author: Matthews :

text:
    Farmers Union State Exchange, Petitioner, v. Commissioner of Internal Revenue, Respondent. Farmers Educational and Cooperative State Union of Nebraska, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 10596, 18105, 27194, 31748.
    Promulgated June 28, 1934.

      Louis B. Montfort, Esq., and A. S. French, O.P.A., for the petitioners.

      P. M. Ciarle, Esq., for the respondent.
   OPINION.

Matthews :

The main issues for determination are (1) whether the Farmers Educational and Cooperative State. Union of Nebraska is an exempt corporation under the provisions of the Revenue Acts of 1916, 1918, and 1921; (2) whether the Farmers Union State Exchange is an exempt corporation under the provisions of the Revenue Acts of 1916 and 1918, and, if not, (3) whether it is taxable on the undistributed savings of 1917 and 1918; and (4) whether the period of limitation for 1918 had expired prior to the date on which the notice of deficiency for that year was mailed.

If the State Union is an exempt corporation, that disposes of all issues raised in Docket Nos. 10596, 27194, and 31748, and some of the issues raised in Docket No. 18105. We will dispose of this issue first.

The State Union earnestly contends that it is entitled to exemption for the years involved under the following provisions of the Revenue Acts of 1916, 1918, and 1921:

Revenue Act of 1916:

Sec. 11. (a) That there shall not be taxed under this title any income received by any—
First. Labor, agricultural, or horticultural organization;
* * * * * ❖ #
Eleventh. Farmers’, fruit growers’, o-r like association, organized and operated as a sales agent for the purpose of marketing the products of its members and turning back to them the proceeds of sales, less the necessary selling expenses, on the basis of the quantity of produce furnished by them.

Revenue Act of 1918:

Seo. 281. That the following organizations shall be exempt from taxation under this title—
(I) Labor, agricultural or horticultural organizations;
* * * * * * *
(II) Farmers’, fruit growers’, or like associations, organized and operated as sales agents for the purpose of marketing the products of members and turning back to them the proceeds of • sales, less the necessary selling expenses, on the basis of the quantity of produce furnished by them.

Kevenue Act of 1921:

Seo. 231. That the following organizations shall be exempt from taxation under this title—
(I) Labor, agricultural, or horticultural organizations;
* * * * * * *
(II) Farmers’, fruit growers’, or like associations, organized and operated as sales agents for the purpose of marketing the products of members and turning back to them the proceeds of sales, less'the necessary selling expenses, on the basis of the quantity of produce furnished by them; or organized and operated as purchasing agents for the purpose of purchasing supplies and equipment for the use of members and turning over such supplies and equipment to such members at actual cost, plus necessary expenses.

The State Union is a division of the Farmers Educational and Cooperative Union of America, commonly called the. National Farmers Union. It was duly chartered by that body and complied with the statutes of Nebraska governing the organization of cooperative societies, and qualified as a cooperative company under the laws of Nebraska on July- 13, 1914. The pertinent provisions of the Nebraska statutes in force at that time are quoted in the margin.

In our opinion, the State Union is both an agricultural organization and a farmers’ cooperative organization, under the provisions quoted above, and is exempt from income and profits tax.

Article 73 of Begulations 33, entitled “ Labor, agricultural and horticultural organisations. — ”, provides in part:

Agricultural or horticultural organizations, which, are exempt under this title, do not include those corporations engaged in growing agricultural or horticultural products, raising live stock or similar products for profit, but will include only those organizations which, having no net income inuring to the benefit of their members, are educational or instructive in character, and which have for their purpose the betterment of the conditions of those engaged in these pursuits, the improvement of the grade of their products, and the encouragement and promotion of those industries to a higher degree of efficiency. (T.D. 2090.)

The same provisions appear- in all the later regulations.

The State Union was not engaged in growing agricultural products or raising livestock; it had no net income inuring to the benefit of its members; it was educational and instructive in character, and had' for its purpose the betterment of the condition of the farmers of Nebraska, the improvement of the grade of their products, and the .encouragement and promotion of agricultural industries to a higher degree of efficiency.

Its purposes, as set forth in its constitution, are set forth in our findings of fact. The facts also show how diligently and with what success it carried out the purposes for which it was organized.

One of the purposes stated is “ to assist our members in buying and selling.” This would result in the betterment of the condition of the farmer by eliminating the middleman’s profits on the farm products sold and on the supplier purchased by the farmer. The cooperative purchasing of supplies in the larger market at Omaha offered the farmers savings in the purchase of their supplies. Hence the activities of the Exchange were started. The sale of their livestock in the large stockyard centers by their own organization offered the shippers the way to save for themselves a large part of the commissions charged by the old line commission houses. Hence the establishment of the livestock commissions.

Although the livestock commissions were operated and originally financed by the Union for its members, no part of the undistributed earnings of the commissions inured to the benefit of the Union.

If the question before us were whether the three livestock commissions are such cooperative sales agents as are exempt from tax under the statutes, they would meet the test prescribed. From about 82 to 90 percent of the net earnings of the livestock commissions was distributed to the patrons each year on a proportionate basis. The undistributed earnings of the livestock commissions were small in proportion to the business done and were certainly no more than were necessary to be reserved for the exigencies of the business. The business with nonmembers was negligible, and upon the nonmember patron becoming a member he received his patronage dividend. The retention of such a small proportion of the savings would not be sufficient to destroy the exempt status of a cooperative sales agent. The operation of the commissions by the Union did not have the effect of taking the Union out of the exempt class.

The Farmers Exchange was incorporated under the statutes of Nebraska governing cooperative corporations. The stock of the Exchange was held by the Union as trustee for its members. No part of the net income of the Exchange inured or could inure to the benefit of the stockholder. It was not conducted for profit, but for the benefit of the members of the State Union. We are of the opinion that the holding of the stock of the Farmers Exchange by the Union, as trustee for the members of the Union, is not sufficient to destroy its classification as an agricultural organization, within the meaning of the several revenue acts.

But if it should be thought that because of these activities the State Union is not an agricultural organization within the meaning of the statute, it is'clearly a farmers’ cooperative association, which is exempt from tax under subdivision (11). It is a cooperative organization under the Nebraska statutes. No part of the savings of the Farmers Exchange inured to it as a stockholder. It held the stock of the Exchange and operated livestock commissions for the benefit of its members. The greater part of the savings of the livestock commissions was returned to the shippers as patronage dividends, the amount retained being no more than a necessary reserve for the exigencies of the business of the commissions, and such amount did not inure to the benefit of the Union.

We hold, therefore, that the State Union is exempt from income tax under the provisions of the Revenue Acts of 1916,1918, and 1921. This disposes of all issues raised with respect to the years 1919, 1920, 1921, 1922, and 1923. It also disposes of the issues raised by the Farmers Exchange for 1917 and 1918 with respect to including in income taxable to the Exchange, the fees, dues, and undistributed earnings of the livestock commissions.

We shall next consider whether the Farmers Exchange is an exempt corporation.

The Farmers Exchange, as stated above, was organized under the Cooperative Statutes of Nebraska. It was both a cooperative sales agent and a cooperative purchasing agent for the members of the Union. The revenue acts in effect in the years 1917 and 1918 do not specifically mention farmers’ purchasing agents as being in the exempt class. Petitioner argues that the inclusion of purchasing agents in the Revenue Act of 1921 in no way indicates that farmer purchasing organizations were not exempt from tax under prior acts and that the inclusion of such organizations in the 1921 Act was the adaptation of the law specifically to a practice already sanctioned.

The Board heretofore had occasion to consider arguments of this nature in Riverdale Cooperative Creamery Assn., 18 B.T.A. 1159; aff'd., 48 Fed. (2d) 711, and held contrary to petitioner’s contention. On the authority of this decision we hold, therefore, that the Farmers Exchange is not an exempt corporation under the Revenue Acts of 1916 and 1918.

