author: Mellott:

text:
    Credit & Investment Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105528.
    Promulgated September 15, 1942.

      Ghartes G. Partin, Esq., and Samuel A. McCain, Esq., for tlie petitioner.

      Charles Oliphant, Esq., for the respondent.
   OPINION.

Mellott:

Petitioner contends that its basis for the computation of gain or loss upon the sale, in the taxable year, of the German securities purchased by it in 1935 upon the Bourse, was $145,408.98. This'amount is the allocable portion of the sum originally invested by it in the Ostdeutsch bond. Respondent determined that the basis is the cost of the securities purchased in 1935 ($51,842.92), which is equivalent to the quoted price of “blocked” marks ($0.1437) on the New York market at the time the purchase was made and which he determined was the fair market value of the 360,771.89 marks used in the acquisition of the securities.

Upon brief petitioner divides its arguments into four parts, some of its contentions being in the alternative. They will be discussed in the order presented.

Petitioner’s first contention is that the provisions of the Revenue Act of 1934 relating to involuntary conversions (section 112 (f)) are applicable and that its basis should be determined under section 113 (a) (9) of the Revenue Act of 1936. The sections relied upon are shown in the margin.

The substance of petitioner’s argument is that the German law of June 9, 1938, was, for all practical purposes, “a condemnation of all foreign exchange or rights to foreign exchange”; that its receipt of marks instead of dollars “was in both form and substance an involuntary conversion within the terms of section 112 (f)”; that the German securities purchased by it in 1935 were “similar or related in service or use” to the Ostdeutsch bond; and that they collectively had its basis.

Respondent denies that the sections relied upon are applicable. . He argues that petitioner had an obligation which matured and which, pursuant to restrictive regulations of the German Government, was paid in reichsmarks at the prevailing rate of exchange; that the fact it was paid in reichsmarks instead of dollars is relevant only in determining the amount of loss sustained, or, possibly, in determining whether there was a closed transaction; that the reichsmarks were convertible into dollars (albeit at a discount) and had a fair market value of $0.1437 when received; and that the transaction was complete, for tax purposes, when the bond was sold. He also contends that petitioner has failed to show that the property purchased in 1935 was “similar or related in service or use” to the Ostdeutsch bond, as Construed by him in article 112 (f) — 1 of Regulations 86, since the bond was a secured obligation while the securities purchased were “capital stock of other corporations.”

The respondent’s determination should not, in our judgment, be overthrown upon the ground suggested. Only by a strained construction of its language could section 112 (f) be held to be applicable. Inferentially petitioner admits as much when it is compelled to resort to the fiction that the German Government condemned its property. “An exercise of the power of * * * condemnation”, as used in the statute, has always, so far as we have been able to ascertain, been construed to refer to the taking of private property for public use, i. e., to the taking of private property through the exercise of the power of eminent domain.

The German law, set out in part in our findings but shown at length in the evidence, did not attempt to make any condemnation of foreign exchange or rights to foreign exchange. It provided that in case a debtor was required to pay his obligation in foreign currency the amount should be converted into reichsmarks “at the official Berlin middle rate of the currency in question on the working-day preceding the date of payment.” After the enactment of that law petitioner had no method of enforcing payment in dollars of the obligations held by it. Cf. Perry v. United States, 294 U. S. 330. But it could enforce payment in reichsmarks and payment was made. True, the reichsmarks were kreditsperrmarks, or “blocked credit marks”, which could be transferred to third parties only with governmental approval or sold to Deutsche Golddiskontbank against foreign exchange. While blocked credit marks were worth less than free marks, they were not without fair market value, as is indicated by the fact that they were quoted on the New York market at $0.1437. They could be used in Germany for many purposes, some uses requiring special permission of the German Government and others requiring no permission. One of the latter was selected by petitioner. As we view the stipulated facts there Avas no involuntary conversion of petitioner’s property in 1935, but a mere reinvestment in German securities of the amount received in payment of a bond which it oivned.

If we have erred in holding, as Ave do, that the involuntary provisions of the statute are not applicable, still Ave think petitioner can not prevail upon the theory advanced because of its failure to show that the securities purchased in 1935 were “similar or related in service or use” to the Ostdeutsch bond. The bond was a secured obligation— “issued under and secured by an indenture” — while the securities, for aught appearing in the stipulated facts, may have been capital stock. It is unnecessary to dAvell at length upon the difference between bonds and stock. In the former the relation of debtor and creditor exists, while in the latter capital is subjected to the ordinary risks of a corporate business. Cases cited by petitioner construing the expression “like kind or use” appearing in section 202 (c) (1) of the Be venue Act of 1921 are not pertinent.

Another circumstance militating against petitioner’s contention that its property was “compulsorily or involuntarily converted, into property similar or related in service or use” is the fact that during 1935 it was able to take out of Germany more than $115,000. This is some indication that the investment of the amount received from the Ostdeutsch bond in German securities was voluntary, notwithstanding the testimony of petitioner’s witness to the effect that it was the policy of the company to get all of its money out of Germany at the earliest possible date. In any event, since the evidence does not prove that petitioner attempted to secure permission to transfer the amount in issue for the purpose of sale outside of-Germany and was unable to do so, no compulsion has been shown.

Petitioner’s second contention is, that if cost is the basis for computing its gain or loss upon the securities, then the value of the marks used in computing such cost was $0.40. This was the official German rate of exchange applicable to free marks. Respondent determined that the cost of the securities was the fair market value of the marks used in their purchase, or $0.1437 per mark, which was the price at which blocked credit marks were quoted on the market in New York at the time the purchase was. made.

Ordinarily the cost of property purchased with foreign exchange is determined by reducing the foreign currency to dollars at the rate of exchange prevailing on the date of purchase. Bernuth Lembcke Co., 1 B. T. A. 1051; Joyce-Koebel Co., 6 B. T. A. 403; James A. Wheatley, 8 B. T. A. 1246. If the purchase were made with free marks, then petitioner’s present contention should be upheld; for it has been stipulated that “the official Berlin rate was at about 40 cents per mark.” The question therefore is: Were the marks “free” or “blocked”?

The fact that the marks could be used for certain purposes within Germany without permission of the German Government did not, in our opinion, make them free marks. They were blocked marks when received and upon sale of the securities in which they were invested the proceeds again became blocked marks. If they had been transferred outside of Germany in 1935 petitioner could have received $0.1437 per mark. As pointed out above, petitioner took out of Germany at about the same time more than $115,000 on that basis. Instead of taking out the 360,771.89 blocked marks remaining to its credit from the sale of the Ostdeutsch bond petitioner invested them in securities which it sold later for 377,891 blocked marks. On the face of the transaction it made a profit of 17,119.11 blocked marks. Respondent has not attempted to tax it upon this paper profit, but has recognized that the purchase and sale of securities in Germany resulted in an actual loss to petitioner equivalent to the difference, in dollars, between their cost (360,771.89 blocked marks at $0.1437 or $51,842.92) and their selling price (377,891 blocked marks at $0.1043 or $39,414.43) or $12,428.49. If petitioner’s contention that it invested free marks in the securities in 1935 were upheld, by a parity of reasoning the transaction resulted in a gain; for it received in 193'6 precisely the same kind of marks which it invested in 1935. In our judgment, however, the marks received upon the payment of the Ostdeutsch bond, the marks used in the purchase of the securities upon the Bourse, and the marks received upon their sale were all blocked marks.

Having concluded that the marks used in the purchase of the securities in 1936 were blocked marks, the question remains whether they had a fair market value. Petitioner urges that “the fourteen-cent rate which was stipulated ($0.1437) to be the sale price in the United States of ‘blocked’ marks of the kind here in question was not applicable” to the 360,771.89 invested in 1935 in the other securities. It relies upon the testimony of its American director as having shown conclusively that those particular marks could not be transferred to this country. We do not so construe his testimony. While he stated that it was the petitioner’s policy to get its funds out of Germany as speedily as possible, he admitted he did not know whether any of its officers had requested that it be permitted to transfer the particular marks in question or not. Later he expressed the opinion that they either had applied for permission to transfer the funds and permission had been refused or “they knew that under the rules, laws and regulations prevailing, they could not obtain permission upon application and therefore did not apply.” The evidence, in our judgment, falls far short of conclusively showing, as petitioner must show, that the particular marks could not have been transferred out of Germany and sold. That a market for them existed is clear. Under the circumstances, therefore, we are of the opinion the Commissioner committed no error in holding that the blocked marks received in 1935 had a fair market value of $0.1437.

