author: Smith:

text:
    The Manufacturers Life Insurance Company, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 90845.
    Promulgated March 12, 1941.

      John, W. Townsend, Esq., for the petitioner.

      William A. Schmitt, Esq., for the respondent.
   OPINION.

Smith:

This proceeding involves deficiencies in income tax of $9,795.01 for 1932, $9,917.78 for 1933, and $10,458.40 for 1934. Some of the issues raised in the pleadings have been settled by stipulation. The remaining issues will be stated and discussed separately below. The parties have submitted a written stipulation of the essential facts in all of the issues.

The petitioner is a life insurance company, organized under the laws of the Dominion of Canada, with its principal office at Toronto, Ontario, Canada. It transacts business in several states of the United States as well as in Canada. It filed income tax returns for the calendar years 1932, 1933, and 1934 with the collector of internal revenue at Detroit, Michigan. Such returns were made on the cash receipts and disbursements basis.

The following provisions of sections 201, 202, and 203 of the Revenue Acts of 1932 and 1934 are involved:

SEC. 2 01. TAX ON LUTE INSURANCE COMPANIES.
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(b) Rate op Tax. — In lieu of the tax imposed by section 13, there shall be levied, collected, and paid for each taxable year upon the net income of every life insurance company a tax as follows:
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(2) In the case of a foreign life insurance company, 13% per centum of it* net income from sources within the United States.
SEC. 202. GROSS INCOME OF UFE INSURANCE COMPANIES.
(a) In the case of a life insurance company the term “gross income” means the gross amount of income received during the taxable year from interest, dividends, and rents.
SEC. 203. NET INCOME OF LIFE INSURANCE COMPANIES.
(а) General Rule. — In ttie case of a life insurance company the term “net income” means the gross income less—
(1) Tax-free interest. — The amount of interest received during the taxable year which under section 22 (b) is exempt from the taxes imposed by this title;
(2) Reserve funds. — An amount equal to 4 per centum of the’ mean of the reserve funds required by law and held at the beginning and end of the taxable year, except that in the case of any such reserve fund which is computed at a lower interest assumption rate, the rate of 3% per centum shall be substituted for 4 per centum. Life insurance companies issuing policies covering life, health, and accident insurance combined in one policy issued on the weekly premium payment plan, continuing for life and not subject to cancellation, shall be allowed, in addition to the above, a deduction of 3% per centum of the mean of such reserve funds (not required by law) held at the beginning and end of the taxable year, as the Commissioner finds to be necessary for the protection of the holders of such'policies only;
(3) Dividends. — The amount received as dividends (A) from a domestic corporation which is subject to taxation under this title, other than a corporation entitled to the benefits of section 251, and other than a corporation organized under the China Trade Act, 1922, or (B) from any foreign corporation when it is shown to the satisfaction of the Commissioner that more than 50 per centum of the gross income of such foreign corporation for the three-year period ending, with the close of its taxable year preceding the declaration of such dividends (or for such part of such period as the foreign corporation has been in existence) was derived from sources within the United States as determined under section 119;
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(5)Investment expenses. — Investment expenses paid during the taxable year: Provided, That if any general expenses are in part assigned to or included in the investment expenses, the total deduction under this paragraph shall not exceed one-fourth of 1 per centum of the book value of the mean of the invested assets held at the beginning and end of the taxable year;
(б) Real estate expenses. — Taxes and other expenses paid during the taxable year exclusively upon or with respect to the real estate owned by the company, * * *
(7) Depreciation. — A reasonable allowance for the exhaustion, wear and tear of property, including a reasonable allowance for obsolescence; and
(8) Interest. — All interest paid or accrued within the taxable year on its indebtedness, except on indebtedness incurred or continued to purchase or carry obligations or securities (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from taxation under this title.
(b) Rental Value of Real Estate. — The deduction under subsection (a) (6) or (7) of this section on account of any real estate owned and occupied in whole or in part by a life insurance company, shall be limited to an amount which bears the same ratio to such deduction (computed without regard to .this subsection) as the rental value of the space not so occupied bears to the rental value of the entire property.
(c) Poeeign Life Insurance Companies. — In the case of a foreign life insurance company the amount of its net income for any taxable year from sources within the United States shall be the same proportion of its net income for the. taxable year from sources within and without the United States, which the reserve funds required by law and held by it at the end of the taxable year upon business transacted within the United States is of the reserve funds held by it at the end of the taxable year upon all business transacted.

1. Our first question is whether in determining petitioner’s net taxable income under sections 202 and 203 of the Bevenue Acts of 1932 and 1934 the tax-free interest from obligations of the United States and tax-free dividends from domestic corporations are deductible from gross income from all sources (world-wide income) or from the income from sources within the United States only; and whether, if the statute is construed as requiring the deduction of such interest and dividends from world-wide gross income, it is constitutional.

