author: Hill:

text:
    Reynard Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 78835.
    Promulgated March 29, 1938.

      E. V. McKeown, Esq., and Franh J. Albus, Esq., for the petitioner.

      J. R. Johnston, Esq., for the respondent.
   OPINION.

Hill:

The petitioner concedes its liability as a transferee of the assets of Reynard for any additional tax found to be due and there is, therefore, no controversy between the parties on that point.

In its petition as amended petitioner alleges that respondent erred in determining that the $3,000 rental value of the dwelling occupied by Fox during the fiscal year, ended March 31, 1932, as compensation for his services, in addition to his salary, was not deductible as a corporate expense for the reason that there was no evidence as to whether such additional compensation was reasonable. The facts show that, while the respondent went through the formality of eliminating the $3,000 rental value of the residence from income and of disallowing the deduction of the amount thereof, Reynard’s net income as reported in its return wherein the $3,000 was included in income as rent and was deducted as salary, remained unchanged.

If Reynard had rented the dwelling to Fox and had received $3,000 cash therefor during the taxable year there would be no question but that the amount would be includable in income as rent. If during the taxable year Reynard had paid the $3,000 to Fox as a part of reasonable compensation for his services there would be no question but that such payment would constitute a deductible expenditure. The net effect of the two items would be to offset each other, and Reynard’s net income apart from them in no wise would be affected. Instead of making cash payments to each other, Reynard gave Fox the use of the house for services and Fox rendered to Reynard the required services for the use of the house. Since Reynard reported in its income $3,000 as rent and as it deducted $3,000 as the payment for services, the two amounts offset each other and Reynard’s taxable net income was neither increased nor diminished by the way the items were reported in the return. Since respondent’s determination in effect has made no change in the two items as reported by Reynard. no injury bas resulted to Eeynard. The only theory upon which it can be held that Eeynard paid the $3,000 to Fox is that it offset that amount against a like amount owed to it by Fox for house rent. Under this theory the rental value of the house was income to petitioner and, if the deduction claimed is to be allowed, such income must be accounted for in determining its correct tax liability. To allow Eeynard a deduction of the $3,000 on any other theory would be allowing a deduction for an amount which it neither paid nor was obligated to pay. Therefore, since Eeynard is not charged for tax purposes with income from house rent it is not entitled to deduct the amount thereof as compensation paid to Fox.

Petitioner contends that our decision at 30 B. T. A. 451, which involved Eeynard’s tax liability for the fiscal years ended March 31, 1930 and 1931, is authority for the proposition that if it be shown that the $3,000 plus the $30,000 paid in cash constituted reasonable compensation for Fox’s services, then it is an allowable deduction. Petitioner also urges that our decision there renders the question res judicata. For the fiscal years 1930 and 1931 Eeynard reported no amount as income with respect to the rental value of the dwelling, nor did it deduct any amount with respect thereto as compensation paid Fox. In determining the deficiencies for those years respondent included in Eeynard’s income $3,000 for the fiscal year 1930 and $7,400 for the fiscal year 1931 as representing the rental value of the residence, but made no change in the deduction taken in each of the years as compensation paid Fox, namely, $30,000. In appealing to this Board Eeynard assigned errors as to respondent’s action in including the $3,000 and the $7,400 in its income for the respective years, but assigned no error as to the respondent’s failure to increase the deductions of $30,000 for compensation paid Fox by the amounts included in income as rental because of Fox’s occupancy of the dwelling. The only other error assigned to respondent’s determinations for those years was as to his disallowance of a deduction in the fiscal year 1930 of $2,588.85 for depreciation because of Fox’s occupancy of the residence. From the foregoing it is clear that the issues involved in the proceeding for the prior years are entirely different from that involved here. There we held that the amounts included in income by respondent on account of Fox’s occupancy of the dwelling did not constitute income to Eeynard and that Eeynard was entitled to the deduction taken for depreciation. Although not an issue in the proceeding, we discussed the question, as to whether Eeynard was entitled to deduct $3,000, the rental value of the dwelling, from income. We concluded that it was not, giving only as our reason therefor a lack of evidence to show that the amount plus the cash payment of $30,000 constituted reasonable compensation for Fox’s services. While the reason given tor our conclusion was sufficient under the circumstances, we -could have consistently given as an added reason therefor that, since the basis of Reynard’s claim of deduction was that it had paid Fox $3,000 as additional compensation by providing for his use a dwelling of a rental value of $3,000, such basis disappeared upon the elimination of the item of rental from Reynard’s income in determining its tax liability. If that item of rental was not income to Reynard in the form of an obligation owed to it, there was nothing against which to offset the $3,000 of claimed added compensation to Fox and Reynard did not pay such compensation either actually or constructively and hence was entitled to no deduction therefor.

The points or questions tried and adjudicated in the former proceeding involved taxable years prior to that involved here and grew out of respondent’s treatment of certain amounts as income, while the point or question in the present proceeding involves the allowance of a deduction. There was a sufficient difference between the issues involved in the two proceedings to prevent our decision in the prior proceeding from being res judicata of the question involved here. Cf. Volunteer State Life Insurance Co., 35 B. T. A. 491, and cases there cited.

The respondent determined that Reynard was subject to tax under the provisions of section 104 of the Revenue Acts of 1928 and 1932. His determination is contested by petitioner. The pertinent statutory provisions are as follows:

SEC. 104. accumulatioN op surplus to evade surtaxes.
(a) If any corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there shall be levied, collected, and paid for each taxable year upon the net income of such corporation a tax equal to 50 per centum of the amount thereof, which shall be in addition to the tax imposed by section 13 * * *.
(b) The fact that any corporation is a mere holding or investment company, or that the gains or profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax.

See section 104 of the Revenue Acts of 1928 and 1932.

The general purpose and scope of the foregoing provisions have been considered in prior decisions and it is not necessary to restate them here. See Rands, Inc., 34 B. T. A. 1094. Whether a corporation was organized or availed of for the purpose interdicted by the statute is a- question of fact. Commissioner v. deMille Productions, Inc., 90 Fed. (2d) 12; certiorari denied, 302 U. S. 713; Almours Securities, Inc. v. Commissioner, 91 Fed. (2d) 427. The respondent’s determination is presumed to be correct and must be sustained unless the evidence shows otherwise. Nipoch Corporation, 36 B. T. A. 662.

Petitioner takes the position that Reynard was neither formed nor availed of for the interdicted purpose. Respondent’s position is that it was both organized and availed of for that purpose. Fon-taine Fox, who caused Reynard to be organized, stated that in forming it he thought its formation would facilitate the execution of certain contemplated business ventures, including some real estate ventures, that by the corporation owning the real estate the necessity of his wife’s signature in case of sales of the property would be unnecessary; that it would facilitate the distribution by will to his children of his property and in event of his death would permit more readily the uninterrupted continuation of the publication of his creations. A corporation organized for the foregoing objects alone would not fall within the interdicted purpose, but the fact that it was organized for such objects is not incompatible with the purpose to prevent the imposition of surtax on its stockholders. Fox categorically stated that in forming Reynard he did not have in mind preventing the imposition of surtax upon his personal income. Such testimony, however, is not to be accepted as conclusive, especially when there is other evidence inconsistent with it. Rands, Inc., supra.