Petitioner’s alternative contention is that no gain or loss was recognizable on the receipt of the blocked marks in 1935 and therefore the basis for the computation of its gain or loss upon the securities sold in 1936 was the cost of the Ostdeutsch bond. It relies primarily upon the rationale of Helvering v. Tex-Penn Oil Co., 300 U. S. 481, its postulate being that “the blocked marks were subject to such serious restrictions that it was impossible to realize dollars upon them.” Such a finding, in effect, was made by this Board in International Mortgage & Investment Corporation, 36 B. T. A. 187. In that proceeding the petitioner could not obtain permission and was unable to transfer out of Germany any of the marks on deposit in German banks on July 13, 1931, there was no market in 1931 for the restricted marks, and the Commissioner’s determination that the acquisition of such marks had resulted in a gain to the taxpayer was set aside. But no such fact has been stipulated or shown in the evidence in the instant proceeding. The restrictions did not prevent the sale of blocked marks; they merely-required that permission to transfer them be secured. Blocked marks were quoted on the market in New York at $0.1437 and some were transferred and sold by petitioner at that figure. No showing has been made that request for permission to transfer the 360,771.89 marks in issue had been made and refused. The evidence shows that $115,-629.69 in dollars was remitted to petitioner during 1935. The notice of deficiency and the Revenue agent’s report attached to the petition indicate that almost a half million dollars ($423,284.15) was remitted during the next year, and the only witness who testified stated that blocked marks were sold by petitioner during each year from 1933 to 1941. In the face of this evidence it can not be found that the restrictions imposed by the German Government made it impossible for petitioner to have taken out the 360,771.89 if it had endeavored to do so. The authorities relied upon are therefore inapplicable.

Petitioner’s final contention is that the rule of Bowers v. Kerbaugh Empire Go., 271U. S. 170, is applicable. It argues that “the Ostdeutsch transaction, including the securities purchased with the blocked mark proceeds thereof, should be regarded as a single transaction in which petitioner attempted to realize dollars and that the result in dollars was exactly that shown by its Federal income tax returns.” We do not agree. The Ostdeutsch bond transaction was concluded in 1935 when petitioner received 440,000 blocked marks. Its subsequent investment of 360,771.89 blocked marks in other securities was a separate transaction. The cited case does not sanction the postponement of realized losses. The sale of the securities purchased with the 360,771.89 blocked marks resulted in a loss, in dollars. This loss has been allowed by the Commissioner in determining the deficiency in tax. Petitioner has failed to show that it sustained a greater one.

Decision will be entered wider Bule 50.

       The record indicates that the sales in the taxable year ended January 31, 1037, all occurred in the year 1936 and that the purchases were made upon the Bourse during 1936. In this opinion, therefore, the date of purchase will be referred to as 1935 and the date of sale as 1936.

       SEC. 112. RECOGNITION OF GAIN OR LOSS.
      ***#♦*»
      (f) Involuntary Conversions. — If property (as a result of its destruction in whole or in part, theft or seizure, or an exercise of the power of requisition or condemnation, or. the threat or imminence thereof) is compulsorily or involuntarily converted into property similar or related in service or use to the property so converted, or into money which is forthwith in good faith, under regulations prescribed by the Commissioner with the approval of the Secretary, expended in the acquisition of other property similar or related in service or use to the property so converted, or in the acquisition of control of a corporation owning such other property, or in the establishment of a replacement fund, no ⅜⅞⅛ or loss shall be recognized. If any part of the money is not so expended, the gain, if any, shall be recognized, but in an amount not in excess of the money which is not so expended.
      SEC. 113. adjusted BASIS FOR DETERMINING GAIN OR LOSS.
      (a) Basis (Unadjusted) op Property. — The basis of property shall be the cost of such property; except that—
      * * * * * * • * <
      (9) Involuntary conversion.- — If the property was acquired, after February 28, 1913, as the result of a compulsory or involuntary conversion described in section 112 (f), the basis shall be the same as in the case of the property so converted, decreased in the amount of any money received by the taxpayer which was not expended in accordance with the provisions of law (applicable to the year in which such conversion was made) determining the taxable status of the gain or loss upon such conversion, and increased in the amount of gain or decreased in the amount of loss to the taxpayer recognized upon such conversion under the law applicable to the year in which such conversion was made. ,

       In the regulation it is stated: * * The benefits of section 112 (f) cannot, be extended to a .taxpayer who does not purchase other property similar or related in service or use, notwithstanding the fact that there was no other such property available,, ^for purchase.”


source: Caselaw Access Project

author: Keen :

license: Public Domain

text:
    Chilhowee Mills, by H. A. Vestal, Managing Partner, and by Miles A. Riddle, Hubert J. Vestal, J. P. Vestal, Marie Kinser, Oscar A. Knox, and H. S. Moody, Partners, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 108922.
    Promulgated September 16, 1942.

      Homer Hendricks, Esq., and Clifford D. Bufón, C. P. A., for the petitioners.

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

Keen :

At the time the corporate charter of CJiilhowee Mills, Inc., was surrendered it was agreed that the business of the corporation should be carried on by the stockholders as partners. New books of account were opened in the name of the partnership showing the interest of each stockholder to be that of a partner with an interest in the partnership equivalent to his former stock interest, and the business was carried on in the name of the partnership.

Upon the dissolution of a corporation the stockholders become the real owners of the corporate property, subject to the rights of creditors and the right of the directors and officers of the old corporation to administer it in dissolution under the state statute. 19 C. J. S. § 1730 (c). When stockholders agree to and do carry on the business of a corporation as partners, a partnership is created. Fletcher, Cyc. Corp. (Perm. Ed.) § 8132. In the instant case the stockholders formed such a partnership and their rights to the income from the business became the immediate and direct rights of partners and ceased to be the secondary, derivative rights of stockholders. No formal instrument in writing was drawn up creating the partnership and defining the rights of the partners, but none was necessary. A partnership may be created by oral contract or one implied from the acts of the parties. 47 C. J. 649.

That a partnership may result from the continuation of corporate business after the dissolution of the corporation by the stockholders has been recognized by us in F. D. Keim, 4 B. T. A. 1240, and O. C. Lee, 6 B. T. A. 541 (affd. sub. nom. Carr v. Commissioner, 28 Fed. (2d) 551).

After a careful consideration of all of the evidence contained in the record before us, we conclude that the organization doing business under the name of Chilhowee Mills, against which the deficiency herein was determined, was a partnership the members of which were the stockholders of the corporation, Chilhowee Mills, Inc., then in dissolution, and the income from such business was partnership income and taxable as such.

Bespondent argues that (1) the organization carrying on business under the name of Chilhowee Mills is not a partnership, and (2) the business carried on under that name is in effect a continuation of the affairs of Chilhowee Mills, Inc., after the expiration of its charter, and therefore, under article 1001-2, Begulations 94, and article 901-2, Begulations 101, the income therefrom should be taxed as the income of an association. Having held that the organization carrying on business under the name of Chilhowee Mills was a partnership, we must necessarily conclude that respondent’s second argument has no validity, for if the business carried on was the business of a partnership it could not be the business or affairs of the corporation.

The cases of Roe Stephens Manufacturing Co., 12 B. T. A. 1254, and John Crocker, 32 B. T. A. 861 (affd., 84 Fed. (2d) 64), may be distinguished on their facts. In those cases the business formerly carried on by the corporation was conducted “in the same manner and under the same corporate name that had theretofore been used, and the same books of account and forms of billheads and letterheads were used.”

Bespondent does not make any contention on brief that the partnership, Chilhowee Mills, had so many features similar to a corporation that it should be taxed as an association (see article 1001-4, Begulations 94), nor do we find any facts in the record upon which such a contention could successfully be made.

Having concluded that the business of the Chilhowee Mills was conducted during the taxable years by a partnership composed of the stockholders of Chilhowee Mills, Inc., a corporation in dissolution, the question then arises whether the partnership is properly before us in the instant proceeding and whether we have jurisdiction.

While the partnership income tax returns for the taxable years are not in evidence, there is in the record uncontradicted testimony to the effect that these returns were made on partnership forms and reported the income involved herein as partnership income. It is also evident that the returns were made in the name of “Chilhowee Mills” and not in the name of “Chilhowee Mills, Inc.” The respondent’s determination of deficiency was addressed to “Chilhowee Mills” and we may assume resulted from his consideration of the partnership returns filed under that name. In his determination respondent does not determine that “Chilhowee Mills” is a corporation, but determines that “Chilhowee Mills is taxable as a corporation for the fiscal years under consideration.” (Italics ours.)

Thus we have in this proceeding a determination of deficiency addressed by the respondent to a partnership, holding that the partnership is taxable “as a corporation.” Under such circumstances, the partnership is properly the petitioner. See, among other cases in which this is implicitly recognized, Royal Syndicate, 20 B. T. A. 255, and Glensder Textile Co., 46 B. T. A. 176.

However, if we hold, as we have in this case, that the petitioner is a partnership and not taxable as a corporation, then the-amount of taxable income, as distinguished from the rate of tax, is to be determined in proceedings in which the individual partners are proper parties petitioner.

Therefore, we are foreclosed from the interesting question latent in this case of whether the proceeds from the sale of the assets of Chilhowee Mills, Inc., title to which remained in the corporation, made iii the name of the corporation by the officers and directors as trustees in dissolution pursuant to an option executed before the surrender of the corporate charter and renewed after its surrender by the same officers and directors as trustees acting on behalf of the corporation, are to be considered as the income of the partnership or income taxable as corporate income pursuant to articles 22 (a)-21, and 52-2, Regulations 94; Taylor Oil & Gas Co. v. Commissioner, 47 Fed. (2d) 108; First National Bank of Greeley v. United States, 86 Fed. (2d) 938; Northwest Utilities Securities Corporation v. Helvering, 67 Fed. (2d) 619; Hellebush v. Commissioner, 65 Fed. (2d) 902, affirming 24 B. T. A. 660; Will T. Caswell, 36 B. T. A. 816. The respondent has not determined a deficiency against Chilhowee Mills, Inc., or against its trustees in dissolution.

