author: Mellott: Smith,

text:
    The Nicollet Associates, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81751.
    Promulgated February 17, 1938.

      Harry A. Blackrmm, Esq., for the petitioner.

      Gerald W. Brooks, Esq., for the respondent.
   OPINION.

Mellott:

The questions for determination are: (1) Upon what basis shall depreciation on the building be computed for the taxable year ? (2) Is petitioner estopped to assert that the basis is the original cost, unadjusted for the payments made by the lessee upon the mortgage? (3) Is petitioner entitled to deduct from gross income the unamortized portion of the commission paid to the real estate firm in 1924 ? (4) Did petitioner receive taxable income in 1932 in the amount of $98,929.74 by reason of the termination of the lease?

While petitioner in its return of income for the taxable year deducted $9,984.09 as depreciation and while the respondent determined that a reasonable allowance therefor was $7,756.67, the present contentions of the parties, following their agreement that the cost of the building and the allowed and allowable depreciation are as shown in our findings, may be depicted in the following schedule:

The parties admit that the petitioner erred in treating the transaction, in its return of income for the year 1924, as a sale of the building. The same error continued throughout the years 1925 to 1931, inclusive. Under the decisions of the courts and this Board, the entire amount received by the petitioner, including the payments made by the lessees for its benefit upon the mortgage, should have been reported by it as income. Nelson Land & Oil Co., 3 B. T. A. 315; Louis Rothenburg, 5 B. T. A. 666; O'Day Investment Co., 13 B. T. A. 1230; Minneapolis Syndicate, 13 B. T. A. 1303; George W. Crile, 18 B. T. A. 588; aifd., 55 Fed. (2d) 804; certiorari denied, 287 U. S. 600; Marvin H. Gates, Trustee, 26 B. T. A. 998; affd., 69 Fed. (2d) 277; James M. Butler, 19 B. T. A. 718. Although petitioner undertook to sell the building, the practical effect of the transaction was only to grant to the lessees the right to use and occupy the building so long as the lease remained in effect. For this right, the lessees paid an additional consideration. As the court said in Gates v. Helvering, 69 Fed. (2d) 277: “It is probably not important whether it be called a bonus in the nature of advance rentals or advance rentals. It was a part of what the lessee was to pay for what he received, and what he received was a leasehold interest in the land and an equivalent interest in the building.” Petitioner, not having sold the building or parted with its capital asset, was entitled to claim depreciation upon the building during the period the lease was in effect; but it did not do so. Recapitulating, during the years 1924 to 1931, both inclusive, petitioner erroneously failed to report income and failed to claim deductions which were allowable.

To some extent both parties are asking that improper adjustments be made in the taxable year' to correct errors made in prior years. Petitioner, pointing to court and Board decisions holding that commissions paid by a lessor for the negotiation of a long term lease may be deducted ratably throughout the term covered by the lease, in effect says: “I deducted the $25,000 commission which I paid in 1924; but that was improper. My theory at the time was that such commission was paid for making a sale of my property. I have since ascertained that the amount which was paid was compensation to my agent for securing a long term lease and, notwithstanding the fact that I did not report as income the amounts received under it, I have now made adjusting entries in my books, debiting my surplus $23,125 representing the portion of the commission heretofore erroneously deducted from income and crediting ‘Amortization of Commissions’ in the same amount. My books now show unamortized commissions aggregating $23,125, and, the lease now having been terminated, I will deduct said amount from my income in the taxable year.”

Respondent, in his determination of a deficiency and upon brief, in effect says: “Petitioner did not correctly report its income during the years 1924 to 1931, inclusive. I will therefore treat the unreported income — which was taxable but upon which no tax was paid— as a return to petitioner of part of its cost of the building. The ‘receipts’ may, and equitably should be considered as adjustments to petitioner’s cost basis under section 113 (b) (1) (A) of the Revenue Act of 1932, though not ‘properly chargeable to capital account’, because petitioner made entries in its books restoring the building to its capital account and because petitioner is estopped from asserting that its cost basis should not be adjusted by the addition of the excess recovered, or $98,929.74.”

While the parties do not state their contentions in the language set out above, their arguments, and the adjustments which they claim should be made, indicate that the contentions are about as stated-They are manifestly untenable. The earlier years are not before us and no adjustments can be made whereby either the income which was unreported can be taxed oi’ the deductions which should have been claimed can be allowed. Our problem is to ascertain the amount of income and deductions for the year 1932, and “The law does not contemplate the adjustment in any part of an incorrectly computed tax by the incorrect computation of another tax.” Union Metal Manufacturing Co., 1 B. T. A. 395, 399. Estate of William Steele, 34 B. T. A. 173, and cases cited. Petitioner is entitled to the depreciation allowed it under the law and to no more and no less than that amount. It is likewise entitled to the deductions allowed by the law and to no more and no less than those allowed.

The statute (sec. 23 (k), Revenue Act of 1932) allows as a deduction from gross income “A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence.” The respondent in his regulations (art. 201, Regulations 77) states that a “proper allowance” is “that amount which should be set aside for the taxable year in accordance with a reasonably consistent plan * * * whereby the aggregate of the amounts so set aside, plus the salvage value, will, at the end of the useful life of the property in the business, equal the basis of the property * * *.” Substantially the same rule was enunciated by the Supreme Court in City of Knoxville v. Knoxville Water Co., 212 U. S. 1, and United States v. Ludey, 274 U. S. 295, and has been applied by this Board in various cases. Cf. Richmond Belt Railway Co., 13 B. T. A. 1291, and Terminal Realty Co., 32 B. T. A. 623.

It is fundamental, and is recognized by the respondent, both in his regulations (art. 204, Regulations 77) and in his brief in the instant proceeding, that “The capital sum to be replaced by depreciation allowances is the cost or other basis of the property in respect of which the allowance is made.” Upon brief, however, respondent, relying upon the provisions of section 113 (b) (1) (A) of the Revenue Act of 1932, contends that the “net adjustment” of $98,929.74 shown in his computation, supra, should be deducted from such basis, his theory being that such net amount constituted a “receipt” within the meaning of the section quoted. Any such construction, however, fails to take into consideration the words of the statute, “properly chargeable to capital account.” We have held that the amounts received in the years 1924 to 1931 from the supposed “sale” of the building constituted income. Respondent agrees with this construction. Cf. James M. Butler, supra. But such income, at least under the circumstances here present, was not “properly chargeable to capital account.” It seems to follow, and we so hold, that the respondent’s contention in this respect can not be sustained.

But, argues respondent, petitioner is acting “unconscionably” in claiming its deduction for depreciation without making any “effort or offer to make the commissioner whole for the tax on said items (the income which it received and did not report in 1924 to 1931, inclusive) which is clearly due.” He contends that the equitable doctrine of estoppel prevents it from taking as a basis for depreciation its cost of the building unless adjusted as shown in his schedule. The petitioner, on the other hand, contends that the equities are all in its favor in that it made overpayments of its tax in each of the years, save one. We have made no attempt to weigh equities, fancied or real. Apparently there were no false representations of fact but at most a mutual mistake of law. In this connection it may be remarked that respondent made an audit of petitioner’s return for the year 1924 and collected an additional tax of $308.78; but he did not attempt to collect, as he might have collected, tax upon the entire amount received during that year if he had recognized that no sale had actual] y been made. He also made an audit of petitioner’s 1926 return and advised it that the return was considered to be correct.

In Estate of William Steele, supra, we said: “We have been referred to no case where estoppel Avas founded on mutual mistake of law alone”, and therein Ave discussed at some length estoppel as applied to tax cases. It Avould serve no useful purpose to repeat the discussion here. Suffice it to say that Ave are of the opinion, and hold, that estop-pel is not applicable under the facts before us. Cf. Sugar Creek Coal & Mining Co., 31 B. T. A. 344; Wobber Brothers, 35 B. T. A. 890, on appeal to the Circuit Court of Appeals for the Ninth Circuit; Commissioner v. Union Pacific Railroad Co., 86 Fed. (2d) 637, affirming Union Pacific Railroad Co., 32 B. T. A. 383; and Salvage v. Commissioner, 76 Fed. (2d) 112.

Petitioner, in support of its contention that the item set up on its books after the termination of the lease as “Unamortized Commissions” is deductible, cites several court and Board decisions which hold that commissions paid by a lessor for the negotiation of a long term lease are deductible from gross income, ratably, over the period covered by the lease. In most, if not all, of the cited cases the issue was simply whether the total amount should be deducted in one year or spread over the term; but the petitioner has cited no case in which the use of both methods has been approved, thus enabling the taxpayer to deduct twice the amount so paid. That, in effect, is what petitioner is seeking to do here. It deducted the amount from its gross income in 1924 and the deduction was allowed. The statute of limitations prevents any adjustment for that year. What has been said above with reference to the respondent’s adjustments and contentions is, at least in part, likewise applicable to the petitioner’s claim that the amount of unamortized commissions is deductible in the taxable year. “There is nothing in the [Revenue] Act that purports to authorize double deduction of losses. * * *" Charles Ilfeld Co. v. Hernandez, 292 U. S. 62.

