it was understood” but that he suggested it to them and he “naturally got the impression they were going to do it.” Herndon stated that the plan included purchase of stocks and bonds by Gertrude Woods Herndon, Ethel P. Buell, and Betty Jane Buell with the proceeds of the money given them, that it was necessary that they buy “at least a certain amount of securities”, that he told Gertrude Woods Herndon the attorney’s plan, including her purchase of securities with the money, and she thought the plan was satisfactory and the securities were going to appeal to her; she said she intended to do it (buy the securities). Mrs. Buell, asked whether she agreed to Buell’s suggestion about the money (the gift to her) being put in the Portland Oil Co., answered: “I didn’t agree, but I said I would be willing.” The Buell daughter, fifteen years of age, was advised by her father about the plan. He suggested that she invest in the Portland Oil Co., and she told him she thought it was a very good idea and that she would like to. She relied on her father’s advice. The mutual understanding is emphasized in the fact that the check by Betty Jane Buell is dated December 3, while the money it represented was not borrowed by her father from the bank until December 6. Such “attenuated subtleties” as contentions that there was not agreement between these parties covering this whole plan do not appeal. The two sole stockholders, Buell and Herndon, represented their corporation, Bu-Vi-Bar. Thomas v. United States, 22 Fed. Supp. 412; Pacific State Bank v. Coats, 205 Fed. 618; and Llewellyn Iron "Works v. Abbott Kinney Co., 155 Pac. 986. Under these circumstances we hold that the acquisition of the stock and bonds of the new corporation by all of the transferors was one transaction, pursuant to one plan, purpose and understanding, that of acquiring a stepped-up basis for the Continental Oil Co. obligation, not separable into parts for income tax purposes. Ahles Realty Corporation v. Commissioner, 71 Fed. (2d) 150; certiorari denied, 293 U. S. 611; West Texas Refining & Development Co. v. Commissioner, 68 Fed. (2d) 77; Tulsa Tribune Co. v. Commissioner, 58 Fed. (2d) 937; McInerney v. Commissioner, 82 Fed. (2d) 665; Edwin L. Dana, 36 B. T. A. 231; Hazeltine Corporation v. Commissioner, 89 Fed. (2d) 513. Petitioner points out that the acquisition of stock and bonds by the women was some three weeks earlier than the acquisition of stock and bonds by Bu-Vi-Bar and its stockholders. The difference in time is, of course, in logic, to be considered, but does not control or of itself demonstrate separateness of transactions. No showing is made of any business transacted by petitioner corporation in the interim. In Royal Marcher, 32 B. T. A. 76, two days elapsed; in Van’s Investment Co., Ltd., 33 B. T. A. 30, the time elapsed was several weeks, yet in both cases the transactions were considered as an integer; and Von’s Investment Co., Ltd., sufra, was reversed and remanded, 92 Fed. (2d) 861, in order for the Board to determine the intent and purpose of the transferors as to whether they were in furtherance of the plan of reorganization. In the instant case, as observed above, the unity of plan and agreement is obvious. Under such circumstances the lapse of time is seen as of no consequence. *«•

Petitioner contends, however, that if we assume that the matters above described constitute a single transaction, nevertheless the “property” referred to in section 113 (a) (7) of which 80 percent interest or control must subsist in the same persons after the transfer, refers to the individual transferor and his own separate property contributed to the transfer; and that therefore, since Bu-Vi-Bar was the owner, exclusive of the women, of the Continental Oil Co. contract, before the transfer, but that after transfer neither Bu-Vi-Bar nor its stockholders had so much as 80 percent control of the new corporation and therefore of the property, then section 113 (a) (7) can not be applied. This view has been repudiated definitely in the following cases and need not be further discussed: Durand-McNeil-Horner Co., 30 B. T. A. 769, 772, 773; affirmed sub nom. Fairbanks Court Wholesale Grocery Co. v. Commissioner, 84 Fed. (2d) 18; certiorari denied, 299 U. S. 582; citing Monarch Electric c& Wire Co. v. Commissioner, 38 Fed. (2d) 417 (affirming 12 B. T. A. 158); Real Estate-Land Title & Trust Co. v. United States, (Not reported.) Snead v. Jackson Securities & Investment Co., 77 Fed. (2d) 19. These cases hold that the property of the transferors, considered together, and not the property of an individual transferor, is considered in computing the 80 percent control or interest within the intendment of the statute. It therefore follows under section 113 (a) (7) of the Kevenue Act of 1928 that the basis for the installment obligation is the same in the hands of the petitioner, Portland Oil Co., as in the hands of the transferors, increased in the amount of gain (or decreased in the amount of loss) recognized to the trans-ferors upon the transfer.

