author: ARUNdell:

text:
    Lewis K. Walker, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 73728.
    Promulgated March 11, 1937.

      Samuel E. Gawne, Esq., for the petitioner.

      E. L. Corbin, Esq., for the respondent.
   OPINION.

Guardian Detroit Union Group, Inc., Stock.

ARUNdell:

The only issue on the sale of this block of stock is? whether the basis of the shares sold should be determined by the' average cost method or the application of the first in, first out rule. Petitioner contends for the average cost method as against the respondent’s use of the first in, first out principle.

All of the Union Group shares were acquired by petitioner at the one time, December 30, 1929, pursuant to a statutory reorganization.. The proper method of allocation of the basis of stock received in connection with a reorganization is the average basis of the stock given-in exchange. Christian W. Von Gunten, 28 B. T. A. 702; affd., 76 Fed. (2d) 670; Commissioner v. Bolender, 82 Fed. (2d) 591.

Detroit Bankers Co. Stock.

In regard to petitioner’s sale of 330 shares of Detroit Bankers Co. stock, the first issue, as in the case of the Detroit Union Group, Inc., stock, is whether the first in, first out rule or the average cost method should be employed in determining the basis of the stock sold. It would appear _that, without the special circumstances present here'which are treated under the next issue, the principle of the Von-Gunten case would apply. The other two issues in connection with this sale are (1) how to determine the amount of the basis which, remains to be recovered, and (2) whether the sale as to part of the 330 shares was completed in 1929 prior to the taxable year in question.

The total cost to the petitioner of all of his stock in the various-predecessor corporations which ultimately through reorganizations. became the Detroit Bankers Co. was $14,110; on Ms sales of two blocks of stock in those predecessor companies in 1925 and 1929 he deducted a cost of $10,600 and so reported the gain on his income tax returns. These' returns were accepted by the Commissioner and as to them the statutory period of limitations has expired. The petitioner now contends that the cost he was allowed on those sales was excessive because of his use of the first in, first out rule when he should have used the average cost method; he further contends that he is not now estopped from using the “correct” (average) method of computing the basis applicable to those sales. We agree that no issue of estoppel is here presented. Indeed, as to the 1925 sale the petitioner appears to have committed no error in using the first in, first out rule, since the shares sold were not received on a reorganization, but in a mere reissue of certificates. Solomon B. Kraus, 38 B. T. A. 1088.

As we understand the first in, first out rule and the other methods for allocating cost, they are not. rules of law in the strict sense, but merely rules of convenience or rules of thumb for making effective in several common situations the provision of the statute that a taxpayer can recover his cost before becoming taxable on any gain. The rules for allocation of basis are not ends in themselves, but only means to the end of returning to the taxpayer his capital investment free from tax, and if they have partially accomplished this result, even through what was perhaps an erroneous application of one method in a situation which more properly called for another, still we do not think it is now appropriate to apply retroactively a theoretically correct method and get an erroneous result. To apply petitioner’s proposal here would leave him in 1930 with a larger basis than actually remains to him in view of the amount of the basis used in computing his gain on the earlier sales. It would result in his recovery of part of his basis twice. What has happened here is that the petitioner recovered $10,600 of his $14,110 basis prior to 1930, leaving $3,510 to be recovered. The statute authorizes the recovery of basis only once. With the exact basis susceptible of determination, and with all the stock finally disposed of, we think it would be error to substitute for the facts a theory which distorts the actual gain or loss. According to the copy of the deficiency notice before us, the respondent used $3,300 as the basis for the gain on the sale in 1930. As stated above, the figures in evidence indicate a remaining basis of $3,510. These figures, if in error, may be corrected in the settlement under Bule 50.

Finally, the petitioner contends that 7/33 of his Detroit Bankers stock was sold in 1929 and that portion of his gain should be allocated to that year. In November of 1929 he ordered the sale of 330 shares of Detroit Bankers stock on a “when, as and if issued” basis. On December 12,1929, he delivered to his brokers a certificate of deposit for 7 shares of the predecessor company which were to become exchangeable for 70 shares of Detroit Bankers Co. stock upon completion of the organization of the latter company. On January 8,1930, the Detroit & Security Trust Co. stock became exchangeable for Detroit Bankers stock and on January 16,1930, the petitioner delivered to his brokers his remaining certificates of deposit of stock of the predecessor, which, together with the certificate for 7 shares previously delivered, were exchanged by the brokers for 330 shares of Detroit Bankers Co. stock. We do not think that the delivery of the certificate for 7 shares in 1929 had the effect of then completing a sale. It was not Detroit & Security Trust Co. shares which the petitioner sold, but rather, as it is specifically stipulated, “330 shares of stock of Detroit Bankers Company when, as and if issued.” There is no evidence to indicate that delivery of the Detroit & Security Trust Co. shares would be acceptable in performance of the petitioner’s contract to sell stock of the reorganized company. There is no evidence to indicate that such delivery was in fact accepted as performance of the petitioner’s contract. The only evidence on this point is of a contrary import. Petitioner’s account with his broker which records the delivery of the certificate of deposit shows the petitioner’s position as of November 29,1929, “Short 330 Det Bankers W I.” The delivery of the 7 certificates of deposit on December 12 is recorded “7 Det & Sec Trust C/D Reed” and the petitioner’s new position is stated “Short 330 Det Bankers W I, Long 7 Det & Sec Trust C/D.” This record shows that the certificate of deposit was not accepted by his brokers as reducing the number of shares he was short in Detroit Bankers stock.- Nor in our opinion would this delivery constitute part performance of his contract as a matter of law. Dealings in stock on a “when issued” basis are not sales of stock, but merely sales of contracts to sell stock which are made on the express condition that no delivery and payment are required unless and until the stock is issued. Meyer on the Law of Stock Brokers and Stock Exchanges, § 30. Unless and until the stock is issued, no performance is required and if the stock is never issued the contract falls by its own terms, the only money changing hands being the broker’s commissions. Sices v. Ungerleider, 314 N. Y. S. 255. There is no evidence in the instant case that at the time-of sale in November 1929 it was assured that the plans of reorganization would be successful and that stock of the new company would ever be issued. This would explain why the stock of the new company was sold on a “when issued” basis. The reorganization was not actually completed and the stock did not become available for exchange until January 8, 1930. Therefore, before that time there could have been no completed sale of Detroit Bankers stock, and all of.the petitioner’s gain from this sale was realized in 1930.

Reviewed by the Board.

Decision will be entered wnder Bule 50~


source: Caselaw Access Project

author: Mellott : TueneR, Leech,

license: Public Domain

text:
    Kaspare Cohn Company Limited (Formerly Rayben Limited), Petitioner, v. Commissioner of Internal Revenue, Respondent. Kaspare Cohn, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 53696, 58428.
    Promulgated March 11, 1937.

      Garl Taylor, Esq., Thomas R. Denypsey, Esq., Rollin Browne, Esq., Hugh Satterlee, Esq., A. 0alder Mackay, Esq., and Todd W. Johnson, Esq., for the petitioners.

      Mason B. Leming, Esq., O. A. Ray, Esq., Paris B. Glanypoole, Esq., and Charles W. Donnally, Esq., for the respondent.
   OPINION.

Mellott :

Petitioners contend that Rayben Limited, the Canadian corporation, was the owner of the gas stocks (stock in the Southern California Gas Co. and stock in the Midway Gas Co.) when they were exchanged in 1927, for cash and bonds of the Southern California Gas Corporation. This ownership, it is argued, was complete, and unconditional and had its inception in May 1927 at, or shortly after the incorporation of Rayben Limited, when Cohn, Inc., the domestic corporation, transferred the gas stocks owned by it to Ray-ben Limited in exchange for the capital stock of the latter corporation. It is therefore insisted that the sale was made by the Canadian corporation, in Canada, and that any profit derived therefrom does not constitute income taxable in the United States.

Respondent contends that the sale of the gas stock (we shall discuss later the exchange and reorganization feature of this transaction, but for present purposes, shall refer to the exchange of the gas stocks for the cash and bonds simply as a sale) was in truth and in fact made by Cohn, Inc.; that Rayben Limited was a mere corporate form created by Cohn, Inc., for use as an instrumentality to give the latter a basis for contending that the sale was made in Canada; that it was merely an agency or instrumentality of Cohn, Inc.; and that it was a mere conduit only for passing title to the gds stocks to the purchaser and for receiving the proceeds arising from the sale for Cohn, Inc., which was the actual and beneficial owner of the gas stocks and the proceeds derived from the sale.

The Revenue Act of 1926 provides that the term “gross income”, in the case of a domestic corporation, includes gains or profits and income derived from any source whatever, and in the case of a foreign corporation, the term means only gross income from sources within the United States. It is apparent, therefore, that if Rayben Limited was the owner of the stock in question, as contended by the petitioners, and sold it in Montreal, Canada, it is not required to include the profit resulting from the sale in its gross income. If, however, as contended by the respondent, Cohn, Inc., was the real owner and vendor of the stock it is required to include the profit in its gross income whether the sale was consummated in the United States or in Canada.