Although cooperative purchasing agencies are not exempt from tax and are required to file returns under the Revenue Acts of 1916 and 1918, the regulations under such acts permit a deduction of the amount of patronage dividends' paid. It has also been held that a deduction is allowable where there is a definite liability to make such payment, Home Builders Shipping Assn., 8 B.T.A. 903; Anamosa Farmers Creamery Co., 13 B.T.A. 907; Farmers’ Union Cooperative Assn., 13 B.T.A. 969. The question then is whether the Farmers Exchange was under such a definite liability to pay the savings for 1917 and 1918 to its patrons as to permit their deduction.

The Exchange was a nonprofit organization conducted for the benefit of the members of the State Union. The bylaws of the Exchange, if any were ever adopted, were not introduced in evidence. The provision in the articles of incorporation that the bylaws shall provide for the distribution of earnings in whole or in part, on the basis of the business done with the members of the Union, may be considered to have the same force as would a provision to like effect in the bylaws. We are of the opinion, however, that the charter provision alone cannot be construed as creating in each year a definite liability to pay the entire savings of that year, or any particular part thereof, to the patrons. In order to make the liability sufficiently definite to permit a deduction of any amount, there should have been some declaration or act on the part of the directors with respect to payment of patronage dividends. In the absence of evidence that any such declaration or act was made or done, we hold that the Exchange is not entitled to any deduction from income for 1917 and 1918 on account of patronage dividends which were not declared or paid.

We turn now to the question of the expiration of the period of limitation on the assessment and collection of the deficiency determined for 1918.

The period for assessment and collection of taxes for 1918 started to run on June 16, 1919, when the tax return was filed, and under the provisions of section 250 (d) of the Revenue Act of 1918 the respondent had five years from that date to assess and collect any additional tax found to be due. On January 15, 1923, the Farmers Exchange executed an unlimited waiver extending the period for the assessment and collection of taxes for 1917 and 1918, “ irrespective of any period of limitations ”, and under date of June 9, 1924, an income and profits tax waiver was executed by the Farmers Exchange which relates to taxes for 1918 and which recites: “ This waiver is in effect from the" date it is signed by the taxpayer and will remain in effect for a period of one year after the expiration of the statutory period of limitation, or the statutory period of limitation as extended by any waivers already on file with the Bureau, within which assessments of taxes may be made for the year or years mentioned.”

It is the petitioner’s position that the five-year period prescribed by the statute would have expired on June 16, 1924, if no waivers had been executed, and that the waiver dated June 9, 1924, extended the statutory period for one year, or until June 16, 1925. The respondent is contending that the unlimited waiver dated January 15, 1923, covered the year 1918 as well as 1917 and that the respondent had a reasonable time within which to act thereunder. The notice of deficiency for 1918 was mailed on May 4, 1926. The respondent argues that the period of 22 months and 18 days which elapsed between the expiration of the original statutory period and the mailing of the notice of deficiency amounts to a reasonable time and that the respondent’s determination is timely,, in view of the execution of the above described waivers.

If the second waiver had not been executed it would be necessary to decide only whether the notice of deficiency was mailed prior to the expiration of the statutory period of limitation as extended by the unlimited waiver. An unlimited waiver does not suspend the running of the statute forever, but only for a reasonable time or until termination by either party upon reasonable notice. As stated, the original statutory period of limitation for the assessment and collection of taxes for 1918 would have expired on June 16, 1924, which is five years after the return was filed. But prior thereto, on June 9, 1924, the second waiver was executed, which extended the period for one year after the expiration of the statutory period of limitation, “ or the statutory period of limitation as extended by any waivers already on file with the Bureau.” The only waiver already on file being the unlimited waiver, the question arises whether that unlimited waiver may. be considered to have given the respondent a reasonable time after the expiration of the statutory period to assess and collect, to which may be added the additional year granted by the second waiver. We are of the opinion that this question must be answered in the negative. The two waivers must be construed together. Stern Bros. & Co., 17 B.T.A. 848, aff'd., 51 Fed. (2d) 1042. To say that the first waiver remained in effect after the execution of the second waiver, under the circumstances set out, would be equivalent to brushing aside the meaning of the latter waiver. It must have been intended that the second waiver should be substituted for the unlimited waiver. Its execution on June 9, 1924, before the unlimited waiver became effective to extend the statutory period, was sufficient "to constitute a reasonable notice that the unlimited waiver was terminated as of that date. Ethel D. Co., 27 B.T.A. 25; aff'd., 10 Fed. (2d) 761. We hold, therefore, that the statute of limitations governing the assessment and collection of taxes for 1918 had expired prior to the mailing of the notice of deficiency on May 4, 1926, and the respondent was barred from making any further determination with respect to petitioner’s tax liability for that year.

Reviewed by the Board.

Judgment will be entered u/nder Rule 50 in Docket No. 18105. Judgment of no- deficiency will be entered in Docket Nos. 10596, B7194-, and 3171f8.

       Revised statutes oí the State oí Nebraska (1913) Part II, ch. 14, Art. XV—
      733 See. 185 “ Co-operative company ” defined,.- — For the purpose of this article, the words “ co-operative company, corporation or association ” are defined to mean a company, corporation or association which authorizes the distribution of its earnings in part, or wholly, on the basis of, or in proportion to the amount o¡£ property bought from or sold to members, or ol labor performed, or other service rendered to the corporation : Provided, nothing, in this article shall be construed as in any way conflicting with or repealing any law relating to building and loan associations or installment investment companies. (1911 p. 195 ; Ann. 4271; Comp. 2241a.)
      734 Sec. 186. Sow incorporated. — Any number of persons, not less.than twenty-five, may be associated and incorporated for the co-operative transaction of any lawful business, including the construction of canals, railways, irrigation ditches, bridges, and other works of internal improvements. (1911 p. 196; Ann. 4272; Comp. 2241b.)
      735. See. 187. Corporate powers. — Every co-operative corporation as such has power:
      First — To have succession by its corporate name;
      Second — to sue and to be sued, to complain and defend in courts of law and equity;
      Third — to make and to use a common seal, and alter same at pleasure;
      Fourth — to hold personal estate, and all such real estate as many be necessary for the legitimate business of the corporation;
      Fifth — to regulate and limit the right of stockholders to transfer their stock;
      Sixth — to appoint such subordinate officers and agents as the business of the corporation shall require, and to allow them suitable compensation therefor;
      Seventh — to make by-laws for the management of its affairs, and to provide therein the terms and limitations of stock ownership, and for the distribution of its earnings. (1911 p. 196 ; Ann. 4273 ; Comp. 2241c.)
      736 Sec. 188. Powers vested without Toeing mentioned. — The powers enumerated ■ in the preceding section shall vest in every co-operative corporation in this state whether the same be formed without, or by legislative enactment, although they may not be specified in its charter or in its articles of association. (1911 p. 196; Ann. 4273; Comp. 2241c.)


source: Caselaw Access Project

author: Seaweuo :

license: Public Domain

text:
    Olive H. Prouty, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 57829.
    Promulgated June 28, 1934.

      Allison L. H. Newton, Esq., for the petitioner.

      F. L. Van Haaften, Esq., for the respondent.
   OPINION.

Seaweuo :

The issue in this proceeding is whether certain dividends received in 1927 and 1928 by the trustees of six trusts created by the petitioner are, under the circumstances detailed in our findings of fact, taxable to the petitioner.

In each of the three trusts, Nos. 1, 2, and 8, constituting the first set of trusts, the trust instruments provided' that the petitioner, Olive H. Prouty expressly reserves to herself the right and power from time to time to change, add to, alter, amend or cancel any or all of the provisions of this declaration of trust * *

Section 219 (g) of the Revenue Act of 1926 (identical with section 166 of the Revenue Act of 1928) is as follows:

Where the grantor of a trust has, at any time during the taxable year, either alone or in conjunction with any person not a beneficiary of the trust, the power to revest in himself title to any part of the corpus of the trust, then the income of such part of the trust for such taxable year shall be included in computing the net income of the grantor.