As we have indicated, the sole question before us under the pleadings is whether petitioner is to be considered, for purposes of taxation, as a partnership or as an association taxable as a corporation— a question involving the method of taxation and not the amount of taxable income.' Since we have concluded that petitioner is a partnership and is to be considered as such for purposes of taxation,

Decision of no deficiency will be entered.


author: Ke:rn: SteeNHageN,

text:
    Capento Securities Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent. Raytheon Production Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 105246, 108295.
    Promulgated September 22, 1942.

      Edward G. Thayer, Esq., and Loring P. Jordan, Jr., Esq., for the petitioners.

      J. T. Easlam, Esq., for the respondent.
   OPINION.

Ke:rn:

(1) Capento had acquired the entire issue of Production bonds for $15,160. It was not a shareholder of Production, • all of the shares being held by the Manufacturing Co. Capento’s only asset was the Production bonds. In the taxable year, pursuant to a plan, Production issued and Capento received 5,000 new preferred shares, worth $50,000, in exchange for the outstanding bonds. The Commissioner determined that by this exchange Capento realized gain of $34,840 which must be recognized. Capento contends that the substitution by Production of preferred shares for bonds was a recapitalization, which, under the Revenue Act of 1934, section 112 (g) (1) (D), was a reorganization, and that, since the bonds were exchange* by it solely for stock, no gain, may be recognized, citing section 112 (b) (3) or (4).

We see no escape from Capento’s position. The substitution of shares for bonds and the cancellation of the latter was a recapitalization, Burnham v. Commissioner, 86 Fed. (2d) 776; certiorari denied, 300 U. S. 683; Sigmund Neustadt Trust, 43 B. T. A. 848 (on review C. C. A., 2d Cir.); Hummel-Ross Fibre Corporation, 40 B. T. A. 821, and Ca-pento’s exchange of its entire property, consisting of the bonds, was an exchange by it of property or securities solely for stock in a corporation party to the reorganization pursuant to the plan of reorganization.

Kespondent’s argument to the contrary is based largely upon the general premise that such a reorganization is a tax-avoiding device and therefore suspect. But we are unable to find that the procedure adopted was without justifiable business foundation, cf. Gregory v. Helvering, 293 U. S. 465. The bonds had, so far as the record shows, been issued bona fide, in 1929; Capento had held them during the two years ■of its existence. Capento is still in existence as Production’s preferred shareholder. It is, of course, true that the two corporations are closely related, directly and through the Manufacturing Co., which owns the shares of each; but that does not necessarily color their transactions and prevent normal tax consideration. Capento invested $15,160 in Production Corporation’s bonds, and by a change in the form of its investment it now holds Production’s preferred shares instead of the bonds. As a shareholder, it has subjected its investment to the risks of the business instead of having, as a bondholder, a fixed obligation; and this was for the purpose, in the interest of the Production Corporation, of further subordinating its own position to that of other lenders. It is hard to see an actual realization of gain which is escaping tax by a factitious device, like that attempted in the Gregory case. There was no doubt an effort to avoid a course which would invite a tax, but this alone is no occasion for disregarding the clear terms of the statute. If the exchange had-been a conversion by the Production Corporation into preferred sharés pursuant to a provision of the bonds, no gain would have resulted to Capento, the bondholder, who perforce would have made the substitution, par for par, of shares of greater value than the cost to it of the bonds.

In Docket No. 105246, the determination is reversed.

(2) The Production Corporation in 1929 issued $500,000 of bonds (the consideration does not appear in evidence, so it may be assumed that they were issued for cash at par). In 1933 Capento bought these bonds from the holder at a cost of $15,160, and retained them as its only asset. Before the taxable year, Production needed working capital, and borrowed $200,000 from a bank upon Capento’s agreement that the obligation of the bonds was subordinated to the new loan. In the taxable year Production needed more working capital and sought to borrow $100,000. It was suggested that Production and Manufacturing, its sole shareholder, consolidate. This suggestion, however, was not adopted, and, instead of expressly subordinating the bonds to the new borrow, the same result as that of subordination was accomplished by substituting preferred shares for the bonds and canceling the bonds. In July 1935 the new preferred was issued in its entirety of $500,000 par value to Capento and the entire issue of bonds was surrendered by Capento and canceled. The preferred shares were worth $50,000. The new borrow was procured in October.

The petitioners argue that under the reorganization sections no gain or loss is realized, and also that no gain or loss is realized by a corporation in the receipt of the subscription price for the original issuance of its shares, citing Regulations 86, article 22 (a)-16. The Commissioner argues that Production realized gain of $450,000 in discharging its bonded indebtedness of $500,000 for its shares worth only $50,000, since under the circumstances the reorganization sections are not permitted to apply.

As we have said, there is no showing in this evidence of circumstances precluding the application of the reorganization sections. Production issued its preferred shares solely in exchange for its bonds, and section 112 (b) (3) describes this situation and provides that no gain or loss shall be recognized. But, leaving aside for the moment the statutory provision, it is hard to see that gain was in fact realized. The corporation had a liability of $500,000 on the bonds, having presumably borrowed that amount. While it discharged that liability, it created a new stock interest which became a balance sheet liability called capital stock. This is plainly different from the discharge of its indebtedness by the payment of money in a less amount than the indebtedness, as in Kirby Lumber Co. v. United States, 284 U. S. 1, and the cases which have followed it. To substitute a capital stock liability for a bonded indebtedness may have its advantages, as this case illustrates, but it can not be called a present realization of gain. The assets are not thereby freed from obligation. They become the subscription price contributed by the shareholder. Even though the shares issued are, for a reason not explained by the evidence, worth only $50,000, the amount whereby the par value exceeds the present value is not a gain, for it is the par value which measures the capital stock liability. Gain is not realized by a corporation in the receipt of the subscription price of its shares, Regulations 86, article 22 (a)-16, and this would seem to be no less true when the subscription price, instead of being newly paid, is the amount which has already been paid in as the principal of a bond loan. While the bond loan has been terminated, the amount borrowed is now committed to capital stock liability instead of to the liability of a fixed indebtedness.

The determination that the Production. Corporation realized gain of $450,000 is reversed.

3. When the preferred was issued for the outstanding bonds, unpaid interest on the bonds had accumulated to the amount of $33,750. This had been deducted by Production when it accrued. It was not paid, and in petitioners’ brief it is said the bondholder’s “claim to accrued interest disappeared.” The Commissioner, in the notice of deficiency, said “this interest item was canceled,” and included the amount in Production Corporation’s income, citing Regulations 86, article 22 (a)-149. Petitioners argue that the cancelation of the right to interest was a consideration for the preferred shares and not a forgiveness of indebtedness; and that, if it was a forgiveness, it was a gift.

We see nothing in the evidence to support the petitioners’ conception, either as consideration for the preferred shares or as a gift. The shares were issued as the consideration for the retirement of the bonds in the same amount, and nothing was said about the interest. The unpaid interest was not an item of the recapitalization plan, cf. Skenandoa Rayon Corporation v. Commissioner, 122 Fed. (2d) 268; certiorari denied, 314 U. S. 696; South Atlantia Steamship Line, 42 B. T. A. 705. The cancelation of the interest is not explained in the evidence. The fact of cancelation is all that appears. By the cancelation assets were freed of the burden of the interest debt, and there was no corresponding obligation in the preferred shares, for they were issued at a par value only equal to the principal of the bonds. Nor is there evidence tending to show that the cancelation was gratuitous or intended as a gift.

The determination that the $33,750 was Production Corporation’s income is sustained.

4. Respondent, by amended answer filed many months after the issuance of the deficiency notices and about the time notices of hearing were mailed, asserts penalties under section 291 of the Revenue Act of 1934, as amended by section 406 of the Revenue Act of 1935, on account of the alleged failure of petitioners to file returns within the time prescribed by law.

The returns were due on August 15, 1936, which was a Saturday. They were prepared and ready for filing on August 14. They were mailed to the collector of internal revenue at Boston. Petitioners’ offices were in Newton which is within the area commonly known as “Greater Boston.” The returns as introduced in evidence bear the file stamp of the collector with the date of August 17, 1936. This may be considered as some evidence that they were filed on that date. However, if petitioners’ failure to file the returns within the time prescribed by law was due to reasonable cause and not to willful neglect, the penalty will not be imposed. Whether the failure in this case to file timely returns was due to reasonable cause is therefore the issue here to be decided.

Respondent's regulation (Regulations 86, art. 53-4) provides that if a return is made and placed in the mails, properly addressed and postage paid, in ample time to reach the office of the collector in due course on or before the due date, no penalty will attach even though the return is not actually received by the collector until after the due date. It further provides that, if there is any question as to whether a return was posted in ample time to reach the collector’s office by the due date, “the envelope in which the return was transmitted will be preserved by the collector and forwarded to the Commissioner with the return.”