Respondent urges that we disregard the separate corporate entity of Cohn, Inc., and Rayben Limited and find that the sale was actually made by Cohn, Inc., while petitioners insist that the separate corporate entity of the two corporations can not be disregarded. Upon brief petitioners say, “The Supreme Court in recent tax cases has had occasion to consider urgent demands for the disregard of corporate entities and in every instance has sustained their full recognition”, in support of which they cite: New Colonial Ice Co. v. Helvering, 292 U. S. 435; Burnet v. Commonwealth Improvement Co., 287 U. S. 415; Burnet v. Clark, 287 U. S. 410; Dalton v. Bowers, 287 U. S. 404; Planters Cotton Oil Co. v. Hopkins, 286 U. S. 382; Klein v. Board of Supervisors, 282 U. S. 19.

While it is true that in each of the cited cases the Supreme Court, under the facts before it, applied the general rule that a corporation and its shareholders are to be treated as separate entities, it was careful to point out that “the rule is subject to the qualification that the separate entity may be disregarded in exceptional situations” (New Colonial Ice Co. v. Helvering, supra) or “under exceptional circumstances” (Burnet v. Clark, supra; Dalton v. Bowers, supra) or in cases presenting “peculiar situations.” (Burnet v. Commonwealth Improvement Co., supra.) It is not necessary to set out herein the facts which the Court had before it in the cited cases. Suffice it to state that in none of them was the Court dealing with a foreign subsidiary corporation, the property, management, and activities of which were completely dominated and controlled by a domestic parent corporation which created it for a special purpose.

In the cases r,elied upon by the respondent, the facts show that the transactions arose under “exceptional circumstances” or presented “peculiar situations.” Southern Pacific Co. v. Lowe, 247 U. S. 330, 337, 338; Gulf Oil Corporation v. Lewellyn, 248 U. S. 71; Chicago, M. & St. P. Ry. Co. v. Minneapolis Civic & Commerce Association, 247 U. S. 490, 500, 501; United States v. Lehigh Valley R. Co., 220 U. S. 257, 272-274; and Palmolive Manufacturing Co. (Ontario) Ltd. v. The King, Canada Law Reports, 1935, p. 131. See also North Jersey Title Insurance Co. v. Commissioner, 84 Fed. (2d) 898, and Munson S. S. Line v. Commissioner, 77 Fed. (2d) 849. In each of them the court disregarded the separate corporate entity.

The basic reason underlying the disregard of the corporate entities in the cited cases is succinctly expressed by the Supreme Court in Chicago, M. & St. P. Ry. Co. v. Minneapolis Civic & Commerce Association, supra, in the following language: “Where stock ownership has been resorted to, not for the purpose of participating in the affairs of a corporation in the normal and usual manner, but for the purpose * * * of controlling a subsidiary company so that it may be used as a mere agency or instrumentality of the owning company or companies. * * * In such a case the courts will not permit themselves to be blinded or deceived by mere forms of law but, regardless of fictions, will deal with the substance of the transaction involved as if the corporate agency did not exist and as the justice of the case may require.” The rule above quoted is of peculiar importance in tax cases. Western Maryland Ry. Co. v. Commissioner (C. C. A., 4th Cir.), 33 Fed. (2d) 695.

In Southern Pacific Co. v. Lowe, supra, a tax, which had been laid upon a holding company for dividends declared upon a subsidiary’s shares, was held to be invalid. The shares of the subsidiary were all owned by the holding company, which dominated and controlled its operations and affairs, and possessed its properties and funds. The Supreme Court said, “While the two companies were separate legal'entities, yet in fact, and for all practical purposes they were merged, the former [the subsidiary] being but a part of the latter [the holding company], acting merely as its agent and subject in all things to its proper direction and control.” Under somewhat analogous facts, similar conclusions were readied, in Gulf Oil Corporation v. Lewellyn, supra, and Palmolive Manufacturing Co. (Ontario) Ltd. v. The King, supra.

In North Jersey Title Insurance Co. v. Commissioner (C. C. A., 3d Cir.), 84 Fed. (2d) 898, where the taxpayer had formed a subsidiary corporation to hold and sell certain real estate which it was obliged to take over in order to protect its business, the court upheld the contention of the taxpayer that it should be permitted to include income and losses of its subsidiary in its income tax return, basing its decision on the fact that the only purpose of the subsidiary corporation was to act as agent for and on behalf of its parent, and that, while in form they were admittedly two separate entities, in substance there was but one enterprise.

In Munson S. S. Line v. Commissioner (C. C. A., 2d Cir.), 77 Fed. (2d) 849, a parent corporation, which took possession of and operated vessels belonging to wholly owned subsidiary corporations and retained the earnings of such vessels, making only a bookkeeping division thereof, was held to be the “owner” of such vessels within a statute offering to the “owner” of a vessel documented in the United States and operated in foreign trade, the allowance of a deduction for computation of war profits and excess profits taxes, as an inducement to invest earnings in additional ships.

We believe that the facts shown in our findings justify and require that we disregard the separate corporate entity and “deal with the substance of the transaction as if the corporate agency did not exist”; for the circumstances before us are quite “exceptional”, if not unique, and create a “peculiar situation.” We shall not attempt to point out all the facts upon which we rely in reaching this conclusion; but it may not be amiss to advert to some of them.

Substantially all of the activities of Eayben Limited in Canada were handled by “dummy” (but we use the word in no opprobrious sense) directors and officers, all of whom were either officers or employees of the Canadian law firm retained by Cohn, Inc., to bring about the organization and incorporation of Eayben Limited under the laws of Canada. They received no compensation from Eayben Limited, had no beneficial interest in the corporation, and were never in the United States in connection with any of its business. They approved and accepted the offer made by Cohn, Inc., under date of May 30,1927, to transfer and assign the gas stocks to Eayben Limited in exchange for all of its capital stock. When, in August 1927, the gas stocks were transferred into the name of Eayben Limited, they designated Milton E. Getz as treasurer of Eayben Limited, though he was not even a stockholder of Eayben Limited at that time. He was, however, the vice president of Cohn, Inc. He was given the exclusive custody of the securities of Rayben Limited and the then members of the board of directors of Rayben Limited, which still consisted only of the officers and employees of the Canadian law firm, adopted a resolution providing that all of the corporate funds of Rayben Limited be deposited with the Union Bank & Trust Co. of Los Angeles, California. At about the same time one of the members of the law firm transferred one share of stock to Ben R. Meyer, who then became a director and vice president of Rayben Limited. Thereupon the directors of Rayben Limited authorized the Union Bank & Trust Co. to pay out the funds of the company upon checks or drafts signed by Meyer or Getz.

The only other activities of the officers and directors of Rayben Limited, in Canada, prior to November 15,1927, consisted of formally approving and signing agreements concerning the sale, or the contemplated sale, of the gas stocks. It is significant that all of such agreements were prepared in the United States after extended negotiations conducted by Meyer, who at all times was president of Cohn, Inc., and that none of the agreements was ever changed in any material way in Canada. It is also significant that the officers and employees of the Canadian law firm, who, during most of the time the negotiations were being carried on, constituted a majority of the board of directors of Rayben Limited, never saw any of the agreements until they were brought to Canada for their formal approval and signature.

During the whole of the period, then, from May 27, 1927, to November 15, 1927, the activities of Rayben Limited in Canada were confined to the activities of its “dummy” directors and officers who, it is apparent, were dominated and controlled by Cohn, Inc. During this period it had no property or funds in Canada, all of its property and funds registered in its name being in the United States in the custody, possession and control of Meyer and Getz, and it transacted no business in Canada. When the sale of the utility stocks was imminent, Meyer disregarded the “exclusive custody” which had been vested in Getz, and took the stocks to Canada on November 15. On November 16, the day preceding the delivery of the stock to the purchaser, the board of directors of Rayben Limited held a meeting, the only directors present being Meyer, Rollin Browne, a member of the firm of New York attorneys who had been made a director of Rayben Limited in August, and Hugessen, the “dummy” director and president. They saw to it that the interests of Cohn, Inc., were well protected by passing resolutions that the funds of Rayben be deposited with Cohn, Inc., and that Meyer and Getz only be authorized to draw checks or drafts against these funds. When on the following day Meyer delivered the stock to the purchaser and received the consideration, he immediately transferred substantially all of the cash received, with the exception of amounts necessary to defray the expenses incident to the sale, to Los Angeles, where it was turned over to Cohn, Inc., in the form, of a loan.