In Baltimore & Ohio Railroad Co., 30 B. T. A. 194; affd., 77 Fed. (2d) 999, the Board, under facts somewhat analogous to those in the instant proceeding, said: “The petitioner elected to claim the expenses as deductions in the respective years in which they were incurred, rather than exhaust them ratably over the life of the bonds. The respondent allowed the claims,, thus giving the petitioner the full benefit of the applicable revenue acts as he then interpreted them. Refusal to allow aliquot portions of the expenses as deductions in the taxable years, when the bar of the statute of limitations precludes adjustments in petitioner’s income tax returns for years prior to 1920, is, we think consistent with, rather than contrary to, principles of equity. The petitioner is in no position to contest the legality of the claims it made.” (Citing cases.) See also Stern Bros. v. United States (Ct. Cls.), 8 Fed. Supp. 105.

It is held (1) that the basis for the computation of depreciation upon petitioner’s building for the taxable year is $254,061.06; (2) that such basis should not be adjusted for the payments made by the lessee upon the mortgage; (3) that petitioner did not receive taxable income in the year 1932 by reason of the termination of the lease; and (4) that the respondent did not err in disallowing the deduction from gross income of the $23,125, described by the petitioner in its return as “Unamortized 1924 Commission Charged Off.” Deficiency shall accordingly be recomputed.

Reviewed by the Board.

Judgment will be entered under Rule 50.

Smith,

dissenting; The first question presented by this proceeding is the allowance for depreciation deductible from the gross income of 1932. The respondent has determined the allowance in the amount of $7,756.57.

Section 23 (k) of the Bevenue Act of 1932 permits a taxpayer to deduct from gross income “a reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence.” The question in issue is what constitutes a “reasonable allowance.” In United States v. Ludey, 274 U. S. 295, it was stated:

* * * The amount of the allowance for depreciation is the sum which should be set aside for the taxable year, in order that, at the end of the useful life of the plant in the business, the aggregate of the sum set aside will (with the salvage value) suffice to provide an amount equal to the original cost. * * *

The stipulated cost of the building was $375,991.74. The depreciation sustained upon the property to July 1, 1924, and deducted from gross income in the taxpayer’s return, was $42,057.96, leaving a remaining cost to the petitioner of $333,933.78. In the petitioner’s tax return for 1924 the petitioner treated the transaction as a sale of the building to the lessee. It received $60,000 cash upon the sale, which was applied against the remaining cost, thereby reducing the cost basis to $273,933.78. Subsequently, the lessee paid $205,000 upon the mortgage, which redounded to the benefit of the petitioner. This reduced the remaining cost of the building to the petitioner to $68,933.98. The parties are agreed that 4 percent of the remaining cost to the petitioner is a reasonable allowance for depreciation for 1932. Four percent of $68,933.78 is $2,757.35. The respondent did not, however, use as the remaining cost of the building $68,933.78, but added thereto $86,197.54, which was the profit returned by the petitioner for 1924 as having been realized upon the sale of the building. The respondent, therefore, determined the remaining cost of the building to the petitioner to be $155,131.32, and he has based his “reasonable allowance” for depreciation as 4 percent of this amount. I do not see how the reasonable allowance for depreciation is an amount greater than the respondent has determined. I think it is entirely immaterial that the petitioner should have returned the $60,000, received in 1924 as a part payment on the building, as additional rent, or the additional $205,000 paid by the lessee in subsequent years upon the reduction of the mortgage. The plain facts are that the only remaining cost of the building to the petitioner at January 1, 1932, was $68,933.78. It is not entitled to recover through depreciation allowance over the useful life of the building a greater amount than represents its investment in the building.

       SEC. 113. ADJUSTED BASIS EOR DETERMINING GAIN OR LOSS.
      *******
      (b) Adjusted Basis. — The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis determined under subsection (a), adjusted as hereinafter provided.
      (1) General Rule. — Proper adjustment in respect of property shall in all eases be made — ■
      (A) for expenditures, receipts, losses, or other items, properly chargeable to capital account, including taxes and other carrying charges on unimproved and unproductive real property, but no such adjustment shall be made for taxes or other carrying charges for which deductions have been taken by the taxpayer in determining net income for the taxable year or prior taxable years.


source: Caselaw Access Project

author: HaRron:

license: Public Domain

text:
    Julian B. Hart, Petitioner, v. Commissioner of Internai Revenue, Respondent.
    Docket Nos. 75030, 78877.
    Promulgated February 17, 1938.

      Ferdinand Tannenbaum, Esq., for the petitioner.

      O. W. Sweeher, Esq., and W. R. Lansford, Esq., for the respondent.
   OPINION.

HaRron:

The sole question is whether petitioner realized income in the years 1931 and 1932 as the result of the construction of a building by a sublessee on leased premises of which the petitioner was a part owner. The building was completed in April 1925 and has an estimated useful life of 30 years to April 1955. The original lease of the premises on which the building was constructed was for a term of 20 years, I months, to April 30, 1944. The lessees had options to renew the lease for three successive terms of 21 years thereafter.

The Commissioner has prescribed alternative methods of reporting income where a lessor realizes income as the result of improvements on premises by lessees. The regulation is quoted in the margin, as amended by T. D. 4282, C. B. VIII-2, p. 82.

The petitioner and the other lessors involved did not report income as a result of the construction of the building in 1925, pursuant to subsection (a) of article 63. The respondent has determined that he should therefore report income pursuant to subsection (b). Respondent has determined a deficiency by applying subsection (5), specifically, as follows: The Commissioner held that the building erected in 1925 by the sublessee had a fair market value of $480,000. From this figure he deducted $320,000 representing 20 years depreciation, the original term of the lease, at 3% percent. As there were old buildings torn doAvn which had a value of $60,000 for which obsolescence was allowable, the “income” received by the lessors by reason of the erection of the building was determined to be $100,000. This amount respondent spread over 20 years, the term of the original lease, under option (5) of article 63 of Regulations 74. He thereby determined that the lessors realized a yearly “income” of $5,000, which, apportioned among the four owners resulted in “income” to the petitioner of $1,250. This amount was added to petitioner’s taxable income in each of the taxable years.

The petitioner, one of the lessors, in his income tax returns for the taxable years reported no income by reason of the erection of the building and the-acquisition of title thereto.

Petitioner contends that he derived no income in the taxable years from the completion in 1925 of a building erected by the sublessee on the premises leased for an original term expiring April 30, 1944, with options for renewals for 3 terms, totaling 63 years, options exercisable by the lessee solely, when the probable life of the building from April 1925 was 30 years. He further argues that he could not realize income from construction of the building until he disposed of his interest in the leased premises. Petitioner relies on Hewitt Realty Co. v. Commissioner, 76 Fed. (2d) 880, which was decided by the Circuit Court of Appeals for the Second Circuit, which reversed this Board’s opinion, Hewitt Realty Co., 29 B. T. A. 1205.

The respondent has determined that petitioner realized taxable income as a result of constructing a building on the premises leased by petitioner and others. This determination has been made pursuant to article 63 (6) of Regulations 74. In applying the pertinent provision of the regulations, respondent has considered only the depreciated value of the improvements at the expiration of the original term of 20 years and has disregarded the option in the lessee to renew the lease for a renewal term of 21 years. This, we now believe to be in error.

In considering the question whether construction of a building on leased property enriches the lessor so that he realizes taxable income, we- must enquire whether the improvement has enhanced the value of the property. Whether or not there is an increase in value is a question of fact. Cf. United States v. Boston & Providence Railroad Corporation, 37 Fed. (2d) 670; Hewitt Realty Co. v. Commissioner, supra, p. 883. The facts are to be considered in relation to the terms of the lease.

In this proceeding the improvements were not removable from the realty and title to them vested in the lessors. The rental for the original term of the lease was fixed upon the basis of the value of the unimproved realty, i. e., ground rent. For the last five years of the original term the rental per year was $105,000. It was provided in the lease that the rental for any renewal term should be not less than $105,000 per year or a ground rental of 5 percent per annum of the value of the land, as found by appraisers, excluding the value of the newly constructed building. In other words the lessors gave the lessee the option to renew without any increase in the rent based on any added value to the property due to the erection of the building. Therefore, so long as the lease should continue into a second term of 21 years from the end of the first 20% years, the improvement resulting from construction of the building would enhance the value of the leased premises only if the useful life of the building were for a period longer than the life of the lease. It is agreed that the building’s estimated useful life was 30 years, to 1955. The second term of 21 years from April 30,1944, would run to April 30,1965, which exceeds the estimated useful life of the building.

Article 68 (&) of Kegulations 74 provides that the depreciated value of a building at the expiration of the lease may be spread over the life, of the lease. This regulation has been interpreted by the Commissioner to mean that the term “expiration” refers to the period covered by the original term of a lease without consideration for whether there may be any renewal. In Hewitt Realty Co., 29 B. T. A. 1205, we approved this interpretation by stating that the lease may not be considered as extending over possible renewal terms, referring to Bonwit Teller & Co. v. Commissioner, 53 Fed. (2d) 381. The Circuit Court of Appeals has held that the Board was in error in its opinion. The opinion of the court is not unanimous on the point of whether the regulation applicable is valid. We believe that the regulation is valid and have so indicated. See Emma C. Morphy, 35 B. T. A. 289; Julia Willms Sloan, 36 B. T. A. 370. However, in these last cited cases the issue was not concerned with the problem of how to apply the pertinent regulation where the improvements were made upon premises subject to renewal lease at rental to be computed on the basis of ground rent, nor were there such other factors as are present in this proceeding. We believe that in determining the issue here involved we must consider whether the improvements on the leased property increased the value of the property so as to result in taxable income to the lessor and that, to properly determine whether there is income to the lessor, consideration should be given to whether the lease may be extended over possible renewal terms.