By 1923 Fox was receiving from the syndication of his cartoons $1,500 or $2,500 a week, or from $78,000 to $104,000 a year. At the time of the formation of Reynard in 1924 he knew that he personally could get a three-year contract with the Bell Syndicate that would pay him a guaranteed minimum of $1,500 a week, or $78,000 a year, for the use of his creations for syndication purposes. There was no requirement by the syndicate that a corporation be formed. Nor was there any requirement that it have substance and financial responsibility, as in Fisher & Fisher, Inc., 32 B. T. A. 211. Instead of entering into the contract personally, Fox, after transferring the greater portion of his property to Reynard for all of its capital stock, entered into a contract with Reynard at a salary of $2,500 a month, or $30,000 a year, to furnish the creations that would be required by the syndicate and then on the same day caused Reynard to enter into a three-year contract with the syndicate for the guaranteed minimum of $1,500 a week for the use of the creations. By this action Fox diverted to Reynard for the next three years at least $48,000 a year of the proceeds resulting from his services. This diverted amount was increased to about $70,000 annually in years subsequent to 1927, when the minimum amount paid by the syndicate was increased to $104,000 a year without there being an increase in the salary of $30,000 a year paid to Fox. Neither Fox nor petitioner explained why it was necessary for such substantial portions of the proceeds from Fox’s services to be diverted to Reynard from its very inception in order to effect the objects Fox stated he had in mind when he caused Beynard to be formed. The situation here is similar to that in Edward Cf. Swartz, Inc,, 33 B. T. A. 355. There Swartz, the owner of a contract under which it was expected he thereafter would receive payments totaling about $500,000 over a period of about four years, organized a corporation and transferred to it the contract, along with certain other assets, in payment for its entire capital stock. The principal business of the corporation thereafter was to receive the payments under the contract. That corporation was held to have been availed of for the interdicted purpose.

Bespecting Fox’s statement that he thought Beynard’s formation would facilitate the execution of certain real estate ventures, only one transaction of this nature was entered into by Beynard down to March 31, 1932. It was entered into for the purpose of providing a dwelling, studio, and garage for the use of Fox, the dwelling being for his exclusive personal use. Such other real estate transactions as were entered into during this period were by Fox in Florida on his own personal account and ip them he used a substantial portion of the only dividend paid by Beynard during the period. In 1934 Beynard purchased 15 acres of suburban land but there is nothing to indicate where the land was situated or what the purchase price was. It may well be that only a nominal sum was involved.

Beynard invested to a considerable extent in policies of insurance on the life of Fox. While he stated that he thought that the policies were payable, to Beynard, he added that it was his expectation that his two children would get the benefit of them.

Aside from its connection with the Short Film Syndicate, which was dissolved in 1928, Fox stated that Beynard’s purchases of stocks and bonds were for the purpose of holding its surplus funds in the form of securities and not. for the purpose of having resources on hand in case it was, decided that Beynard should enter into some other business nr venture.

Considering the circumstances surrounding the formation of Beynard, the source of its income, and the manner in which its income was handled, we think that, it was formed for the purpose of preventing the imposition of surtax on the greater portion of the proceeds, from Fox’s personal services and on the income arising from property transferred by him to it and on the income arising from the investment of such proceeds and income, Beynard’s having been formed for such purpose is alone sufficient to sustain respondent’s determination. Saenger, Inc. v. Commissioner, 84 Fed. (2d) 23, affirming 33 B. T. A. 135; Rands, Inc., supra.

In the event we, are, in error as to our conclusion that Beynard was formed for the interdicted purpose, we will consider whether it was availed of during tbe year in controversy for that purpose. Under the revenue acts, if a corporation is a mere holding or investment company or if its gains or profits are permitted to accumulate beyond the reasonable needs of its business, either of such facts constitutes prima facie evidence of a purpose to escape surtax.

Considering the character of the property turned over to Eeynard by Fox and the proportion it constituted of that owned by him, together with the nature and source of Eeynard’s earnings and the manner in which they have been invested and were invested on March 31, 1932, we think Eeynard was a mere holding or investment company and that such limited activities as it engaged in were only incidental to its main purpose as such a company. Cf. R. & L., Inc., 33 B. T. A. 857; affd., 84 Fed. (2d) 71; certiorari denied, 299 U. S. 588.

Conceding for the sake of discussion that Eeynard was not a mere holding company, were its profits or gains permitted to accumulate beyond the reasonable needs of its business? In attempting to justify the failure to make a distribution of gains and profits during the year in controversy, Fox stated that the directors considered it necessary for Eeynard to conserve its surplus to provide for the syndication of his creations in event the Bell Syndicate went out of business or declined to renew the contract at its expiration, which would require an investment of about $75,000; to provide funds for Eeynard engaging in the production of sound films featuring animated cartoons created by him, which would require about $100,000; to provide funds for Eeynard’s entry into the real estate field, which the directors were contemplating doing; and to provide funds for the expansion of Eeynard’s transactions in securities.

We recognize that the statute contemplates that any business shall have the right to grow, William C. DeMille Productions, Inc., 30 B. T. A. 826; petition for review dismissed, 80 Fed. (2d) 1010; R. cfi L., Ino., supra; and also that it contemplates that a corporation may provide for contingencies. Cecil B. DeMille, 31 B. T. A. 1161; affd., 90 Fed. (2d) 12; certiorari denied, 302 U. S. 713. The reasons advanced by Fox for Eeynard’s failure to make a distribution of profits during the year in controversy are lacking in persuasiveness. On March 31, 1932, Eeynard’s contract with the Bell Syndicate had two years to run. There is nothing in the record to indicate that the syndicate was contemplating going out of business or that there was any expectation that the contract would not be renewed at its expiration, as had been done in prior years. Further, the record shows that it was not until in 1937 that a renewal was not made on a term basis as before. Then, however, steps were not taken to syndicate Fox’s creations, but a temporary working arrangement was entered into by the petitioner and the syndicate pending negotiations looking toward a contract for a term of years. Down to March 31, 1932, there do not appear to have been any disputes or friction between Reynard and the syndicate respecting the continuation of the contractual relationship between them and the record is bare of any fact existing on that date to cause Reynard’s directors to be apprehensive as to the future of such relationship.

From 1924 films of Fox’s creations had been made by a picture corporation under a royalty contract with Fox. On April 1,1932, he assigned this contract to Reynard. So far as we know there has never been any change in this arrangement or in the desirability of its continuation. No action was ever taken by Reynard or petitioner looking toward their production of films of Fox’s creations except the organization of the Short Film Syndicate, which was abandoned in 1928 after a short life during which none of his creations were used.

While Reynard’s security transactions were somewhat more numerous in the years following March 31,1922, however, so far as the record shows they were made primarily for the purpose of holding the surplus funds in the form of securities, as was done in prior years. Aside from the purchase of land by Reynard in 1926 for the purpose of providing a residence and studio for Fox, the only other purchase was in 1934 of suburban land which has been considered heretofore.

Petitioner argues that since on March 31, 1932, Reynard was indebted to Fox on open account for a substantial amount and had been indebted to him in substantial amounts in prior years, this is an indication that Reynard was not availed of for the interdicted purpose. Where one who is substantially the sole stockholder of a corporation transfers to it large amounts of his personal funds each year as loans without interest and the corporation, for no business reason, continues to accumulate its profits without distributing them, the stockholder is availing himself of the corporation to prevent the imposition of surtax on the income that would have arisen to him if he had employed the amounts in normal use or investment. Bands, Inc., supra. We think that principle is applicable to the situation here.

Considering all the evidence bearing on the point, we are of the opinion that there was no reasonable business need justifying Rey-nard in retaining its gains or profits instead of distributing them during the year in controversy, and that it was availed of for the purpose of preventing the imposition of surtax on Fox.

Reviewed by the Board.