The record shows that in the original trust instruments of the first set of trusts the petitioner expressly reserved to herself the right and power from time to time to change, amend, or cancel any or all of the provisions of the trusts and thereby revest in herself title to the corpus of trusts Nos. 1, 2, and 3. Such right and power appear from the record not to have been limited or restricted by any change thereof until the aforesaid trust amendment of March 24, 1927, which expressly revoked the aforesaid power originally reserved by petitioner. After this amendment, in our opinion, and we so bold, these trusts became in a sense irrevocable — no longer revocable within the meaning of section 219 (g) of the Revenue Act of 1926 or the corresponding section of the Revenue Act of 1928.

The record herein not showing that the dividends or any portion thereof received in 1927 by the trustee of the first set of trusts was received after the trusts became irrevocable as aforesaid by reason of the trust amendment of March 24, 1927, and it also appearing from the record that the petitioner “ at a time during the taxable year ” 1927 (up to March 24, 1927) had the power within herself, acting alone, to revest in herself title to the corpus of trusts Nos. 1, 2, and 3, and there being no sufficient evidence in the record to overcome the presumption of the correctness of the respondent’s determination with respect to the matter, it is our opinion and we hold that the dividends received from the first set of trusts for the taxable year 1927 should be included in computing petitioner’s net income for that year. Corliss v. Bowers, 281 U.S. 376; Clapp v. Heiner, 51 Fed. (2d) 224; John G. Hormel, 25 B.T.A. 703.

At no time during the taxable year 1928 did the petitioner have the power with reference to the first set of trusts that existed prior to the trust amendment of March 24, 1927. During the year 1928 these trusts were revocable by petitioner only in conjunction with Lewis I. Prouty. Petitioner contends that Lewis I. Prouty was a beneficiary under these trusts and therefore petitioner could not revoke any of them acting “ alone or in conjunction with any person not a beneficiary of the trust.” The section of the revenue act to which reference has been made uses the word “ beneficiary ” without qualification or enlargement of its ordinary meaning or scope.

In Smith v. Commissioner, 59 Fed. (2d) 56, the Circuit Court of Appeals of the First Circuit said:

It would seem that Congress did not intend, by the use of the term “ beneficiary ” in section 219 (g) only a beneficiary having a present vested interest, but intended to include within that term a beneficiary or beneficiaries having contingent interests as well as those having present or vested ones.
Undoubtedly Congress could have drawn a line between beneficiaries holding vested and contingent interests, or between those having contingent interests based on their respective degrees of remoteness, but it has done neither of these things. It is therefore far more reasonable to conclude that by the word “ beneficiary ” Congress intended to include persons or classes of persons designated, in the particular trust under consideration, entitled to take present or contingent interests thereunder.

In the case of Bessie R. Jones, 27 B.T.A. 171, the interests of the beneficiaries, her husband and her son, as trustees, were similar to the interests of Lewis I. Prouty and his children, Jane C. and Richard Prouty, respectively, under the second set of trusts, and in the case of Bessie R. Jones, supra, we held, in accordance with the opinion of the court in Smith v. Commissioner, supra, that the trust involved, was not revocable within the meaning of section 166 of the Revenue Act of 1928, which in all respects pertinent to this case is the same as section 219 (g) of the Revenue Act of 1926. See also Langley v. Commissioner, 61 Fed. (2d) 796; Iola Wise Stetson, 27 B.T.A. 173; Margaret A. Holmes, 27 B.T.A. 660. Cf. David J. Lit et al., Executors, 28 B.T.A. 853.

We are of opinion, and so hold, that Lewis I. Prouty was a beneficiary under trusts Nos. 1, 2, and 3 during all of the year 1928, and the dividends received therefrom in that year are not includable in computing the petitioner’s net income for 1928.

In the other three trusts, Nos. 4, 5, and 6, created by petitioner June 11, 1927, Lewis I. Prouty was trustee. The record shows that all of them were irrevocable within the meaning of section -219 (g) and section 166, swpra, none of them being revocable by the petitioner acting “ alone or in conjunction with any person not a beneficiary of the trust.” We are of the opinion and hold, therefore, that none of the dividends received by the trustee under any of these trusts are includable in computing petitioner’s net income for either 1927 or 1928.

Judgment will be entered under Rule -50.


author: Seawell:

text:
    Louis Schoen, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 56776.
    Promulgated June 28, 1934.

      '.Joseph Getz., Esq., for the petitioner.

      George R. Sherrijf, Esq., for the respondent.
   OPINION.

Seawell:

The main controversy is the quantum of interest the. petitioner had in the award paid to him by the city of Yonkers in the condemnation of the real estate mentioned. He says it was only one half, by reason of the fact that he had conveyed away one half to his daughters and their husbands by the deeds put in evidence. With this contention we do not agree for several reasons. In the first place there is no evidence that the alleged deeds were ever delivered to any of the respective grantees. This was, of course, necessary. Ten Eyck v. Whitbeck, 156 N.Y. 341. Petitioner, witness for himself, never testified that he delivered any of the deeds, and none of the alleged grantees or others were witnesses. There is no presumption that the deeds were delivered. None of them was registered or filed with the public registry. But there is a more substantial ground for denying the contention of petitioner. Almost a year before any of these alleged deeds were executed, on November 24, 1926, the city of Yonkers commenced condemnation proceedings against this real estate in the hands of the petitioner and filed lis pendens, and the land was condemned for public use.

It is provided in the New York statutes that from the time of filing of the notice of the pendency of the action {lis pendens) it “ shall be constructive notice to a purchaser or incumbrancer of the property affected thereby * * * and a person whose conveyance or incumbrance is subsequently executed or subsequently recorded, is bound by all the proceedings taken in the proceeding after the filing o.f the notice, to the same extent as if he was a party thereto ” — McKinney’s Consolidated Laws of New York, Annotated, Book 9, A, sec. 13. From the time of the judgment of condemnation, November 24, 1926, petitioner’s claim to any interest in the real estate was limited to the collection of the award thereafter to be made; and when that award was paid, it had reference back to the filing of the Us pendens and annulled all intermediate conveyances or encumbrances. Apparently, petitioner understood the situation, or his adviser did, for none of the instruments relied on were filed for registration; and none of the parties intervened in the condemnation suit to claim any interest in the fund. At most, petitioner’s alleged conveyances were nothing more, under the circumstances, than promises to give to the parties certain interests in the proceeds of the award in the condemnation proceeding when he thereafter received the money. In that situation the money received was first income to him, though his promises were carried out and payments were made out of the award to his daughters and their husbands. J. D. Varnell, 28 B.T.A. 231; T. J. Primm, 28 B.T.A. 13.

If the deeds in question were valid and effective for the purpose contended for by petitioner, his claim that only one half of the $72,052.94 is taxable to him could not be sustained. The deeds are made expressly subject to encumbrances, and the grantees were not promised each 12% percent of one half of $72,052.94, the net profit on the deal to petitioner, but such percentage only after petitioner’s debts which were liens on the property had been canceled. These liens on the property amounted to $80,216.90, according to petitioner’s Exhibit 8, showing final accounting with the alleged grantees. Cancellation of his obligations, under the circumstances, could not be ignored in determining gain to petitioner on the transaction in question. We feel we must sustain the respondent on this issue, which we do.

Petitioner, in his pleading, maintained that the $11,891.24 interest on the award paid him by the city of Yonkers is not subject to income tax, because it was interest on an obligation of a political subdivision of a state. He frankly says, however, in the brief that this issue has been decided by the Board against his view in Mary Lincoln Isham, 26 B.T.A. 1040, and he merely wishes to preserve his rights pending the determination of the issue in the Circuit Court of Appeals. We sustain the respondent on this issue. D.S. Trust Co. v. Anderson, 65 Fed. (2d) 575; certiorari denied, 290 U.S. 683; John J. Bliss, 21 B.T.A. 803.