The same result follows when section 113 (a) (8) of the Kevenue Act of 1928 is considered, since we find that the transferors of the property acquired control of petitioner corporation substantially in proportion to their holdings of the property prior to the transfer within the language of section 112 (b) (5). Under section 113 (a) (8), of course, it is immaterial whether there is 80 percent control of the particular property being considered by the former owners, and transferors, of that particular property. Halliburton v. Commissioner, supra.

Petitioner argues that section 112 (b) (5), and therefore section 113 (a) (8), can have no application because upon the completion of the transfer the Bu-Yi-Bar Petroleum Corporation owned no securities in taxpayer corporation. The transfer of stock and securities from the petitioner corporation was made to the Bu-Yi-Bar Petroleum Corporation and by it they were distributed to its stockholders. Immediately after the transfer, the transferors were in control of the transferee corporation. Royal Marcher, supra.

Petitioner next, in the alternative, contends, however, that, assuming the applicability of section 113 (a) (7) and (8), since such sections specifically give the property in the hands of the transferee a base consisting of the original base plus the amount of gain recognized to the transferor in the transfer, under section 44 (d) of the Bevenue Act of 1928 gain was recognized to the full extent of the balance due under the installment contract (less the original base as adjusted by application of payments already made) and that therefore the petitioner under either section 113 (a) (7) or section 113 (a) (8) has the benefit of a basis increased by such recognized gain.

We can not assent to such a view. It misconceives the object of the whole revenue law as to nonrecognition of gain or loss in connection with reorganization matters. No such exception is indicated by the general law on the subject and petitioner is logically under a burden of demonstrating such exception. It is necessary, to agree with such view, to say that the provisions affording relief from present taxation to those reorganizing their business organizations, and deferring such taxation to the future, permit, not deferring, but the complete escape of tax, in case an installment obligation is transferred in connection with the reorganization under circumstances constituting a nontaxable exchange. Not only is it inconceivable that such could have been the intent of the statute, but examination of the report of the Senate Committee on Finance, May 1, 1928, as to section 44, covering installment sales, shows that it closes by saying:

Whether or not the gain or loss realized under the section is recognized for tax purposes, depends upon general principles of law embodied in the income tax provisions, the exchange of installment obligations in connection with tax-free exchanges, for instance, being cared for by section 112.

Section 112 being the section as to recognition of gain or loss, it is apparent that the above language can only mean that the exchange of installment obligations in connection with tax-free exchanges is subject to general law as to recognition of gain or loss— in other words, is not to be excepted from the application of section 112 as to recognition or section 113 as to the basis for determining gain or loss. The “general principles of law embodied in the income tax provisions” can not be applied, as above suggested by the Senate Committee, without reaching that conclusion. Obviously in consonance with the above Committee report, article 355 of Regulations 74, covering installment payments, reads:

The entire amount of gain or loss resulting from the disposition or satisfaction of installment obligations shall be recognized except as provided in section 112 and articles C71-5S0.

Moreover, petitioner errs in contending that section 44 (d) recognizes gain upon exchange of installment obligations. That section merely states (so far as the facts herein concerned are involved) that in case of an exchange of an installment obligation “gain or loss shall result” — to the extent of the difference between the base and “the amount realized.” The mere fact that gain “results” would not require recognition thereof. Section 113 (a) (7) and section 113 (a) (8) in terms add to the original basis the amount of gain “recognized.” Recognition depends upon section 112 — as expressly indicated by the Senate Committee as above seen. Section 112 does not recognize gain in case of transfer for stock or securities of a corporation controlled by transferor or transferors proportionately to property previously held, nor in case of exchange of property by a corporation in pursuance of a plan of reorganization solely for stock or securities in another corporation a party to reorganization. It thus appears that not only within the language of the statutes, but also within the view of the Senate Committee, there is not, in the situation here at hand, the recognition of gain which, upon the theory of the petitioner, is necessary in the language of section 113 (a) (7) and section 113 (a) (8) to give the increased base desired by petitioner. The expression “increased in the amount of gain” used in sections 113 (a) (7) and 113 (a) (8) refers to taxable gain. Gann v. Commissioner, 61 Fed. (2d) 201; certiorari denied, 287 U. S. 650, affirming 23 B. T. A. 999. We conclude that petitioner’s alternative contention is not well founded, and that section 44 (d) can not be relied upon to add to the original basis of the property transferred.

We therefore hold that the basis for amounts collected in 1931 by the petitioner on the installment obligation is the original cost basis, adjusted only to that portion thereof applied against collections made in 1930. The parties having stipulated that the amount of the deficiency determined by the Commissioner is correct, if petitioner is subject to tax in 1931 on the excess of the amounts collected by it in that year under the Continental Oil Co. contract over the portion of the basis not used by the Bu-Vi-Bar Petroleum Corporation on its 1930 return, we hold that such deficiency so determined by the respondent is correct. The respondent having in effect abandoned his contentions as to fraud penalty, no fraud penalty is allowed.