This regulation assumes, and in our opinion rightfully so, that if taxpayers mail returns to the collector, “properly addressed and postage paid,” in time for them to arrive at the collector’s office according to the period usually required for the transmission and delivery of mail, then the failure of the returns to arrive at the collector’s office within the time allowed by law is not due to the willful neglect of the taxpayers, but, so far as they are concerned, is due to reasonable cause. The regulation also correctly assumes that, if there is any question concerning the time at which the returns were mailed, then the envelopes in which they were mailed would constitute the best evidence.

In order to show in the instant case that the failure to file timely returns was due to reasonable cause, petitioners could offer proof that the returns had been timely “placed in the mails, properly ad.dressed and postage paid,” either through the oral testimony of the corporate officer charged with the filing of the returns or through the documentary evidence of the envelopes in which they were mailed. The corporate officer in charge of their filing died before the date of hearing (and before the filing of respondent’s amended answer). Petitioners were therefore confined in their proof on this issue to the envelopes which would have definitely proved the time when the returns were mailed to the collector and which, in all cases involving a question of whether a return was posted in ample time to reach the collector’s office by the due date, should have been “preserved by the collector and forwarded to the Commissioner with the return.”

Three days before the hearing herein petitioners’ counsel served on respondent’s counsel a notice to produce these envelopes. This notice was in writing and was in confirmation of an oral request to the same effect made several weeks before. At the hearing respondent’s counsel was asked whether he had the envelopes specified in the notice to produce. He answered, “I have not. I have been unable to produce them.” His sole explanation was: “It might be that the Commissioner had no doubt about the situation and there was no necessity for keeping the records.”

When a party fails to produce documentary evidence pursuant to a notice to produce and no satisfactory explanation for such failure is given, an inference may properly be recognized that the evidence would be unfavorable to the party failing to produce it. Jones on Evidence, 3d Ed. §§ 19, 20 and cases cited. We can think of no situation which more clearly demands the application of this rule than that presented in the instant case, where the respondent has raised an issue involving the imposition of a penalty at a time in the proceeding when he has had in his possession the only evidence which can give a definite answer to the issue which he has raised, which by his own regulation he should have preserved in the event of any such question, and which he failed to produce pursuant to proper notice.

From the facts shown, the explanation given by respondent’s counsel for his failure to produce the envelopes at the hearing, and the failure to impose the penalties in question at the time the deficiencies were determined, we can draw the logical inference that at the time when the returns were received for filing and at the later time when the deficiencies were determined, the collector and the Commissioner were satisfied that no penalty would attach because of the late filing of the return, and we may ascribe this satisfaction on their part to the fact that the returns were mailed at a time which brought the matter within the purview of respondent’s own regulation which we have quoted. This is the logical explanation for the inability of respondent’s counsel to produce the envelopes, for if the collector and the Commissioner were satisfied that no penalty should attach, there would be no reason for the preservation of the envelopes. We feel confident that if the envelopes had been preserved they would have been produced at the hearing. We conclude that they were not preserved and from that fact we draw the foregoing inference.

Having considered all of the evidence on this issue, and the inferences above referred to, we conclude that the failure of petitioners to file the returns in question within the time prescribed by law was due to reasonable cause and not due to willful neglect, and that no penalty should be imposed against petitioners pursuant to the statute.

We have considered this issue without deciding whether, in cases in which respondent alleges in an afiirmative answer the failure of petitioner to file a timely return and therefore asks the imposition of a penalty, the burden is on respondent to prove that the failure to file such a timely return is due to willful neglect and not to reasonable cause. If the respondent has such a burden of proof, then the result which we have already reached by another line of reasoning would be a fortiori.

Reviewed by the Board.

Decision will be entered wider Bule 50.

SteeNHageN,

dissenting in part: I am in agreement with the decision as to each of the first three points upon the merits. But I can not find that the failure to file the returns on the fifteenth, as the statute required, was due to reasonable cause and not due to willful neglect. The statute expressly requires that the penalty shall be added except when it is shown that the failure to file was due to reasonable cause. The evidence shows that the return was not filed within the time required by law, but does not show the cause of the failure. I therefore see no escape from the 5 per centum addition to the tax.

Mellott and DisNEY agree with this dissent.

         The evidence does not show from whom the bonds were purchased.


author: Hakron:

text:
    Mary F. Waggoner, Petitioner, v. Commissioner of Internal Revenue, Respondent. T. J. Waggoner, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 104161, 104162.
    Promulgated September 22, 1942.

      Robert Ash, Esq., and G. *0. Parfet, O. P. A., for the petitioners.

      Franle B. Appleman, Esq., for the respondent.
   OPINION.

Hakron:

The question under the main issue is whether or not petitioners’ gift of one-half of their interest in royalties and revenues-which might arise from oil and gas leases after the date of the gift-constituted a partial “termination” of oil leases which had not produced oil or gas prior to the gift, within the purview of subsection (c) of article 23 (m)-10'of Regulations 101, which is set forth ra-the margin, so as to require petitioners to return as income in the-year of the gift the proportionate amount (one-half) of the statutory percentage depletion allowances taken on the cash bonuses which, were received upon the execution of the particular leases, notwithstanding the fact that the leases were in full effect under their terms at the date of the gift, and no gift was made of any part of the cash bonuses which, rather, were retained in full by the petitioners.

The particular question has not been raised before this Board before.

The respondent’s theory will be better understood if background is sketched briefly. Following the decision in Herring v. Commissioner, 293 U. S. 322, respondent’s general counsel issued G. C. M. 14448, Cumulative Bulletin XIV-1 (1935), p. 98, under which he ruled that “A depletion deduction on the percentage of income basis is * * * allowable in every case of a bonus payment received in advance of production” and that under article 216 (c) of Regulations 69, which provides substantially as does article 23 (m)-10 (c), a taxpayer must restore to income the amount of a bonus depletion deduction taken on the percentage of income basis as of the year of the termination of a lease where there has been no production from the leased premises, just exactly as he must do where a bonus depletion deduction has been taken on the cost basis. That ruling has received the approval of this Board and one of the Circuit Courts of Appeal (C. C. A., 5th Cir.). Grace M. Barnett, 39 B. T. A. 864; J. T. Sneed, Jr., 40 B. T. A. 1136; affd., 119 Fed. (2d) 767; rehearing denied, 121 Fed. (2d) 725; certiorari denied, Thompson v. Commissioner, 314 U. S. 686; Dolores Grabb, 41 B. T. A. 686; affd., 119 Fed. (2d) 772 (remanded on another point, 121 Fed. (2d) 1015). It appears that a rule is now established that, even where the statutory deduction for depletion on a bonus is taken on the percentage of gross income basis, under section 114 (b) (3) (Revenue Acts of 1936 and 1938), when the lease is terminated, abandoned, or expired before mineral has been extracted, the taxpayer must “restore to income” the amount of such deduction as of the year of the termination of the lease. If, on the other hand, there has been actual production from the lease, however small, prior to the termination of the lease, there is no duty to “restore to income” the bonus depletion deduction previously taken on the percentage of income basis, because there has been actual depletion, though small in amount, percentage depletion having no relationship to cost. Dolores Crabb, supra.

In this case the reason that respondent made the restoration to income of one-half of the bonus depletion deductions is because petitioners’ legal interests in the leases, in the future royalties on production under the leases, were diminished by one-half by virtue of a gift to a trust in the taxable year. None of the leases had beeen terminated, abandoned, or expired. But respondent seeks here to extend his regulation, under a new'interpretation, to apply to the case where an interest in an oil lease is reduced by a gift. Respondent argues that, since the statutory depletion allowance on a bonus on a lease is a deduction “for anticipated depletion or exhaustion of the oil and gas reserves,” when petitioners divested themselves of one-half of their interest in the land and the oil and gas reserves at a time when no production had ever been had under the leases, it became certain that the petitioners never could have any depletion on the one-half of the oil and gas for which they had previously received a depletion deduction, and that, therefore, the leases had “terminated,” in so far as petitioners were concerned, with respect to the one-half interests which were given away.

Respondent’s theory is not sound when tested by the meaning of the percentage of income method of computing depletion.

Petitioners continued to have an economic interest in oil under the leases in question after the gifts, and, of course, stood in a position where their interests, or the bonuses on the leases in question, still were subject to depletion and exhaustion, the leases being in full force and effect. The deductions for depletion on the bonuses were taken under the arbitrary percentage method. Percentage depletion is not based on cost, or on the value or size of the interest, but is based on gross income from property. It is an arbitrary allowance fixed at 27½ percent of gross income from property during the taxable year. Louisiana Iron & Supply Co., 44 B. T. A. 1244. “Cost” depletion is determined on a different basis from “percentage” depletion. Under the first method of computing the depletion allowance, depletion deductions are limited by the cost or value of the depletable property, and when the cost of the property has been recovered through depletion allowances, no further deductions for depletion are allowable. Under the “percentage” method, “It is possible, and not unusual, for a taxpayer to recover tax free, through percentage depletion, an amount greater than the cost of the property.” Louisiana Iron <& Supply Go., supra, p. 1246. See also, article 23 (m)-l of Regulations 94, pp. 71, 72. From the above, petitioners having elected the “percentage” method for taking the statutory depletion allowances, it is immaterial, for purposes of article 23 (m)-10 (c), that the interest of petitioners in the leases was diminished under a gift in the taxable year at a time when no production under the leases had yet occurred. Respondent, obviously, confuses the situation here with depletion under the “cost” method. Under “cost” depletion, the total depletion allowance being limited by the cost to the taxpayer of his property, or interest, a diminution in the size of the property or interest retained by a taxpayer would seem to be material, although we do not decide that point here. (Respondent falls into the same error in citing John D. Lamont v. Commissioner, 120 Fed. (2d) 996, where depletion was computed on the basis of the value of the ore reserve on March 1,1913.)