As shown in our findings of fact, at the time the award was paid to petitioner there was interest amounting to $3,452.16 accrued on the liens on the real estate condemned which petitioner paid out of the award, but for which he failed to claim deduction in his return for the year. In section 23 (b) of the Revenue Act of 1928 it is provided:

In computing net income there shall be allowed as deductions:
*******
(b) Interest. — All interest paid or accrued within the taxable year on indebtedness * * [Remainder of paragraph not material here.]

Petitioner having paid this interest on his indebtedness within the taxable year, we sustain petitioner on this issue.

Another issue raised on the pleadings was expressly abandoned by petitioner.

Judgment will be entered under Rule 50.


author: Marquette :

text:
    Ared Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 49978.
    Promulgated June 29, 1934.

      Robert N. Miller, Esq., George M, Wolcott, Esq., and Melvin D. Wilson, Esq., for the petitioner.

      M. B. Leming, Esq., for the respondent.
   OPINION.

Marquette :

The respondent has determined a deficiency in income tax for the year 1927 in the amount of $18,271.21. Several errors are assigned which, in the last analysis, resolve themselves into but one question, viz., What basis is petitioner entitled to use in determining the gain or loss upon the sale of certain stocks in 1927 ?

The facts were stipulated and the stipulation is made a part hereof.

It appears from the stipulation that petitioner is a dissolved corporation. It was organized on September 27, 1927, under the laws of Delaware, and dissolved on or about September 1, 1930.

A. E. Peat on and prior to September 12, 1927, was an officer of the Southern California Gras Co. and Midway Gas Co., and on that date had knowledge of negotiations pending whereby certain New York banks, acting for others, were planning to purchase all the common stock of the Southern California Gas Co. and Midway Gas Co. at prices which would net approximately the amounts shown below as the value of these stocks on October 8, 1927.

The Norwalk Corporation was organized under the laws of the State of Nevada on September 12, 1927. On that date there were transferred to it by A. E. Peat, for 1,000 shares of its capital stock, the following assets:

988 shares Southern California Gas Co. common stock having a par value of $25 per share, a cost to the transferor of $24,392, and a fair market value on September 12, 1927, of $129,675.
167 shares of Midway Gas Co. common stock having a par value of $100 per share, a cost to the transferor of $56,765.70, and a fair market value on September 12, 1927, of $86,665.
1,700 shares of Studebaker Corporation no par value common stock having a fair market value on September 12, 1927, of $104,550. Norwalk Corporation assumed liabilities of A. E. Peat to the amount of $175,617.50.

All shares of stock which were assigned by A. E. Peat to the Nor-walk Corporation for the 1,000 shares of its stock were acquired by A. E. Peat prior to July 29,1927, and he had the full interest therein and control thereof.

The stock of the Norwalk Corporation was, on October 8, 1927, owned and controlled as follows:

998 shares of common no par stock by A. E. Peat
1 share of common no par stock standing in the name of E. M. Peat
1 share of common no par stock standing in the name of L. M. Copple

The two shares of Norwalk Corporation stock issued in the names of E. M. Peat and L. M. Copple were endorsed back to A. E. Peat on September 12, 1927.

On September 27, 1927, petitioner issued 10 shares of its common stock as follows:

A. E. Peat_8 shares
E. M. Peat_1 share
L. M. Copple-1 share

A. E. Peat and E. M. Peat are husband and wife, and L. M. Copple is their daughter.

E. M. Peat took by assignment the original incorporator’s subscriptions for the 10 qualifying directors’ shares. She never paid for those shares, but upon the dissolution of the company the amount of the subscription was deducted from the distributive share of the assets.

On October 8, 1927, petitioner issued 350 shares of common stock and 150 shares of voting preferred stock to E. M. Peat, in consideration for the transfer to petitioner of securities having a fair market value of $122,000. Petitioner assumed an indebtedness of $73,144 against these securities. These 500 shares of petitioner’s stock, upon their receipt, became and thereafter remained the sole and separate property of E. M. Peat.

Thereafter, on October 8, 1927, petitioner issued 1,000 shares of common stock and 350, shares of voting preferred stock to the Nor-walk Corporation in consideration for the transfer by the Norwalk Corporation to petitioner of securities and cash having a fair market value on that date of $320,890. Petitioner assumed liabilities against these securities of $176,617.50. The values and bases to the transferor of the securities received, were as follows:

The total number of shares of stock of petitioner outstanding after the transaction described in this paragraph was 1,860.

The value of the stock issued by petitioner for the assets last above mentioned was $144,272.50. The preferred stock of petitioner had a par value of $100 per share; the common stock was without par value. Both classes of stock had equal voting rights.

Thereafter, in 1927, petitioners sold a portion of the securities as follows: 996 shares of Southern California Gas Co. common stock for $133,301.35; 167 shares of Midway Gas Co. common stock for $87,767.94. Petitioner reported a profit of $4.29.

It was determined in the deficiency notice that the sale of stocks referred to above resulted in a profit of $139,911.59, and it is agreed that, if petitioner is limited to the basis of the stock in the hands of the Norwalk Corporation, petitioner is taxable upon said sum of $139,911.59.

It is claimed by the respondent that no taxable gain was realized by A. E. Peat on the transfer by him of the Southern California Gas Co. and Midway Gas Co. stocks to the Norwalk Corporation, and that neither the Norwalk Corporation nor E. M. Peat (wife of A. E. Peat) derived any taxable gain on the transfers by them to the petitioner under section 203 (b) (4) of the Revenue Act of 1926. The basis of the property here in question in the hands of the Nor-walk Corporation was the same as it was in the hands of A. E. Peat, because after the exchange A. E. Peat was in control of the Norwalk Corporation. Secs. 204 (a)(8) and 203 (i). Osburn California Corp. v. Welch, 39 Fed. (2d) 41; certiorari denied, 282 U.S. 850; Perthur Holding Corp., 23 B.T.A. 1129; aff'd., 61 Fed. (2d) 785; certiorari denied, 288 U.S. 616; T. W. Phillips, Jr., Inc., 23 B.T.A., 1272; aff'd., 63 Fed. (2d) 101. The respondent insists, however, that the basis of the property in the hands of the petitioner is the same as it was in the hands of the Norwalk Corporation, and he relies upon section 204 (a) (8) of the Revenue Act of 1926. That subsection provides as follows:

If the property (other than stock or securities in a corporation a party to a reorganization) was acquired after December 31, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in paragraph (4) of subsection (b) of section 203 (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money in addition to such stock or securities), then the basis shall be the same as it would be in the hands of the transferor, increased! in the amount of gain or decreased in the amount of loss recognized to the trans-feror upon such transfer under the law applicable to the year in which the transfer was made.

Subsection (4) of section 203 (b) provides:

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.

“ Control ” is defined in section 203 (i) as follows:

As used in this section the term “ control ” means the ownership of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.

From the stipulated facts it appears that on October 8, 1927, the petitioner issued to E. M. Peat 350 shares of common stock and 150 shares of voting preferred stock in exchange for net assets of $48,856, and thereafter, on the same date, issued 1,000 shares of common stock and 350 shares of voting preferred stock to the Norwalk Corporation in exchange for net assets of $144,272.50. The total number of shares of stock of petitioner outstanding after these transfers was 1,860, including 10 directors’ qualifying shares which E. M. Peat took by assignment from the original incorporators. Both classes of stock issued by petitioner had equal voting rights.