Reviewed by the Board.

Decision will be entered for the respondent.

       SEC. 44. INSTALLMENT BASIS.
      (a) Dealers in personal property. — Under regulations prescribed by the Commissioner with the approval of the Secretary, a person who regularly sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year which the gross profit realized or to be realized when payment is completed, bears to the total contract price.
      (b) Sales of realty and casual sales of personalty. — In the case (1) of a casual sale or other casual disposition of personal property (other than property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year), for a price exceeding $1,000, or (2) of a sale or other disposition of real property, if in either case the initial payments do not exceed 40 per centum of the selling price, the income may, under regulations prescribed by the Commissioner with the approval of the Secretary, be returned on the basis and in the manner above prescribed in this section. As used in this section the term “initial payments” means the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable period in which the sale or other disposition is made.
      (c) Change from accrual to installment basis. — If a taxpayer entitled to the benefits of subsection (a) elects for any taxable year to report his net income on the installment basis, then in computing his income for the year of change or any subsequent year, amounts actually received during any such year on account of sales or other dispositions of property made in any prior year shall not be excluded.
      (d) Cain or loss upon disposition of installment obligations. — If an installment obligation is satisfied at other than its face value or distributed, transmitted, sold, or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and (1) in the case of satisfaction at other than face value or a sale or exchange — the amount realized, or (2) in case of a distribution, transmission, or disposition otherwise than by sale or exchange — the fair market value of the obligation at the time of such distribution, transmission, or disposition. The basis of the obligation shall be the excess of the face value of the obligation over an amount equal to the income which would be returnable were the obligation satisfied in full.

       SBC. 113. BASIS FOR DETERMINING- GAIN OR LOSS.
      (a) Property acquired after February 2¾ ISIS. — The basis for determining the gain or loss from the sale or other disposition of properly acquired after February 28, 1913, shall be the cost of such property; except that—
      * * * * * # *
      (7) TRANSFERS TO CORPORATION WHERE! CONTROL OH PROPERTY REMAINS IN SAME PERSONS. — If the property was acquired after December 31, 1917, by a corporation in connection with a reorganization, and immediately after the transfer an interest or control in such property of 80 per centum or more remained in the same persons or any of them, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made. This paragraph shall not apply if the property acquired consists of stock or securities in a corporation a party to the reorganization, unless acquired by the issuance of stock or securities of the transferee as the consideration in whole or in part for the transfer;
      (8) Same — Corporation controlled by transferor. — If the property was acquired after December 31, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5) (including also, cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities), then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.


author: Black :

text:
    Thomas F. Bayard, Trustee of the Eastern Utilities Investing Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 59550.
    Promulgated October 7, 1938.

      Charles M. Trammell, Esq., Bradford S. Magill, Esq., Dean P. Kimball, Esq., and Francis J. Sweeney, Esq., for the petitioner.

      Chester A. Gwirm, Esq., for the respondent.
   OPINION.

Black :

The sole issue in this proceeding is whether petitioner was affiliated with the Associated Gas & Electric Co. (generally referred to in this report as the Associated Co.) for the period August 1, 1927, to December 31, 1928. The applicable statutes are section 240 (d) of the Revenue Act of 1926 and section 142(c) of the Revenue Act of 1928. The pertinent provisions of these sections are substantially identical. Those of the 1928 Act provide:

(c) Definition of affiliation.- — For the purpose of this section, two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns at least 95 per centum of the stock of the other or others, or (2) if at least 95 per centum of the stock of two or more corporations is owned by the same interests. As used in this subsection the term “stock” does not include nonvoting stock which is limited and preferred as to dividends.

The ownership referred to in the applicable statutes pertaining to affiliation means beneficial ownership. Handy & Harman, v. Burnet, 284 U. S. 136.

The parties are in agreement that the question of affiliation in this proceeding is narrowed to a determination of the beneficial ownership of the 100,000 shares of petitioner’s class B voting common stock during the period August 1, 1927, to December 31, 1928. If this beneficial ownership was in the Associated Co. or its wholly owned subsidiary, the Associated Gas & Electric Securities Co., respondent concedes our decision must be for the petitioner; otherwise, petitioner concedes it must be for the respondent.