The only other transaction entered into by Eayben Limited in Canada was in January 1928 when part of the bonds received on November 17 were delivered to the bankers in Canada for cash. The cash, however, was immediately transferred to Los Angeles. The gentlemen we have heretofore referred to as “dummy” directors and officers of Eayben Limited then resigned, Meyer became president, Getz became vice president, and Margaret E. Feehan, a bookkeeper for Cohn, Inc., became its secretary. They held the same offices in Cohn, Inc. On February 17, 1928, a letter was addressed to Eayben-Limited at Montreal, signed by Getz, as vice president of Cohn, Inc., and Margaret E. Feehan, as secretary, offering to transfer all the assets of Cohn, Inc., to Eayben Limited in consideration of the cancellation of all indebtedness owing by Cohn, Inc., to it and the assumption by it of all liabilities of Cohn, Inc. Getz, as vice president of Eayben Limited and Margaret E. Feehan, as secretary of that corporation accepted the offer on the same day. Eayben Limited then moved into the office of Cohn, Inc., in Los Angeles, its name was changed to “Kaspare Cohn Company Limited”, the ledger of Cohn, Inc., became the ledger of Eayben Limited, and as a result of these manipulations, Cohn, Inc., had $2,610,000 of the proceeds of the sale and its transplanted offspring had all of its assets. Obviously it made no' difference to Cohn, Inc., at that time whether its assets were carried in its name or in that of its alter ego.

Cohn, Inc., acting through its president, Ben E. Meyer, was the unquestioned master and dominated and controlled every move that was made from the time it became apparent in May 1927 that the banters would purchase the gas stocts until the proceeds of the sale were safely deposited in Los Angeles, California. He directed the organization of Eayben Limited; employed New York attorneys to act for the petitioners before Eayben Limited was incorporated; wrote the letter offering to transfer the gas stocks to Eayben Limited; took a prominent part in all of the negotiations in the United States leading to the consummation of the sale; caused the gas stocks to be transferred into the name of Eayben Limited; had a schedule prepared under his supervision in New York City showing the precise amount of cash and bonds each of the record holders of the gas stocks was to receive; took the gas stocks to Canada; received the consideration; transferred it to the bank of which he was president in California; and paid the legal expenses and broker’s commission. He liad, as lie expressed it, “verbal authority” from a majority of the stockholders and directors of Cohn, Inc., to act for that corporation in connection with the sale of the gas stocks. He had no such authority from Rayben Limited or its Canadian officers and directors and he needed none. He had employed the members of the Canadian law firm to do what he wanted done and that is all that they ever did. They served him and Cohn, Inc., just as they would have served any other client.

We can not escape the conclusion that Rayben Limited was acting as a mere agency or instrumentality of Cohn, Inc., in transferring the gas stocks to the Southern Corporation and receiving the consideration therefor. All of the facts show that it was created and brought into being by its parent for that very purpose. Cohn, Inc., never participated in the affairs of Rayben Limited in the manner that a parent corporation normally participates in the affairs of a subsidiary but, through its president, Meyer, dominated and controlled its every move, especially during the period before it was transplanted in the United States. The whole transaction is not “in fact what it appears to be in form”, and what was actually done “contradicts the apparent transaction.” (Chisholm v. Commissioner, 79 Fed. (2d) 14; certiorari denied, 296 U. S. 641.) We hold that Cohn, Inc.,'was the real owner and vendor of the gas stocks when the sale was made. “To hold otherwise would be to exalt artifice above reality.” Gregory v. Helvering, 293 U. S. 465. We do not rest our decision upon the fact that the obvious purpose of the Canadian formalities was to escape taxation on the profit from the. sale of the gas stocks. We recognize that a taxpayer has the legal right to decrease the amount of what otherwise would be its taxes by means which the law permits. Gregory v. Helvering, supra. But, “fictional corporate camouflage can not be made the device to escape taxation.” North Jersey Title Insurance Co. v. Commissioner, 84 Fed. (2d) 898. It follows that the profit derived from the sale, to the extent hereinafter set out, should be included in the gross income of Cohn, Inc., for the year 1927.

Having concluded that Cohn, Inc., owned and sold the stocks, we need not discuss the other questions raised by the parties upon brief One is whether the sale was consummated in the United States or in Canada; the other is whether the accounts of the two petitioners should be consolidated and the profit thus be allocated to Cohn, Inc., under the provisions of section 240 (f) of the Revenue Act of 1926. If we are correct in our conclusion that the sale was made by Cohn, Inc., then it is liable for any tax upon the profit, regardless of whether the sale was made in the United States or elsewhere. (Sec. 213 (a), supra.) It is therefore unnecessary to determine where the sale was made. It is likewise unnecessary to decide whether the accounts of the two corporations should be consolidated; for, if so, the only effect would be to allocate the profit to Cohn, Inc. We must, however, decide whether the transfer of the gas stocks to the Southern Corporation, which we have heretofore referred to as a sale, was in fact, as petitioners contend, a partially tax-free reorganization, the gain from which is not recognizable in any event in excess of the amount of the cash received.

The pertinent provisions of the Eevenue Act of 1926 are set forth in the margin. In order to bring the transaction here in controversy within these provisions, petitioners must show (1) that there was a plan of reorganization; (2) that the Southern California Gas Co., the Midway Gas Co., and the Southern California Gas Corporation, were all parties to a reorganization; and (3) that there was an exchange of stock in one or more of these corporations for stock or securities in one of the others, and cash, pursuant to the plan of reorganization.

The plan relied upon by petitioners is embodied in the agreement of October 17, 1927. It provided for the organization of a new corporation called the Southern California Gas Corporation; for the acquisition by the Southern Corporation of not less than 95 percent of the common stock of the Southern Co. and not less than 95 percent of the capital stock of the Midway Co. from the stockholders of those companies, in exchange for collateral trust bonds of the Southern Corporation to the extent of about 60 percent of the consideration and cash as to the balance; it provided further for the acquisition by the Southern Co. of all the assets of the Midway Co. in exchange for stock and bonds of tlie former, and that the Midway Co. be liquidated and distribute to the Southern Corporation its pro rata share of the 80,000 shares of the Southern Co.’s common stock which the Midway Co. received for its assets.

Section 203 (h) (1) of the Revenue Act of 1926, supra, provides that the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation is included within the meaning of the term “reorganization.” The Midway Co. had but one class of stock and had outstanding 23,264 shares. Its shareholders delivered 23,121 shares of this stock to the Southern Corporation on November 17. The Southern Corporation had outstanding on October 17, 1927, 240,000 shares of common stock and 166,879 shares of preferred, both classes of stock having equal voting rights. It later issued 80,000 additional shares of common stock which were delivered to the Midway Co. as part consideration for its property and assets. On November 17 the Southern Corporation received from the stockholders of the Southern Co. 239,608 shares of that company’s common stock and when the Midway Co. liquidated on December 10 it received 79,508 of the 80,000 shares of the Southern Co.’s common stock which had been transferred to the Midway Co. It is apparent therefore that the plan embodied in the agreement of October 17 was a plan of reorganization, the Southern Corporation having acquired more than a majority of the total number of shares of the voting stock of the Southern and Midway Companies. Neither of these companies had outstanding any nonvoting stock.

The Southern Corporation and the Southern and Midway Companies are clearly parties to a reorganization within the meaning of section 203 (h) (2), supra, which provides that “a party to a reorganization” includes both corporations in the case of the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation.

We are of the opinion that the transaction here in controversy falls within the exchange and reorganization provisions of the statute, as Cohn, Inc., and the other stockholders of the Southern and Midway Companies transferred their stock in these two companies to the Southern Corporation in exchange for bonds of the latter, and cash. By reason of the receipt of the bonds, the stockholders acquired a definite and material interest in the affairs of the Southern Corporation which represented a substantial part of the value of the stock transferred. The exchange was made pursuant to a plan of reorganization, and we hold that under the provisions of section 203 (d) (1), supra, the taxable gain to be recognized is limited to the amount of the cash received, although the actual gain is in excess of this amount. Helvering v. Watts, 296 U. S. 387; Helvering v. Minnesota Tea Co., 296 U. S. 378; Lilienthal v. Commissioner, 80 Fed. (2d) 411; Miller v. Commissioner, 84 Fed. (2d) 415.

The profit from the sale of the utility stocks, to the extent of the cash received, should be added to the gross income reported by Cohn, Inc., for the year 1927. Having held that Cohn, Inc., and not Rayben Limited, made the sale, it follows that no part of the profit realized should be included in the gross income of Raspare Cohn Co. Limited (formerly Rayben Limited) for the fiscal year ended October 31, 1928.

Reviewed by the Board.

Judgment will be entered u/nder Bule 50.

TueneR,

concurring: I concur in the conclusion reached in the majority opinion that the gain realized upon the sale of the stock in question is taxable to the petitioner, but for a different reason. In my opinion the facts definitely show that the sale was made in the United States and under the circumstances it matters not whether it was made by Cohn, Inc., or by Rayben Limited.

Arundell agrees with the above.

Leech,

dissenting: In my judgment, the theory upon which the majority opinion is supported, is not tenable. That theory seems to be that Rayben Limited, organized for the purpose of avoiding income taxes by its incorporator, but still existing and now owning the assets and business of that incorporator, Kaspare Cohn Co., shall be recognized for income tax purposes in a sale of its corporate property, merely as agent of its stockholders and shall there be deemed, only, a “fictional corporate camouflage * * * device to escape taxation”, where such sale was conceived by its organizer before its incorporation, although no contract to sell then existed.