Therefore, giving recognition to the fact that the creation of one renewal term of the lease under the option to renew would put the date of expiration of the lease beyond the depreciated life of the building, and where, further, the option to renew does not involve any increase in rent based upon any added value to the property due to the erection of the building, we believe that it can not be said that the petitioner in this proceeding realized any taxable income in the taxable years. We believe that the question of when or whether taxable income is realized may not be determined until the time, under the terms of the lease, when the lessee will elect either to renew or not to renew the lease for a further term of 21 years. Therefore, the Commissioner erred in ignoring the possibility of renewal for another term in estimating the depreciated value of the building a,t the termination of the lease for purposes of taxation.

It is held that the Commissioner erred in determining the deficiency and there is no deficiency in No. 75030.

Reviewed by the Board.

Decision will be entered for petitioner in No. 75080. Decision will be entered imder Bule 50 in No. 78877.

       Article 63 of Regulations 74, as amended, reads in part as follows :

        “Improvements hy lessees. — When buildings are erected or improvements made by a lessee in pursuance of an agreement with the lessor, and such buildings or improvements are not subject to removal by the lessee, the lessor may at his option report the income therefrom upon either of the following bases :

        “(a) The lessor may report as income at the time when such buildings or improvements are completed the fair market value of such buildings or improvements subject to the lease.
      “16) The lessor may spread over the life of the lease the estimated depreciated value of such buildings or improvements at the expiration of the lease and report as income for each year of the lease an aliquot part thereof.”


author: Disnex:

text:
    Paul L. Case, Petitioner, v. Commissioner of Internal Revenue, Respondent. Fannie I. Case, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 73767, 73768.
    Promulgated February 18, 1938.
    Ivan F. Phipps^ Esq., Oarl E. Da/oidson, Esq., and Charles E. McCulloch, Esq., for the petitioners.

      William, E. Davis, Esq., F. B. Shearer, Esq., and B. M. Brodshy, Esq., for the respondent.
   OPINION.

Disnex:

(1) The petitioner contends first that the transaction resulted in nonrecognizable gain or loss within the meaning of section 112 (i) (1) (B) and section 112 (b) (3) of the Kevenue Act of 1928. The former defines the term reorganization as “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.” The latter provides for nonrecognition of gain or loss “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.” The term control means “ownership 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 the corporation.” Sec. 112 (j).

The agreement of July 2, 1928, labels the transaction as a “reorganization wherein and whereby two corporations will own and operate the assets of the present corporation instead of one as heretofore”, and provides that it should not be construed as a liquidation of the assets of the Peckham-Case Co. The designation of a plan as a reorganization is not enough. Ballwood Co., 30 B. T. A. 644. There must be an actual reorganization, otherwise the statute is inapplicable. Edison Securities Corporation, 29 B. T. A. 483; affirmed on this point, 78 Fed. (2d) 85. The character of a distribution must be determined from its peculiar facts and not from the label the parties see fit to attach to it. John Milton, 33 B. T. A. 4; Lincoln National Bank, Executor, 23 B. T. A. 1304; affd., 63 Fed. (2d) 131; Gossett v. Commissioner, 59 Fed. (2d) 365.

The petitioner argues, in effect, that his tax liability from the transfers should be determined by treating each step as a separate transaction, instead of part's of a single transaction. He asserts that, so considered, the first step was an exchange by Peckham-Case Co. of assets for the stock of Case Furniture Co., and that it comes squarely within section 112 (i) (1) (B), leaving the transferor in control; and that the second step was an exchange of petitioner’s stock in Peckham-Case Co. for the stock of Case Furniture Co., meeting the terms of section 112 (b) (3).,

We have said that the reorganization provisions of the statute, being exceptions to the general rule taxing gains and allowing deductions for losses, may not be availed of by a taxpayer unless he establishes a transaction coming clearly within their terms. Warner Co., 26 B. T. A. 1225; Dolomite, Inc., 28 B. T. A. 1271; John C. Shaffer, 28 B. T. A. 1294; Charles Hall, 31 B. T. A. 125. They are not applicable unless there is some continuity of interest on the part of the transferor or its stockholders in the transferred assets. Cortland Specialty Co. v. Commissioner, 60 Fed. (2d) 937; certiorari denied, 288 U. S. 599, cited with approval in Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462; West Texas Refining & Development Co. v. Commissioner, 68 Fed. (2d) 77. Whether the plan here consisted of two separate and distinct transactions, or a single transaction, is a question of fact. Helvering v. Ward, 79 Fed. (2d) 381; Commissioner v. Harris, 92 Fed. (2d) 374.

Is reorganization of a corporation to be found in the situation here at hand? Patently this transaction was not merger, consolidation, recapitalization, or mere change in identity, form, or place of organization. Such suggestion is apparently not presented, but if presented, is not tenable. Reorganization must be found, if at all, in the fact of transfer of corporate assets by one corporation to another and immediate control of such other corporation by the old corporation, or its stockholders.

The original contract, as above seen, recited that:

* * * a new corporation will be formed to take over a portion of the assets of said Peckham-Case Company, and Paul L. Case will withdraw from said Peckham-Case Company and take over the management and ownership of such new corporation * * *.

Petitioner pleads:

* * * the purpose being to bring about the result of a division of the assets of Peckham-Case Company, * * * and the new corporation to be organized would take over and acquire eighty-five one hundred eighty-eights (85/188) of the assets of Peckham-Case Company, representing the interest of the shareholder Paul L. Case, in said corporation. * * *

Petitioner testified that the real object of the agreement was to segregate his interests in the Peckham-Case Co. from Peckham’s interest.

For more than one reason, we can not agree with petitioner’s idea of reorganization. In the first place, we having found that the object of the whole matter was, as shown in the petition, the original contract, and by other evidence, the segregation of Paul L. Case’s proportionate interest in the Peckham-Case Co. from that of C. V. Peck-ham, the real owner of all other stock, it is plain that to determine the question of reorganization the whole matter must be viewed together and that the first step in the transaction, the transfer of assets of the Peckham-Case Co. for stock of the Case Furniture Co., can not be viewed separately. Wilbur F. Burns, 30 B. T. A. 163; affd., 85 Fed. (2d) 8; certiorari denied, 299 U. S. 592; Halliburton v. Commissioner, 78 Fed. (2d) 265. To do so would be to disregard the prime object of the contract and to exalt a single step above the purpose of the whole transaction. It is apparent that Paul L. Case had a contractual right to the control of the stock of the Case Furniture Co. from the beginning of the transaction, and that upon completion of the transfer, regardless as to what point is considered the point of completion thereof, he, and not the Peckham-Case Co. nor the stockholders thereof, was in control of the stock of the Case Furniture Co. He was, in the terms of the contract, to have “management and ownership of such new corporation, the stock now held by Paul L. Case in said Peckham-Case Company to be transferred to said corporation in exchange for the capital stock in such new corporation”, and, referring to issuance of the new corporation stock for assets of the Peckham-Case Co., “after which said stock shall be transferred to Paul L. Case in consideration of his assigning his present stock in Peckham-Case Company to said corporation.” Petitioner pleads, “The new corporation to be under the management and control of Paul L. Case.” That such contractual control prevents application of the reorganization statute has been often decided. Hazeltine Corporation, 32 B. T. A. 110; affd., on this point, 89 Fed. (2d) 513; West Texas Refining & Development Co. v. Commissioner, supra.

In Commissioner v. Schumacher Wall Board Corporation, 93 Fed. (2d) 79, considering the question of control under section 113 (a) (7) of the Revenue Act of 1928, the court said:

We agree with the holding of the Board. The statute is obviously intended to reach those cases where unfettered substantial control of a corporation survives a reorganization, regardless of subsequent disposition of that control. We do not believe it was intended to apply to a situation where there is a binding contract simultaneously performed, by which the stock merely passes through intermediate holders to those to whom the contract compels immediate delivery.

The holding by the Peckham-Case Co. of the stock of the Case Furniture Co., as was said in Helvering v. Bashford, 302 U. S. 454, was “transitory and without real substance; it was part of a plan which contemplated the immediate transfer of the stock * *

Therefore we conclude that there was no corporate reorganization involved in the transaction before us, completed, as it was, only when ownership of the corporate stock had vested in petitioner, who had contractual control at all times over the corporate stock of the Case Furniture Co. There was lacking that continuity of interest which is of the essence of reorganization: on the contrary, the contract was entered into only in order to destroy continuity of interest and control — to segregate from the Peckham-Case Co. and its stockholder Peckham, the petitioner Paul L. Case and assets proportionate to his stockholdings, in the form of corporate stock. This end was accomplished, and when accomplished, neither the old corporation nor its stockholder had connection with, or control over, the new organization.