Decision will he entered for the respondent.


source: Caselaw Access Project

author: T-Ttt.t, :

license: Public Domain

text:
    F. E. Waddell, R. T. Waddell, and B. B. Stone, Independent Executors of the Estate of W. N. Waddell, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 87405.
    Promulgated March 29, 1938.

      George 8. Atkinson, Esq., for the petitioners.

      Frank M. Thompson, Jr., Esq., and R. B. Gannon, Esq., for the respondent.
   OPINION.

T-Ttt.t, :

The first and principal issue in this case is whether or not the death of W. N. Waddell, who was a member of the partnership of W. N. Waddell & Co., which partnership owned two installment notes at the date of his death, caused a disposition otherwise than by sale or exchange of such obligations, or any interest therein, within the purview of section 44 (d) of the Revenue Act of 1932, resulting in taxable income to decedent or to his estate, no bond having been filed under the provisions of the statute.

For a discussion of the constitutionality and application of section 44 (d), see Crane v. Helvering, 76 Fed. (2d) 99, affirming 30 B. T. A. 29; Nuckolls v. United States, 76 Fed. (2d) 357; Provident Trust Co. of Philadelphia v. Commissioner, 76 Fed. (2d) 810, affirming 29 B. T. A. 374; Moore v. United States (Ct. Cls.), 10 Fed. Supp. 143.

There is no suggestion in the record before us that the installment notes referred to were not worth face value when received by the partnership, nor that the unpaid notes were worth less than face value at the date of decedent’s death. There is affirmative evidence that the notes bore interest, and after decedent’s death they were paid in full. We have accordingly found as a fact that at both dates mentioned the notes were worth face value. Also, there is no suggestion that the installment obligations had any cost basis and the face value, therefore, represented realized gain to the partnership. The distributive share therein of the decedent has been stipulated by the parties. The sole question presented is whether or not the death of decedent caused a disposition of such installment obligations otherwise than by sale or exchange, within the meaning of the statute, resulting in taxable income to decedent. This question, we think, in the light of circumstances shown, must be answered in the affirmative.

These installment obligations, when received, constituted gain then and there realized by the partnership to the extent of their face value, and the full amount thereof would have been includable in the partnership’s gross income for the year of receipt, except for the fact that the statute permits the installment plan of reporting the income for taxation. The provisions of the statute created a privilege which a taxpayer at his election may exercise by reporting for taxation the realized gain when the installment obligations are paid, subject however to the condition imposed by the statute that in the case of a disposition otherwise than by sale or exchange, gain or loss shall result to the extent of the difference between the basis of the obligation and its fair market value at the time of such disposition. Nuckolls v. United States, supra; Lawler v. Commissioner, 78 Fed. (2d) 567, affirming, on this point, 29 B. T. A. 227.

If the facts of the instant case bring it within the terms of the statute, the full amount of the installment obligations unpaid at the time of decedent’s death constituted gross income to the partnership. This brings us to a consideration of the specific question whether or not decedent’s death resulted in a disposition of such obligations, otherwise than by sale or exchange, under circumstances creating income taxable to decedent.

Petitioners contend that at the time of his death decedent did not own the installment obligations, and hence they were not transmitted as a result of his death; that the notes were the property of the partnership, which insulated decedent against taxation thereon; that all he owned was an undivided interest in the net worth of the partnership and he was entitled only to a distributive share of the net income after payment of its debts. Under this concept the income of a partnership loses its identity as of the particular kind or characteristic when received, and becomes merely ordinary income when distributable to the partners. Johnston v. Commissioner, 86 Fed. (2d) 732, affirming 34 B. T. A. 276. It is unnecessary, we think, to decide here whether the partnership technically was the owner of the installment obligations, or whether decedent owned directly an undivided two-thirds interest therein. In either event, the deficiency determined by respondent must he approved. If the partnership be regarded as the owner of the installment obligations, a distribution or disposition thereof by the partnership, otherwise than by sale or exchange, resulted from decedent’s death, so that the partnership derived recognizable gain equal to the face value of the notes, and decedent became taxable on two-thirds thereof as ordinary income. If decedent be regarded as owning directly a two-thirds interest in ■the installment obligations, his death effected a transmission thereof resulting in taxable gain of the same amount under section 44 (d).

For an extended discussion of the status of partnerships in relation to income taxation, see Edward B. Archbald, 27 B. T. A. 837; affd., 70 Fed. (2d) 720; certiorari denied, 293 U. S. 594; Johnston v. Commissioner, supra. It is sufficient for present purposes to point out that by the death of decedent the old partnership was automatically dissolved, and the surviving partners and the decedent’s estate immediately thereupon became entitled to their respective proportions of the net assets as liquidating distributions. This principle is so generally recognized that citation of authority seems unnecessary. It is also the law of Texas, as was recognized by the partnerships heie involved. Cf. Carroll v. Commissioner, 70 Fed. (2d) 806. Such is plainly indicated by the following facts; Instead of a formal distribution of the properties of the old partnership, a new partnership was formed by the surviving partners and the decedent’s estate, each contributing as partnership capital his interest in the predecessor partnership. The latter filed a return of income on form 1065 for the period January 1 to and including the date of decedent’s death on September 14,1982. The new partnership filed a return of income on form 1065 for the period September 15 to December 31, 1932, showing the date of its organization as September 15,1932. Separate accounts were set up for the new partnership, in which decedent’s estate was shown as a partner instead of decedent.

From these facts, we think it is clear that there was in substance and in fact a disposition, otherwise than by sale or exchange, of the installment notes owned by the old partnership, first to the surviving partners and decedent’s estate as liquidating distributions, and secondly there was such a disposition by them to the new partnership in the form of capital contributions according to their several undivided interests, all as a direct result of the death of decedent. But petitioners argue that nevertheless decedent derived no taxable income on account of the installment obligations in question because (1) the partnership was entitled to maintain its capital intact, (2) it was indebted to the bank in an amount in excess of the face value of the installment notes, and (3) the proceeds of the notes were paid on the indebtedness to the bank, and therefore neither decedent nor his estate ever became entitled to receive any distributive share of such proceeds.

In our opinion, petitioners’ contention on this point is unsupportable. Since decedent’s estate, at the time of his death and consequent dissolution of the old partnership, became entitled to his distributive portion of the gain represented by the installment obligations, petitioners can not escape tax thereon by reason of the fact that they elected to reinvest such amount in the new partnership. And the mere fact that the old partnership was indebted to the bank is not sufficient to show that such right to receive decedent’s distributive share did not exist, and there is no proof that if the installment obligations had been converted into cash, a distribution thereof to the several surviving partners and decedent’s .estate would have resulted in an impairment of the partnership capital. A partner is taxable directly upon his distributive share of the partnership net income, whether distributed or not.

The case at bar is distinguishable from Harold G. Ferguson, 34 B. T. A. 522, cited by petitioners. There we held that the transfer of beneficial interests in a trust, the corpus of which consisted of installment obligations, was not the equivalent of the disposition of installment obligations within the meaning of section 44 (d). Also, in Detroit Trust Co. et al., Executors, 34 B. T. A. 586, we held that installment, obligations which constituted the corpus of a trust were not transmitted by the death of the beneficiary, and that section 44 (d) did not operate to charge the decedent’s estate with taxable gain for the period prior to his death. Here there was an actual disposition of installment obligations themselves as a result of decedent’s death, not merely a transmission or disposition of a beneficial interest therein.

On the first issue, respondent’s determination is approved.

The second issue involves the 25 percent penalty determined by respondent for failure to make and file a return within the time required by law, as provided in section 291 of the Revenue Act of 1932. No return was filed by petitioners in the instant case, on the theory that there was no taxable income. But since we have found that there was taxable income, it follows that a return should have been filed. In these circumstances, the imposition of a penalty is mandatory. Paul L. Case, 37 B. T. A. 365, and authorities cited.