Petitioner, in support of its contention that its class B stock was during the period in question beneficially owned by the Associated Co. or one of its affiliates, relies upon six points, namely, (1) that the issue before us has in effect been admitted by the respondent by reason of the fact that in the proceedings for reorganization of petitioner under section 77 B of the Bankruptcy Act, now pending in the United States District Court for the District of Delaware, the United States Attorney in a petition for examination of designated persons, referred to the Associated Co. as petitioner’s “parent company” during the year 1929; (2) that during the period involved the Associated Co. or one of its determined affiliates had legal title to petitioner’s class B stock; (3) that if the trust had any title to petitioner’s class B stock, it held such title only as an agent or nominee of the Associated Co.; (4) that, by virtue of the option contract of July 25, 1927, as construed by the contracting parties, the record transfer to the trust of petitioner’s class B stock was not a sale, but at most a transfer in trust; (5) that by virtue of oral agreements and understandings between the parties involved, the Associated Co. was the beneficial owner of petitioner’s class B stock; and (6) that the purpose of the revenue acts, and particularly the provisions thereof relating to consolidated returns, can be carried out only by permitting the consolidation of petitioner with the Associated Co. We shall consider these points in their regular order.

Point (1). — Petitioner contends that the sworn statement made by the United States Attorney for the District of Delaware in the petition for examination of designated persons filed in the proceedings for reorganization of petitioner, pursuant to section 77 B of the Bankruptcy Act, as amended, now pending in the United States District Court for the District of Delaware, that a certain prospectus issued by petitioner in 1929 failed to state that petitioner’s substantial investment in the “stock of its parent company, Associated Gas and Electric Company * * *” has the effect of an admission on the part of the respondent in the instant proceeding that petitioner was affiliated with the Associated Co. as the term “affiliated” is used in the applicable statutes, sections 240 (d) and 142 (c), supra. The basis of this contention is that, where corporations are deemed affiliated within the applicable revenue statute, it is customary to refer to the corporation which owns the required percentage of the stock of another or others as the parent corporation. In fact, Congress, in providing for consolidated returns for 1929 and subsequent years, in section 141 (d) of the Revenue Act of 1928, used the term “a common parent corporation * * Petitioner argues therefore that, when the United States Attorney for the District of Delaware referred to the Associated Co. as petitioner’s “parent company”, such allegation under oath had the same effect as if counsel for the respondent in the instant proceeding had admitted that the two corporations were affiliated, since, as contended by petitioner, the United States Attorney and counsel for respondent are both in effect representatives of the United States of America. Assuming without deciding that the United States Attorney for the District of Delaware could, in another different proceeding and in the manner alleged by petitioner, bind the United States on some issue involved in an entirely separate proceeding such as we now have before us, we do not think he did so in the present instance.

Without discussing all the arguments made pro and con by the parties on this point, we deem it sufficient to say that the term “parent company” is by no means synonymous with the term “affiliated” as used in the applicable statutes. Frequently in cases involving the question of affiliation one of two corporations will for convenience be referred to as the “parent company” and yet the two corporations will be held not affiliated. In Commissioner v. Terre Haute Electric Go., 57 Fed. (2d) 697; certiorari denied, 292 U. S. 624, the Circuit Court’s opinion opened with the question: “Were the taxpayer, the Terre Haute Electric Company, and its parent company, the Terre Haute, Indianapolis and Eastern Traction Company, affiliated within the meaning of that word as used in the Revenue Act?” [Italics supplied.] The two companies in that case were held not affiliated, although the one company was the parent company of the other. Crowell’s Dictionary of Business and Finance (Rev. Ed.), defines “parent company” as follows:

Parent Company. One of which other companies derive authority. A company owning a patent may grant to other companies the right to use the patent. The parent company generally owns a controlling interest in a company which operates under authority from it, but this is not necessarily the case. This term is sometimes used for Holding Company or Controlling Company. * * *

In the large field of corporation law the term “parent company” is often used in referring to a corporation owning a bare majority of the stock of another or others. See Fletcher Cyclopedia Corporations (Permanent Ed.), vol. 6, secs. 2821 to 2844. But a bare majority is not sufficient to permit affiliation under the revenue acts. The term “parent company” is not defined in the applicable statutes now under consideration. As previously shown, it is a rather loose term, lacking in any precise definition. During the period in question petitioner had outstanding several classes of preferred stock, substantially all of which was owned by the Associated Co. We think this preferred stock could also be considered in determining whether in a broad sense the Associated Co. was petitioner’s parent company. Since the Associated Co. or one of its wholly owned subsidiaries owned 100 percent of petitioner’s class A common stock and substantially all of its preferred stock, it is apparent that it owned more than a majority of all the outstanding stock. But without the ownership of the required amount of the class B stock the two corporations would not be affiliated, although one might be referred to as the parent of the other. Therefore, it is our opinion that the allegation made by the United States Attorney that the Associated Co. was petitioner’s parent company does not in any way prove that petitioner was affiliated with the Associated Co. during the period in controversy. The petitioner’s contention on this point is denied.