In my judgment, the legality of the corporate status and acts of Rayben Limited, its continued existence and present ownership of the proceeds of the disputed sale, contradict conclusively any such fictional characteristic. Nor does any authority cited in the majority opinion, or otherwise, so far as I know, justify the limitation of recognition of a corporation as a separate entity, in the status of principal, to those of its acts which were conceived after its incorporation. And, although conceding “that a taxpayer has the legal right to decrease the amount of what otherwise would be its taxes by means which the law permits”, the conclusion of the prevailing opinion nullifies that conceded rule.

Moreover, I do not think a conclusion resulting in a deficiency in these proceedings can be sustained on any sound legal ground.

The purpose in organizing Rayben Limited is not material here. Cf. Gregory v. Helvering, 293 U. S. 465. The record discloses that the stocks in question were legally, effectively, and unconditionally transferred to a corporation in exchange for all of the stock of that corporation. The Revenue Act of 1926, section 203 (b) (4), is unambiguous. In my opinion, it is controlling. It may have been a legislative mistake that, under this act, the gain from such a transaction as is presented should escape tax. But that mistake, particularly in a taxing statute, affords the Board no proper authority for supplying, as it seems to me the majority opinion does, what Congress omitted. That Congress realized that this very so-called “serious loophole for avoidance of taxes” existed under the applicable revenue act, supra, is clearly established by the Report of the Ways and Means Committee to the House of Representatives, accompanying the Revenue Act of 1932. That legislation could and did supply the omission which Congress recognized existed in the earlier law.

       Sec. 213. (a) « * *
      Tile term “gross income” includes gains, profits, and income derived irom * * » businesses, commerce, or sales or Sealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; * * * or gains or profits and income derived from any source whatever.
      Sue. 217. (a) In the case of a nonresident alien individual or of a citizen entitled to the benefits of section 262, the following items of gross income shall be treated as income from sources within the United States ;
      * * * * * * *
      (e) * * * Gains, profits and income derived from the purchase of personal property within and its sale without the United States or from the purchase of personal property without and its sale within the United States, shall be treated as derived entirely from sources within the country in which sold, * * *.
      (f) As used in this section the words “sale” or “sold” include “exchange” or “exchanged”; * * *
      Sec. 233. (a) In the case of a corporation subject to the tax imposed by section 230 the term “gross income” means the gross income as defined in sections 213 and 217, except that mutual marine insurance companies shall include in gross income the gross premiums collected and received by them less amounts paid for reinsurance.
      (b) In the case of a foreign corporation, gross income means only gross income from sources within the United States, determined (except in the case of insurance companies subject to the tax imposed by sections 243 or 246) in the manner provided in section 217.

       Sec. 203. (a) Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 202, shall be recognized, except as hereinafter provided in this section.
      * * $ sK * * *
      (b) (2) No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
      # * * * * * #
      (d) (1) If an exchange would be within the provisions of paragraph (1), (2), or (4) of subdivision (b) if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.
      *******
      (h) (1) The term “reorganization” means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation or substantially all the properties of another corporation), * * *
      (h) (2) The term “a party to a reorganization” includes a corporation resulting from a reorganization and includes both corporations in the case of an acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation.

       RECOGNITION OF GAIN OR LOSS FROM SALES AND EXCHANGES.
      Sec. 203. (b) (4) No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock Or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.

       House of Representatives, 72d Congress, 1st sess., Rept. No. 708, p. 20 :

        Property may be transferred to foreign corporations without recognition of gain under the exchange and reorganization sections of the existing law. TMs constitutes a serious loophole -for avoidance of taxes. Taxpayers having large unrealized profits in securities may transfer such securities to corporations organized in countries imposing no tax upon the sale of capital assets. Then, by subsequent sale of these assets in the foreign country, the entire tax upon the capital gain is avoided. For example, A, an American citizen, owns 100,000 shares of stock in corporation X, a domestic corporation, which originally cost him $1,000,000 but now has a market value of $10,000,000. Instead of selling the stock outright A organizes a corporation under the laws of Canada to which he transfers the 100,000 shares of stock in exchange for the entire capital stock of the Canadian company. TMs transaction is a nontaxable exchange. The Canadian corporation sells the stock of corporation X for $10,000,000 in cash. The latter transaction is exempt 'from tax under the Canadian law and is not taxable as United States income under the present law. The Canadian corporation organizes corporation Y under the laws of the United States and transfers the $10,000,000 cash received from the sale of corporation X’s stock in exchange for the entire capital stock of Y. The Canadian corporation then distributes the stock of Y to A in connection with a reorganization. By this series of transactions, A has had the stock of X converted into cash and now has it in complete control. [Emphasis supplied.]

       SEC. 112. RECOGNITION OF GAIN OR' LOSS.
      (k) Foreign Corporation. — In determining the extent to which gain shall be recognized in the case of any of the exchanges or distributions (made after the date of the enactment of this Act) described in subsection (b) (3), (4), or (5), or described-in so much of subsection (c) as refers to subsection (b) (3) or (5), or described in subsection (d) or (g), a foreign corporation shall not be considered as a corporation unless, prior to such exchange or distribution, it has been established to the satisfaction of the Commissioner that such exchange or distribution is not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes.


author: Smith:

text:
    Joseph B. Strauss, Petitioner, v. Commissioner of Internal Revenue, Respondent. Annette Strauss, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 81902, 82498.
    Promulgated March 12, 1937.

      Henry C. Clausen, Esq., and Kenneth N. Logan, C. P. A., for the petitioners.

      Chester A. Gwinn, Esq., and John D. Kiley, Esq., for the respondent.
   OPINION.

Smith:

We have heretofore held, in George H. Harlan, 30 B. T. A. 804, affirmed by the Circuit Court of Appeals for the Ninth Circuit in Commissioner v. Harlan, 80 Fed. (2d) 660, that the Golden Gate Bridge and Highway District was an instrumentality of the State of California engaged in an essential governmental function and that the regular salary of the attorney for the Bridge District was immune from Federal income tax. The petitioner herein relies strongly on that case in claiming tax immunity on the compensation paid him- as engineer for the Bridge District. He Undertakes to show that he was an officer of the Bridge District standing essentially in the same relationship to it as the attorney.

Undoubtedly a strong parallel is to be found between the cases, particularly in the statutory authorization for the appointments and in the character of some of the services which the attorney and the engineer rendered to the Bridge District. We are of the opinion, however, that the parallel is not so close as to be compelling and that under necessity of distinguishing facts the petitioner must be classified as an independent contractor rather than as an officer or employee of the Bridge District.

First, the petitioner undertook his services for the Bridge District under a separate and distinct employment contract, the terms of which he himself either suggested or agreed to. He was bound only by the terms of this contract. Thus, in a very real sense, he was an independent contractor. His compensation was fixed by the contract strictly on a fee basis. In the Harlan case there was no contract of employment with the attorney. His duties were fixed by statute or by the board of directors. The compensation which the Board and the court held to be immune from Federal tax consisted only of the attorney’s regular salary from the Bridge District.

The facts here bring the instant case directly in line with Metcalf & Eddy v. Mitchell, 269 U. S. 514. There, as here, the taxpayers were engineers employed under contract with the states or state instrumentalities. Their employment was for one or more particular projects and their compensation was fixed, in some instances at a gross sum for the completed job. The .Court there said:

We think it clear that neither of the plaintiffs in error occupied any official position in any of the undertakings to which their writ of error in No. 183 relates. They took no oath of office; they were free to accept any other concurrent employment; none of their engagements was for work of a permanent or continuous character; some were of brief duration, and some from year to year, others for the duration of the particular work undertaken. Their duties were prescribed by their contracts and it does not appear.to what extent, if at all, they were defined or prescribed by statute. We therefore conclude that plaintiffs in error have failed to sustain the burden cast upon them of establishing that they were officers of a state or a subdivision of a state within the exception of section 201 (a).
An office is a public station conferred by the appointment of government. The term embraces the idea of tenure, duration, emolument and duties fixed by law. Where an office is created, the law usually fixes its incidents, including its term, its duties and its compensation. United States v. Hartwell, 6 Wall. 385, 18 L. Ed. 830; Hall v. Wisconsin, 103 U. S. 5, 20 L. Ed. 302. The term “officer” is one inseparably connected with an office; but there was no office of sewage or water supply expert or sanitary engineer, to which either of the plaintiffs was appointed. The contracts with them, although entered into by authority of law and prescribing their duties, could not operate to create an office or give to plaintiffs the status of officers. Hall v. Wisconsin, supra; Auffmordt v. Hedden, 137 U. S. 310, 11 S. Ct. 103, 34 L. Ed. 674. There were lacking in each instance the essential elements of a public station, permanent in character, created by law, whose incidents and duties were prescribed by law. See United States v. Maurice, Fed. Cas. No. 15,747, 2 Brock. 96, 102, 103; United States v. Germaine, 99 U. S. 508, 511, 512, 25 L. Ed. 482; Adams v. Murphy, 165 F. 304, 91 C. C. A. 272.