(2) Since the transaction herein involved has been held not to constitute reorganization, it follows that the segregation and distribution made to Paul L. Case was one in partial liquidation of the Peckham-Case Co., it being obvious that such distribution was no ordinary dividend, and there being no such contention. The petitioner does not contend that there was not distribution in partial liquidation in the event reorganization is denied, and pleads that the Case Furniture Co. stock was on July 24, 1928, of the value of $68,415.53, which is the value determined by respondent; but argues that such distribution was in 1981, when petitioner actually turned in his certificates of stock in the Peckham-Case Co. and received certificates covering the Case Furniture Co. stock. The Peckham-Case Co. distributed in partial liquidation to Paul L. Case a portion of its assets, to wit, corporate stock in the Case Furniture Co. The only question that remains, therefore, is as to whether such distribution was made in the taxable year.

It appears from allegations in the petition that Paul L. Case, Fannie I. Case, and M. H. Eustace were the directors of the Case Furniture Co.; that Paul L. Case was president and general manager; Fannie I. Case, secretary-treasurer; and M. H. Eustace, vice president ; that pursuant to the agreement of July 2, 1928, there was presented at a meeting of the directors of the Case Furniture Co. on August 13, 1928, a written proposal from the Peckham-Case Co. to sell and transfer to the Case Furniture Co. 8%ss of the assets of the Peckham-Case Co. in exchange for all the capital stock of the Case Furniture Co., and said proposal was accepted by the Case Furniture Co., and its officers were authorized and directed to, and did, issue and deliver to the Peckham-Case Co. all of its authorized capital stock (excepting therefrom three shares issued to the three directors of the Case Furniture Co. to qualify them to serve as directors, but which were endorsed over to the Peckham-Case Co., so that company acquired all of the stock of the Case Furniture Co.), in full payment for 8%88 °f the assets of the Peckham-Case Co.; that the proposal from the Peckham-Case Co. recites that the inventory and valuation of its assets has just been concluded, and that it is proposed that the capital stock of the Case Furniture Co. is to be issued to the order of the Peckham-Case Co. upon delivery to the Case Furniture Co. of “proper instruments of transfer and conveyance of the above mentioned property and rights” (already referred to as “eighty-five one hundred eighty-eights of all of the assets of this corporation, including the merchandise, fixtures, accounts and other property”); that approval by the' directors of the Case Furniture Co. of the proposal, by a proper resolution, will constitute contract between the two corporations; that such proposal was accepted by the directors of the Case Furniture Co., and the president and secretary were authorized to do all acts necessary to carry out the agreement consummated by the acceptance of the proposal and the taking over of the property, and to issue the 250 shares of capital stock to persons designated by the Peckham-Case Co.; and that the shares were thereby allotted to such respective persons. The petition also alleges that the stockholders of the Peckham-Case Co., on July 11, 1928, amended the articles of incorporation by changing the name of the corporation to Peckham' Furniture Co., and by enlarging the powers and objects of the corporation, and that a certificate of amendment was thereafter filed in the office of the Secretary of State of Idaho.

Such allegations of fact in the petition are binding upon petitioner in the absence of proof to the contrary. Henderson v. Carbondale. Coal & Coke Co., 140 U. S. 25; Cavender v. Cavender, 114 U. S. 464; Howard v. Halsted, 296 Fed. 782; Hilliard v. Lyons, 180 Fed. 685; vol. 2, Wigmore on Evidence, 2d ed., p. 586.

• Petitioner testified that the Peckham-Case Co. owned the Case Furniture Co. stock during the period thereafter up to December 1931. The Peckham-Case Co., under the proposals and intent of the original contract of July 2, 1928, and the above provisions accepted by the Case Furniture Co., could receive the Case Furniture Co. stock only upon delivery by proper instruments of transfer and conveyance of ss/is8 of the entire assets of the Peckham-Case Co. Since the petitioner and his wife, as the executive officers of the Case Furniture Co., had the matter of delivery of its stock for such a consideration in their hands, it is reasonable to conclude that they did not deliver the Case Furniture Co. stock until receipt of proper evidences of title, “proper instruments of transfer and conveyance”, to the “property and rights” constituting the consideration moving from the Peckham-Case Co., and therefore that the Case Furniture Co. received in 1928 such evidences of title as the consideration for the stock it passed to the Peckham-Case Co. in that year, and to which the Peckham-Case Co. then received legal title. Even if the division of the property between the two corporations may not have been completely consummated in that year, division of the assets does not negate the idea that an 8%88 interest (undivided, if not divided), in the Peckham-Case Co. assets passed in 1928 to the Case Furniture Co. “Property and rights” indicates that undivided interests were referred to and considered, for the same corporate minutes referring thereto refer to the assets having already been inventoried, and evidence shows that at the same time the physical assets were largely divided between the corporations. Eeceipt by the Case Furniture Co. of title to the 8%ss interest in the Peckham-Case Co. assets, as provided by the duly adopted proposal, is the only reasonable explanation of the fact of surrender by the petitioner of the stock in the Case Furniture Co. Petitioner had the burden of overcoming the presumption of correctness of respondent’s determination of taxable distribution received in 1928, yet his admissions of the issuance of the Case Furniture Co. stock upon delivery of “instruments of transfer and conveyance” of the proper proportion of the assets of the Peckham-Case Co. confirm rather than refute the respondent’s determination that such distribution was made. However, whether muniments of title passed or not, by delivery of its stock as consideration, the Case Furniture Co. took equitable title to 85iss of the assets o.f the Peckham-Case Co. We conclude that in 1928 the Peck-ham-Case Co. received legal title to the Case Furniture Co. stock, and that in consideration thereof the Case Furniture Co. received title to 8%88 the assets of the Peckham-Case Co.

But under the basic contract of July 2,1928, the capital stock of the Case Furniture Co. was to be issued to the Peckham-Case Co., or its order, “whereupon said Peckham-Case Company shall transfer to said Paul L. Case the capital stock in such new corporation in exchange for the eighty-five (85) shares of stock held by said Paul L. Case in the Peckham-Case Company.” In other words, the right of Paul L. Case to turn in his stock in the Peckham-Case Co. and receive all the stock of the Case Furniture Co. was coincident with the right of the Peckham-Case Co. to receive such stock in return for 8%S8 °f its assets. Under the contract, the instant that the Peckham-Case Co., by delivery of a portion of its assets, became entitled to and did receive the capital stock of the Case Furniture Co., Paul L. Case had a right, and an obligation enforceable by the Peckham-Case Co., of accepting and receiving the Case Furniture Co. stock in return for his stock in the older corporation. The Peckham-Case Co. did receive the Case Furniture Co. stock. It became the legal holder thereof ; but in the same instant Paul L. Case became the beneficial owner thereof. His right thereto was secured not only by contract between the stockholders, but by adoption thereof by both corporations.

Under the contract, the Peckham-Case Co. could have secured from Paul L. Case specific performance of his duty to surrender his Peck-ham-Case Co. stock and accept the Case Furniture Co. stock. The fact that the 8%88 of Peckham-Case Co. assets were not yet divided would not, under the provisions of the contract, have been a defense to him, for the contract, although it provides for and discusses division of the assets between the corporations, does not provide that such division shall take place before the issuance of Case Furniture Co. stock to the Peckham-Case Co., and consideration of the contract compels the opposite conclusion — as indeed is evidenced by the treatment the parties accorded the matter in transferring the Case Furniture Co. stock to the older corporation prior to complete adjustment of assets. The division of assets'was not a condition precedent to passage of title to stock. The contract shows plainly that delay in the passing of title to stock was not expected. Paul L. Case was to “withdraw from said Peckham-Case Company and take over the management and ownership of such new corporation”; while “Peckham-Case Company shall continue operations under its present charter, its stock to be held by C. V. Peckham and M. H. Eustace and such associates as they may hereafter associate with.” But though the tangible assets had been largely divided and the intangible assets were to be divided, in general, as collected, it was not expected that final adjustment could be had for at least a year, for provision was made for determination by the parties at the end of one year as to disposition of uncollected notes and accounts. The relative rights of the two corporations in the assets formerly held by the Peckham-Case Co. were the same, whether the assets were divided or undivided. Complete adjustment could come later. When the rights of the two corporations were determined, Paul L. Case’s position in equity with relation to the stock of the new corporation was fixed. He owned the beneficial interest in the stock of that corporation, it could enforce its rights to an undivided 85/18S of the assets of the old corporation, and the fact that the stock certificates did not pass between him and that company until 1931 did not delay the distribution of beneficial ownership of the stock in liquidation to him. A stock certificate is not stock and he was, by contract with the old stockholders of Peckham Co. and with both corporations, the stockholder owning the stock in the Case Furniture Co., even though stock certificates had not yet reached him. Federal Grain Corporation, 18 B. T. A. 242; Anita Owens Hofer, 24 B. T. A. 22.