Point (£). — Petitioner’s second point is that, since it was stipulated that the certificate representing the 100,000 shares of its class B stock was during the period involved in the name of Daly & Co., as nominees of an undisclosed principal, deposited in a vault leased by the Associated Co., and also in view of Hopson’s testimony that the undisclosed principal of Daly & Co. was the Associated Co., the legal title to the shares was never transferred to the trust, but remained in the Associated Gas & Electric Securities Co., a wholly owned subsidiary of the Associated Co. Petitioner cites Fletcher Cyclopedia Corporations (Permanent Ed.), vol. 12, sec. 5484; Bank of Atchison County v. Durfee, 118 Mo. 431; 24 S. W. 133, and Be Broomhall, Killough & Co., 47 Fed. (2d) 948, in support of the general rule that, in the absence of an express agreement to the contrary, there must be a delivery of some document representing shares of stock in order to constitute a valid transfer. This is undoubtedly the general rule, but section 5484, supra, also states:

Tliere may be a constructive delivery and acceptance, unaccompanied by a manual delivery or actual change of custody resulting from acts and conduct from dealing with stock, when there has been a change in the relation of the parties to it.

In De Nunzio v. De Nunzio, 90 Conn. 342; 97 Atl. 323, it was stated that “Both acceptance and receipt and therefore delivery may be inferred from the attendant circumstances.” The attendant circumstances in the instant proceedings are set forth at length in our findings. We think they were of such a nature as to show a very decided intention on the part of the contracting parties to dispense with the manual delivery or actual change of custody of the certificate in question. The certificate during the entire period was in the “street” name of Daly & Co., a circumstance which was not at all uncommon in view of the option to repurchase contained in the contract of July 25, 1927, between the trust and the Associated Co. See Fletcher Cyclopedia Corporations (Permanent Ed.), vol. 19, sec. 8981, on stock in “street” names. Daly & Co. was the street name, or nominee partnership, for all the companies in the Associated Gas & Electric System, which included the trust and the Associated Co. and its wholly owned subsidiaries. Therefore, Daly & Co. was the trust’s agent as well as the agent for the Associated Co., and, in view of the July 25,1927, contract above referred to and the contemporaneous records made by the trust and the Associated Gas & Electric Securities Co., the conclusion, in our opinion, is inescapable that Daly & Co. held the certificate for the 100,000 shares of petitioner’s class B voting common stock during the period August 1,1927, to December 31,1928, for the trust rather than the Associated Co. or its subsidiary, the Associated Gas & Electric Securities Co., as testified to by Hopson.

Petitioner also cites Stiver v. Commissioner, 90 Fed. (2d) 505, as being a case in which. a,n alleged similar agreement was held to be an option rather than a sale. We do not, however, regard this case as being in point, as its facts are quite different from those here involved.

Points (-3), (J), (5). — Under these points petitioner argues that if the trust held any title to petitioner’s class B stock, it held such title as an agent, nominee or trustee for the Associated Co., and that therefore the latter company was the beneficial owner of petitioner’s class B stock. Petitioner cites eight court and Board decisions and also a Bureau ruling, to wit, G. C. M. 8982, C. B. X-l, p. 250, in support of the proposition that a corporation, as well as an individual, may hold technical title to property as a mere nominee, agent, or trustee. We do not question the soundness of such a view, but we fail to see wherein it is of any help to petitioner in the instant case. An examination of the 37-page declaration of trust shows that the trust was organized and had authority to engage in an unusually wide and diversified field of business activities. It issued to a party unaffiliated with the Associated Co. all of its stock for $100,000 in cash. It then entered into a written contract with the Associated Co. in which it agreed to purchase petitioner’s 100,000 shares of class B voting common stock for a consideration of $100,000, and further agreed that the Associated Co. “shall have the option, at any time after the expiration of five years and prior to the expiration of ten years” from the date of issuance to the trust “or its nominee” of petitioner’s class B stock, to purchase such stock upon the terms set out in our findings. The Associated Gas & Electric Securities Co. then purchased from petitioner all of its class A and class B common stock for $100,000. The stock was issued in the name of Daly & Co. and placed in a vault leased by the Associated Co. On the books of Associated Gas & Electric Securities Co. the trust was charged with $100,000 “To record sale as at July 31, 1927, of 100,000 shares Eastern Utilities Investing Corp. Class £B’ Stock.” On the books of the trust the investment account was charged with 100,000 shares of class B stock of the Eastern Utilities Investing Corporation, “To record the purchase of the former securities for $100,000 cash.” The trust later used the $100,000 which it received for the issuance of its own stock to pay for the 100,000 shares of petitioner’s class B stock, which $100,000 was received by the Associated Gas & Electric Securities Co. on or about April 10, 1928.