Reviewed by the Board.

Judgment will be entered for the respondent.

       SEC. 44. INSTALLMENT BASIS.
      *******
      (d) Gain oe Loss upon Disposition of Installment Obligations. — If an installment obligation is satisfied at other than its face value or distributed, transmitted, sold or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and (1) in the case of satisfaction at other than face value or a sale or exchange — the amount realized, or (2) in case of a distribution, transmission, or disposition otherwise than by sale or exchange — the fair market value of the obligation at the time of such distribution, transmission, or disposition. The basis of the obligation shall be the excess of the face value of the obligation over an amount equal to the income which would be returnable were the obligation satisfied in full. This subsection shall not apply to the transmission at death of installment obligations if there is filed with the Commissioner, at such time as he may by regulation prescribe, a bond in such amount and with such sureties as he may deem necessary, conditioned upon the return as income, by the person receiving any payment on such obligations, of the same proportion of such payment as would be returnable as income by the decedent if he had lived and had received such payment.


author: TTttu :

text:
    Howard Oots, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 84123.
    Promulgated March 29, 1938.

      Samuel M. Wilson, Esq., for the petitioner.

      Gonway N. Kitchen, Esq., for the respondent.
   OPINION.

TTttu :

The only issue in this case is whether the loss sustained by petitioner in 1933 from the sale of the property known as No. 218 North Broadway, Lexington, Kentucky, constitutes, an allowable deduction from gross income. Such loss is not allowable unless (1) it was incurred in trade or business, or (2) incurred in a transaction entered into for profit, though not connected with the trade or business. Sec. 23 (e) (1), (2), Eevenue Act of 1932. Concededly the loss in question was not incurred in connection with petitioner’s trade or business, but he contends that it was incurred in a transaction entered into for profit.

Petitioner purchased the Lexington property on October 16, 1928. At that time he and his wife were occupying a house on a tract of land, originally part of the Dixiana Farm, which he purchased and sold in the same year to one Fisher, who shortly thereafter demanded possession. Petitioner and his wife thereupon occupied the house in Lexington on November 20, and remained- there until December 28, when they went to Florida. From 1928 to 1933, when the property was finally sold, petitioner and his wife occupied the Lexington house approximately four months in each year, usually about two months in the spring and two months in the fall. A considerable portion at least of the balance of each year they spent in Florida, or elsewhere outside of the State of Kentucky.

Article 171 of respondent’s Regulations 77, issued under the Revenue Act of 1932, provides that a loss on the sale of residential property purchased or constructed by a taxpayer for use as a personal residence, and so used up to the time of sale, is not deductible; but where property so purchased or constructed is, prior to sale, rented or otherwise appropriated to income-producing purposes and is so used up to the time of sale, a loss from the sale is properly allowable. It will be noted that under this regulation property acquired by a taxpayer for use as a personal residence must not only be abandoned for such purpose but must be thereafter rented or otherwise appropriated to income-producing purposes and actually be so used up to the time of sale in order to render a loss thereon deductible.

Similar provisions were contained for the first time in Regulations 74 under the 1928 Revenue Act. Prior regulations provided that a loss on residential property could not be deducted unless the property was originally purchased or constructed “with a view to its subsequent sale for pecuniary profit.”

In Heiner v. Tindle, 276 U. S. 582, decided April 9,1928, the Court declined specifically to pass upon the correctness of the early regulations above referred to for the reason that the question was not before it, but the Court- did refuse to apply the principle embodied therein. In effect, the Court held that the provision of the regulations that a loss was not allowable unless the property was originally purchased or constructed with a view to its subsequent sale for a pecuniary profit was not in conformity with the statute, and further held that, where property so purchased or constructed was subsequently abandoned for that purpose and, was thereafter devoted to business uses in the production of taxable income until sold, a loss from the sale was properly allowable. Accordingly, the regulations under the 1928 Act were conformed to the doctrine enunciated in the Tindle case, and similar provisions have been continued in the regulations issued under the subsequent revenue' acts.

The principle appears now to be well settled that a loss from the sale of a residence is not an allowable deduction unless (1) the use of the property as a residence was abandoned, and (2) it was devoted exclusively to the production of taxable income from the time of abandonment until sold. Abandonment of a personal residence, followed by a listing of the property with the real estate agent for sale or rent, is not sufficient. In Morgan v. Commissioner (C. C. A., 5th Cir.), 76 Fed. (2d) 890; certiorari denied, 296 U. S. 601, the taxpayer built a home in 1913 in which he resided until 1927, when he removed to Florida. He placed the property in the hands of a real estate agent, “with instruction to diligently endeavor to rent the same in whole or in part or to sell it.” The property was not rented, with the exception of a garage, but it was sold in 1929 at a loss. In denying the right to deduct such loss, the court, after a discussion of Heiner v. Tindle, supra, said:

Tlie question here is whether the residence abandoned as such and put into the hands of an agent “to rent in whole or in part or to sell” is devoted exclusively to the production of taxable rentals, or whether indeed there is a transaction at all within the meaning of the statute. We think not. The owner did not remodel or recondition the house, or do anything that specially devoted it to rental purposes. He spoke only to his agent, which in legal effect is speaking to himself; and his instructions were as much to sell as to rent it and a sale was the actual outcome. * * * Here the taxpayer could have returned any day to his home or have sold it without hindrance. What he did does not amount to a transaction.

To the same effect see also Rumsey v. Commissioner (C. C. A., 2d Cir.), 82 Fed. (2d) 158; certiorari denied, 299 U. S. 552, and Fremont C. Peck, 34 B. T. A. 402, 405.

Petitioner contends most strenuously that the cited cases are not in point for the reason that the property in controversy was not acquired in the first instance as a personal residence; that his original purpose in purchasing the property was to sell it for a profit, and therefore it was a transaction entered into for profit; that he never used the property as a personal residence, but merely stayed in the house and occupied it temporarily from time to time. We are not impressed by this argument.

Petitioner’s intentions in the matter, we think, are best demonstrated by his actions. The undisputed evidence clearly shows that the property was never in fact converted to business property, or used for income-producing purposes; that the petitioner resided there with his wife for a substantial portion of each year from the time of purchase in 1928 until the property was finally sold in 1933. The fact that he intended to occupy the residence only temporarily, if such was the case, and did so from time to time as suited his convenience, is immaterial.

In R. C. Bayliss, 35 B. T. A. 1128, we denied the right of the taxpayer to deduct a loss on the sale of residential property, although it appeared that the purchase was originally made with the intention of using or disposing of it as in a transaction entered into for profit, and it further appeared that the property was occupied by the taxpayer only temporarily, or until a new residence was completed for his occupancy. In that connection we held that the taxpayer abandoned his original intention by using the property as a residence, and since it was not used at any time to produce income, the purchase and sale lost the characteristics of a transaction entered into for profit.

We hold that petitioner here is not entitled to the deduction claimed.

Judgment will be entered for the respondent.


author: Arundell :

text:
    Consolidated Freight Lines, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88246.
    Promulgated March 29, 1938.

      Robert R. Rankin, Esq., for the petitioner.