In Elvira Scatena, 32 B. T. A. 675, 678; affd., 85 Fed. (2d) 729, the respondent took a position analogous to that of the petitioner here — that a dividend paid by a corporation in stock of a second corporation was taxable in the year when “actual physical delivery of the certificates was made to the petitioner.” We said in part:

* * * His argument ignores the vital distinction between the ownership ol an interest in a corporate enterprise and the certificates which are a mere evidence of that ownership. * * *
* * * * * * *
In Minal E. Young, Executor, 6 B. T. A. 472, the Board considered the same question on similar facts. In that case a resolution was passed by the corporation in 1918 declaring a dividend of certain stock owned by it in another corporation and held by voting trustees under a voting trust agreement. We held in that case that, notwithstanding there was no actual delivery of the certificates during the year 1918, the stockholders were nevertheless the recipients of income in that year and not in the year x919. In support of the conclusion reached, we said:
Under the resolution of March 11, 1918, the taxpayers became the owners of their proportionate part of the voting trust certificate for the stock of the Salt Greek Producers Association, Inc., owned by the New York Oil Co. The resolution provided that the certificates of stock of the Salt Greek Producers Association, Inc., would be issued to the stockholders of the New York Oil Co. upon the surrender of their old certificates in the New York Oil Co. to be exchanged for new certificates or reduced par value. This, in our opinion, related merely to the receipt of the certificates representing the stock which became theirs by virtue of the resolution of March 11. While it may be true that a division or distribution by a corporation is not taxable to a stockholder who is on the cash receipts and disbursements basis until the amount of the distribution is made available to him, this does not mean that, when stock of one corporation is distributed by another, the certificate itself must actually be received before there can be taxable gain. Since a person may be a stockholder in a corporation without ever having received a stock certificate, the time of the actual receipt of the stock certificate is immaterial. The question is, when did the taxpayers become the beneficial owners of the stock of the Salt Greek Producers Association, Inc.? We think they became the owners thereof in 1918 by virtue of the resolution distributing the stock.

The “resolution distributing the stock” upon surrender of old certificates in the cited case corresponds to the contract, when adopted by the corporations herein, providing for transfer of Case Furniture Co. stock after the stock of the new corporation had been received by the old in consideration for transfer of a fractional interest in its assets.

As to retention by petitioner Paul L. Case of the Peckham-Case Co. stock: In considering a distribution in liquidation in James P. Gossett, 22 B. T. A. 1279, 1286, we said (and repeated in Florence M. Quinn, 35 B. T. A. 412 (414)), that “it is immaterial whether at the time of the distribution all or any part of the shares were surrendered or1 retired.”

To the above considerations may be added the thought that under the record in this case the transaction, except actual exchange of stocks, was very largely at least concluded in 1928, even as to actual division between the corporations. “The merchandise and furniture and fixtures in the several stores were divided between the two corporations at the time of the inventory * * * ■’ — so petitioner alleges, and the proof shows — and we have found from the evidence that the major portion of the general scheme under the contract of July 2, 1928, was carried out in 1928. In fact, it is not shown that the new corporation finally received more than what it received in 1928, and petitioner alleges that an intensive campaign to collect was started immediately after July 24, 1928, and that all notes and accounts receivable which were collectible were collected, so that apparently a very large share, at least, of the assets finally received by the Case Furniture Co. were actually in its possession in 1928. The petitioner Paul L. Case took charge of the three stores in that year as manager for the new corporation (as against one of which he had been manager prior to that time). Indeed, petitioner, referring to receipt by the Case Furniture Co. of assets of the Peckham-Case Co. of the value of $68,415.53, the division of the assets, and the adjustments made to equalize the division, states that it is unnecessary to show the adjustments “for the reason that the net value of the total assets of Peckham-Case Company, acquired by Case Furniture Company, was not changed.” It is obvious, therefore, that what occurred in 1931 was adjustment, and not, in fact, division, that substantial division had already occurred, and that the Case Furniture Co. (which was not given the real estate, the principal item of difference) had already received its share of the assets of the old corporation. Certainly, with the burden upon him, petitioner has not shown that the complete distribution of assets to the Case Furniture Co. was not made in 1928. Final adjustment when made in 1931 was “as of” 1928, indicating that the parties at that time considered that in effect the segregation had taken place in 1928 — consistent with the provisions of the contract and with petitioner’s allegation of vote on August 11,1928, to change the name of the Peckham-Case Co., and for that company to continue operation with Peckham and Eustace, and associates they might choose, as stockholders.

Under all of these circumstances, in addition to the above consideration of the beneficial ownership of the stock in petitioner Paul L. Case in 1928, we conclude that the final balancing of accounts between the corporations in 1931, even though it may have entailed some minor items of actual division of assets, is not sufficient to demonstrate that distribution of corporate stock was not made to petitioner in 1928, or to overcome tbe presumption of correctness in respondent’s determination of taxability in that year.

We therefore hold that petitioner received the Case Furniture Co. stock as a distribution in partial liquidation in 1928.

Section 291 provides for the imposition of a penalty of 25 per centum of the tax for failure to make and file a return within the time prescribed by law except in case a return is filed after such time and the failure to file was due to “reasonable cause” or not due to willful neglect. It has not been shown and no contention is being made that the petitioners filed a joint return or separate returns for the taxable year. The petitioners' seek to have the penalty set aside on the ground, as we understand their argument, that their counsel advised them that they had no gross income or net income to report. Such advice, if given, is not sufficient to avoid the imposition of the penalty. The statute provides in unambiguous terms that a return must be filed to obtain relief from the penalty for any cause. A-C Investment Association, 24 B. T. A. 582; Searles Real Estate Trust, 25 B. T. A. 1115; Scranton, Lackawanna Trust Co., Trustee, 29 B. T. A. 698; affd., 80 Fed. (2d) 519; certiorari denied, 297 U. S. 723; Harry D. Kremer, 31 B. T. A. 566; Douglas L. Edmonds, Administrator, 31 B. T. A. 962; affd., 90 Fed. (2d) 14; certiorari denied, Oct. 11, 1937; Schroeder Employees Thrift Club, 36 B. T. A. 645. In Dayton Bronze Bearing Co. v. Gilligan, 281 Fed. 709, relied upon by the petitioners, the taxpayer filed a belated return. The imposition of the penalties was mandatory under the circumstances prevailing here.

Reviewed by the Board.

Decision will be entered for the respondent.


author: Tyson :

text:
    Frank J. Moore, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 77485.
    Promulgated February 23, 1938.

      R. M. O'Hara, Esq., for the petitioner.

      L. W. Greason, Esq., for the respondent.
   OPINION.

Tyson :

This proceeding involves income tax deficiencies a portion of which had been assessed on November 11, 1933, and fraud penalties for the calendar years 1929,1930, and 1931, as follows:

Petitioner assigns as error the respondent’s determination (1) that petitioner had taxable income from racing transactions in excess of that reported on his return for each of those years and (2) that he filed a false and fraudulent income tax return for each of those years. Further, petitioner pleads the statute of limitations in bar of assessment and collection of any deficiency for either of those years. Also, petitioner seeks a determination that the portion of the deficiencies in controversy which were assessed on November 11,1933, constitute over-assessments.

The respondent affirmatively alleges that petitioner filed false and fraudulent returns with intent to evade tax for each of the years 1929, 1930, and 1931 and that with intent to evade tax he willfully failed to keep books and records as required by the tax laws and regulations and willfully understated his income from his business of accepting wagers on horse races by the amounts of $117,625.02 for 1929, $110,592.72 for 1930, and $22,787.78 for 1931. By amended answer, respondent alleges the due execution and filing of a waiver for the year 1930. By reply, the petitioner denies all of the respondent’s affirmative allegations.

The petitioner is an individual, having his principal office in New York City, New York. During the years in controversy, and also prior and subsequent thereto, the petitioner, as a bookmaker and betting commissioner, was engaged in the business of accepting wagers on horse races at various race tracks in New York State. As a bookmaker he accepted wagers in which he alone participated with the other party to the wager. As a commissioner he accepted wagers and hedged by betting a portion thereof, in his own name, with other bookmakers.

Petitioner regularly maintained an office and employed a cashier and a bookkeeper. During the racing season of about 26 weeks the petitioner employed from 10 to 18 additional persons to assist him at his book stands, in the club houses, in the turf and field enclosures, and in the grandstands, to receive bets as well as to furnish information and services to his patrons. His pay roll during the five or six months of the racing season in each year amounted to approximately $52,000. The cashier handled all of the money used in the business, received all the bets, and made all of the pay-offs. The bookkeeper kept a journal in which he made daily entries of petitioner’s bank deposits and withdrawals on account of his wagering transactions, both as a betting commissioner and a bookmaker, and also entries of bank deposits of dividends and rents and withdrawals for petitioner’s personal use.

The petitioner’s so-called “bank roll” was taken in cash to the track each day by his cashier. As bets were accepted the cashier received the money therefor. Each bet was immediately recorded on a separate card which showed whether the bet was by cash, check, or on credit. After each race the cashier paid the winners in cash if they so desired and marked the cards accordingly, but some of petitioner’s patrons wished to be and were paid by check or by cash on the following day. If petitioner cashed checks or loaned money as an accommodation at the track, the cashier made entries on cards reflecting such transactions. After return of the petitioner and his employees to petitioner’s office from the race track the day’s business was balanced by checking the entries on the cards with the “bank roll”, other cash and checks brought back from the track. Frequently the “bank roll” was held overnight in the office safe for use in the next day’s business. The other cash was usually placed in a bank night depository and the checks were deposited in bank the following day.

Each day’s deposits of cash and checks were posted in the journal on the left-hand side of the page under the heading of “deposits” for that day. Each check was listed by the name of its drawer and its amount. The total amount of cash deposited was usually designated “P. M.”, meaning night depository. In two instances, occurring in September 1931, the cash brought back from the track by the cashier in the amounts of $851 and $1,000, respectively, was turned over to petitioner instead of being deposited in bank and was so entered on the journal under “deposits.” All deposits from petitioner’s racing transactions! were made in the National City Bank or the Saratoga Bank, except once in November 1931, when the amount of $909 was deposited in the County Trust Co. and so entered on the journal.