It is not necessary to set forth the text of G. C. M. 14448, to which reference is made. It is stated there that “The allowance of the deduction in the year of the execution of the lease rests upon an anticipation of production,” and, “If on the termination of the lease there has been no production, then there has in fact been no depletion.” It can not be said here that it became certain on April 1, 1938, the date of the gift, that there would be no production under the leases in question. Cf., opinion denying rehearing in Sneed v. Commis sioner, 121 Fed. (2d) 725. As a matter of fact, there was production on several of the leases in question after that date. As long as petitioners had an economic interest in the leases and there still remained the leasehold right to carry on production, petitioners had a depletable interest. The bonuses received on the leases were still subject to depletion. As the court stated in the opinion denying a rehearing in the Sneed case, “The whole question turns about the bonuses and whether they represent any depletion.” Also, here, as opposed to the situation in the Sneed case, the question also turns upon a possible productivity under the leases in which petitioners retained economic interests.

Also, as is pointed out in G. C. M. 14448, supra:

* * * For the computation of depletion on the percentage of income basis, the Vase is the gross income from the property. Since * * * a bonus received in advance of production is “gross income from the property” in the case of oil and gas wells, * * * and as such is a part of the Vase for the computation allowed in anticipation of production, such a bonus is subject to depletion without the establishment of any other Vase.

It follows that when statutory depletion is taken on the percentage of income basis, and when the bonus on a lease, the base, is retained by the lessor, the donor of a part interest in the lease, and when there is no occurrence at the time of the gift of an interest in the lease which determines that there will be no production under the lease, then the position of the donor of part of an interest in the lease is no different after he makes a gift of a part interest from what it was before, for purposes of depletion on the bonus and for the purposes of article 23 (m)-10 (c). “Percentage” depletion is an arbitrary method. In each taxable year during the term ’of the lease, the base which is being depleted is a new and different thing, namely, the gross income from the property received in that year. Such income is apportioned under section 114 (b) (3), by application of the flat percentage, to income and to capital returned through depletion. The depletion allowance of 27½ percent of the income is taken in the 3rear of receipt of income. A capital sum, as is the case in “cost” depletion, is not being recovered over a period of years through depletion. In each year the gross income that is realized from the property in that year is the base for the allowance of depletion. Gross income from the property in each year is a different thing. There is a new base in each year that gross income is realized from the property, and there is a base upon which depletion is allowable for as long as there is income from the lease. That, of course, is not so when the “cost” method of depletion is followed. And that is the reason why different rules must be applied with respect to “restoration” of income with respect to a depletion allowance on a bonus on a lease when “precentage” depletion is the method used and when “cost” depletion is the method used. Just as long as the lessor who received the bonus retains an economic interest in the lease, the question which respondent has raised here does not arise, as a matter of law. It is only when the lease terminates, in fact, without production, ending the existence of the economic interest, that the question presented here can arise.

Respondent’s theory here results from failure to distinguish the different underlying elements in the two methods of computing the statutory depletion allowances. If no distinction is to be made between “cost” depletion and “percentage” depletion on lease bonuses in the situation presented by the gift of an interest in an existing lease, as respondent seems to think, then respondent’s treatment here is inconsistent in his failing to apply article 23 (m)-10(c) to the bonuses on the leases which had become productive prior to the time of the gift of a part of petitioners’ interests therein. Under respondent’s theory, how can it be said that the bonuses on the leases under production were not affected, for purposes of depletion and “recapture” of income for tax, by the diminution of petitioners’ interest in those leases because of the gift, in just the same way as in the case of the bonuses on the leases which were not under production? In our opinion the lease bonuses as a whole, on both classes of leases, were not brought within the requirements of article 23 (m)-10(c), and the reason for so holding is the same for the bonuses on both classes of leases.

Upon the foregoing discussion it is held with respect to each of respondent’s contentions that:

(1) Petitioners were not required in 1938 to return as income one-half of the percentage depletion deductions on the bonuses received on the leases in question in 1937 and 1938, for reasons already stated.

(2) Petitioners, electing the “percentage” depletion method, were entitled to take depletion deductions on the bonuses paid to them in 1938 on the particular class of leases involved, even though during 1938 gifts of one-half of their interests therein were made, because the bonuses were income to petitioners, no one else, and the bonuses were the base in their hands on which to compute depletion, and the depletion allowance could be deducted only by petitioners. Herring v. Commissioner, supra. The rule that tax is assessed on the basis of annual returns showing the net result of all the taxpayer’s transactions during a fixed accounting period, Burnet v. Sanford & Brooks Co., 282 U. S. 359, has no applicability under the facts of this case.

(3) Under authority of the Sneed case, there is properly restored to the income of petitioners in 1938 the amount of $137.50 which was deducted in 1937 as percentage depletion on the bonus allocable to the part of the Jones lease which was terminated before production in 1938 under the terms of the lease. Respondent “restored” the above amount to petitioners’ income in “two bites” of $68.75 each, under his theory under the main issue, which method was wrong although the result was right. This separate issue in the case demonstrates that •no inequity results to respondent under the holding made here under the main issue. No “income” derived from a cash bonus on a lease •escapes tax under application of article 23(m)-10(c), strictly according to its terms, to depletion deductions taken on the “percentage” method of depletion by waiting for the occurrence of actual termination of the lease. There is no sound reason for depriving a taxpayer ■of the full benefit of the “percentage” depletion allowance on a bonus for the reason that his legal interest in the lease is diminished by a gift made at a time when no production has yet taken place, but is still fully possible under the terms of the lease. There may be other considerations having a different effect where a lessor sells an interest in a lease before production has taken place, but that question is not raised here.

Respondent’s determination under the main issue is reversed. The provisions of article 23(m)-10(c) are not applicable to the situation presented in the main issue.

Reviewed by the Board.

Decision will be entered u/nd&r Bule 50.

       (c) If for any reason any such mineral lease expires or terminates or is abandoned before the mineral which has been paid for in advance has been extracted and removed,, the lessor shall adjust his capital account by restoring thereto the depletion deduction» made in prior years on account of royalties on mineral paid for but not removed, and a corresponding amount must be returned as income for the year in which the lease expires, terminates, or is abandoned.


author: Harron:

text:
    Caldwell Oil Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104240.
    Promulgated September 22, 1942.

      R. B. Gannon, Esq., and Benjamin L. Bird, Esq., for the petitioner.

      Frank B. Appleman, Esq., for the respondent.
   OPINION.

Harron:

Issue 1. — The question in this issue is whether the net proceeds in 1937 and 1938’ from the;sale of oil produced on the Fox lease is income of petitioner or of Caldwell. Under the assignments of November 2,1936, and the agreement made by petitioner in 1937, Caldwell was to receive all of the net proceeds from oil and gas sold from the lease. The parties argue the question under the terms of the assignment of November 2, 1936, and it will be considered with respect to the terms thereof.

The facts are that Caldwell acquired an oil payment right, that is, the right to receive a specified sum out of the oil production, if, as, and when oil was produced, saved, and sold as the consideration for his payment for the costs of drilling and equipping the wells. The instrument in clear terms gave Caldwell an interest in the proceeds of a full seven-eighths working interest in all the wells, after deducting the necessary and actual expenses of operation, until the “proceeds of the interest” paid $44,024.03 plus 6 percent interest to Caldwell. While it is true that petitioner was to pay Caldwell proceeds up to a specified amount, such payments were to be made only out of oil, if, as, and when produced. Caldwell so testified. There was no personal obligation in petitioner to make repayment to Caldwell, and there was no obligation in petitioner to make repayment from any other source. Further, the repayments were not to be made from petitioner’s “net profits,” as respondent contends. For example, there were certain outstanding liens against the Fox lease when petitioner acquired it, but the assignment did not provide that Caldwell was to receive proceeds from the sale of oil after deducting amounts necessary to take care of existing liens as well as operating expenses. Nor were any other items, such as developmental expense, to be deducted from the proceeds from the oil such as enter into the calculation of “net profits.” The facts here do not bring this case within the rule of Helvering v. O'Donnell, 303 U. S. 370; Helvering v. Elbe Oil Land Development Co., 303 U. S. 372; and Anderson v. Helvering, 310 U. S. 404.