It is claimed by petitioner that since the property sold was acquired from the Norwalk Corporation in a separate transaction and after the exchange the Norwalk Corporation was not in control of petitioner, the petitioner is entitled to use a new basis in determining-gain or loss upon the disposition of the property. The percentage of stock of the petitioner acquired by the Norwalk Corporation. through the exchange was 74.7029 and the percentage acquired by E. M. Peat through the exchange by her was 25.2971. The petitioner issued 1,850 shares in exchange for the properties in the proportion of 1,350 shares to the Norwalk Corporation and 500 shares to E. M. Peat, and the respective percentages were 72.9730 and 27.0270.

The basis provided by section 204 (a) (8), where property is acquired through the issuance of stock in connection with a transaction described in paragraph (4) of subsection (b) of section 203, including also cases where part of the consideration for the transfer of such property to the corporation was property or money in addition to such stock and securities, is the same as it would be in the hands of the transferors; and section 203 (b) (4) provides that no gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock and immediately after the exchange such person or persons are in control of the corporation. The statute further provides that in an exchange by two or more persons it shall apply only if the amount of stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange. Section 203 (i) defines control ” to mean the ownership of at least 80 percent of the voting stock and at least 80 percent of the total number of shares of all other classes of stock of the corporation.

In the recent case of American Compress & Warehouse Co. v. Bender, 70 Fed. (2d) 655, the court decided practically this same question. In that case the taxpayer was organized with a capital stock of 5,000 shares. It issued 2,280 of such shares to the Louisiana Co. in exchange for property having an appraised value of $228,000, and it also issued 2,720 of such shares to the Shreveport Co. in exchange for property having an appraised value of $272,000. In holding that under section 204 (a) (8) and section 203 (b) (4) of the Revenue Act of 1924 (which sections are identical with the same numbered sections in the 1926 Act) the taxpayer was required to use the same basis for depreciation as was used by the two transferor corporations, the court said in part:

It was contended in argument for the appellant that the transaction in question is different from the one provided for by the statute (Sec. 203 (b)(4)) by reason of the circumstance that the transferred property was not owned jointly or in common by the transferor corporations, each of which transferred to appellant property owned solely by it. The language of the just referred to provision indicates that the framers of it had in mind what frequently occurs in bringing a corporation into existence. It is by no means an unusual occurrence for a corporation to be a result of several separate owners of different properties associating themselves for the purpose of bringing about the creation of a corporation by severally subscribing for stock in the proposed corporation, each subscriber for stock agreeing to pay therefor by transferring to the corporation property solely owned by him at a valuation equal to the amount of stock subscribed for by him. To say the least, the language of the provision is consistent with the existence of an intention to make it applicable whether the property transferred by two or more persons to a corporation solely in exchange for stock of such corporation was owned jointly or in common by the transferors or consisted of separate parcels or groups of properties separately and solely owned by the several transferors, respectively. We think the contention under consideration is not sustainable.
The statute deals with a transaction whereby the relation of one or more persons to property is so changed that, upon their ceasing to be owners of that property they come into control of a corporation upon the latter becoming the owner of that property by the former owners thereof transferring it to that corporation solely in exchange for stocks of that corporation. The statute evidences a recognition that the transaction therein described effects a change in form, but not in substance, of the beneficial interests of the transferors in the transferred property. The transaction described in the statute lacks a distinguishing characteristic of a sale, in that, instead of the transaction having the effect of terminating or extinguishing the beneficial interests of the transferors in the transferred property, after the consummation of the transaction the transferors continue to be beneficially interested in the transferred property and have dominion over it by virtue of their control of the new corporate owner of it. Statutory consequences of the recognized continued existence of the beneficial interests of the transferors in the transferred property immediately alter the exchange of it for corporate stock is consummated are that the transaction does not make the parties to it liable for profits taxes, and does not give rise to a new basis for computing the deduction allowable to the transferee corporation for depletion or depreciation of the transferred property. Cortland Specialty Co. v. Commissioner of Internal Revenue, 60 Fed. (2d) 937; Pinellas Ice & Cold Storage Co. v. Commissioner of Internal Revenue, 57 Fed. (2d) 188. To attribute to the exchange now in question of property solely for corporate stock the effect of causing gain or loss to a party to that exchange, or of justifying the adoption of a new basis for computing depletion or depreciation of the transferred property, would involve an obvious disregard of substance and reality, as, immediately after the exchange was effected, the beneficial interests of the transferors in the transferred property remained in existence and unimpaired, being substantially the' same as they were before the exchange occurred, no third person then having acquired any beneficial interest in property which was a subject of the transfer. It is apparent that property owners do not gain or lose by transferring their properties solely in exchange for all the capital stock of a corporation brought into existence to take over that property where such stock is apportioned between the transferors in accordance with their respective beneficial interests in the transferred property.
* * * * # * ♦
Under the clear language of the statute the allowance to appellant for depletion or depreciation is governed by the same bases and rates as would have been applicable if the Louisiana and Shreveport Companies had not transferred their properties to the appellant solely in exchange for the latter’s stock. It appearing from the record that the appellant underpaid its taxes for the years in question, the ruling that appellant was not entitled to recover anything was not erroneous.

While the facts in the above case appear to bring it squarely within the provisions of section 204 (a) (7) rather than 204 (a) (8), the discussion by the court of the latter provision of the statute is illuminating and we adopt that construction as effectuating the intention of Congress. We therefore hold that the Case is not taken out of section 203 (b) (4) because of the fact that the property sold had been the separately owned property of the Norwalk Corporation and exchanged in a separate transaction.

Finally, was the amount of stock received by E. M. Peat and the Norwalk Corporation substantially in proportion to their respective interests in the properties prior to the exchange % We append below a table showing the respective percentages of stock and assets exchanged. It will be seen from this table that the value of the stock received by the Norwalk Corporation was approximately 1.73 percent less than its interest in the property prior to the exchange, and that the value of the stock received by E. M. Peat was the same percentage more than her interest in the property exchanged by her prior to that exchange. The statute requires that the stock received by each shall be substantially in proportion to the respective interests in the property prior to the exchange. This, of course, does not require that the proportionate interests shall be exact, but leaves the question of what is substantially proportionate to be decided in each case. We are of opinion, that in the present case a deviation of only 1.73 percent in each, exchange is not too much of a deviation from an exact proportion to require a holding that the amounts of stock received were not substantially in proportion to the respective interests prior to the transfer, and we so hold. Since the amount of stock acquired by E. M. Peat and the Norwalk Corporation was in excess of 80 percent of all the stock of the petitioner, they were in control of the petitioner under the provisions of section 203 (i) of the act. The exchanges, therefore, are within the provisions of section 203 (b) (4) of the Revenue Act of 1926, and under section 204 (a) (8) of that act the basis of the property in the hands of petitioner is the same as it was in the hands of the transferors.

Reviewed by the Board.

Judgment will be entered for the respondent.

       See the following table:


text:
    Estate of Philip McRae, Louise C. McRae, Executrix, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 32303.
    Promulgated June 29, 1934.

      Garey Van Fleet, Esq., for the petitioner.

      W. F. Wattles, Esq., and Bernard D. Dcmiels, Esq., for the respondent.
   opinion.

Seawell:

The respondent has determined a deficiency of $4,844 in estate tax on account of the estate of Philip McRae, who died July 12, 1925, at the age of 84. The issues are whether there should be included as a part of the gross estate of decedent (1) the full value of community property and (2) the value of certain rea] property, notes, and stock as transfers made in contemplation of death or intended to take effect in possession or enjoyment at or after death. The parties are in agreement as to the value of the property in dispute.

No evidence was offered concerning the first issue and it is not referred to in the petitioner’s brief. This Board and the courts have frequently held that the full value of community property of husband and wife, domiciled in California, the, state in which the decedent and his wife apparently were domiciled, must be returned in the gross estate of the deceased husband for estate tax purposes. Griffith, Henshaw, Executor, 12 B.T.A. 1441; aff'd., 31 Fed. (2d) 946; certiorari denied, 280 U.S. 565; Talcott v. United States, 23 Fed. (2d) 897; certiorari denied, 277 U.S. 604; Emma Melczer, Executrix, 23 B.T.A. 124; petition to review dismissed, 63 Fed. (2d) 1010. On this issue the respondent is sustained.