Each day’s withdrawals from banks were posted in the journal on the right-hand side of the page under the heading of “Checks Drawn” for that day. Checks drawn on the following day to pay winners of the preceding day were listed in the names of the payees and in their respective amounts. The proceeds of certain checks drawn to cash, and so entered on the journal without any identifying letters, were used to pay off winners who preferred to come to petitioner’s office to collect. The total amount withdrawn to pay off bets by cash at the track on the following day was covered by one check drawn to cash and entered on the journal as “Cash ENV.” The total amount withdrawn each week to meet petitioner’s pay roll was covered by one check drawn to cash and entered on the journal as “Cash PE.” The withdrawal, when necessary, of funds to be used as the “bank roll” at the track was covered by a check drawn to cash and entered on the journal as “Cash BE.” Withdrawals of funds for petitioner’s personal use were usually covered by checks drawn to cash and entered on the journal as “Cash PEE” or “Cash FJM,” but some withdrawals for petitioner’s personal use were by checks made payable to petitioner’s personal creditors, in which instances the name of the payee and the amount were entered on the journal.

For each of the years 1929, 1930, and 1931 a journal was kept on the basis of the above described method of making daily entries. For each of those years the journal recorded all of petitioner’s deposits of funds derived from his business of accepting wagers and also recorded all withdrawals pertaining to the carrying on of such business. The journal for 1931 was submitted in evidence, but neither the journal for 1929 nor 1930 was so submitted, both having been destroyed. An examination of the journal entries for 1931 discloses that no definite ascertainment of the exact character of all of the numerous withdrawals during any one year can be made therefrom.

In preparing the petitioner’s income tax return for each of the years in controversy, the bookkeeper examined each item entered in the journal for the taxable year and made his determination of the character of the item. He then transferred the deposit items to his work sheets under headings such as deposits from the betting business, rents and dividends, respectively, and he similarly transferred the withdrawal items under headings for various business expenses and various personal expenses, respectively. As a result he secured a column showing the items and the total deposits of what constituted his determination of the gross deposits from petitioner’s wagering business and a column showing the items and the total withdrawals of what constituted his determination of the deductible expenses of that business. The difference between those two totals represented his calculation of petitioner’s gain or loss from his business of accepting wagers. In his income tax returns for 1929 and 1930 the petitioner reported as “income from racing transactions” the gain calculated by his bookkeeper in the amounts of $3,500 for 1929 and $3,100 for 1930. In his income tax return for 1931 petitioner did not report either a gain or a loss from such source because his bookkeeper’s calculations showed a loss from betting transactions for that year. The petitioner did not attach to his return for each or any of those years a schedule of his gross receipts and expenses of his betting transactions.

A letter dated on or about the 1st of February 1931 requested the petitioner to bring his records for the year 1929 to the office of the revenue agent in charge of the third New York district. In reply the petitioner, by letter dated February 5,1931, stated that his records for that year were at his office and that he desired to have them examined at that place. The request by a taxpayer for a field audit is not unusual and the records in the office of the revenue agent in charge show that petitioner’s return for 1929 was thereafter transferred to the field audit division. No field audit was made at that time.

In or about April 1932 revenue agent Hussey made a routine examination of petitioner’s return for 1930 and in connection therewith he made a so-called spot check of petitioner’s bank statements and journal for that year. His report stated that petitioner’s income of $3,100 from racing transactions, as shown on the return, “was verified from the check book and found correctly reported.” He recommended an overassessment of $32.08 on account of an adjustment in petitioner’s income from rents.

Subsequent to the receipt in 1932 of a refund check for $32.08 for the year 1930, the petitioner considered that the Commissioner was satisfied as to the correctness of his income tax returns for both of the years 1929 and 1930 and he thought that there would be no occasion for further use of his 1929 and 1930 journals, which he had retained solely for income tax purposes. He thereupon destroyed the journal and the bookkeeper’s work sheets for each of those years because they pertained to a business which was illegal in New York State during those years.

In October of 1932 revenue agent Weisel made an investigation of petitioner’s returns for the years 1929, 1930, and 1931, because in the course of his work on another case he had secured information as to the payment of large sums of money to petitioner. At that time petitioner’s records for 1929 and 1930 had been destroyed and his records for 1931 had been misplaced and could not be found. Through bank records the agent secured information as to all of petitioner’s bank deposits for each of the years 1929, 1930, and 1931 and he eliminated all items ascertained, through this and other information obtained, to represent deposits of funds received from sources other than petitioner’s betting transactions. Then, upon the basis that all unexplained bank deposits represented petitioner’s gross income from his wagering transactions and, further, from the experience and knowledge he had gained as a revenue agent in determining income from bank deposits in a number of other similar cases, revenue agent Weisel determined that 5 percent thereof would constitute a reasonable net return from the petitioner’s gross income from betting transactions. The agent determined that petitioner’s bank deposits, or gross income from his betting transactions, amounted to $2,442,500.37 for 1929, $2,273,854.50 for 1930, and $1,308,942.68 for 1931, and that petitioner derived taxable net income from his betting transactions in the amounts of $121,125.02 for 1929, $113,692.72 for 1930, and $65,447.10 for 1931, and submitted a report to that effect. Thereafter, the petitioner’s journal for 1931 was found and submitted to the revenue agent in charge. Agent Weisel examined the journal and finding that it purported to be a complete record of all of petitioner’s racing transactions for 1931 and accounted for large sums of money paid to petitioner in that year, he reconsidered the taxable year 1931 upon the basis of the journal entries for that year, determined petitioner’s taxable net income from racing transactions to be $22,787.79 instead of $65,447.10, determined his income tax liability to be $1,672.58 for 1931, and submitted a report to that effect.

The petitioner’s bookkeeper was unable to locate his original work sheets made from the 1931 journal upon which the return for that year was based, which sheets showed a loss from racing transactions for that year. For the purpose of this proceeding the bookkeeper made up another set of work sheets from the 1931 journal in the same manner he had theretofore done for that and other years in connection with the preparation of petitioner’s income tax returns. The result of his calculations showed gross deposits from racing transactions in' the amount of $1,222,719.67; total withdrawals of $1,222,636.06, representing expenses pertaining to that business, and a net income of $83.61 from such business without deducting the estimated expense of an automobile used to transport petitioner and several of his employees to and from the race tracks and the salary of a chauffeur hired only during the racing season.

In asserting the deficiencies and penalties in controversy the respondent determined that petitioner had net income from racing transactions in the amounts of $121,125.02 for 1929 and $113,692.72 for 1930, as “net bank deposits considered business income” and $22,787.79 for 1931 as “income from business” based on the report of revenue agent Weisel.

The charge of fraud is regarded as a serious matter. Fraudulent intent and acts on the part of a taxpayer are never presumed and the ordinary preponderance of evidence is not sufficient to establish fraud. The respondent’s burden of establishing as a fact that the petitioner herein filed false and fraudulent tax returns with the intent to evade his income taxes for the years 1929, 1930, and 1931 must be met by clear and convincing evidence. Charles J. Delone, 34 B. T. A. 1139; Doric Apartment Co., 32 B. T. A. 1187; Henry S. Kerbaugh, 29 B. T. A. 1014; affirmed per curiam, 74 Fed. (2d) 749; J. William Schultze, 18 B. T. A. 444.

There is no evidence of deliberate omissions of income which the petitioner knew he had received. For each of the years involved petitioner kept a record of his betting transactions and from such records his bookkeeper calculated petitioner’s income from such business, which income was duly reported. In our opinion, the bookkeeper made his calculations honestly and according to his best judgment on the information before him. Under the circumstances disclosed by this record, the disparity between the amount of taxable income determined by respondent for each of the years in controversy and the amount of taxable income for 1929 and 1930 and a loss for 1931, determined by petitioner’s bookkeeper, is not evidence of fraud, for there existed a considerable latitude for reasonable differences of opinion between the petitioner and respondent as to certain basic facts. Cf. Doric Apartment Co., supra. The principal differences of opinion related to the question of the proper deductions on account of the expenses incurred in the petitioner’s business of accepting wagers and the petitioner’s method of accounting clearly shows a basis for honest differences of opinion as to what items may have constituted proper deductions. The petitioner’s failure to attach to his returns a schedule of his gross income and claimed deductions from racing transactions, and also his destruction of his records for the years 1929 and 1930, have been, in our opinion, sufficiently and reasonably explained so that we do not regard those acts as indicating an intention to defraud.

We conclude and find as a fact that the petitioner did not file false and fraudulent income tax returns with the intent to evade tax for either of the years 1929, 1930, or 1931. The respondent erroneously asserted fraud penalties for each of those years.

The next question for our determination is presented by petitioner’s plea of the bar of the statute of limitations as to all three years in controversy.

Petitioner’s return for the year 1929 was duly filed on March 11, 1930, reporting a net taxable income of $13,426.51 and an income tax liability of $165.77. No waiver for the year 1929 has been executed. The two-year period of limitation upon assessment, as provided by section 275 (a) of the Bevenue Act of 1928, had expired prior to the mailing of the deficiency notice on June 30, 1934, and also it had expired prior to the assessment on November 11,1933, of a portion of the deficiency in the amount of $2,473.20 for 1929. Accordingly, there is no deficiency for the year 1929 and there is an overassessment in the amount of $2,473.20 for that year.