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

Arundell :

In its income tax return for 1934 the petitioner claimed losses on account of the worthlessness of the franchises acquired under the above certificates in the following amounts:

Yakima-Prosser______^ $13,025. 00
Yakima-Easton_¿,_ 5,000.00
Spokane-Ephrata-Wenatcliee__ 36,388.98
Spokane-Yakima_ 1,000.00
Seattle-Wenatchée_•_ 20,025. OO

By amended pleadings in this proceeding the petitioner claims the loss on the Spokane-Ephrata-Wenatchee certificate should be increased by $7,000 to $43,388.98. By the same pleading petitioner concedes the correctness of the Commissioner’s disallowance of the loss of $4,500 claimed on the return for a Certificate covering an interstate route from Yakima, Washington, to Bortland, Oregon.

The question for decision here is whether or not the petitioner suffered a deductible loss by reason of legislation which was enaoted by the State of Washington in 1983 and took effect January 17, 1934. The successive legislative acts of the State of Washington referred to by the parties may be briefly described. It appears that regulation of motor carriers began with an enactment in 1921. Laws of 1921, ch- HI. That act gave the Department of Public Works (subsequently, the Department of Public Service) authority to regulate motor carriers operating “for the transportation of persons and, or, property for compensation between fixed termini or over a regular route in this state * * *.” The regulation was to be accomplished through the medium of granting or withholding certificates of “public convenience and necessity.” The statute contained a mandatory provision, commonly called the “grandfather clause”, requiring issuance of such certificates to carriers operating on January 15, 1921. Certificates for competitive lines could be issued, after hearing, only when the existing line failed to provide satisfactory service. By statutory provision, certificates could be “sold, assigned, leased, transferred or inherited as other property, only upon authorization of the Commission.” Sec. 4, ch. Ill, Laws of 1921.

The purpose of section 4 of the 1921 statute is described in Buck v. Kuykendall, 267 U. S. 307, 315, as follows:

* * * Its primary purpose is not regulation with a view to safety or to conservation of the highways, hut the prohibition of competition. It determines not the manner of use, but the persons by whom' the highways may be used. It prohibits such use to some persons while permitting it to others for the same purpose and in the same manner. * * *

The effect of the 1921 statute was to grant monopolies to those carriers in operation on January 15,1921, and the first comers thereafter in other territory, and to perpetuate the monopolies in successors who acquired the certificates of public convenience and necessity by purchase or otherwise. Thus the certificates, by reason of granting the right of operation to their holders to the exclusion of others, came to have considerable value. The certificates acquired by the petitioner, as described in the findings of fact, were certificates issued under the 1921 statute.

The 1921 statute limited regulation to motor carriers operating “between fixed termini or over a regular route.” Statutes enacted in 1933 (ch. 166, Session Laws of 1933) extended the regulatory power of the Department of Public Service to other classes of motor carriers, designated “contract haulers”, “for hire carriers”, and “private carriers.” These classes of carriers were required to procure permits from the Department of Public Service in order to engage in motor transportation. This legislation did not affect the certificates of convenience and necessity issued under the 19?1 statute.

Chapter 55 of the Extraordinary Session Laws of 1933, which became effective January 17,1934, and are herein for convenience called the 1934 statute, elaborated the provisions of the earlier statute of the year 1933. The particular provision added by the Extraordinary Session Laws which is of interest here is as follows:

Nothing herein contained shall be construed to confer upon any person the exclusive right or privilege of transporting property for compensation over the public highways of the State of Washington.

The 1934 statute, like the old, required carriers like the petitioner to procure certificates of public convenience and necessity which, as under the 1921 statute, could be “assigned, sold, leased, transferred or inherited as other property only upon authorization of the. department.” The 1934 statute did not, like the 1921 statute, limit the power of the department to authorize competing lines only in case of inadequacy of service, but could, after hearing, issue or refuse in whole or in part, certificates authorizing competing service in the same territory. Section 18 of the 1934 statute provided that operators under certificates issued under the 1921 statute “shall continue to operate under said certificates in the same manner and to the same effect as if such certificates were granted under the provisions of this act.” The substance of the changes wrought by the 1934 statute is succinctly stated in State v. Valley Milk Transp. Inc., 183 Wash. 329; 48 Pac. (2d) 208, 209, where the court said that the changes established “the principle of regulated competition * * ®.”

With this resume of the successive statutes before us, we face the question of whether the statutory changes that became effective in 1934 so affected petitioner’s certificates of public convenience and necessity as to result in a deductible loss. Petitioner’s view is that under its certificates issued under the 1921 statute it had monopolistic rights which were destroyed by the 1934 statute; that such rights had been acquired at substantial cost and had considerable value; and that the destruction of them resulted in a deductible loss.

A comparison of the statutes and the description of them in the court cases cited above leaves no doubt that the 1921 statute granted monopolistic rights and that the 1934 statute destroyed the monopolistic character of those rights. It does not follow, however, that a deductible loss was sustained. When the petitioner acquired the certificates such certificates were a prerequisite to the conduct of the business of transporting property over state highways between fixed termini or over a regular route. They were obviously acquired by the petitioner for the purpose of engaging in that business, as it thereafter did operate such a business. The monopolistic character of the certificates is not, as far as the record shows, a thing separate and apart from the right to carry on a business under them. In other words, there is no showing that the certificates were bought and sold like shares of stock or bonds which are so often held by the owner for income or appreciation without thought of his engaging in the business that gives value to the securities. Such monopolistic features as the certificates had were, in fact, effective only if the holder engaged in the business to which the certificate related. If he did not conduct the business authorized and did not do it in such a way as to furnish service satisfactory to the issuing department, certificates could be issued to others to serve the same territory and thus destroy the petitioner’s monopoly. Thus, the monopoly granted by the certificates can not be viewed as a thing separate and distinct from the other rights granted and duties imposed by them. The monopoly was only one element that gave them value.

The complete enmeshing of the monopolistic and operating aspects of the certificates distinguishes this case from those in which the right to operate a business is lost or destroyed. Petitioner cites O. R. Fuller, 11 B. T. A. 1025, as authority for its claim. In that case the taxpayer paid some $10,000 to an operator of bus lines in California for what he thought were rights to operate over certain highways in California. In 1921 the California Railroad Commission decided that the vendor had no operative rights over the particular highways. The result of this was, as we found, that the taxpayer “had paid a purchase price for certain operative rights, but had acquired nothing.” We allowed a loss deduction. That decision does not support the petitioner’s case. There, upon conclusion of the proceedings before the local regulatory body, the taxpayer had no operative rights — his business was completely obliterated. Here, the petitioner’s operative rights and its business carried on in virtue of its certificates continue, they have neither been lost nor in any way hampered. On like ground there must be distinguished the cases allowing obsolescence and loss deductions where businesses were affected by prohibition legislation. See V. Loewers Gambrinus Brewery Co. v. Anderson, 282 U. S. 638; William Zakon, 7 B. T. A. 687; McAvoy Co., 10 B. T. A. 1017; Elston Co. v. United States, 21 Fed. Supp. 267 (Ct. Cls., Dec. 6, 1937). The last three cited cases involved deductions for liquor or saloon licenses, and the facts, particularly in the Elston case, concerning the acquisition and holding of licenses are quite close to the facts here. In the Elston case the taxpayer had purchased a number of saloon licenses which, because of an ordinance limiting the number thereof on the basis of population but containing a grandfather clause, were valuable and were bought and sold and for some purposes were treated as property. With the advent of prohibition legislation in 1919 the licenses became worthless and were abandoned by the taxpayer in that year. The Court of Claims allowed a deduction in the amount of the cost to the taxpayer of its licenses. The court, citing the above mentioned Board cases, said:

* * * The renewal rights of saloon licenses in those cases, as in the instant case, were income producing assets, subject to purchase, sale and assignment, separate from the business itself. They were assignable assets distinct from the business. In this respect they were in the same category with patents, contracts and franchises. * * *

At first glance this language would seem to support the petitioner’s position here. However, it must be borne in mind that the court was speaking in the light of the factual situation of the destruction of the business to which the licenses related. When so considered it can not be said that the Elston case, or the others cited, stand for the allowance of deductions in respect of licenses where the business goes on despite a change in some feature or characteristic of the license.