The determination of the issue turns on whether or not Caldwell acquired an economic interest in the oil under the instrument relied on. It appears that respondent could not seriously contend that Caldwell did not obtain an economic interest, in the face of such authorities as Palmer v. Bender, 287 U. S. 551, and Thomas v. Perkins, 301 U. S. 655, and see also Commissioner v. O'Shaughnessy, Inc., 124 Fed. (2d) 33, but for the provision that actual operating expenses were to be deducted from proceeds from the sale of oil. The weight of authority leaves little doubt, if any, that such provision is immaterial. First, the rule is now clear, as stated in the O'Shaughnessy case, supra, that:

* * * One who acquires by contract, in whatever form, a right to the production from an oil and gas well, or the proceeds thereof until a stipulated amount has been paid, without any other or further security except the contingency of the production, thereby becomes the owner of an economic interest in oil in place * * * . [Italics supplied.]

See also, Hugh Hodges Drilling Co., 43 B. T. A. 1045, 1069:

* * * the owner of oil payment rights, who is required by the terms of the contract to look solely to the oil and gas or the proceeds from production for the agreed payments, has an economic interest in the oil and gas in place, is taxable upon the gross income derived from his interest, and is entitled to an allowance for depletion thereon.

In Ortiz Oil Co., 37 B. T. A. 656, affd., 102 Fed. (2d) 508; certiorari denied, 308 U. S. 566, among the facts, most of which have a close similarity to the facts here, Ortiz, which executed an oil payment contract with persons who advanced money for the acquisition of property, and the drilling of wells, was to manage, develop, and operate the properties and pay all expenses. The Board found as a fact, p. 660, that “They [Westbrook and Thompson] had an ‘overriding’ interest, all expenses of development and operation being paid by petitioner.” The Board held (p. 664), that, in substance, the money-furnished by Westbrook and Thompson was a cash consideration for the purchase of certain specified portions of the oil production, “to the extent of $359,333.34 in value, if, as, and when same should be produced,” and that such portions of the production belonged to and constituted property of Westbrook and Thompson. The Board recognized that their portions of the oil runs was “net” to them, Ortiz paying all expenses. The Board and the court held that West-brook and Thompson acquired an economic interest in the oil in place and that their right to share in the oil produced constituted an economic interest in the properties to the extent of the amount agreed upon. It is not necessary to set forth all of the facts of the Ortiz case, other than to point out that Westbrook and Thompson were entitled to receive certain portions of the proceeds of sales. The determining factor there was, and here is, that the persons who received rights to the proceeds of production from oil wells in consideration for advances, stood to be reimbursed only if oil was produced; otherwise, their money was lost. See also, Transcalifornia Oil Co., Ltd., 37 B. T. A. 119.

While we believe it is immaterial that petitioner was to retain out of proceeds from the sale of oil enough to pay actual operating expenses, it is pointed out that under the assignment to Caldwell his right was not limited to a share in the proceeds of oil produced and sold, but was a right in the entire seven-eighths working interest in all of the wells. Petitioner was no more than an operator. In order to realize anything from the oil payment right, expenses had to be entailed to lift the oil and deliver it to pipe lines. In reality, petitioner retained no interest in the oil in place, but had only a rever-sionary interest to come back to it when and after Caldwell’s right was exhausted. If petitioner had assigned to Caldwell a right to participate in only a share of the production, it is conceivable that the parties might have executed an operating contract under which operating and supervisory costs would be borne in proportion to their interests. Cf. Taylor Hardwick Trust, 44 B. T. A. 370 (reversed on a point not involved here). Under the facts it appears that petitioner was no more than an agent of Caldwell, its chief stockholder, to operate the lease. Whatever other questions this suggests we do not consider, because no other questions are in issue.

It is held that Caldwell’s right to the oil payments constituted an economic interest in the oil in place and that the amounts which he received therefrom during the taxable years constituted gross income to him, not to petitioner. Ortiz Oil Co., supra; Hugh Hodges Drilling Co., supra; Taylor Hardwick Trust, supra; Thomas v. Perkins, supra.

Issue 2. — Respondent contends that petitioner is estopped from raising the above issue. Petitioner included in gross income in its returns for each taxable year the amounts of the oil payments paid to Caldwell. After the respondent determined the deficiencies, petitioner, by an amendment to its petition, alleged that the oil payments should be excluded from its income in each year. Caldwell did not report the oil payments in income in his returns. Petitioner contends that, even though the oil payments constituted Caldwell’s income, nevertheless, he is not taxable upon the oil payments because they equaled his capital investment in the wells. That question, which is not in issue, is not considered, but see T. W. Lee, 42 B. T. A. 1217, 1228; affd., 126 Fed. (2d) 825, on the point of recoupment of cost out of production prior to reporting income from production.

Respondent raises the estoppel issue because he can not make any assessment against Caldwell for the years 1937 and 1938, more than three years having elapsed since the returns for those years were filed. Sec. 275 (a), Internal Revenue Code. The facts are that Caldwell’s returns were filed when due, on March 15, 1938, and March 15, 1939. • Petitioner filed the amendment to the petition on February 28, 1941, which was prior to the expiration of the period within which respondent could have made assessment of an income tax deficiency against Caldwell for both years. Also, the date of the hearing in this proceeding, October 8, 1941, was prior to the expiration of the assessment period for the year 1938. There is nothing in the facts to show that Caldwell, as president of petitioner and as an individual taxpayer, concealed any of the facts regarding the oil payments in question, from the respondent’s agents, or misrepresented them. He put at the disposal of the agents the records of petitioner and himself. In petitioner’s returns it is stated that its books are in the care of D. K. Caldwell. Also, Caldwell signed petitioner’s returns as its president. Caldwell’s returns bear the stamps of respondent’s auditor, the return for 1937 having been audited April 28, 1939, and the return for 1938 having been audited January 26, 1940. The 1938 return of petitioner bears the stamp “Received — • Audit Division — ” under date of April 17, 1939. The record shows (Tr. 145) that the agent asked Caldwell for figures pertaining to his income and the corporation’s income. Caldwell testified that, when respondent’s agent came to his office to audit his return for 1937, he asked the agent to check petitioner’s books, “since they both were related and had [sic] books all there in the office together.”

The question is whether petitioner’s mistaken course of conduct in including the oil payments in gross income in its returns, under a mistake of law, has estopped it from raising the question here. The respondent contends that he lost his right to assert a deficiency against Caldwell because lie relied upon the returns as filed. But this respondent must prove, “for estoppel is an affirmative defence.” Helvering v. Brooklyn City R. Co., 72 Fed. (2d) 274. It does appear now thiffi some income may escape tax under the holding made in the main ⅛¾&, but this is not because respondent was misled by petitioner’s return#. The respondent was advised of petitioner’s position in season to, assess tax upon the income in question in the hands of Caldwell. Nespohdent, apparently with full knowledge of the facts, relied upon Ml él'ídheous theory of the law, to wit, that the oil payments constituteidwpetM'bner’s income. His predicament is not due to reliance upon$MS®ynl|§c|)$$qct or misrepresentation by petitioner, but to his own mis^@SgS&tiq5jjQ4#ie law. Under the facts, respondent should have made his detq5ig%^%-||gg\ on the matter of whether the oil payments constituted income to Caldwell when he learned of petitioner’s claim, and hetíhp.uIHAasmpsseliM tax against Caldwell during the period allowed brille 'státutsi Astaá been stated succinctly by the Circuit Court of Circuit, “if he wished to avoid the runningioá ⅛⅛ ¾⅛⅝⅜;iheHmqsk make up his mind for himself.” Helvering v. Schine Chain Theatres, Inc., 121 Fed. (2d) 948; Helvering v. Brooklyn City R. Co., supra Respondent makes no claim that petitioner. eAfceaffidíífa'etsvpBÍdnutó misleading statements. Respondent’s pléauh#%star]bpfel oaaraoiibe^suss tained, because he had knowledge of albtheifácte, qáffaí}.pasSthfejre¿¡tad before us shows. He offered no proof'to,theT',onfea®y:. t§?ee Estate of Emma Frye, 44 B. T. A. 835. Petitioner’s failure to exclude the foi^oSM in question from its return was due to- aimistake of law and not to misrepresentation of fact. There is no basis hepe for estoppel. Salvage v. Commissioner, 76 Fed (2d) 112; affd., 297 U. S. 106; Estate of William Steele, 34 B. T. A. 173

By an affirmative pleading reépándqht aÜfegdfl ¿Na'ü'petiímSer’s come for 1938 should be increased’’by the amouiit'df ⅛?accrued interest on its note to Caldfv'élí ^hl:¿K1whs''fqrgavent|)yspaí|ll^ÍFin> 1938. Respondent has abanHbiipd this ís^e,'icóhhedih'g''it7’'uffier issued raised by the pleadings arh'no íohger isáüeptó fe^consiSefecf^nView^oi the holding under issueÍ'.!Í ■i‘°

.rr-'I'-ir'sUiJM «raj.^jqo rou-.iü-ouy vijlriu to Vecisio’n.wül.Qé enteredLunder Bule 50, nww. 'F'iuo j.HiK ,⅜⅞⅝/


author: Smith :

text:
    The United Gas Improvement Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 106504.
    Promulgated September 22, 1942.

      John H. Minds, Esq., for the petitioner.