Upon the granting of an extension of time for filing a return for 1930, it was duly filed by petitioner on March 28, 1931, reporting a net taxable income of $11,641.96 and an income tax liability of $164.33. Within two years of the filing of such return and under date of January 27, 1933, the petitioner and the Commissioner executed a waiver providing that any income taxes due from petitioner for 1930 might be assessed at any time on or before June 30, 1934. Assessment of the asserted deficiency for 1930 was not barred at the time the deficiency notice was mailed on June 30,1934, and since that date the running of the statute of limitations has been suspended during the pendency of this proceeding by operation of section 277 of the Revenue Act of 1928. The assessment on November 11, 1933, of $2,277.74 of the asserted deficiency for 1930 was timely made.

Petitioner’s return for the year 1931 was filed sometime between January 28 and March 15, 1932, reporting no taxable net income and no income tax liability. Within two years from such filing of that return the respondent made an assessment on November 11, 1933, of additional income taxes in the amount of $1,672.58, which is the deficiency for 1931 embraced in the deficiency notice mailed on June 30, 1934. Pursuant to section 276 (c) of the Revenue Act of 1928, such asserted deficiency, having been assessed within the period of limitation, may be collected at any time within six years after assessment, and the collection of the asserted deficiency was not barred at the time of the mailing of the deficiency notice. Pursuant to section 277 of the Revenue Act of 1928, the running of such six-year collection period has been suspended during the pendency of this proceeding.

The last issue is on the merits and involves petitioner’s assignment of error in the respondent’s determination that petitioner had income from racing transactions in excess of that reported on his tax returns for the three years in controversy. The petitioner has the burden of establishing error in the amount of the deficiencies determined by respondent. Welch v. Helvering, 290 U. S. 111; Old Mission Portland Cement Co. v. Helvering, 293 U. S. 289.

Since the assessment and collection of any additional income tax for the year 1929 is barred by the statute of limitations, we need not consider this case on the merits as to that year.

As to both of the years 1930 and 1931, the respondent’s determination of the amount of petitioner’s taxable income from his betting transactions is prima facie correct and the testimony and evidence adduced by petitioner is not sufficient to establish error.

The fact that petitioner’s records for the year 1930 have been destroyed is unfortunate, but that circumstance does not relieve the petitioner of his burden of proof. Cf. Burnet v. Houston, 283 U. S. 223; Pennant Cafeteria Co., 5 B. T. A. 293. The testimony of the bookkeeper that he correctly calculated petitioner’s net income from racing transactions for that year and that as so calculated it was correctly shown in the return does not establish the correctness thereof or error in the Commissioner’s determination, for the calculations of the bookkeeper were based upon his determination of what receipts constituted gross income from petitioner’s betting business and his determination of what expenditures constituted deductible expenses of that business.

To determine petitioner’s net taxable income from his betting transactions the respondent has, in the absence of any accounting records for 1930, resorted to the method of using 5 percent of petitioner’s total bank deposits, after eliminating therefrom certain deposits ascertained not to represent income. Such method, in effect, allows petitioner a deduction of 95 percent of gross income as the ordinary and necessary expenses of that business. In numerous prior cases involving analogous facts and circumstances, this Board has approved the respondent’s use of such method in arriving at a taxpayer’s net taxable income. The petitioner has failed to establish error in the respondent’s determination of the amount of his gross income from betting transactions or the amount allowed by respondent as a proper deduction therefrom for the year 1930. Accordingly, upon failure of proof, the deficiency determined by the respondent for 1930 must be sustained.

For the year 1931 the petitioner submitted in evidence the journal in which is recorded the bank deposits and withdrawals pertaining to his betting transactions and also deposits of income from other sources and withdrawals for petitioner’s personal use. Based upon an examination of such journal and his determination therefrom that petitioner’s taxable net income from betting transactions amounted to $22,787.79, the respondent determined the deficiency in controversy for 1931. The petitioner has failed to show any specific errors in such prima facie correct determination. Petitioner has submitted in evidence his bookkeeper’s so-called work sheets, comprising about 21 pages, made up from the journal from which petitioner calculated his taxable net income from betting transactions to be $83.61. However, those work sheets do not establish error in the respondent’s determination for they are merely the bookkeeper’s calculations based upon (1) his own determination of what deposits constituted gross income derived from the petitioner’s betting transactions, and (2) upon his own determination of what withdrawals constituted deductible expenses of the business. The mere conclusion of the bookkeeper so reached, that certain amounts entered in the journal constituted proper deductions as business expenses, is not proof of the deductibility of such amounts. Even if the Board should assume the function of making an audit of the journal, such an audit would not clearly reflect petitioner’s income so as to enable us to determine whether petitioner had made gains, or sustained losses in 1931, because an examination of the journal discloses entries the character and purpose of which are not explained in the bookkeeper’s description of the method used in keeping the journal, or otherwise. Accordingly, upon failure of proof, the deficiency determined by respondent for the year 1931 must be sustained.

Decision will be entered under Bule 50.

        Yorkville Live Poultry Co., Inc., 18 B. T. A. 47; Julius Gann, 15 B. T. A. 594; affd., 39 Red. (2d) 73; Moses P. Ginzburg, 14 B. T. A. 324; I. Goldman, 12 B. T. A. 874; Fellipo Dicenso, 11 B. T. A. 620; F. G. Bishoff, 6 B. T. A. 570; affd., 27 Fed. (2d) 91; M. Cohen, 5 B. T. A. 240; E. Muelhoefer & Son, 4 B. T. A. 586; Benjamin Colitz, 3 B. T. A. 947; and Jacob Roffwarg, 2 B. T. A. 332.


author: Hill :

text:
    Ralph W. Crews, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 66701, 66702, 66703, 66718, 66766, 66767.
    Promulgated February 23, 1938.

      Albert L. McRiTl, Esq., for the petitioners.

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

       Proceedings of the following petitioners are consolidated herewith: Robert E. Crews; Amy Tresner; Mary Willis; Charles Crews ; and Everett J. Crews.

   OPINION.

Hill :

These proceedings are before us on mandates from the Circuit Court of Appeals in the following circumstances: The cases of Ralph W. Crews, No. 66701; Robert E. Crews, No. 66702; Amy Tresner, No. 66703; Mary Willis, No. 66718; and Charles Crews, No. 66766, were first considered by us, after hearing, and a report promulgated May 2, 1934, at 30 B. T. A. 615. The issue submitted and decided involved the amount of depletion allowance to which each petitioner was entitled for the taxable year 1930. The same cases were reconsidered and a supplemental opinion promulgated September 19, 1934, at 31 B. T. A. 187.

The case of Everett J. Crews, No. 66767, was considered by us and a report promulgated September 18, 1935, at 33 B. T. A. 36. This case was submitted on the record made in the former proceedings above mentioned, and in that connection it was found necessary to make certain modifications of our prior findings of fact and opinion. As a result of such modifications, our former decisions in the cases first above referred to were reconsidered and modified to bring them into harmony with the facts and conclusions reached in the case of Everett J. Crews, No. 66767. To that end a supplemental opinion was promulgated November 12,1935, at 33 B. T. A. 441.

In Everett J. Crews, supra, after referring to section 114 (b) (3) of the Revenue Act of 1928, which provides that the allowance for depletion of oil and gas wells shall be 27% per centum of the gross income from the property, but not exceeding 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, we considered the evidence in reference to the gross income from the property involved, and, with respect to the determination of the net income, then said:

The determination of the net income of the heirs from the property involves a consideration of the items that are to be deducted from gross income from the property in order to arrive at the net income therefrom. The parties have stipulated that the cost of drilling, equipping, and operating wells and certain miscellaneous expenses applicable to the production of oil and gas amounted to $849,-544.37, and they are in agreement that this amount constitutes a proper deduction in determining the net income from the property. We, therefore, hold this amount is an allowable deduction in determining the net income of the heirs from the property.

Subsequent to our decisions above mentioned, petitions for review in all of tlie cases were filed with the United States Circuit Court of Appeals for the Tenth Circuit, which court, by mandates filed herein May 12, 1937, reversed our decisions, and remanded the cases for further proceedings in accordance with the opinion of the court rendered March 29, 1937 (89 Fed. (2d) 412). In its opinion the court said:

Here the petitioners received in 1930 a one-eighth royalty on the production during that year, $355,000.00 in cash in the nature of a bonus or advanced royalty * * * $849,544.37 discharged of the obligation to indemnify the bank, and an agreement to receive the funds in escrow which agreement was worthless. The amount of the one-eighth royalty plus the sums of $849,544.37 and $355,000.00 constituted their gross income from the property in 1930.
The depletion allowance should be 27% per cent of $1,204,544.37 plus the amount of the one-eighth royalty received in 1930 or 50 per cent of the net income of the petitioners from the property, whichever amount is the lesser.
Reversed and remanded to the Board for further proceedings in accordance with this opinion.