Notwithstanding all of the above recorded corporate and trust evidence of what the transactions were, petitioner now offers the testimony of Hopson, who was the financial vice president of the Associated Co., an officer of petitioner, and one of the trustees of the Associated Gas & Electric Properties, to prove that the transactions were something different from that which they purported to be. But we are not convinced by this testimony. The trust was more than a mere agency or conduit or nominee of the Associated Co. Its business transactions were real and not mere bookkeeping entries and must be given their usual legal effect. Cf. Consumers Construction Co. (Del.), 35 B. T. A. 966. In the latter case pretty much the same sort of a contention was made as is made in the instant case, but we denied it. The main difference in that case from the instant case is that in the Consumers Construction Co. case the issue was as to income, whereas here the issue is as to affiliation, but we do not think this difference serves to distinguish the two cases, as petitioner argues in its brief. Our decision was affirmed by the Second Circuit in Consumers Construction Co. v. Commissioner, 94 Fed. (2d) 731.

Income taxes are levied with respect to annual periods, and each annual period must necessarily stand by itself. Burnet v. Sanford & Brooks Co., 282 U. S. 359; Burnet v. Thompson Oil & Gas Co., 283 U. S. 301; Woolford Realty Co. v. Rose, 286 U. S. 319; Helvering v. Morgan's Inc., 293 U. S. 121; MacMillan Co., 4 B. T. A. 251. We are concerned here with the situation as it existed during the taxable years 1927 and 1928 and not as it existed in 1932. During the period from August 1, 1927, to December 31, 1928, it is our opinion, and we have so found as a fact, that the beneficial ownership of petitioner’s 100,000 shares of class B voting common stock was in the trust and not in the Associated Co. or any of its subsidiaries. To otherwise hold would be to completely disregard corporate and trust records which were made contemporaneous with the transactions involved and to rely upon oral testimony which is not convincing. It follows therefore that the trust beneficially owned the title to the stock for itself and not as nominee, agent or trustee for the Associated Co. or any of its subsidiaries. The cases of Dome Co., 26 B. T. A. 967, and Mark A. Mayer, 36 B. T. A. 117, specifically relied upon by petitioner, are distinguishable upon their facts.

As we said in Savoy Oil Co., 1 B, T. A. 230:

The taxpayer can not convert a sale into a conditional sale, a trust, a joint adventure, or an advance merely by its board of directors deciding that they did not consider it a sale. The taxpayer did not produce the minutes of any meeting of its stockholders or directors as evidence of its contentions, it did not produce any evidence of a collateral agreement between it and the Burke-Hoffield Oil Co., showing that the sale evidenced by the agreement of May 1, 1917, was not a sale but was something else; instead, it chose to rely on parol evidence of conclusions drawn, after the lapse of seven years, by officers of the corporation.
In the absence of convincing evidence that the transaction evidenced by the agreement of Blay 1, 1917, was not what it purports to be, viz., a sale, this Board can not accept any of the contentions advanced by the taxpayer purporting to show error on the part of the Commissioner in determining the tax.

Before passing these points we shall refer briefly to Lavenstem Corporation v. Gommissioner, 25 Fed. (2d) 375, cited by petitioner as having a controlling effect on the instant proceeding. That case involved the question whether the petitioner there was affiliated with the Lavenstein Brothers Co. under section 240 (b) of the Revenue Act of 1918, and the question turned on whether the three Lavenstein brothers, who owned all the stock of the petitioner in that case, also owned substantially all the stock of the other corporation. The facts showed that the brothers had transferred all the stock, except two shares, of the Lavenstein Brothers Co. to a creditors’ committee “as security for the claims of creditors * * The Fourth Circuit, in allowing affiliation, held that the brothers, however, remained the owners of the stock so transferred because “the Lavensteins could have had the stock transferred to them at any time by merely paying the claims of creditors * * In the instant proceeding the Associated Co. did not have the right to reacquire petitioner’s class B stock during the taxable years in question and not until after the expiration of five years from the date of issuance to the trust, nor was the class B stock up as security to secure the payment of any loan. Therefore the Lavenstein case, in our opinion, does not control the question here involved.

Point (6). — Under this point petitioner’s main propositions are that facts rather than bookkeeping entries control; and that our decision in United, National Corporation, 33 B. T. A. 790, is practically on all fours with petitioner’s contentions in the instant proceeding and that therefore the Board should reach the same conclusion here as it did there.

“Bookkeeping entries, though in some circumstances of evidential value, are not determinative of tax liability.” Helvering v. Midland Mutual Life Insurance Co., 300 U. S. 216. But when the bookkeeping entries actually record the true facts, the rule thus emphasized by petitioner is not applicable. We think this is the situation in the instant proceeding. We have carefully considered all the evidence in the case and are unable to find that the intention of the parties interested in petitioner’s class B stock was other than that which was so clearly expressed in the written agreement between the Associated Co. and the trust on July 25,1927. This agreement provided, among; other things (see paragraph 3 of the agreement set out in our findings), that “until and unless said option shall be exercised,” the trust “shall be and continue to remain the absolute owner” of the shares in question. There were urgent business reasons why this should be so.