The petitioner here took the usual oath, of office but it does not appear that lie was required to do so by law or that taking the oath of office was of any special significance in determining his duties or relationship to the Bridge District or the state. See Edward M. Lynch, 30 B. T. A. 727; Eric E. Hall, 33 B. T. A. 953; Commissioner v. Murphy (C. C. A., 2d Cir.), 70 Fed. (2d) 790. The petitioner was appointed not for a term of years, but for the duration of a particular project. His duties were only briefly referred to in the statute (see section 12, supra) but were fully defined in his contract with the Bridge District. His compensation also was fixed by the contract and not by statute.

Neither can it be said that the petitioner was an employee of the state or the Bridge District. We quote further from the Court’s opinion in Metcalf & Eddy v. Mitchell, supra;

* * * In each instance the performance of their contract involved the use of judgment and discretion on their part and they were required to use their best professional skill to bring about the desired result. This permitted to them liberty of action which excludes the idea that control or right of control by the employer which characterizes the relation of employer and employee and differentiates the employee or servant from the independent contractor. * * *

See also Commissioner v. Modjeski (C. C. A., 2d Cir.), 75 Fed. (2d) 468, where the court held, reversing the Board, that a consulting engineer, employed by the Delaware River Joint Commission, created by the Legislatures of Pennsylvania and New Jersey for the purpose of building a bridge over the Delaware River, was an independent contractor.

In Edward M. Lynch, supra, we held that the compensation paid to the city engineer for several cities of the State of California was not exempt from Federal income tax. The facts there were not materially different from those in the instant case. In holding the taxpayer’s compensation subject to tax we said:

The petitioner insists that his compensation as city engineer of the cities of Compton, Fillmore, Lynwood, Taft, Southgate, and Tujunga, is exempt from Federal income taxation on the ground that he was an officer of each city. In support of this he points to his appointment by each of the boards of trustees and to the fact that he qualified in each case by taking an oath of affice. On the other hand the length of his employment, when such period was fixed, his duties, and his compensation were prescribed in each case by his contract and not by law. He agreed to do the work for a compensation measured always by a percentage of the total contract price. All help on the jobs was to be furnished by him free of cost to the cities. He was to maintain at his own expense in each city, except Compton, a resident engineer and the necessary assistants. Bach contract, except that with the city of Compton, recites that its purpose is to obligate the petitioner to perform in a thorough and workmanlike manner all engineering and inspection services. These are words of contract and do not import duty imposed by law. * * *

To the same effect is F. A. Pease, 30 B. T. A. 17; affd., 83 Fed. (2d) 122. In its affirming opinion the court said:

Here the petitioner’s employment in some instances was for brief periods, in others from year to year, and others for the duration of a particular work undertaken. He was paid on a commission basis according to agreement negotiated with the city council or with the city manager, and employed his assistants and helpers and paid them out of his own earnings. He was engaged in practicing his profession of engineering and was employed by each of the municipalities as he might or could have been employed by any other client. In our opinion he was an independent contractor, and the income which he received from his employment was taxable.

See also Consoer, Older & Quinlan, Inc. v. Commissioner (C. C. A., 7th Cir.), 85 Fed. (2d) 461, affirming the Board’s memorandum opinion. In Joseph Milton Howe, 19 B. T. A. 849, where we held that the compensation received by a civil engineer for Harris County, Texas, was subject to tax, we said:

In our opinion that enactment (Harris County Road System law, section 24) does not create the office of county engineer. It provides for the selection of an engineer who is to be employed by contract, which is incompatible with the idea of a public office. In 221 Ruling Case Law, p. 379, we find the general rule that “A public office is not the same thing as a contract, and one contracting with the government is in no just and proper sense an officer of the government.” Again, on page 380 of the same volume it is stated; “The fact that the duties of a particular position or governmental function do not depend on contract is itself one of the criteria that it is a public office.” And to similar effect is the holding in Hall v. Wisconsin, 103 U. S. 5.

In Erie E. Hail, supra, which involved facts quite similar to those in the instant proceedings, we held that the county architect for Cook County, Illinois, was an independent contractor and that his compensation was not immune from Federal income tax. Cf. Underwood v. Commissioner, 56 Fed. (2d) 67.

The evidence here unmistakably shows that the petitioner served the Bridge District in the capacity of an independent contractor and not as an officer or employee. He maintained his own office, hired his own assistants, paid his own office expenses, was at liberty to perform other engineering services, and as compensation received fees based upon the cost of the work to be done. Our conclusion is that under the facts here presented and by the great weight of authority the petitioner’s compensation is not immune from tax.

The respondent now concedes in his brief that the income in dispute should be allocated to the petitioners on a community property basis. This issue, as well as the remaining issue relative to the amounts of petitioner’s personal exemptions, will be settled under Rule 50 in accordance with the above findings of fact.

Reviewed by the Board.

Judgment will be entered under Rule 50.


author: ITakron :

text:
    George Trosk, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 76256, 77204.
    Promulgated March 12, 1937.

      George Trosk, Esq., pro se.

      James H. Teatman, Esq., for the respondent.
   OPINION.

ITakron :

The petitioner contends that he was an employee of the State of New York and that consequently compensation received from the State of New York is not subject to Federal income tax. Respondent concedes that the Joint Legislative Committee was an instrumentality of the state and that the conduct of the investigation of the administration of the government of New York City was the exercise of an essential governmental function, but the respondent contends that this petitioner and others whose petitions were consolidated for hearing with this proceeding, were not employees but were independent contractors. It is contended that the Joint Legislative Committee did not control the work of petitioner so as to bring him within the status of an employee. The sole question is whether petitioner was an employee of the State of New' York, for, if he was, compensation paid to him would not be subject to Federal income tax.

The facts have been set forth at length. It is noted that petitioner was appointed by the Joint Legislative Committee at a fixed monthly salary for the duration of the investigation, with the understanding that he would devote all of his time to the work of the committee. Petitioner served the committee continuously from the date of his appointment until the conclusion of the investigation and gave up his private law practice and the use of his private law office. He was not the general counsel of the committee, but one of several assistants, and his work consisted of carrying on the routine work of the investigation as directed by the committee. In these and in other respects this proceeding is distinguishable from the cases relied on by the respondent, namely, D. Frederick Burnett, 31 B. T. A. 1092, where the petitioner was the general counsel in whose control the legislative investigation rested, who was engaged to accomplish certain objectives, who was not in fact restricted from engaging in other work, and whose compensation was not fixed; Burnet v. McDonough, 46 Fed. (2d) 944; Russell E. Watson, 31 B. T. A. 1097; affd., Watson v. Commissioner, 81 Fed. (2d) 626; Commissioner v. Murphy, 70 Fed. (2d) 790; Buckner v. Commissioner, 77 Fed. (2d) 297; Medalie v. Commissioner, 77 Fed. (2d) 300.

To determine whether the employee relationship exists, it is fundamental that control or the right of control by the employer over the alleged employee exists. See Metcalf & Eddy v. Mitchell, 269 U. S. 514. In the instant proceeding the investigation of the governmental structure of the city of New York was made by the Joint Legislative Committee empowered by the state legislature to make the investigation. It is evident that the magnitude of the investigation required that the committee obtain assistants in order that the investigation could be made and the legislature appropriated a maximum of $250,000 to meet expenses of the committee. The committee, with the aid and advice of its general counsel, Seabury, mapped the course of the investigation. It conducted the public hearings and determined what witnesses examined in private hearings should be called for public hearing. The investigation was not turned over to this petitioner nor to any staff of lawyers. The committee determined what work was to be done and the methods to be used. Petitioner received assignments of .work, from the committee and had the general task of doing the work. He reported on his work to the committee. His work was performed in the name of the committee and he was not free to act on his own determination. This serves to distinguish this case from David A. Reed, 13 B. T. A. 513. The petitioner exercised his own judgment in the use of his professional skill, but this does not prevent his occupying the status of an employee if his work is controlled and directed by his employer. It is also noted that petitioner was not engaged to perform any one or several specific tasks or arrive at any definite result, but rather was required to do the routine work of the investigation and his work developed as the investigation progressed. In this respect this proceeding is distinguishable from Carl Newman Davie, 26 B. T. A. 1007.

In our opinion the Joint Legislative Committee exercised continuous control and supervision over petitioner’s services, as to what should be done and the methods to be used and had exclusive command over all his time so as to bring petitioner within the status of an employee. See Charles J. Tobin, 17 B. T. A. 1261; Frederick A. Brown, 22 B. T. A. 581; Robert Carey, 31 B. T. A. 839; Hector McGowan Curran, 34 B. T. A. 946, and cases cited therein. This case is distinguishable on facts from Watson v. Commissioner, 81 Fed. (2d) 626.

The petitioner occupied an office furnished by the state and all supplies and stenographic and clerical help were furnished by the state. He signed the state pay roll each month and was paid on vouchers of the state comptroller out of the state treasury. These factors are also material characteristics of an employee.

It is held on the evidence that petitioner was an employee of the Joint Legislative Committee and therefore of the State of New York, so that the compensation he received from that state, during (he taxable years, is immune from Federal income tax.

Reviewed by the Board.

Judgment wild be entered for the petitioner.


author: ARUndell:

text:
    A. M. Campau Realty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 70340.
    Promulgated March 12, 1937.