      \Broohs Fullerton, Esq., and Harry L. Brown, Esq., for the respondent.
   OPINION.

Smith :

The petitioner alleges in its petition to this Board that in the determination of the deficiency for 1937 the respondent made the following errors:

(a) The Commissioner of Internal Revenue, * * * erroneously disallowed deductions of a loss in the amount of $2,473,062.52, which loss petitioner sustained in the year 1937 through bankruptcy of Nashville Gas and Heating Company, a Tennessee corporation, to which corporation petitioner had loaned large sums of money and in the preferred and common stocks of which corporation petitioner had invested large sums of money.
(b) The said Nashville Gas and Heating Company was also indebted to petitioner on two other items — one for an account receivable in the amount of $200.22, and the other for accrued interest in the amount of $333.34 — both of which sums of money petitioner lost through the same bankruptcy proceedings and both of which the Commissioner of Internal Revenue erroneously disallowed as a deduction when computing petitioner’s net income for the year 1937.

The alleged loss of $2,473,062.52 is composed of the following items:

Investment in the preferred stock- $726, 860. 67
Investment in the common stock- 188,140. 35
Loans to company from 10/9/21 to 1/1/22, the aggregate of which was charged off on the petitioner’s books of account in 1922 but not claimed as a deduction from gross income of that year_ 1, 036, 336. 50
.Loans to company which had not been charged off at date of bankruptcy proceedings- 522, 225. 00
2,473, 062. 52

The account receivable of the Nashville Gas & Heating Co. of $200.22 and, the item of accrued interest of $333.34 were not affected by the plan of reorganization. That plan specifically provided that the liabilities of Nashville Gas & Heating Co., other than those specifically mentioned in the plan of reorganization, were not to be affected. The petitioner has offered no evidence in support of its claim for the deduction of these two items and it will be considered that the petitioner has waived its claim thereto.

The respondent’s position is that the petitioner sustained no recognizable loss on the transactions in question, since it turned in to the corporation its obligations to petitioner, and other property, and received in exchange therefor all of the capital stock and some bonds of the reorganized corporation. Eespondent further contends in the alternative that the stock and securities, as well as the indebtedness of the Nashville Gas & Heating Co., became worthless, if at all, prior to the taxable year 1937. In his answer in which' he makes such alternative contention the respondent alleges that upon payment of the guaranteed bonds of the Nashville Gas & Heating Co. petitioner became subrogated to the rights of the bondholders and that in effect petitioner surrendered such bonds, together with those which it already owned, for the common stock of the reorganized corporation of a greater value, thereby realizing a taxable gain of over $1,300,000.

The material provisions of the statute (Eevenue Act of 1936) read as follows:

SEC. 112. RECOGNITION OP GAIN OR LOSS.
(a) General Rule. — 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.—
⅜ ***** *
(3) Stock for stock on reorganization. — No gain or loss shall he recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
* ***** *
(g) Definition of Reorganization. — As used in this section and section 113—
(1) The term “reorganization” means (A) a statutory merger or consolidation, or (B) the acquisition by one corporation in exchange solely for all or a part of its voting stock; of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of another corporation; or of substantially all the properties of another corporation, or (C) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (D) a recapitalization, or (E) a mere change in identity, form, or place of organization, however effected.

It should be observed that we are not dealing here with a merger or consolidation of corporations. The Nashville Gas & Heating Co. had the same assets after the reorganization as it had before. Its liabilities were reduced. It was the same corporate entity as before. Even if none of the other requirements of a reorganization as defined in section 112 (g) was met, there was certainly a “recapitalization” of the Nashville Gas & Heating Co. under section 112 (g) (1) (D). See Benjamin W. Fredericks, 21 B. T. A. 433; affd., Kistler v. Burnet, 58 Fed. (2d) 687; Walter F. Haas, 29 B. T. A. 900; affirmed without opinion (C. C. A., 6th Cir.), Jan. 14, 1936; Hoagland Corporation, 42 B. T. A. 13; affd., 121 Fed. (2d) 962; Helvering v. Alabama Asphaltic Limestone Co., 315 U. S. 179; Edith M. Greenwood, 41 B. T. A. 664; Daniel MacDougald, 44 B. T. A. 1046.

At the beginning of the reorganization proceedings under section 77B of the Bankruptcy Act petitioner owned practically all of the Nashville Gas & Heating Co.’s common stock (15,834.4 shares out of 16,000), all of its outstanding preferred shares, $37,000 of its guaranteed bonds, and $40,000 of its unguaranteed bonds. At the conclusion of the reorganization proceedings, and upon consummation of the plan of reorganization, petitioner owned all of the corporation’s common stock (it had no issued preferred stock) and $40,000 of its new bonds. Petitioner argues, however, that under the reorganization plan there was no exchange of the old shares for the new shares within the meaning of section 112 (b) (3), but that the new shares were issued to it solely in consideration for the cash payment of $1,968,207.86 which petitioner furnished to pay off the guaranteed bonds.

While the reorganization plan expressly provided that the holders of the old stock, both common and preferred, would turn those shares in to the trustee for cancellation and would receive nothing in exchange for them, we do not think that this determines what- was actually done in the reorganization, or the tax consequences thereof.

In the first place, it is obvious that the petitioner was the principal party interested in the reorganization of the Nashville Gas & Heating Co., since it owned practically all of its capital stock, was the guarantor of most of its outstanding bonds, and was its principal creditor. It was of no consequence to the other bondholders or to anyone else, unless to the minority common stockholders, whether the reorganization plan provided that the new shares should be issued to the petitioner in exchange for the old shares and the indebtedness or in consideration for petitioner’s payment of the guaranteed bonds. Petitioner was obligated by contract to pay off the bonds in any event. We do not know who the minority common stockholders were. They held only 1.03 percent (165.6 shares out of 16,000 shares) of the common stock. They made no objection to the plan of reorganization. The plan which was approved by the court provided that the rights and interests of all common stockholders would be terminated by the execution of the plan. The Nashville Gas & Heating Co. was not adjudged and never^ claimed to be insolvent. The proceedings for reorganization under , section 77B were based upon the company’s inability to meet the obligations on its bonds and other fixed payments as they became due. The petitioner points out in its brief in this proceeding that the corporate balance sheets for 1935 and 1936 show only a slight impairment of capital and a “very substantial equity, sufficient in amount to return to petitioner the major portion of its investment in the preferred and common stocks of Nashville Gas & Heating Company.”

In view of these circumstances we can not escape the conviction that the real consideration which petitioner gave for the new stock was the old stock and bonds and the indebtedness.

It has been held repeatedly that all of the different steps taken under a reorganization plan must be regarded as component parts of the plan and can not be treated as isolated transactions in determining the tax consequences. Prairie Oil & Gas Co. v. Motter, 66 Fed. (2d) 309; West Texas Refining & Development Co. v. Commissioner, 68 Fed. (2d) 77; Ahles Realty Corporation v. Commissioner, 71 Fed. (2d) 150; Sam Pickard, 40 B. T. A. 258; affd., 113 Fed. (2d) 488; Morgan Manufacturing Co., 44 B. T. A. 691.

In Hoagland Corporation, supra, there was a reorganization under section 77B of the Bankruptcy Act which the taxpayer conceded, and which we held, to be a reorganization under section 112 (g) (1) (D). Pursuant to the reorganization plan, there was a replacement of old stock and bonds with new stock. The taxpayer surrendered his old shares and a large indebtedness owed to it by the reorganized corporation for cancellation and in exchange received new class B shares. We held that the taxpayer did not sustain any recognizable loss on the transaction, and the Circuit Court of Appeals for the Second Circuit affirmed. In the instant case the petitioner surrendered for cancellation shares of the old stock, bonds, and the debt of the old corporation and received all of the newly issued common stock and some of the new bonds.

The facts in the instant case would not be distinguishable from those in the Eoagland Corporation case except for the express provision in the reorganization plan here that the old shares and the indebtedness owing to petitioner would be canceled and nothing would be given in exchange for them. As stated above, we do not think that the wording of the reorganization plan determines what consideration was actually paid for the new shares. The plan does not state specifically that petitioner’s payment of the guaranteed bonds would constitute the entire consideration for the new common stock. It says merely that:

If, on the consummation of the Plan, the Guarantor of the payment of principal and interest of the said guaranteed bonds (Nos. 1 to 2000, inclusive) shall pay to the Girard Trust Company, as trustee, cash in an amount sufficient to make the payments to the guaranteed bondholders as stated in (a) above, to be used for such purpose, the Guarantor shall receive all of the capital stock of the Company, namely, 20,000 shares of $100 par value each.

Petitioner was already legally bound to pay both principal and interest on the bonds, the due date of which was May 1,1937. The cash for that purpose was deposited with the trustee on April 23,1937.

Regardless of the wording of the plan, we think that in effect petitioner exchanged its old common and preferred stock and most of its claims against that company for the new common stock. See W. C. Coleman, 31 B. T. A. 319; affd., 81 Fed. (2d) 455.

As to the old common and preferred stock, there was clearly an exchange of “stock or securities ⅜ * * solely for stock or securities” within the meaning of section 112 (b) (3) and no gain or loss is recognizable on the transaction.