In determining the deficiency in dispute the respondent included as a part of the gross estate of - the decedent the following assets, on the ground that the property was transferred by the decedent in contemplation of death or intended to take effect in possession or enjoyment at or after death:

By deeds executed on February 16, 1915, the decedent conveyed to his wife, the petitioner here as executrix of his estate, and his daughter Katherine C. McRae, now Mrs. Empey Robinson, respectively, as gifts, the ranch and lots referred to above as items 1 and 2 and the lots referred to in item 8. The respective grantees promptly placed the instruments of conveyance in a joint safe-deposit box of the grantor and his wife, where they remained until placed on record March 28, 1925.

During all of their married life the decedent and his wife maintained a joint checking account. All of the earnings of the decedent and the income derived from the operation of the ranch before and after February 16, 1915, were deposited in the joint account. The decedent delivered to his daughter Katherine the proceeds derived from the sale of walnuts grown on the lots conveyed to her.

The ranch was sold in 1921 on the installment basis. The first installment payment, amounting to $20,000, was invested in notes of the Hanford Water Co., Hanford, California, of which the decedent had been a director for many years. In about 1923 other payments made under the contract of sale were invested in stock of the Pacific Gas & Electric Co. and the. Union Oil Co. The decedent delivered the notes and stock to his wife, who deposited them in the joint safe-deposit box with the deeds.

The uncontradicted testimony is that at all times important here the decedent was actively engaged in serving as a director of several corporations and looking after extensive business interests; that he traveled considerably; that he had no organic disease of any kind; that he was a vigorous man for his age; and that he was always cheerful, never depressed. His excellent health continued until about July 1, 1925, when, while on a visit at the home of his daughter, he suffered a cerebral hemorrhage* which caused his death about two weeks later. The last will and testament of the decedent was executed in 1903, a considerable period prior to the time the transfers in question were made. The transfers were not testamentary in character and were not made in contemplation of death. United States v. Wells, 283 U.S. 102.

In 1892 the decedent promised his wife to give her the ranch if she would locate in California with him, and on several occasions prior to the execution of the deed therefor, he informed his daughter of his intention to give her the lots. After the deeds were executed and delivered the decedent frequently referred to the properties as belonging to his wife and daughter, respectively. The intention to give and the delivery of the deeds is satisfactorily proved by the evidence. Clearly there was an acceptance, for the deeds were held by the respective grantees for about ten years and then placed on record. The gifts were complete when the deeds were accepted Sullivan v. Hess, 203 Cal. 165; 263 Pac. 220; McCarthy v. Security Trust & Savings Bank, 188 Cal. 229; 204 Pac. 818; Ruiz v. Dow, 113 Cal. 490; 45 Pac. 867; Frank G. Williams et al., Executors, 25 B.T.A. 1078. The fact that the decedent paid taxes on the lots conveyed to his daughter is not important. McCarthy v. Security Trust & Savings Bank, supra. Any enjoyment the decedent may have had of the property thereafter was wholly at the sufferance of the grantees.

There was some discussion between the decedent and his wife concerning the purchase of the notes and stock with funds derived from the sale of the ranch, and from her testimony it appears that she was present at the time the stock of the Pacific Gas & Electric Co. was bought. The notes and stock of the Pacific Gas & Electric Co. were issued in favor of the decedent for reasons not explained in the record. The evidence does not show to whom the Union Oil Co. stock was issued. Counsel for the petitioner sought to prove by oral testimony of Mrs. McEae and her son-in-law, who assisted her in administering the estate, that the decedent endorsed all of the securities to his wife. We declined to receive such offer of proof of the fact in the absence of a showing that the notes and stock certificates, the best evidence on the point, could not be produced. Thus there is no proof that the decedent did not have absolute title to all of the securities at the time of his death. Under the circumstances, we find no error on the part of the respondent in including as a part of the decedent’s gross estate the notes and stock at the values set forth above.

Keviewed by the Board.

Decision will he entered under Rule SO.


author: McMahon :

text:
    International Educational Publishing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 46778.
    Promulgated June 29, 1934.

      Fred'eriok L. Pearce, Esq., and J.F.W. EeinboJcél, O.P.A., for the petitioner.

      James L. Polls, Esq., and Harold F. Noneman, Esq., for the respondent.
   OPINION.

McMahon :

This proceeding involves the redetermination of a deficiency in income tax for the calendar year 1927 in the amount of $5,978.02. The issue presented is whether petitioner sustained a deductible loss in 1927.

The petitioner is a corporation, with its principal office in Scranton, Pennsylvania. Its business is the sale by mail ■ of technical and commercial courses of study, commonly known as the International Correspondence School courses.

The International Correspondence Schools originated in 1890 or 1891, growing out of a need for educating the anthracite coal miners in Pennsylvania. The success of the initial course, that for mine foremen, so encouraged the founder of the school, T. J. Foster, that additional courses were added from time to time until the school was teaching several hundred courses, the total cost of development thereof being approximately $4,500,000. The courses proved to be very popular, about 1,000 students being enrolled by the end of the first year, and this enrollment was doubled during the second year, with continually increasing enrollments thereafter.' In 1897 Foster discontinued the mail order plan of selling the correspondence school courses and employed salesmen on a commission basis. During 1898 and 1899 there was a considerable increase in enrollments and by 1900 the average yearly enrollments had grown to approximately 100,000 scholarships a year. Early in its existence the International Correspondence Schools began enrolling students in the other English-speaking countries and it had representatives throughout Canada, New Zealand, and Australia. Immediately after the war between Spain and the United States, schools were established in the Philippines, and later, owing to the amount of business in Spanish-speaking countries, the correspondence school textbooks were translated into Spanish.

By 1908 the business of the International Textbook Co. had become so large, the enrollment for that year being approximately 132,000 students, that Foster decided that some organization would have to be created to attend to the foreign business of the International Correspondence School.

The International Educational Publishing Co., the petitioner herein, was created in or about 1908 for the purpose of developing the foreign business of the International Textbook Co., the company that was sponsoring the correspondence school courses. (The precise business relationship between the International Textbook Co. and others, besides petitioner, interested in International courses is not shown by the record.) The petitioner obtained concessions from the Textbook Co. for privileges to use their textbooks and materials in virtually all parts of the world except the United States and Canada. It first acquired the territorial rights to Great Britain and her colonies in 1908 or 1909; next, territorial rights to the Spanish-speaking countries in 1909; and in 1910 it acquired territorial rights to other European countries, to Africa, and to Russia.

Petitioner’s foreign activities were handled largely from its London offices, which covered the British Empire, including Great Britain, Ireland, the British Commonwealths and Dominions, Egypt, Malay, India, Ceylon, South Africa, Australia, Siam, and New Zealand. The London office gave particular attention to the hiring and training of representatives and salesmen for selling the courses. In addition the office staff was constantly endeavoring to increase the work of the schools and the registration of new students, and to promote generally the correspondence school courses throughout the Empire. At one time the petitioner had over 100 branch offices in Great Britain, Ireland, Scotland, and Wales. It had offices in India, Singapore, Egypt, and South Africa, and many offices in Australia, New Zealand, and other parts of the British commonwealth and dominion. Petitioner’s enrollment in Great Britain alone has amounted to over 200,000 students in one year. The experience of the petitioner in the Far East, particularly in India and Singapore, encouraged the London office to suggest to the home office at Scranton, Pennsylvania, prior to 1911, that it would welcome the addition of the Chinese and Japanese territories.