      Lee I. Park, Esq., and Kins Collins, C. P. A., for the petitioner.

      Chester A. Gwinn, Esq., and Hugh Brewster, Esq., for the respondent.
   OPINION.

ARUndell:

This proceeding involves a deficiency in income tax in the amount of for the year 1930. The only question involved is whether an amount of $5,208.35 was properly accrued on the books of account of the petitioner and reported by it as income for the year 1930.

The facts were stipulated and, briefly stated, are as follows:

The petitioner is a Michigan corporation with its principal office at Detroit, Michigan.

During 1930 and for several years prior thereto the petitioner owned certain real estate in Detroit, Michigan. By an agreement dated September 1, 1925, the petitioner leased such real estate, consisting of a store, together with the basement space connected therewith, located at 2040 Park Avenue, to Janney-Bowman, Inc., a Michigan corporation, hereinafter referred to as the lessee, for a period of 10 years at a total rental of $120,000, payable in monthly installments as follows: $833.83 per month from November 1, 1925, to and including October 1, 1928; $1,041.67 per month from November 1, 1928, to and including October 1, 1930; and $1,083.33 per month on November 1, 1930, to and including October 1, 1935.

On or about August 10, 1928, the petitioner learned that a substantial portion of the lessee’s assets had been distributed to its stockholders, and on the basis of such circumstances brought an action at law in the Circuit Court of Wayne County, Detroit, Michigan, against the lessee for anticipatory breach of the lease. On September 11, 1928, the lessee filed its answer, in form a mere demand for trial and designated in the court records as a “Plea of General Issue.” On March 7, 1930, a decision adverse to the petitioner, with costs to the defendant lessee, was rendered by the court. On March 11, 1930, the petitioner filed a motion for new trial, but before any action was had thereon the petitioner filed on April 18, 1930, a discontinuance of the suit and on May 3, 1930, the court entered its final order of dismissal.

On March 3, 1930, prior to the termination of the above action the petitioner filed a suit in equity against the lessee and others in the Circuit Court of Wayne County, in chancery. It its complaint therein the petitioner, among other things, alleged that on April 1, 1928, the lessee had vacated the demised premises, sold its stock and fixtures, and assigned its remaining assets to a trustee for liquidation for the benefit of its stockholders; that prior to and on or about April 1, 1928, the lessee requested release from its lease upon payment of six-month rental which the petitioner refused to grant; that the trustee had during May and July 1928 made two distributions to stockholders; that no assets were retained available for the payment of rentals due the petitioner from the lessee; and that it had a claim of $89,924.99 against the lessee. On May 8, 1930, the lessee and other named defendants filed their answer wherein, among other things, it is alleged that tfie principal business of the lessee was the sale of certain pianos at retail; that in March 1928 it was notified that its franchise as dealer of such pianos would be discontinued at the end of such month; that thereupon lessee sold all of its stock of goods and fixtures to the sole representative in Detroit of the manufacture of such pianos and was paid therefor m cash, using most of it to discharge its current obligations; that it vacated the leased premises; that, having discontinued the retail sale of pianos, the lessee had no other activities thereafter than the collection of balances due upon its so-called leases for the sale of pianos, which in the usual course of business would run for a period of about three years after March 31, 1928; that after the disposal of its physical properties it had no need for a large capital and therefore took appropriate corporate proceedings during March and April 1928 to reduce its authorized capital stock from $25,000 to $5,000 and to declare a dividend payable to its stockholders of all the surplus remaining after the reduction of its capital stock; that on August 10, 1928, the petitioner without warning or notice elected to terminate the lease and thereupon filed an action at law against the lessee; and that by reason of such termination the lessee was thereupon relieved of making any further payments of rentals under the lease.

On April 9,1930, the petitioner filed a second action at law against the lessee in the Circuit Court of Wayne County, and the lessee filed its answer thereto on or about April 30, 1930.

The suit in equity and the second action at law were compromised in September 1931 by the payment of the amount of $18,812.33 by the lessee to the petitioner and the release by the petitioner of the lessee of all further liability with respect to the lease involved. The amount of $18,812.33 so received in settlement was included as taxable income in petitioner’s income tax return for 1931.

The rentals under the lease were paid up to and including August 31, 1928. No rental was paid for any period subsequent to August 1928 other than rentals, if any, included in the settlement payment of $18,812.33. However, the petitioner accrued on its books and reported as taxable income in 1928, 1929, and 1930, respectively, rentals for the period of September 1, 1928 to May 31, 1930, as follows:

Sept. 1 to Dec. 31, 192S_$2, 916. 67
Calendar year 1929_ 12, 600. 04
Calendar year 1930_ 5, 208. 35

Each of the above amounts represents the aggregate of the monthly rentals as provided in the lease less the actual rentals petitioner ’was able to obtain for the premises from other sources. The amount of $5,208.35 is reflected in the taxable net income shown in the deficiency notice herein.

No rentals under the lease involved here were accrued by the petitioner on its books subsequent to May 1930. Prior to the closing of its books for the calendar year 1930 the petitioner’s executive vice president instructed its accountant, who periodically audited its books and prepared its return for that year, to charge off as a bad debt the rentals accrued for the period from September 1, 1928, to May 31,1930. Such charge-off was made on the accountant’s working papers pertaining to petitioner’s affairs, but no entry reflecting such charge-off was ever actually made on the petitioner’s regular books of account. The respondent, among other adjustments made by him, disallowed a deduction in the amount of $19,855.96 representing the account of Janney-Bowman, Inc., as a bad debt or loss, if any, on the ground that it was not definitely determinable in 1930.

While there is no stipulation as to the method employed by the petitioner in keeping its books of account, the proceeding has been presented on the assumption that such books were kept on an accrual basis and on brief the respondent states:

It will not be questioned that petitioner kept its accounts and rendered its return for the taxable year on the accrual basis. And it must be assumed that that method reflected the true income of this taxpayer.

The respondent, however, contends that the rentals in the amount of $5,208.35 were properly accrued on petitioner’s books of account and reported as income in 1930.

It has been held that an “accrual of income takes place when all events have occurred which fix the amount of income and determine that it is to be received by the taxpayer.” Leo M. Klein, 20 B. T. A. 1057, 1060. It has also been held that a “taxpayer on the accrual basis can not be charged with income if there exists good reason for believing that the income can not be collected”, American Fork & Hoe Co., 33 B. T. A. 1139, 1149, and that “to accrue payment which probably never will be received would distort income.” Emanuel Solomon Ullmann, 30 B. T. A. 764, 768; affd., in Commissioner v. Ullmann, 77 Fed. (2d) 827; certiorari denied, 296 U. S. 631. In Commissioner v. R. J. Darnell, Inc., 60 Fed. (2d) 82, the court stated:

* * * if income has neither actually been received during the taxable year, nor the right to its receipt been definitely fixed during the year, as to both the existence of an obligation on the part of the payor and the amount to be paid, such income is properly to be allocated only to that year in which it was in fact received or in which the right to receipt became fixed and liquidated.

It appears from the answer of the lessee filed May 8, 1930, that it considered itself relieved from the payment of rentals after August 1928 under the lease on the ground that the petitioner had terminated the lease; that it, the lessee, during March and April 1928, had disposed of its physical properties, consisting of all of its stock in trade and fixtures, by sale thereof; that most of the cash received therefor had been expended; that it had decreased its capital stock from $25,000 to $5,000 and declared a dividend of all the surplus remaining; that it discontinued business and thereafter engaged in no activities except the collection of some balances due upon so-called leases for the sale of pianos. From such allegations it appears that the lessee questioned the right of the petitioner to any further rental after August 1928 under the lease; that it would not, and did not, intend to pay any further rentals unless compelled to do so, and in fact pursued a course of action which practically made it impossible for it to pay the rentals provided for in the lease. Furthermore, in March 1930 a judgment against the petitioner and in favor of the lessee was rendered in the first action commenced by the petitioner in 1928. Although the petitioner had commenced another action, there was no certainty that the result therein would be more favorable to the petitioner than the result in the first action had been.

It was alleged in the answer of the lessee filed in the equity suit that the petitioner in connection with its first action at law against the lessee garnisheed not only the “assets” of the lessee but also the “assets” of the individual stockholders so far as they represented dividends paid to them by the lessee. Assuming this allegation to be true, the garnishment of such assets did not constitute a constructive receipt of such assets by the petitioner. Such garnisheed assets were not subject to its disposition. Its right to such assets, or any part thereof, was contingent upon the determination of the court, and the court’s determination was unfavorable to the petitioner. This action was dismissed in 1930 and presumably the garnisheed assets thereunder were also released. The petitioner at no time received, actually or constructively, earnings or income “under a claim of right and without" restriction as to their disposition.” North American Oil Consolidated v. Burnet, 286 U. S. 417. In that case, as in this proceeding, the right to receive certain income was in question. In that case the Supreme Court stated:

* * * The net profits were not taxable to the company as income of 1916. For the company was not required in 1916 to report as income an amount which it might never receive. [Citing cases.] There was no constructive receipt of the profits by the company in that year, because at no time during the year was there a right in the company to demand that the receiver pay over the money. Throughout 1916 it was uncertain who would be declared entitled to the profits. It was not until 1917, .when the District Court entered a final decree vacating the receivership and dismissing the bill, that the company became entitled to receive the money. Nor is it material, for the purposes of this case, whether the company’s return was filed on the cash receipts and disbursements basis, or on the accrual basis. In neither event was it taxable in 1916 on account of income which it had not yet received and which it might never receive.