Assuming in the present case that the monopolistic features of the certificates issued under the 1921 statute had some value apart from the operative rights, and that the monopolistic features were destroyed by the 1934 legislation, the petitioner has not shown what part of cost is attributable separately to those features. Hence it has not established its basis for gain or loss.

We find no error in the respondent’s determination.

Decision will be entered for the resfondent.


author: Smith :

text:
    Geneva Water Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89249.
    Promulgated March 31, 1938.

      Lawrence A. Baker, Esq., and Henry Bavenel, Esq., for the petitioner.

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

Smith :

The questions for our determination are whether the petitioner is a tax-exempt organization either within the meaning of section 103 (14) of the Revenue Act of 1932 (appearing as section 101 (14) of the Revenue Act of 1934), or on the broad constitutional grounds that Federal taxes can not be imposed upon a state instrumentality, and, if the petitioner is not entitled to an exempt status, whether a portion of its income is exempt from taxation under the provisions of section 116 (d) of the Revenue Acts of 1932 and 1934. The petitioner has made no protest against the imposition of the penalty for failure to file returns. The sections of the statutes referred to read in material part as follows:

SEO. 103. EXEMPTIONS PROM TAX ON CORPORATIONS.
The following organizations shall be exempt from taxation under this title—
*******
(14) Corporations organized for the exclusive purpose of holding title to property, collecting income therefrom, and turning over the entire amount thereof, less expenses, to an organization which itself is exempt from the tax imposed by this title.
SEO. 116. EXCLUSIONS PROM GROSS INCOME.
In addition to the items specified in section 22 (b), the following items shall not be included in gross income and shall be exempt from taxation under this title:
# * * * * * *
(d) Income op States, Municipalities, Etc. — Income derived from any public utility or the exercise of any essential governmental function and accruing to any State, Territory, or the District of Columbia, or any political subdivision of a State, or Territory, or income accruing to the government of any possession of the United States, or any political subdivision thereof.

In Decatur Water Supply Co. v. Commissioner (C. C. A., 7th Cir.), 88 Fed. (2d) 341, the court held, reversing 34 B. T. A. 290, that a corporation which was organized for the same purpose and in substantially the same manner as the petitioner and whose functions were but little different from those of the petitioner, was an instrumentality of the State of Illinois and that the amounts paid to it by the city of Decatur, Illinois, out of the water rents collected by the city were not income to the company and were not subject to Federal income tax. In its opinion tbe court said:

It is thus seen that the corporate entity (the taxpayer) was but an instrumentality adopted by the City of Decatur for the accomplishment of a specific purpose. As a means of raising necessary funds, citizens subscribed to the company’s stock, thus creating a fund for the acquisition of the property required by the city. The city in effect pledged its water revenue for the repayment of this capital by agreeing that all over operating expenses be set up in a special fund, ninety per cent of which was paid to the company. The company in turn was obligated by its charter provisions and by its contract to apply its percentage of this fund (after payment of expenses and 7% dividends on preferred stock) to the retirement of its preferred stock at par. From the time of its receipt such fund was earmarked for a single purpose — the return of capital to its preferred stockholders. The company could not and did not profit by its receipt, but in effect it acted as an agency for restoring to the investors the corpus of their investment. To the extent that seven per cent dividends were paid, a taxable income is conceded, but it is difficult to see how this restoration of capital can equitably be said to be a taxable income of the company.
* * * sji * * *
* * * How can it be said in the instant case that the Company has received anything for its use and benefit? The money received was for the use and benefit of those who had furnished the capital — the preferred stockholders. The charter and contract set up a barrier to its use otherwise. The Company had no freedom of disposal, but its disposition was limited to a very narrow channel; rather do we think it fairer to say that such sums were at the predetermined disposal of the city. Such funds had no exchangeable value because of the restrictions attaching to their receipt. The company was not enriched by their receipt either in fact or on its books. When it reduced its stock liability by the return of such funds to stockholders, it also reduced by that same amount its future right to receive the capital investment made for the city. To state it in another way the city gained by such payments an additional equity of equal amount in the property it had optioned from the company and which the company later transferred to it. With each payment to the company, thus earmarked for its stockholders, the city built up an additional equity in the property in ratio to the sums paid. Carried to its ultimate consummation it meant the return in full of the funds advanced by the preferred stockholders and the acquisition, unrestricted by the city, of the property which those funds purchased — a simple transfer of the property purchased to the municipality, without profit to the company, and in full compliance with the letter and spirit of the charter and contract.

The respondent attempts to distinguish the instant case from Decatur Water Supply Co. v. Commissioner, supra, on the facts, but obviously the distinction, if any, is superficial. The facts as well as the questions of law presented are substantially the same in both cases. The petitioner had no taxable income for the years 1932, 1938, and 1934.

Eeviewed by the Board.

Judgment will be entered for the petitioner.

SterNiiageN, Murdock, Leech, and Mellott dissent.


text:
    Charles S. Davis, Successor Trustee, u/w and of the Estate of Otto Ernst Isenberg, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket. No. 74249.
    Promulgated March 31, 1938.

      F. Eberhart Haynes, Esq., J. Marvin Haynes, Esq., and Ebert J. Botts, Esq., for the petitioner.

      J. L. Baclcstrom, Esq., and Allen T. Ahin, Esq., for the respondent.
   OPINION.

Smith :

The issues presented in this proceeding all arise from the administration of the trust estates created under the will of Otto Ernst Isenberg, who died in 1902. A portion of the assets of the trust estates fell into the hands of the Alien Property Custodian during the World War and have not yet been released.

The decedent’s will is clearly drawn and the provisions creating the trust estates are not complicated or ambiguous. The testator left the residue of his estate in trust, one-third to be set apart for the benefit of his widow for life and the other two-thirds to be apportioned to his surviving children, or their survivors, in equal shares. Each child was to receive the income from his portion annually or oftener and at the age of 25 years was to receive the corpus. Upon the death of the widow the one-third share of the corpus and undistributed income set apart for her benefit was to be divided and administered in the same manner as the other two-thirds part of the trust estate.

At the time of the World War all but two of the children had arrived at the age of 25 years and had received their distributable portions of the two-thirds part of the corpus of the trust apportioned to them. One of these, Dorothea, arrived at the age of 25 on November 16, 1917, but her portion was not paid over to her because she was in Germany and an “enemy” within the meaning of the Trading with the Enemy Act of October 6, 1917. The other, Paul, born in 1895, was also an enemy. He died in Germany on November 16, 1918. During 1917 the trustees under the will of Otto Ernst Isen-berg held the undistributed assets of the estate in three separate trust funds: (1) The property of which the widow was the life beneficiary together with accumulated income, (2) the property of Dorothea, and (3) the property of Paul.

Early in 1918 the Alien Property Custodian, through his depositary, the Trent Trust Co., Ltd., oí Honolulu, took oxer all of the trust assets then in the hands of the trustees, thereby preventing them from administering the trust estates in accordance with the provisions of the testator’s will. On its application to the court made in 1918 the Trent Trust Co. was, on October 81, 1918, named trustee of the estate of Otto Ernst Isenberg, deceased. After that date it represented the trust estates in dual capacities, first, as depositary of the Alien Property Custodian, and, secondly, as trustee. The courts later held that it was improper for it to act as trustee while it was still the depositary of the Alien Property Custodian.