On or about March 14, 1911, the petitioner acquired the territorial rights to China and Japan in exchange for 20,000 shares of its preferred stock and 50,000 shares of its common stock, the par value of each class of stock being $50 per share. At the time petitioner was negotiating for the acquisition of these rights it had the option of purchasing the rights to either country separately for 10,000 shares of preferred and 25,000 shares of common, but after considering their success in selling the correspondence courses elsewhere, it determined to and did acquire the rights to both countries. The instrument evidencing the agreement between the petitioner and the International Textbook Co., which sets forth the terms and conditions under which petitioner was to exploit its territorial rights in these countries, was received in evidence and is incorporated herein by reference (Exhibit 2).

The International Textbook Co. was a stockholder of the petitioner prior to and at the time the aforementioned transaction respecting the Chinese and Japanése territorial rights occurred. Its stockholdings of the petitioner at December 31, 1910, consisted of 31,614 shares of petitioner’s preferred stock and 56,30T shares of common. Each class of petitioner’s capital stock had equal voting rights and on December 31, 1910, the Textbook Co. held a total of 87,921 shares of the petitioner’s total outstanding stock, which consisted of 120,000 shares of preferred and 100,500 shares of common.

On February 27, 1911, the petitioner sold 30,000 shares of its preferred stock to the Textbook Co. for cash at $50 per share, less a 15 percent selling commission. During the calendar year 1911 the Textbook Co., by means of its own sales’ organization, sold stock of the petitioner throughout the country. Units of one share of preferred stock and one half a share of common stock were sold at $50 per unit, but no preferred stock was sold separately during 1911 by the Textbook Co. for less than $50 per share, and no common stock was sold separately for less than $20 per share. However, preferred and common stocks were sold separately through stock exchange brokers at prices ranging from $37 to $50 per share for preferred, and $15 to $23 per share for common. During 1911 the Textbook Co. sold 46,614 shares of petitioner’s preferred stock and 17,625 shares of its common stock. The selling cost approximated 13y2 or 14 percent, so that the Textbook Co. realized a profit on the resale of the 30,000 shares of preferred stock which it purchased on February 27, 1911.

On December 31, 1911, the Textbook Co. owned 35,000 shares of petitioner’s preferred stock and 88,682 shares of its common stock out of petitioner’s total outstanding issue of 170,000 shares of preferred and 150,500 shares of common.

The Japanese and Chinese territorial rights were entered upon petitioner’s books by a journal entry dated March 14, 1911, in the amount of the par values of the preferred and common stocks, that is, $1,000,000 for preferred and $2,500,000 for common, less an item of $30,595.42 representing miscellaneous accounts of the Textbook Co. which were transferred to the petitioner by the agreement of March 14, 1911.

Practically no attention was paid to China and Japan by the petitioner during the period 1911 to 1923, because its principal activities were devoted to the English and Spanish-speaking countries, and because the World War disrupted its foreign business. During this interval, petitioner’s representative in these two countries was an agent at Shanghai, China, who enrolled new students on a commission basis.

Beginning in 1923 more attention was given to Japan and China, partly, no doubt, because of a verbal offer made in April 1923 by a group of men who proposed to organize a Japanese corporation with capital of 1,000,000 yen. These men proposed to issue 40 percent of the Japanese corporation’s capital stock to the petitioner in exchange for the right to use its texts and courses in Japan, to issue 40 percent of the capital stock in Japan for cash, and to give the remaining 20 percent of the capital stock to the promoters in payment for their services.

The petitioner’s general sales manager, C. J. Sabiston, who later became its president, made a trip to Japan in September 1923 to investigate the above offer, but due to the Japanese earthquake, which had just occurred, he found it impossible to reach Tokyo. Continuing to Shanghai, he reorganized the office of the petitioner in that city, replacing the commission agent with a salaried manager who took over the Shanghai office on or about May 1, 1924. In June 1924 Sabiston returned to Japan to further investigate the aforesaid proposal, and as a result of his investigations he recommended to petitioner’s board of directors that the offer be declined, and that petitioner itself proceed with the development of the Japanese territory. Accordingly, petitioner rejected the offer, and in 1925 Sabiston made a third trip to Japan in connection with the development of petitioner’s business in that territory. At that time he gave instructions to petitioner’s local manager that a comprehensive survey of Japan should be made at the earliest opportunity for the purpose of determining whether petitioner should invest additional capital in the development of the territory.

This survey was made in 1927, and as a result thereof petitioner’s Japanese manager recommended that petitioner invest additional capital in Japan, that it engage in an advertising campaign, that it appoint representatives in various parts of the country, and that it intensify its activities to secure additiona.1 students. At the time these recommendations were -made, petitioner was securing only one or two enrollments per month from Japan, and petitioner’s officers believed that the adoption of its manager’s recommendations would result in additional monthly enrollments of 70 to 90 new students. Accordingly, Sabiston instructed the manager to advertise in the various English-speaking newspapers, inviting applicants of English-speaking Japanese to represent the petitioner in Japan, and late in 1927 he made his fourth trip to. Japan for the purpose of interviewing applicants. These interviews were held in Tokyo and Kobe, but the applicants proved to. be unsatisfactory, or were not interested when informed of what the petitioner woujd expect from them.

In April 1927 Seiti Hirota, a director and professor in. the Kobe Technical College, visited various educational institutions in the United States and, among others, visited' petitioner’s home offices in Scranton. In the course of his visit he confessed to Sabiston that he had been a student of the International Correspondence School and at the same time admitted that he had enrolled under an assumed name. Upon checking the records Sabiston found that such a student had actually been enrolled from Tokyo, Japan.

While in Kobe interviewing the various applicants, Sabiston accepted Hirota’s invitation to visit the Kobe Technical College and discovered that that college was using the International Correspondence School’s textbooks in teaching its class on electrical engineering. Sabiston’s objections that such use was unauthorized and in direct violation of Hirota’s contract, which might result in legal action being taken against him, were met by Hirota’s good natured reply “ go ahead and take it.”

Sabiston immediately consulted an American Lawyer in- Kobe, who informed him that, while petitioner might seek a remedy in court, he advised against a lawsuit. seeking protection under its students’ contracts. Returning to Shanghai, Sabiston consulted petitioner’s counsel in that city, who was also the United States Commissioner in China. The Commissioner was one of the leading attorneys in Shanghai and had been in the Orient for many years. He investigated the Japanese law for Sabiston and advised him to the same effect as had the attorney in Kobe. Upon receipt of this information, Sabiston who had been authorized by petitioner’s board of directors to take whatever steps necessary in developing the Japanese territory, determined that no further efforts would be made to extend petitioner’s business in Japan. He announced his decision to counsel in Shanghai, instructed the local manager to make no efforts whatever to do any more business in Japan, and wrote the comptroller of the company in Scranton advising him what action he had taken and instructing him to write off of petitioner’s books the cost of the Japanese rights. This letter was mailed late in November or early in December 1927, but it is not shown when the comptroller received the letter. Sabiston had full authority from the directors of the petitioner before leaving on this trip to investigate and decide in respect to the extension of the work in Japan, or to decide whether to abandon the territory.

Pursuant to Sabiston’s instructions the petitioner charged off one half of the total cost of the Japanese and Chinese rights, amounting to $1,750,000, by a journal entry dated December 31, 1927.

Petitioner had been securing enrollments from Japan regularly but after the Japanese earthquake, and particularly after the resentment caused in Japan by the Exclusion Act of July 1924, the number of enrollments dropped considerably.

David J. Gray, comptroller and vice president of the petitioner, made a search for any records which the petitioner might have from which a segregation could be made of the number of the students enrolled in Japan and China. However, he found none, since all the students were carried under the one heading Chinese Agency.” He did find one statement, which was for the fiscal year ended April 30, 1919, which showed that 27 new enrollments were made in Japan in that year.