The case of Brooklyn Union Gas Co., 22 B. T. A. 507; affd., in Commissioner v. Brooklyn Union Gas Co., 62 Fed. (2d) 505, cited by respondent, is distinguishable in that therein the taxpayer had the right to receive and could demand payment to it of the earnings there involved without restriction as to its disposition.

We, therefore, conclude that the item of $5,208.85 was not properly acoruable as income in 1930 and hence not returnable as taxable income for that year.

Decision will be entered under Rule 50.


author: HaeRon:

text:
    Howard Ewart, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 78336.
    Promulgated March 18, 1937.

      John L. McMaster, Esq., for the petitioner.

      George D. Brabson, Esq., for the respondent.
   OPINION.

HaeRon:

The issue in this proceeding involves determining the relationship of the petitioner to 10 municipalities in New Jersey from which he received compensation in 1932 for services rendered in that year and prior years. Petitioner claims that he was an officer of each municipality. It is not entirely clear whether petitioner also rests his claim on the contention that he was an employee, but consideration will be given to this possibility. There is also some reliance upon the argument that to tax this petitioner’s income from various municipalities will result in imposing a burden upon local governments of the state contrary to the constitutional immunity of the instrumentalities of state government from Federal taxation. Respondent concedes that the services performed by the petitioner for the municipalities were in the exercise of essential governmental functions, but contends that petitioner was an independent contractor.

Petitioner was appointed township and borough attorney for 10 municipalities for one-year periods, excepting in one instance where be was appointed for four years. In this latter instance, because of the presence of other factors, this appointment for a longer period does not serve to distinguish it from any of the others. Examination of the provisions of the pertinent statutes of New Jersey which govern the townships and boroughs involved shows that these municipalities were authorized under permissive statutory provisions to employ or appoint attorneys and the language of these provisions provides in terms for the “appointive office” of township or borough attorney. It is evident in the statutes that, if a local government elects to exercise its right to fill such appointive office, the appointive officer is required to execute and file an oath of office. Failure to file an oath of office under the provisions of the statute results in the office becoming vacant. C. S. of N. J., vol. 4, p. 5572, secs. 5, 7, and 8; C. S. of N. J., vol. 1, p. 231, sec. 8. These statutes do not prescribe the duties of the township or borough attorney, nor do they fix the salary or compensation to be paid, but leave these matters for the action of the municipal government concerned. There is no evidence before us that the municipalities involved here defined the duties of the office which petitioner claims to have occupied, and upon the evidence it is clear that compensation was not fixed either. From the above, it appears that petitioner’s appointment was authorized by statute, but it is not clear that the municipalities appointed petitioner to an office so as to make him an officer whose compensation would be exempt from Federal taxation under constitutional immunity.

The question of whether an individual is an officer of a state instrumentality of government is not answered by the fact that he was given a title of officer. It is necessary to consider the real relation of the individual to the government agency and the nature of his activities. Helvering v. Powers, 293 U. S. 214. It must also be kept in mind that issues such as the one before us here require consideration of whether the relation of the individual to an instrumentality of state government is plainly within the realm of a doctrine placing restrictions on the taxing powers of both State' and Federal Governments so as to protect the independence of these governments within their respective spheres under our constitutional system. In numerous appeals of this kind the petitioner has rested his claim that he was an officer of a political subdivision of a state upon the fact that he was retained to perform services under the title of an officer, or because there was some reference in pertinent statutes to the existence of an office which he claimed to occupy. Without referring to these cases at this time it is pointed out that in every instance the issue has been determined by resorting to facts showing claimant’s real relationship to the governmental agency involved and the nature of his duties.

It is inherent in the meaning of the term “officer” that the relationship must be official; that the duties must be prescribed by law and that the nature of the work is the execution of official duties. The requirement of an oath of office is primarily to execute a pledge that the individual will faithfully execute his duties as an officer. Usually the compensation is fixed and the duties are continuous and occupy a major portion of the individual’s time. The essential characteristics of a public office have been set forth in Metcalf & Eddy v. Mitchell, 269 U. S. 514, and they have been quoted so frequently that specific quotation will be omitted here. This petitioner does not meet the requirements of an officer so as to be exempt from Federal taxation within the requirements of Metcalf & Eddy v. Mitchell, supra, for the following reasons: His duties were not prescribed; he did not execute an oath of office; his compensation was not fixed; his services were intermittent rather than continuous; and the work for each municipality required a very small part of his time.

Petitioner was known to be experienced and competent in matters relating to the municipal laws of the State of New Jersey and his advice and services were very helpful to the municipal bodies governing these towns, for their membership was made up chiefly of townsmen unacquainted with the requirements of municipal law in relation to their official duties. Petitioner gave them general advice and when they referred matters to him they stated the general object which the municipality wished to achieve and petitioner applied his knowledge of municipal law in preparation of ordinances, resolutions, notes, bonds, and other instruments and gave his recommendations for their proper enactment or execution. He also took care of litigation referred to him; in one instance a single tax foreclosure proceeding for which he was paid over $2,000, the largest payment from any municipality. The relationship of attorney and client clearly appears in this instance.

With respect to compensation, petitioner testified in this proceeding that he was never appointed attorney for a borough or township without a verbal understanding in advance with an official of the local government as to what retainer he would require and the rate of fees generally that he would charge for his services. After such understanding was arrived at by conference with an official, the local governing body then appointed him attorney in accordance with such understanding. Petitioner maintained his own law office and performed all the work for these municipalities from his office and during the period of all of his services for these municipalities he carried on concurrently a private law practice which occupied 80 percent of his time. He submitted bills to the municipalities setting forth his fees for various services and these charges, which he fixed himself, were paid without question.

Further, it is not consistent with the essential meaning of the term “officer” that one person can be an officer of a number of local governments. The weight of the argument that an individual.is an officer of a local government diminishes in proportion to the number of municipalities, served, under such facts as are present here. It is difficult to believe that the question of removal from “office” could ever arise under the state of facts surrounding petitioner’s various engagements. In the most extreme case the worst that could happen would be that no matters would be referred to petitioner from the municipality. It has been noted that two of the boroughs involved, having a commission form of government, are not governed by the statutes referring to the borough attorney as an officer, so that petitioner’s claim'to be an officer in these two instances has even less weight than in the others. It has also been noted that in the case of Hayter v. Benner, 67 N. J. L. 359; 52 Atl. 351, it was held that in quo warranto proceedings one who had not taken an oath of office had no title to the office. The fact that petitioner did not take an oath of office under any of his appointments is considered as indicative of the lack of an official relationship. The primary consideration, however, is whether there are any official duties to make the taking of an oath a significant act.

Under all these circumstances we find that petitioner’s relationship to the municipalities was that of attorney and client and that there was no real official relationship except in name.

Petitioner has advanced the argument that his work was in the exercise of essential governmental functions of the municipalities he served and that to tax his compensation would impose a burden upon these municipalities in exercising their sovereign rights and duties. In an appeal to justice, it has been argued that a seashore hamlet is as much entitled to protection from such burdens as a large city. This argument begs the question for it assumes that denial of the claimed exemption to this petitioner would result in denying the constitutional immunity to officers of small municipalities. Holding as we do that petitioner was not an officer of the various municipalities, the argument has no bearing on determination of the issue here. We are not convinced by anything in the record, or by anything of which we can take judicial notice, that the imposition of the Federal income tax on this petitioner’s compensation from the various municipalities would impair in any substantial manner the petitioner’s ability to discharge his obligations to any political subdivisions or their ability to procure legal services or to exercise their sovereign functions.

It has already been indicated that we are not convinced that these municipalities filled the “office” of a township attorney or that the relationship was official. .Giving further consideration to the nature of petitioner’s work for the municipalities, we have reviewed several court decisions where it was held that because the plaintiffs had performed services to local governmental agencies in the exercise of governmental functions they were in effect instrumentalities of local government and their compensation was immune under the constitutional protection. See Blair v. Mathews, 29 Fed. (2d) 892; Howard v. Commissioner, 29 Fed. (2d) 895; United States v. Butler, 49 Fed. (2d) 52. However, the Supreme Court, in Commissioner v. Howard, 280 U. S. 526, reversed the decision of the Circuit Court in Howard v. Commissioner, supra, which relied on Blair v. Mathews, supra. It is noted that the Circuit Court in United States v. Butler followed Blair v. Mathews. Whether these decisions are authority to sustain petitioner’s claim is doubtful. The Supreme Court in the decision of Commissioner v. Reed, 281 U. S. 699, reversing Reed v. Commissioner, 34 Fed. (2d) 263, has indicated that the services of attorneys for states and political subdivisions thereof are not so directly linked with the exercise of sovereign functions, even though aiding in the execution of them, as to impose an unconstitutional burden upon these governmental agencies in denying the tax exemption claimed by such attorneys. See Devlin v. Commissioner, 82 Fed. (2d) 731, and cases cited therein. Petitioner relies strongly on the decision of Halsey v. Helvering, 75 Fed. (2d) 234. The Court of Appeals for the District of Columbia in that decision was not primarily concerned with determining whether Halsey was an officer of a municipality, but, on the facts in that case, concluded that his work was in the exercise of official duties and passed,to the consideration of whether his work was in the exercise of essential governmental functions. This decision does not set forth any rule to follow in determining whether or not an individual is an officer of a municipality and in our opinion does not constitute sufficient authority to sustain petitioner’s contention in this proceeding. The decision in the Halsey case serves chiefly to distinguish the decision of Helvering v. Powers, 293 U. S. 214. In our opinion the decision in Halsey v. Helvering, supra, does not aid the petitioner.