Certain of the trust assets were sold by the Alien Property Custodian in 1919.

When the trust company, as trustee, undertook to make its final report in 1921 the beneficiaries objected and claimed that the Trent Trust Co. was liable for damages for its failure as trustee to have in its possession certain shares of stock (670 shares of Kekaha Sugar Co., Ltd., stock) which had been sold by the Alien Property Custodian in 1919 and in the interim had greatly increased in value. A judgment was finally obtained against the Trent Trust Co. for $287,323.40, which amount represented the difference in the value of the‘trust estates at the date of reference to a master for the purpose of determining the facts, August 24, 1923, and the value that the trust estates (exclusive of that of Dorothea) would have had if properly administered by the Trent Trust Co. as trustee.

By decree of the trial court entered April 7, 1924, the Trent Trust Co. was removed from its position as trustee and Charles S. Davis, the petitioner herein, was named successor trustee under the will and of the estate of Otto Ernst Isenberg, deceased. By reason of an appeal from the decision of the trial court the decree did not become effective until 1929.

The judgment of $287,323.40 plus interest of $100,083, or a total amount of $387,406.40, was paid over to the petitioner trustee by the Trent Trust Co. on June 21,1929.

The principal dispute in this proceeding is over this item of $387,406.40. The respondent has determined that it is all taxable income to the petitioner as trustee under the will and of the estate of Otto Ernst Isenberg for 1929, while the petitioner contends that none of it is taxable income to him as such trustee for 1929 or any other year.

In paragraph (d) of the amended petition filed herein the contention is made that the income in dispute, if taxable at all, is taxable to ten separate trusts rather than to the petitioner as trustee of a single trust.

The Board held in its prior opinion that under the will of Otto Ernst Isenberg there was created only one trust and that such trust was liable to income tax on all of the taxable income received by it in the taxable years under consideration. We are now of the opinion, however, after a careful review of the evidence and the law bearing on the question, that our prior ruling was erroneous in this regard.

We think it is apparent from the provisions of the will of Otto Ernst Isenberg that he intended to and did create one trust for the benefit of his widow and a trust for each of his children.

Paragraph second of the will directs that one-third of the remainder of the estate be “set apart” for the “use and benefit of my wife * * * to pay to her the net income, issues and profits thereof so long as she shall live.” No clearer words than those are needed to create a separate trust estate in such one-third interest for the benefit of the widow. The income on the widow’s portion was to be paid to her “annually or oftener.”

Paragraph third of the will directs that the remaining two-thirds of the estate be divided into “as many equal portions as I shall have children then living” and that one “such portion” shall be paid over to each child at the age of 25 years. The issues or profits thereof, that is, the issues or profits from such portion was to be paid over annually or oftener to the child for whom it was held. This language is equally plain in its requirement for the setting aside of a one-ninth interest in the two-thirds of the testator’s remainder estate at the time of his death in trust for each of his nine living children. Furthermore, the evidence conclusively shows that the trustees, Schultze and Kodiek, interpreted the will as creating a trust estate for the benefit of the widow and separate trust estates for the benefit of the children. In 1917 the trustees were trustees of three trusts: (1) The property held for the benefit of the widow; (2) the property constituting the separate estate of Dorothea; and (3) the property constituting the separate estate of Paul. The examining revenue agent stated in his report of March 25, 1931, covering the “Estate of Otto Ernst Isen-berg, Deceased”, for the years 1918 to 1929, inclusive, that “the income and disbursements of each separate share of the estate were kept separate on the records of both the Trustee and the Alien Property Custodian.”

On October 31, 1918, the Circuit Court of the First Judicial Circuit, Territory of Hawaii, entered an order appointing the Trent Trust Co. as “trustee of the estate of Otto Ernst Isenberg, deceased.” We do not think, however, that this appointment was intended to merge the three trust estates turned over to it by the former trustees into a single trust estate. The Trent Trust Co., as had the predecessor trustees, kept separate accounts for each trust estate received by it. It received income upon the trust estates for the widow and for Paul, but never received any income on the trust estate of Dorothea. As trustee of Dorothea’s estate, the Trent Trust Co. received on November 4, 1918, a deposit by the Alien Property Custodian of $5,362.63, which amount was thereafter returned to the Alien Property Custodian without any accretion thereto. The trust estate of Dorothea is not involved in any way in this proceeding. In 1921 the Trent Trust Co. paid over to the Alien Property Custodian all property belonging to Paul and thereafter never received any of the income or of the assets belonging to Paul. The petitioner never received from the Trent Trust Co. or from the Alien Property Custodian any of the assets of Paul’s estate. From 1918 the Trent Trust Co. received income upon the assets constituting the trust estate of the widow, Helen L. Isenberg, and it is these assets which were paid over to the petitioner, Davis, on June 21, 1929, in the amount of $97,709.74 cash, plus bonds and shares of stock.

In the computation of the deficiencies for all of the years 1918 to 1929, inclusive, the revenue agent determined the amount of income attributable to the trust estate of which the widow had the life interest and the amount of the income received both by the Trent Trust Co. and by the Alien Property Custodian upon Paul’s estate. After 1921 all of the income received on Paul’s estate was received by the Alien Property Custodian. The respondent in the determination of the deficiencies has added together the income received by the trust estates of the widow and Paul by both the Trent Trust Co. and the Alien Property Custodian, and has taxed it to the petitioner as the trustee of a single trust.

We are of the opinion that the respondent was clearly in error in taxing to a single trust the income for 1918. The income received in that year and involved in this proceeding was upon the separate trust estates for the widow and Paul. It was currently distributable to the beneficiaries, the widow and Paul, under the terms of the will of Otto Ernst Isenberg, and is therefore taxable to them. They and not the trustee for the estate of Otto Ernst Isenberg are taxable upon the income received. Cf. Freuler v. Helvering, 291 U. S. 35. There is no deficiency in tax due from the petitioner for 1918.

The income received by the Alien Property Custodian for Paul’s estate for the years 1924 to 1929, inclusive, was the income of Paul’s estate. It was never the income of the Trent Trust Co. or of the petitioner. Neither received the income and neither was the trustee of his estate.

There remains for our determination the liability of the petitioner for income taxes due upon certain income received for the years 1924 to 1929, inclusive. The petitioner is successor trustee “under the ■svill and of tlie estate of Otto Ernst Isenberg.” Petitioner contends that any such income received by him was income “currently distributable” to the beneficiaries or else that it was income taxable to ten separate trusts, namely, the estate of the widow, Helen L. Isen-berg, who died April 2, 1923, and the nine children or their legal representatives. Under the terms of the will of Otto Ernst Isenberg the entire trust estate in which the widow had a life beneficial interest became distributable upon her death.

The Supreme Court of the Territory of Hawaii stated in its opinion of September 1,1925, as follows:

All of the nine children of the testator survived him. All of them except Paul Otto who reached the age of twenty-five. Paul Otto died November 16, 1918, and had he lived would have been twenty-five on November 10, 1920. In our opinion each of these nine children was given by the will a vested one-ninth interest in the two-thirds of the property referred to in the third clause of the will and also in the one-third of the property referred to in the second and fourth clauses. By this we mean that each, immediately upon the death of the testator, became definitely and certainly the owner of a one-ninth interest in the property, vested in right, with merely the possession and the enjoyment of the principal itself deferred until the time stated, that is, when each became twenty-five or would arrive at the age of twenty-five if living. The same was as true in the case of Paul Otto as in the cases of the others. Paul Otto’s interest as well as the interest of each of the others was descendible, devisable and alienable.