On its income tax return for 1927 the petitioner claimed a deduction of $805,000, representing an alleged loss sustained by the abandonment of its Japanese territorial rights. The respondent refused to allow any part of the alleged loss, upon the theory that “ the operations in Japan had always shown a loss and from this it would appear that Japanese rights had no value at any time. It has not been shown wherein conditions changed in 1927 which made the rights worthless in that year, neither has an equitable basis for the allocation of the cost of the Japanese rights been presented.”

Petitioner has arrived at the loss sustained as a result of its alleged abandonment of the Japanese territorial rights by assuming that one half of the stock issued for the Japanese and Chinese rights was allocable to the rights to Japan, and that the fair market value of such stock was $380,000 for preferred, at $38 per share, and $437,500 for common, at $17.50 per share. From the sum thereof, $817,500, petitioner deducted one half of the accounts receivable, inventories, and miscellaneous items, amounting to $15,297.71 (one half of $30,595.42), thereby arriving at the sum of $802,202.29 which it contends is the cost of the Japanese territorial rights on March 14, 1911, and the amount of the loss sustained in 1927.

The loss in question is grounded on the provisions of section 234 (a) (4) of the Kevenue Act of 1926, which reads as follows:

Sec. 234. (a) In computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise *. * ». The basis for determining the amount of the deduction for losses sustained shall be the same as is provided in section 204 for determining the gain or loss from the sale or other disposition of property.

Section 204 (b) provides:

The basis for determining the gain or loss from the sale or other disposition of property acquired before March 1, 1913, shall be (A) the cost of such property * * * or (B) the fair market value of such property as of March 1, 1913, whichever is greater.

The petitioner contends that it has sustained a deductible loss under the above sections because it abandoned, during 1927, its territorial rights in Japan. The respondent’s holding that the petitioner did not sustain a deductible loss in 1927 upon its investment in its Japanese territorial rights is prima facie correct, and the burden in this proceeding is upon the petitioner to overcome the presumption in favor of the respondent’s determination. We are not satisfied that the petitioner has met its burden. The respondent disallowed the deduction partly upon the theory that the operations in Japan had always shown a loss, that the Japanese rights had no value at any time, and that there was no showing that conditions changed in 1927 which made the rights worthless in that year. There is no adequate showing that this holding of the respondent is not correct.

In the first place there is some doubt as to whether the rights in question were worthless in the year 1927. T. J. Foster, who was president of the International Correspondence School until 1916, testified that there was nothing done to develop the business in Japan between 1911 and 1916, the period of his connection with the company. There was practically nothing done in this respect previous to 1924. Previous to that year petitioner was absorbed in developing its business elsewhere. He also testified that, generally speaking, petitioner’s business was susceptible of successful and profitable development everywhere in the world. Furthermore, it is to be noted that in 1927 petitioner’s Japanese manager, after a survey of the territory, recommended that petitioner invest additional capital in Japan, that it engage in an advertising campaign, and that it intensify its activities to secure additional students. This indicates that in the manager’s opinion the rights were still valuable in 1927. However, assuming for the purpose of argument, but not deciding, that the rights were worthless in 1927, there is no showing that such rights became worthless in the year 1927. We can not determine from the evidence that any identifiable event transpired in 1927 giving rise to a loss upon these rights. Losses are allowable as deductions only when fixed by identifiable events. See United States v. White Dented Mfg. Co., 274 U. S. 398, and Charles O. Middleton, 25 B.T.A. 484, 487.

The petitioner acquired the territorial rights to Japan on March 14, 1911, for stock. Up to 1923 no attention was paid by the petitioner to the development of its business in Japan. Its agent for Japan was stationed at Shanghai, China. The evidence shows that, beginning in 1923, more attention was given to the development of business in Japan. In 1927 the petitioner was securing only one or two enrollments per month in Japan, but there is no evidence upon which we can determine that the situation with regard to the enrollment of students in Japan became worse in 1927 than it was in prior years. The evidence which we do have before us tends to indicate that there was very little change, if any, in the number of enrollments. The evidence shows that there were 27 new enrollments in Japan in the fiscal year ended April 30,1919, and the evidence shows that thereafter, after the Japanese earthquake, and particularly after the resentment caused in Japan by the Exclusion Act of July 1924, the number of enrollments dropped very considerably.

It is true that in 1927 Sabiston, for the first time, learned that the Kobe Technical College was using the International Correspondence School’s textbooks in teaching its class on electrical engineering and that the petitioner probably could obtain no redress in the Japanese courts. This, it is claimed by the petitioner, influenced it to abandon the rights and forms the basis for the deduction of a loss in this regard. It is to be noted in this connection that when Sabiston made his trip to Japan in 1927 he was fortified with authority to abandon the territory if he saw fit. This indicates that even before learning of the use of the textbooks by the Kobe Technical College there was some idea of the possibility of abandoning the rights in that territory. However, even if the. use of its textbooks by the college were considered such an event as might establish a loss to the petitioner, there is no showing as to when that college commenced to use the books. Losses are deductible in the year in which actually sustained and not in the year in which the loss is ascertained by the taxpayer. Charles O. Middleton, sufra. The very fact that the petitioner could not obtain redress for any violation of its rights in Japan tends to indicate that the holding of the respondent that such rights had the same value all the while is correct. If one college could use the books with immunity, any number of others might. T. J. Foster testified that the company never made inquiries as to whether the Japanese law gave the company protection similar to that afforded by the copyright laws of the United States, but that if the company had translated its books into the Japanese language it could have probably gotten copyrights. This indicates that during the whole time that the petitioner was operating in Japan it was subject to the hazard that other organizations might have pursued the same policy as the Kobe Technical College, and tends to sustain the respondent’s holding that nothing transpired in this regard to render the rights worthless in 1927.

To permit the petitioner to deduct a loss in 1927 simply because it decided to charge the rights off its books in that year and actually charged them off in that year would be to allow the petitioner the right to choose the year in which to take the deduction. This, we believe, was not the intention of Congress in enacting the statute. The decision to charge off and the actual charge-off must bear some reasonable relation to the time when the property became worthless. In Celluloid Co., 9 B.T.A. 989, 1004, we stated: A. discontinuance of the use of machinery alone does not prove a loss in respect of the machinery. In Baltimore County Jeffersonian Printing & Publishing Co., 8 B.T.A. 941, we stated:

The action of the respondent in disallowing the cost of the “ New Era ” as a loss sustained and charged off in the taxable year is approved. Upon the evidence, assuming that the frarchase in question resulted in the loss claimed, it is clear that such loss was not sustained in-1922. The “New Era” was acquired in November of 1921, and its publication as a newspaper was discontinued after only one or two issues. It is also in evidence that the petitioner still retains the ownership and right to publish the “ New Era.” In fact it now owns everything that it purchased from the New Era Publishing Co. and the fact that it (Discontinued, the issue of the “ New Era is not in itself sufficient to convince us that the property acquired became worthless in the tamable year. [Emphasis supplied.]

It is to be noted in the instant proceeding that there is no showing that the petitioner actually canceled or surrendered its contract with the Textbook Co., which granted it the territorial rights in question, or that it in any way relinquished such contractual rights as between it and the Textbook Co. Apparently the petitioner still has all of the rights which it obtained from the Textbook Co. and simply ceased to exercise such rights. Under the above authorities this is not sufficient to show that the rights became worthless in 1927. It is true, of course, that a loss may become complete enough for deduction without the taxpayer’s establishing that there is no possibility for eventual recoupment, Wheeling Tile Co. v. Commissioner, 25 Fed. (2d) 455, but from the record here we are not satisfied that there was an intention to abandon coupled with an abandonment of the rights in question in the year 1927. The evidence here does not satisfy us that the petitioner was reasonably justified in concluding, if it did conclude, that the rights became worthless in 1927.

In the view we have taken it is unnecessary to consider the question of the basis to be used in computing the loss on the rights in question.

The respondent’s determination is approved.

Reviewed by the Board.

Decision will be entered for the respondent.

Tkammell dissents.