Fred S. Burroughs testified as a Avitness for petitioner. He was a member of the board of directors of the Associated Co. and was the representative on the board of Harris, Forbes & Co., bankers for the Associated Co. He testified that in 1927, when Harris, Forbes <⅞ Co. agreed to float $35,000,000 debentures for petitioner, the bankers did not want the control of petitioner to appear in the Associated Co. This testimony and other testimony in the record shows to our satisfaction that it was the purpose of all the parties to the transaction to have the trust acquire actual ownership of petitioner’s class B stock, with the option that the Associated Co. or one of its subsidiaries could, after five years, reacquire the stock, and that what was done was to accomplish that purpose. Now, after the lapse o f several years, petitioner asks us to find that what was done, as shown by the corporate and trust records, was a sham and subterfuge and that from the beginning it was the intention that the beneficial ownership of petitioner’s class B stock should not be in the trust, but should be in the Associated Co. or one of its subsidiaries. We are asked to do this largely on the strength of the testimony of the witnesses Hopson and Burroughs. We think we may not treat trust and corporate records so lightly, especially when there is ample evidence in the record to corroborate the fact that these records were meant to record the transactions as they really were.

The United National Corporation case is easily distinguishable from the instant proceeding. There the alleged sale was made to a subsidiary of the alleged seller. Here the trust was not a subsidiary of the Associated Co. But of much more importance is the distinguishable fact that in the United National Corporation case the alleged seller had an option to repurchase at any time, whereas in the instant proceeding the Associated Co. had no option to repurchase whatever during the taxable years in question. Furthermore, the evidence in the United National Corporation case was clear and convincing that the whole transaction was intended as a loan, with the stock merely being transferred as collateral security therefor. Here the convincing evidence is that of an outright sale to the trust of 100,000 shares class B stock of petitioner, with an option to repurchase after a period of five years.

It is our conclusion, and we have so found as a fact, that during the period August 1,1927, to December 31,1928, petitioner’s 100,000 shares of class B voting common stock were owned by the Eastern Utilities Investing Trust. It follows, therefore, that during the taxable years 1927 and 1928, petitioner was not affiliated with the Associated Gas & Electric Co. and its affiliated corporations and associations.

Beviewed by the Board.

Decision will be entered wider Rule 'SO.


author: Arundell : Steenhagen,

text:
    Ruth Wight Bill, Petitioner, v. Commissioner of Internal Revenue, Respondent. Beatrice Bill Talbot, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 79853, 79854.
    Promulgated October 7, 1938.

      William W. Johnston, O. P. A., for the petitioners.

      Bernard D. Daniels, Esq., for tlie respondent.
   OPINION.

Arundell :

The claim of these cases for a partial worthlessness deduction is made under that part of section 23 (j) of the Revenue Act of 1932, which authorizes the Commissioner to allow a deduction of less than the whole amount of a debt “when satisfied that a debt is recoverable only in part * *

The Commissioner’s regulations have long provided for deductions for entire or partial worthlessness of bonds where the owner ascertains that upon maturity he will recover none or only a part of the debt evidenced by the bonds. The same regulations have also provided that no deduction may be taken merely on account of market fluctuation. Art. 154, Regulations 62, 65, 69; art. 194, Regulations 74, 77. We have followed the same rules and have refused to allow bad debt deductions based on nothing more than fluctuations in value. “Market fluctuation * * * is an unsafe criterion for determining the reasonableness of an addition to a reserve for bad debts * * South Hills Trust Co., 19 B. T. A. 674, 678. “Admission of a decline in value of securities prior to maturity by no means implies an admission as to the obligor’s ultimate condition or that its obligations will not be paid or paid only in part upon maturity.” Securities-Allied Corporation, 36 B. T. A. 168, 177; affd., 95 Fed. (2d) 384. In the latter case we quoted the Commissioner’s regulations, art. 194, Regulations 74, and held that the requirements thereof must be met by the taxpayer. On the other hand, where the evidence satisfactorily establishes “that the debts were, at least to the extent of the charge-off, beyond recovery”, we have allowed a deduction for partial worthlessness. Second National Bank of Philadelphia,, 33 B. T. A. 750. In that case the bonds with respect to which we allowed a deduction were in default, the debtors were in receivership, and a national bank examiner directed that they be written down on the books of the bank.