The fact that the cash or other property than “stock or securities” is given in exchange “solely for stock or securities” does not prevent the application of section 112 (b) (3). W. H. Hartman Co., 20 B. T. A. 302; First National Bank of Champlain, N. Y., 21 B. T. A. 415; George E. Hamilton, 30 B. T. A. 160; Securities Co. v. Commissioner, 64 Fed. (2d) 330. While the indebtedness for moneys advanced to the reorganized corporation was not “securities” (or stock), it was nevertheless, we think, an additional consideration for the new stock and for that reason may not be treated as a bad debt of the taxable year.

As an additional reason for disallowing the deductions claimed by the petitioner, we think the evidence fails to establish that the securities of the Nashville Gas & Heating Co., or its indebtedness to the petitioner at the time of the reorganization, became worthless during the taxable year 1937. The book value of the common stock, as shown by the company’s balance sheet at December 31, 1937, was $3,310,278.25, which figure is arrived at by adding to the par value of the stock ($2,000,000) the capital surplus ($1,417,371.56) and by deducting from the total the deficit in earned surplus of $107,093.31. There is nothing in the evidence to indicate that the petitioner would have been willing to part with the securities or relinquish the debt as proposed in the plan of reorganization without receiving the entire new issue of capital stock. The plan contemplated a cutting down of the liabilities of the company, the cancellation of the preferred and common shares outstanding, and the substitution therefor of 20,000 shares of common stock. Consideration must be given to the entire plan of reorganization. When so given, it must be held that the common stock was issued in consideration of all that was done by the petitioner. See W. G. Goleman, supra.

The respondent’s claim for an increased deficiency for the taxable year was an alternative contention. Since we have sustained the respondent’s contentions upon which the deficiency was determined, it is not necessary to consider the alternative contention.

Reviewed by the Board.

Decision toill be entered for the respondent.

Murdock, Leech, and Kern dissent.


author: Van Fossan:

text:
    Virgil Schaeffer, Petitioner, v. Commissioner of Internal Revenue, Respondent. William G. Pickrel, and Margaret B. Pickrel, Petitioners, v. Commissioner of Internal Revenue, Respondent. Lowell P. Rieger, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 109894, 109895, 109901.
    Promulgated September 22, 1942.

      Edward M. Woolf, Esq., for the respondent.
   OPINION.

Van Fossan:

The respondent determined deficiencies as follows:

For the year 1937 the respondent determined an overassessment of $86.56 in the case of William G. Pickrel and Margaret B. Pickrel, but the Board has no jurisdiction over overassessments. Cornelius Cotton Mills, 4 B. T. A. 255.

The cases were submitted on separate stipulations of facts, which are adopted as findings of fact as to each petitioner. The sole question is whether the profit realized from dividends received on certain “certificates of claim” against an insolvent bank, purchased by petitioners at less than par value, is ordinary income or capital gain under, section 117 (f) of the Revenue Act of 1938. Respondent held it to be ordinary income. Petitioners contend that it is capital gain.

The petitioners filed their income tax returns for the years involved with the collector of internal revenue for the first district of Ohio.

Briefly the facts are:

The Union Trust Co. of Dayton, Ohio, a state bank chartered under the laws of Ohio, was closed October 31, 1931, and taken over for liquidation by the Superintendent of Banks of Ohio. The bank had approximately $28,000,000 in deposits and some 90,000 depositors. All accounts known as “school children accounts” were paid off in full immediately after closing. Likewise, all preferred and all secured creditors of the bank were paid off shortly thereafter. All persons who were indebted to the bank and had deposits therein were given credits against their debts'by the way of set-off and their accounts closed. By April 1932 all of the above adjustments had been completed and negotiable certificates of claim were issued to all remaining depositors of the bank, approximately 50,000 in number, and amounting to more than $15,000,000 in money.

The bank, with the approval of the superintendent of banks, permitted the liquidation of debts by borrowers by the use of certificates of claim, in some cases accepting these certificates at full face value and in other instances accepting them at less than face value but more than market value. Debtors being able to use certificates of claim in this manner purchased them from the bank’s creditors, thus enabling the creditors to liquidate their certificates. An extensive business of dealing in the Union Trust Co. certificates of claim grew up with the various brokerage houses until finally an exchange for handling such certificates and other claims was established. The certificates were purchased by the public for speculative purposes as well as for use in the liquidation, of debts.

At various times dividends were paid by the liquidator on the certificates of claim, such dividends being endorsed on the back of each certificate when paid. The market for the exchange of certificates continued until the final liquidation of the bank. Other banks accepted certificates of claim as collateral security on loans.

The certificates of claim were issued over the signature of the Superintendent of Banks of Ohio and certified that “The Union Trust Company of Dayton, Ohio, is justly indebted to the above named claimant in the sum of_dollars.” Various provisions appeared on the face of the certificate, among which was “this certificate shall be sole evidence of the above claim and must be presented when each dividend is paid and surrendered on payment of the final dividend.” No provision appears on the face of the certificate of claim requiring or providing for the registration of the certificate. No interest coupons were attached to the certificate.

Petitioners Virgil Schaeffer and William G. Pickrel, law partners, purchased in 1937 certain certificates of claim from various persons. After the purchase the certificates were paid through the liquidation of the Union Trust Co. and the taxpayers (including Margaret B. Pickrel) received a profit, all of which they reported as capital gain in 1939. A dividend of 5 percent received in 1938 was not reported in that year.

Petitioner Kieger purchased a certificate of claim which represented a consolidation of the certificates of numerous individuals, previously purchased by Bieger Brothers & Co., which individual certificates were surrendered and one certificate issued in lieu thereof. Liquidating dividends were paid in 1938 on account of the certificate of claim, resulting in a profit to the petitioner which he returned as capital gain in that year. In 1939 a final liquidating dividend was paid which was reported as capital gain in that year. Upon payment of the final liquidating dividend the certificate was surrendered to the superintendent of banks.

On this set of facts petitioners contend that the profit realized was taxable as capital gain under section 117 (f), quoted above. The question thus addressed is: Were the certificates of claim “certificates or other evidences of indebtedness” under the statute ?

In Norman Buckner, 43 B. T. A. 958, the Board held that certificates of proof of claim issued by a national bank receiver were not such certificates of indebtedness as to justify treating payment thereon as a sale or exchange so as to make applicable section 117 (f). In that case we stated:

* * * We ean not accept the view that the careful and exclusive language of the section under consideration was designed to include anything so far afield as a receiver’s certificate of proof of claim.

In Mary D. Gerard, 40 B. T. A. 64; affd., 120 Fed. (2d) 235, we held that a bond and mortgage given by a corporation to secure a loan from an individual do not come within the terms “bonds, debentures, notes, or certificates or other evidences of indebtedness issued by any-corporation,” as those terms are used in section 117 (f) of the Eevenue Act of 1934. In that case we pointed out that the bond and mortgage failed to meet the statutory test in that they did not bear interest coupons nor were they registered. We then observed that a more basic reason for the decision was that a bond and mortgage given in the form and circumstances there present “under the old and well established doctrine of noscitur a sociis, are not included in the term ‘bonds, debentures, notes, or certificates or other evidences of indebtedness issued by any corporation.’ ” We stated further, “obviously, Congress, by the use of the word ‘other,’ intended to limit the scope of the term, ‘evidences of indebtedness.’ ”

Applying the same tests to the situation at hand, we arrive at the same conclusion announced in the above cases. The certificates of claim bore no interest coupons and there is no evidence that they were registered. Therefore, they would fail of qualification under Mary D‘. Gerard, supra. Moreover, we do not believe the instruments in question come within either the literal or the intended scope of the statute. Norman Buchner, supra.

We are wholly unimpressed by the argument of- petitioners’ counsel that we should look to the definition of “securities” as contained in the Ohio Securities Law. The Federal statute under consideration is explicit and is to be construed from consideration of its own terms. The all-comprehending definition of a “security” found in G. C. 8624-2 (Ohio Securities Act) can -not be read into the language of section 117 (f).

Although certain statements in the stipulations of facts would lead to the conclusion that the certificates of claim were issued by the Trust Co., it appears from the specimen of such certificate attached to the stipulation that it is issued by the state superintendent of banks as an official certification that the Trust Co. is indebted to the claim-holder. Thus, it may well be concluded that it was not a certificate or other evidence of indebtedness “issued by any corporation.” Likewise, the present situation fails to come within the parenthetical clause “including those issued by a government or political subdivision thereof.” The debt was not owed by the State of Ohio. It was a debt of the Union Trust Co. The superintendent of banks is not a political subdivision of the State of Ohio and did not purport to issue a certificate of indebtedness against the state.

We hold that the profit on liquidation was ordinary income and not capital gain.

Decisions will be entered for the respondent.

       SEC. 117. CAPITAL GAINS AND LOSSES.
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      (f) Retirement of Bonds, Etc. — For the purposes of this title, amounts received by the holder upon the retirement of bonds, debentures, notes, or certificates or other evidences of indebtedness issued by any corporation (including those issued by a government or political subdivision thereof), with interest coupons or in registered form, shall be considered as amounts received in exchange therefor.