We thus see that after the death of the widow on April 2, 1923, each of the nine children or his or her legal representatives had a distributable share in the trust estate created by Otto Ernst Isen-berg for the life of the widow. Although the interests were not immediately paid over to the children by reason of the pending litigation, we think it clear that the trustee held the undivided interests for the children and that each interest constituted a separate trust estate. In Lynchburg Trust & Savings Bank v. Commissioner, 68 Fed. (2d) 356, where it was held that three separate trusts were created rather than a single trust, the court said:

* * * Moreover, as we have seen, a separate account has been set up for the portion of the income withheld from each grandchild and the investment thereof by the trustees. This method would naturally be adopted by any one who wished to insure to each grandchild his equal share in the estate. The amounts withheld in the discretion of the trustees were of necessity unequal, by reason of the difference in the ages of the grandchildren, a situation which the testator must have had in mind. It would have been well-nigh impracticable to have ascertained accurately at any particular time the respective percentage to which each grandchild would have been entitled in a common fund, in view of the constant additions of varying sums and the changing valuations of the real and personal property constituting the corpus, involving as it would, the uncertainty of frequent appraisals. * * *

The facts here are substantially the same as those in United States Trust Co. of New York v. Commissioner, 296 U. S. 481. There, the trust instrument as amended provided that the trust estate should be divided into separate equal shares for each of three beneficiaries and further provided for the disposition of the income of each separate share. The Supreme Court held, reversing the Circuit Court of Appeals for the Second Circuit, 75 Fed. (2d) 973, and affirming the Board, that under the trust agreement there were three separate trusts. In its opinion the Court said:

* * * If the various securities Rad been divided physically, if new certificates of stock had been obtained for the several beneficiaries, and such certificates and specific bonds and cash had been set aside for each, there would be no room for argument that three separate trusts were not created. But it was not necessary to have such a physical division in order to carry out the clear intention of the parties. An undivided interest in property may constitute the corpus of a trust. * * * Where there is an intention to create separate trusts, the fact that “the trusts” are “kept in one fund” does not necessarily defeat the intention and require the conclusion that there is but a single trust. In re Colegrove’s Estate, 221 N. Y. 455, 459, 117 N. E. 813. “In many cases,” said the Court of Appeals of New York in Vanderpoel v. Loew, 112 N. Y. 167, 180, 19 N. E. 481, 484, where “income and principal were given in equal shares, although out of one fund kept in solido for convenience of investment, a severance of the trust into its component parts has been adjudged. * * * The shares and interests are several, although the fund remains undivided.” See, also, Rollestone v. National Bank of Commerce, 299 Mo. 57, 71, 252 S. W. 394.

We are of the opinion that, under the Supreme Court’s decision in the case above cited, the interests of the widow and of the nine children in the testator’s estate were separate trust entities and must be so treated for tax purposes. The property in the hands of the Trent Trust Co. after the death of the widow was distributable to the estate of the widow and to the nine children or their legal representatives. Any income received on their distributable shares was taxable to the distributees and not to the estate of Otto Ernst Isen-berg, the probate of which was closed in 1905.

We do not have before us in this proceeding the separate trusts. We are not therefore called upon to determine the tax liability of any of them. We determine as to the petitioner that he is not liable to any deficiencies in income tax as the trustee of the estate of Otto Ernst Isenberg for any of the years 1918 to 1929, inclusive, involved in this proceeding.

Eeviewed by the Board.

Judgment of no deficiencies will be entered.

Mellott dissents.


author: Sternhagen :

text:
    John A. Gebelein, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 90943.
    Promulgated March 31, 1938.

      James A. Montgomery, Jr., Esq., J. Willison Smith, Jr., Esq., and John H. Biohardson, Esq., for the petitioner.

      Benjamin H. Néblett, Esq., for the respondent.
   OPINION.

Sternhagen :

The respondent moves to dismiss for want of jurisdiction. He contends that (1) no deficiency has been determined, (2) that no notice of deficiency has been sent to the petitioner, and (3) that the paper attached to the petition may not be regarded as a statutory notice of deficiency because it was not sent by registered mail.

The taxes which the petition attempts to litigate are the unjust enrichment taxes imposed by Title III, Revenue Act of 1936, and there is no suggestion by either side that such taxes are not justiciable by the Board, section 503, Revenue Act of 1936.

The taxpayer filed a return setting up the factors of computation which it believed approximated those prescribed by the statute, and upon its return the computation was shown to result mathematically in a tax figure of $20,130.86. Appended to the return and filed as part of it was a rider in which the taxpayer unmistakably asserted that notwithstanding the mathematical tax figure no tax was due because the statute was unconstitutional. Essentially, therefore, the petitioner was filing a return which embodied a clear statement that no tax was legally due. If the freedom from liability were alleged to be attributable to a statutory provision legislatively granting exemption to a described class, such as personal service corporations, or building and loan corporations, it would be clear that a determination had been made which upon proper notice would be the foundation of a proceeding within the Board’s jurisdiction, Continental Accounting & Audit Co., 2 B. T. A. 761, and Fred Taylor, 36 B. T. A. 427. See also I. T. 2400, VII-1 O. B. 138. But the claim here is not for statutory exemption, but for constitutional immunity, and, since for another reason the notice was ineffective to support a petition, consideration must be reserved as to whether the question is the same. Arguendo, it may be assumed that it was, and that the “amount shown as the tax by the taxpayer upon his return”, as the factor of equation is called in section 271, is zero.

Upon the filing of such return, the collector sent to the taxpayer by mail, although not registered, a notice of assessment and demand for payment of $20,130.86. At the argument, respondent’s counsel left it in some doubt as to whether his contention that the collector’s notice was not a statutory notice of deficiency is because the collector lacked authority to send such a notice. There is nothing in the face of the papers to indicate that the assessment was a jeopardy assessment, and neither side suggests that it should be so treated. Tet belief of jeopardy is the only circumstance which would support an assessment before a notice of deficiency is mailed. So if this were not a notice of jeopardy assessment or a notice of deficiency, it would be wholly without force and the taxpayer would probably be entitled to resist the collector’s demand by an injunction, despite R. S. 3224. See section 272 (a) ; Capital Building & Loan Association v. Burnet, 63 Fed. (2d) 462; Ventura Consolidated Oil Fields v. Rogan, 86 Fed. (2d) 149; Heinemann Chemical Co. v. Heiner, 92 Fed. (2d) 344.

Treating the notice as otherwise valid and authorized, the question remains whether it is ineffective to afford the right to institute a proceeding before the Board because it was not sent by registered mail. The notice need not be in any special form or advise the taxpayer of his right to file a petition with the Board, Ventura Consolidated Oil Fields v. Bogan, supra; Commissioner v. Oswego Falls Corporation, 71 Fed. (2d) 673. But it must be sent by registered mail, Henry Wilson, 16 B. T. A. 1280; American Felt Co., 18 B. T. A. 509; John M. Mitchell Estate, 22 B. T. A. 1365; William M. Oreve, 37 B. T. A. 450. The statute says that if the Commissioner determines a deficiency he is authorized to notify the taxpayer thereof by registered mail. “When a statute limits a thing to be done in a particular mode, it includes the negative of any other mode.” Botany Worsted Mills v. United States, 278 U. S. 282. See Henry M. Day, 12 B. T. A. 161. Since the notice attached to the petition was not sent by registered mail, it may not be regarded as an authorized notice of deficiency, Heinemarm Chemical Co. v. Heiner, supra. The petition is therefore prematurely filed and, for want of jurisdiction, the proceeding must be Dismissed.

Reviewed by the Board.

Hill concurs only in the result.