The question here, as in other bad debt cases, must be decided upon examination of the facts to determine to what extent there is an ascertainment of worthlessness, or, to use the view of the regulations, to what extent the taxpayer will recover upon maturity of the bonds. This question can not, as pointed out above, be solved solely by reference to fluctuation in market prices. Included in the stipulated facts in this case are profit and loss statements and balance sheets for the years 1931 to 1936, inclusive. Upon examination of these we find that while there was a drop in railway operating revenues from $54,426,916 in 1931 to $40,712,215 in 1932, nevertheless at the end of 1932 the railway company had a profit and loss balance of $4,694,448. Its balance sheet carries the same item, $4,694,448, which we construe as being the same as surplus in the balance sheets of manufacturing or merchandising concerns. In determining the status of the bonds there must be added to the surplus the amount set aside for capital stock liability, which in round figures is $114,000,000. These facts alone give a surplus in excess of $118,000,000 to secure the outstanding prior lien bonds of $183,445,400. Moreover, it is stipulated that the entire issue of prior lien bonds is secured equally by mortgage or collateral lien on the railway’s “entire property.” The road and equipment alone are valued in the balance sheets at over $420,000,000. In addition the bonds are secured by $46,000,000 face value of stocks and bonds of affiliated companies. With these assets securing the bonds, we are of the opinion that there could have been no determination by the petitioners in 1932 that they would recover only $200 per $1,000 face value of their bonds.

Counsel for petitioners makes some argument based on liquidating value of the railway company’s assets. This is purely argument, unsupported by facts. There is no evidence as to what the balance sheet values were based on. Assuming that they are going concern values, it was part of petitioners’ case to prove any other values on which the decision should rest. This they did not do.

Based on the stipulated facts showing the amount of bonds outstanding, the security for the bonds, and the income and general financial condition of the debtor, we hold that the petitioners have not established that a determination could have been made in 1932 that only a part of the debts evidenced by the bonds would be recovered at maturity. Consequently, we affirm the respondent.

Reviewed by the Board.

Decision will be entered for the respondent.

Steenhagen,

dissenting: These proceedings have been submitted upon a stipulation, and there is therefore no room for dispute as to the primary or evidentiary facts. The only question is whether they reasonably support a finding that the debt covered by the railroad’s bonds was recoverable only in part. If they do, the finding should not be withheld through any fear that unforeseen events or possible economic conditions may perchance bring about a complete recovery of the debt at its maturity in 1950.

It seems to me clear from the evidence that at the end of the taxable year no one could reasonably doubt that the debt would not b8 entirely paid. Earnings had been steadily diminishing, interest was defaulted, and a receiver had been appointed at the behest of a creditor. The petition for receiver averred that the interest ($13,330,491) exceeded the gross operating income ($10,211,785). There is not the slightest indication in the stipulation that conditions would improve or that the prospect for complete recovery in 1950 would become any brighter. Certainly no one in the open market was optimistic enough to appraise the chances as very good. Why then should the Board refuse to recognize what the market so realistically reflects? I do not mean to stand for the idea that fluctuations in market value of bonds are to be taken as gauges of the extent of recoverability or as measures of the statutory deductions. That idea was rejected in Second National Bank of Philadelphia, 33 B. T. A. 750. But when the other evidence indicates that the debt is recoverable only in part, the market prices may help to give realistic assurance that the taxpayer’s best judgment of the future is not too lugubrious.

This, I thought, is what the full Board had decided in Second National Banh of Philadelphia, supra. There the taxpayer’s officers weighed the extent of recoverability of some railroad and other bonded debts, “which in 1931 were in default as to interest, and the debtor was, as to each, in receivership”, concluded they were recoverable only in part, and wrote off and deducted the remainder of $26,050. The charge-off was made before the bank examiner had appeared and entirely on the taxpayer’s own initiative. The evidence of nonrecoverability was quantitatively less and was no more convincing than this, and upon such evidence it was, after full Board review, held that the deductions were proper. In that case there was another point — a further charge-off upon the mere direction of a national bank examiner the Board held was not within the statute; but that was because it was thought that a categorical direction of a bank examiner based only upon a drop in market value was not sufficient to satisfy the revenue act. The $26,050 deduction was not affected by the bank examiner’s direction but was supported by default and receivership. So that decision seems to me to be a complete precedent for a deduction here, and there is no reason to discriminate between a national bank acting upon the judgment of its officers and an individual acting upon his own judgment. Botli must be tested by the evidence of record, and I think the evidence here supports the taxpayer’s judgment no less than did the evidence there. Either that decision should be overruled (although it was not appealed, and the Commissioner acquiesced in it, C. B. XV-2, p. 21), or this decision should follow it. They can not consistently stand together.

As to the quantum of recoverability, it seems to me the taxpayer was well this side of the doubtful area when she adopted 20 as the recoverable part and treated only the excess above this as the nonrecoverable part which she might properly deduct.

Melloít agrees with this dissent.