Decisions of this Board and of the courts which have denied immunity from Federal taxation to those claiming to be officers or employees of political subdivisions of a state are too numerous to summarize, but the following are referred to as authority for our conclusion here that petitioner is not immune from taxation: F. A. Pease, 30 B. T. A. 17; affd., 83 Fed. (2d) 122; George H. Gabel, 25 B. T. A. 60; Richard F. Burges, 25 B. T. A. 1191; affd., 69 Fed. (2d) 609; Walter G. Winne, 27 B. T. A. 369; Register v. Commissioner, 69 Fed. (2d) 607; Childers v. Commissioner, 80 Fed. (2d) 27; Haight v. Commissioner, 52 Fed. (2d) 779; Milo R. Maltbie, 31 B. T. A. 614; Harry D. Kremer, 31 B. T. A. 566; Consoer, Older & Quinlan, Inc. v. Commissioner, 85 Fed. (2d) 461; Melvin L. Griffith, 31 B. T. A. 1029; E. A. Simpson, 28 B. T. A. 556. In most of the above cases the petitioners were lawyers and performed legal services for one or several municipalities or political subdivisions of states and claimed to be officers or employees. They were held to be independent contractors under facts in many instances similar to the facts before us here.

Exemption has been granted to attorneys claiming to be officers or employees of a state or political subdivision thereof in the following decisions, under circumstances showing that the petitioner met the requirements of an officer as set forth in Metcalf & Eddy v. Mitchell, supra. The duties of the officer were prescribed by law and the compensation was fixed. Rosalie C. Rand, Executrix, 27 B. T. A. 182; Commissioner v. Coughlin, 87 Fed. (2d) 670; George H. Harlan, 30 B. T. A. 804; affd., 80 Fed. (2d) 660.

Petitioner makes some claim to being an employee of the various municipalities, in the alternative. We are unable to sustain this contention for the record does not disclose facts to show the necessary continuity of service and control over his work by the governing bodies of the municipalities so as to bring petitioner within the status of an employee, as set forth in Metcalf & Eddy v. Mitchell, supra; Louisville Railroad Co. v. Wilson, 138 U. S. 501. See Milo R. Maltbie, supra; Donald Francis Campbell, 33 B. T. A. 101, and cases cited therein; Register v. Commissioner, supra; George H. Gabel, supra; Richard F. Burges, supra; Blair v. Byers, 35 Fed. (2d) 326. Cf. Susan H. Mathews, Executrix, 32 B. T. A. 682; and Commissioner v. Coughlin, supra.

It is held that the petitioner was not an officer of the 10 municipalities of New Jersey, but that he was an independent contractor under circumstances which show that the relationship of attorney and client existed.

Judgment will be entered for the respondent.


author: Hill :

text:
    Harry E. Wiese, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 77690.
    Promulgated March 19, 1937.

      H. Kennedy McCook, Esq., for the petitioner.

      B. H. Neblett, Esq., for the respondent.
   OPINION.

Hill :

The issue presented for decision in this case is whether the withdrawals by petitioner of funds from the printing company, of which he was the sole stockholder, in the years prior to 1932, constituted dividends taxable to him as income for the respective years in which withdrawn, as contended by petitioner, or whether there was a dividend taxable to petitioner in the year 1932 in the aggregate amount of such withdrawals, as contended by the respondent.

Section 115 (a) of the Revenue Act of 1932 defines the term “dividend” as meaning any distribution made by a corporation to its shareholders, whether in money or other property, out of its earnings or profits accumulated after February 28, 1913.

It is agreed by the parties that the printing company at all times had accumulated earnings or profits in excess of petitioner’s withdrawals.

The issue here presents primarily a question of fact. It is obvious that a withdrawal by a stockholder of funds of a corporation does not necessarily constitute a distribution of profits, even if the corporation has an accumulation of profits in excess of the withdrawal; and such withdrawal may or may not, in the light of that fact alone, be said to be a dividend. A corporation may lend its funds, including earnings, with or without interest, on open account or upon notes, secured or unsecured; and such privilege is not restricted to the lending of its funds to persons other than stockholders. Therefore, whether the withdrawals of corporate funds by petitioner, here in controversy, constituted loans or dividends in the years when withdrawn must be determined from the facts in the record before us; and the record, we think, clearly identifies the withdrawals as being loans prior to December 1932.

Petitioner points to the fact that he paid no interest on the amounts withdrawn, nor was any charged, and that he executed no notes or other evidences of indebtedness to the corporation. But these facts are not necessarily controlling. The withdrawals may still have been bona fide loans.

The amounts withdrawn each year were charged against petitioner’s account on the books of the corporation, and were concurrently treated as loans both by the corporation and by petitioner. This is evidenced on the part of petitioner by the fact that in his original individual returns he did not report the amounts as dividends. If they were in reality dividends, and petitioner had no intention of repaying the amounts to the corporation, then, this fact necessarily being known to petitioner, the premises compel the conclusion that he fraudulently understated his taxable income. However, fraud is not lightly to be imputed, nor such presumption indulged except as the result of clear and convincing proof. Henry S. Kerbaugh, 29 B. T. A. 1014; affd., 74 Fed. (2d) 749. In the absence of proof, we can not assume that the withdrawals were at the time intended to be distributions of profits, and not loans.

Also, the uncontradicted evidence affirmatively shows that the corporation consistently treated the withdrawals as loans on its books up to December 1932. In the balance sheets of the corporation attached to its original returns for each of the years from 1925 to 1931, inclusive, petitioner’s withdrawals were included as accounts receivable and shown as an asset. This was wholly inconsistent with the idea that the withdrawals were dividends in the respective years.

As of December 31, 1932', petitioner’s account on the corporation’s books was credited with the full amount of the total withdrawals and a new account opened with a corresponding debit. The new account was entitled “Withdrawals of Profits not Formally Authorized in the Minutes of the Company.” Thereafter, the amount of the withdrawals was no longer carried as an asset, and, in the balance sheets of the corporation attached to its original return for 1932, the amount was not included in accounts receivable.

Petitioner argues on brief that by the entries referred to the debit balance of his account was not charged ofi the books, but we think the record does not support this contention. Not only did the balance of petitioner’s account disappear as an asset of the corporation because of the credit to his account, but the amount in effect was charged against surplus. It is apparent that the new account, which recorded the unauthorized withdrawals removed from petitioner’s personal account, was in effect merely a subdivision of the surplus account. True surplus could not be determined except by transferring the debit balance of that account into the surplus account.

By the action taken by the corporation in December 1932, petitioner for the first time acquired the unrestricted ownership of the withdrawn funds in his individual capacity. As the result of that action, the aggregate amount became a dividend, and petitioner was released from liability to repay. The effect was precisely the same as if the corporation had formally declared a dividend in that amount and credited the same to petitioner’s account. Theretofore, if the corporation had become insolvent, creditors might have required petitioner to pay into the corporation the amount shown as owing to it on his account; or, if by reason of a new venture or an expansion of business, the corporation needed additional funds, which were furnished by petitioner and credited on his account, it would not have constituted a contribution of capital but a payment of his indebtedness to the corporation.

Respondent has determined that the withdrawals in controversy constituted loans in the years in. which withdrawn and that by the corporate action taken in 1932, with the consent of petitioner, a dividend in the total amount of the loans was credited to petitioner in discharge of the loans, and that such dividend was taxable in the year 1932. The evidence is insufficient, we think, to establish that respondent’s determination is erroneous.

We had before us a similar situation in Moses Cohen, 28 B. T. A. 190; affd., 77 Fed. (2d) 184; certiorari denied, 296 U. S. 610. That case involved debit balances as of December 31, 1924, standing on the books of a corporation of which the petitioners were stockholders, and representing withdrawals previously made by them. We held the amounts to be income to the petitioners not when the withdrawals were made, but in 1928, when, by appropriate corporate action, the balances were canceled and charged against surplus. To the same effect see Fred T. Wood, 27 B. T. A. 162; and compare J. O. W. Gravely, 29 B. T. A. 29.

The conclusion reached renders it unnecessary to consider respondent’s plea of estoppel.

Judgment will be entered for the respondent.