On June 28, 1937, petitioners filed a motion that the cases be set down for hearing for the purpose of receiving additional evidence alleged to be necessary under the court’s mandate in order to determine the correct “net income from the property, the allowable depletion, and the further deductions allowable to the taxpayers.” On brief in support of their motion, petitioners point out that the sum of $849,544.37 which the parties originally agreed constituted a proper deduction from gross income, and which the Board allowed as such, in determining the net income from the property for the purpose of applying the limitation on the percentage depletion allowance, included amounts representing development and equipment costs; and that deduction of the development and equipment costs in computing net income from the property was subsequently held to be erroneous in Ambassador Petroleum Co. v. Commissioner (C. C. A., 9th Cir., Feb. 5, 1936), 81 Fed. (2d) 474, and Wilshire Oil Co. (Feb. 10, 1937), 35 B. T. A. 450.

By order dated September 28,1937, petitioner’s motion was granted in part, and the cases set for hearing for the purpose of receiving (1) the additional evidence indicated in such motion, and (2) proof to establish the amount of the one-eighth royalty received by petitioners on the production during 1930. At the hearing on November 24, 1937, the parties filed a stipulation that the amounts of the one-eighth royalty received by petitioners on the production during 1930 are as follows:

The parties further stipulated that the items which constituted the sum of $849,544.37 referred to above are as shown in the following tabulation:

OPERATING Expense:
Production Expense-$272, 042. 56—
General Overhead Expense- 31,107. 34—
Depletion on Equipment- 110, 888.17—
Total Operating Expense-_$414, 038.07—
Development Expense (drilling costs) _ 387,982.80
Equipment-$158,411. 67
Less: Depletion sustained-110,888.17
- 47, 523. 50
Total_$849, 544.37

Clearly our decisions in these proceedings were reversed by the Circuit Court of Appeals and the cases remanded with a procedendo. The court’s opinion concluded with the words, “Reversed and remanded to the Board for further proceeding in accordance with this opinion.” Respondent concedes that under the court’s mandate a further proceeding was proper to determine the amount of the one-eighth royalty received by petitioners on production during 1930, but objects to the receipt of additional evidence as to what items constituted the sum of $849,544.37, which, under the Board’s opinion (33 B. T. A. 36, 50), was deducted as production expense in computing the net income from the property for the purpose of determining the limitation on the allowance for depletion.

Respondent’s objections are predicated upon the following grounds: (a) That the petitioners seek to raise an issue which is inseparably a part of and an essential factor of one of the issues heretofore presented to and decided by the Board and the Circuit Court of Appeals; (b) in the alternative^ that petitioners are seeking to inject into these proceedings a new issue not heretofore presented to or decided by the Board or the Circuit Court of Appeals; (c) that petitioners are seeking for the first time other and further relief not accorded by the decision of the Circuit Court of Appeals; and (d) that the Board has no power in the present circumstances to receive evidence as to what items constituted the aforesaid sum of $849,544.37, for the reason that the setting of these proceedings for that purpose is not clearly within the purview of the mandate of the Circuit Court of Appeals.

Respondent’s objections, we think, are not well founded. He cites and relies on Peavy-Byrnes Lumber Co., 31 B. T. A. 985; affd., 86 Fed. (2d) 234; certiorari denied, 300 U. S. 674. There we held that, where a proceeding is reviewed by the Circuit Court of Appeals on the merits, the Board’s decision reversed, and the case remanded with directions to redetermine the tax liability upon a specific basis, the Board is without authority thereafter to permit the pleadings to be amended to raise new issues, or to give any other or further relief. In our opinion we said:

The rule seems to be well settled by tbe weight of authority that an inferior tribunal, upon remand of a cause by an appellate court, can not take any action not reasonably within the express or implied directions of the reviewing court. * * * The mandate must be interpreted according to its subject matter; and the decree of the appellate court, as well as that 'of the court below, may be taken into consideration in the interpretation thereof.

The proceedings at bar are clearly distinguishable on the facts. Here there is a remand with a procedendo. What further proceedings, then, are “within the express and implied directions of the reviewing court”? Certainly we are not here directed, as in the cited case, to make merely a mathematical calculation according to a formula stated in the mandate.

The sole issue involved is the amount of the depletion allowance, which, under the statute, is 27% percent of the gross income from the property, limited by 50 percent of the net income from the property. The Circuit Court of Appeals in its opinion found that the gross income from the property was $1,204,544.37, plus the amount of the one-eighth royalty received by petitioners in 1930. We are plainly directed to ascertain such additional amount in a further proceeding, which we have done. The parties stipulated, and we so find, that the total amount of the one-eighth royalty is $8,911.72. Thus, gross income from the property under the court’s opinion is $1,213,456.09. We are without power to add to or take away from this amount. It is the settled law of the case.

However, the other factor which enters into the computation of the depletion allowance, namely, the amount of net income from the property, the court did not determine. It did not by inference or otherwise approve, but on the other hand specifically disapproved, our determination on this point. In its opinion the court declared that the depletion allowance should be 27% percent of the gross income as therein determined, “or 50 percent of the net income of the petitioners from the property, whichever amount is the lesser.” The language used, in our opinion, requires us to compare 27% percent of the gross income, as determined by the court, with “50 per cent of the net income of the petitioners from the property” and allow the lesser amount as the depletion deduction. The phrase “net income of the petitioners from the property” means the true net income and not the amount heretofore determined by us, which the court held to be in error.

The record before us discloses that in our former decision, which has been reversed on review, we determined the net income from the property by deducting from the gross income the sum of $849,544.37, which sum included drilling and equipment costs. Under subsequent decisions, which will be referred to hereinbelow, it has been held that drilling and equipment costs may not be deducted for such purpose under the statute. It follows, therefore, that in order to comply with the mandate of the court we must compare 27% percent of the gross income from the property, as determined by the court, with 50 percent of the true net income from the property, computed by eliminating from the deductions from such gross income the drilling and equipment costs before erroneously included, and allow the lesser amount.

Kespondent further argues at length that, even if we have implied authority under the court’s mandate to redetermine the net income from the property, we should not exclude from the deductions from gross income the amount of drilling and equipment costs, where such items were deducted in computing the taxable net income.

In Ambassador Petroleum Co. v. Commissioner, supra, it was held that development expenses are not deductible in computing the net income from the property. The reasons which led to that conclusion need not be repeated here. But respondent contends that the present proceedings are distinguishable from the Ambassador decision because that case arose under the 1926 Act, and his regulations under that act were silent in respect of the controverted point, while the present cases arose under the 1928 Act and are therefore controlled by article 221 (i) of Regulations 74, which provides that “net income of the taxpayer (computed without allowance for depletion)” means the gross income less the deductions in respect to the property upon which depletion is claimed, including overhead and operating expenses, development expenses (if the taxpayer has elected to deduct development expenses), etc.

In Wilshire Oil Co., supra, following the Ambassador decision, we rejected a similar contention of the respondent, saying:

Thus the Commissioner, by virtue alone of his regulation, seeks an interpretation of the identical terms of the 1928 Act different from the authoritative judicial interpretation of such terms in the 1926 Act. This would give to his regulation a sanction greater than that of the adjudicated meaning of the same term. This is without support. * * * The Commissioner is without power to change this meaning by a regulation.

We further pointed out that the House and Senate reports on the 1928 Bill treated the term “net income from the property” in the depletion section as meaning operating income, and that the court held also that reason leads to the same meaning. But respondent here insists that his regulation under the 1928 Act now has received legislative approval by reason of the reenactment of the same provisions in subsequent revenue acts. This argument likewise must fail, for the reason that an administrative regulation which misinterprets an unambiguous provision of a statute is not given the force and effect of law by subsequent reenactments of the same statutory provision. “Where the law is plain the subsequent reenactment of a statute does not constitute adoption of its administrative construction.” Biddle v. Commissioner, 302 U. S, 573; Helvering v. New York Trust Co., 292 U. S. 455; Louisville Nashville Railroad Co. v. United States, 282 U. S. 740; Iselin v. United States, 270 U. S. 245.

In addition to Wilshire Oil Co., supra, we have followed the principles declared in Ambassador Petroleum Co. v. Commissioner, in Mountain Producers Corporation, 34 B. T. A. 409; reversed on other grounds, 92 Fed. (2d) 78; Rocky Mountain Oil Co., 36 B. T. A. 365; I. Rudman, 36 B. T. A. 803, 807.

In the present case, the total gross income from the property, determined in accordance with the mandate and opinion of the court, was $1,213,456.09. The parties have stipulated that the total operating expense was $414,038.07. It follows that the true net income from the property was $799,418.02, and since 50 percent of such net income is greater than 27% percent of the gross income from the property, the latter amount represents the depletion allowance. The deficiencies will be recomputed accordingly.

One further point is raised by petitioners. In their motion mentioned above it is stated that the sum of $849,544.37, originally stipulated by the parties as “production expense” and treated wholly as “operating expense”, has been, “together with the sum of $173,000.00 expended for attorneys’ fees, taken from the gross income from the property to determine the net income from the property for the purpose of applying the 50% limitation on depletion.” In their briefs petitioners assert that “these attorneys’ fees have been set up as an operating cost”, and argue that they should be treated in the same manner as development expenses and equipment costs.

In the situation presented here, we need not decide this point. However the item of attorneys’ fees may have been formerly treated, it will not under this opinion be reflected in the recomputation of the net income from the property for the purpose of applying the 50 percent limitation on the depletion allowance. Since the net income from the property, as determined on the basis of the facts stipulated by the parties, does not limit the amount of the allowance for depletion, such allowance will be 27% percent of the gross income from the property, as determined under the court’s opinion and mandate.

Judgment will be entered wnder Rule 50.