In computing petitioner’s taxable income for the years 1932,1933, and 1934 the respondent first determined the net income by including in gross income the items of interest, dividends, and rents, as provided in section 202 (a) above, and deducted therefrom the items allowable under section 203 (a), including tax-free interest and dividends. He then determined the amount of the petitioner’s net income from sources within the United States, on which the tax is levied, under section 201 (b) (2) by the use of proportional factors based on the percentages of reserves for its foreign and domestic business as provided in section 203 (c).

The petitioner’s contentions are that its tax-free interest and dividends should be deducted solely from its income from sources within the United States rather than from its “world-wide” income. This would, of course, materially reduce the amount of petitioner’s taxable income since it would permit the deduction of all of the tax-free interest and dividends from an already partially determined net income, that is, the income arrived at after deducting from gross income all of the allowable items except such interest and dividends and then applying the percentage of reserves formula.

The gist of petitioner’s argument is that the statute as construed and applied by the respondent discriminates against foreign life insurance companies to the advantage of domestic life insurance companies.

Petitioner’s contention, as far as we know, is a novel one. No case in which the question has been decided is called to our attention, and we know of none.

The most obvious and at the same time the most convincing objection to the method of computation urged by the petitioner is that it is not the method prescribed by the statute. The relative merits of the two methods is a matter which addresses itself to the lawmakers rather than to us.

The statute under consideration is not ambiguous. It provides a complete plan for taxing life insurance companies, both domestic and foreign, differing in many respects from that under which other taxpayers are taxed. The items of gross income as well as those deductible in computing net income are specific and limited. No distinction is made between domestic and foreign companies either as to the gross income or net income. In the case of a foreign life insurance company, after computation of the net income in accordance with section 203 (a) and (b) the net income from sources within the United States, on which the tax is levied, is determined by application of the percentage of reserves formula as provided in section 203 (c). The respondent has applied the statute literally in determining the petitioner’s tax liability for the years involved. The petitioner’s complaint lies with the substance of the statute rather than with the method of its administration.

This brings us to petitioner’s alternative contention that the statute, as construed by the respondent, is violative of the Fifth Amendment and therefore unconstitutional.

Even assuming that the statute discriminates against foreign life insurance companies in favor of domestic companies, which, we may say, is not evident from the facts in the instant case, this would not constitute any infringement of petitioner’s rights under the Fifth Amendment. The Supreme Court has held in a number of cases that to be violative of the Fifth Amendment the taxing statute must be so arbitrary and capricious as to result in the confiscation of property rather than the levying of a tax. Knowlton v. Moore, 178 U. S. 41; Brushaber v. Union Pacific Railroad Co., 240 U. S. 1; Nichols v. Coolidge, 274 U. S. 531; Tyler v. United States; 281 U. S. 497; Heiner v. Donnan, 285 U. S. 312.

In Veazie Bank v. Fenno (75 U. S.), 8 Wall. 533, 548, it was said that “if a particular tax bears heavily upon a corporation, or a class of corporations, it cannot, for that reason only, be pronounced contrary to the Constitution.”

In Mager v. Grima (49 U. S.), 8 How. 490, the Court said with reference to a tax levied by the State of Louisiana: “We can see no objection to such a tax, whether imposed on citizens and aliens alike, or upon the latter exclusively.” See also McCray v. United States, 195 U. S. 27; Flint v. Stone Tracy Co., 220 U. S. 107; Steward Mach. Co. v. Davis, 301 U. S. 548; Ashwander v. Tennessee Valley Authority, 297 U. S. 288.

In Steward Mach. Co. v. Davis, supra, the Court said:

The Fifth Amendment unlike the Fourteenth has no equal protection clause. LaBelle Iron Works v. United States, supra [256 U. S. 377] ; Brushaber v. Union Pacific R.R. Co., supra, * * * But even the states, though subject to such a clause, are not confined to a formula of rigid uniformity in framing measures of taxation. Swiss Oil Corporation v. Shanks, 273 U. S. 407 * * *. They may tax some kinds of property at one rate, and others at another, and exempt others altogether. [Citing cases.] They may lay an excise on the operations of a particular kind of business, and exempt some other kind of business closely akin thereto. [Citing cases.] If this latitude of judgment is lawful for the states, it is lawful, a fortiori, in legislation by the Congress, which is subject to restraints less narrow and confining. Quong Wing v. Kirkendall, supra, [223 U. S. 69].

The petitioner’s contention that the statute in question as construed and applied by the respondent is unconstitutional is not sustained.

2. Is the petitioner entitled to a deduction under section 203 (a) (2) of the 1932 and 1934 Acts on account of reserves held to liquidate future unaccrued and contingent liabilities under permanent total disability provisions of ■ life insurance policies, in respect of benefits that may become payable, if disability continues, to policyholders disabled at the date of the reserve computation?

The facts regarding the reserves in controversy have been fully set forth in the stipulation and need not be stated here. For our present purpose it suffices to say, as the respondent concedes in his brief, that these reserves are of the same type as the reserves which were under consideration in Equitable Life Assurance Society of the United States, 33 B. T. A. 708; Monarch Life Insurance Co., 38 B. T. A. 716; affd. (C. C. A., 1st Cir.), 114 Fed. (2d) 314; Pan-American Life Insurance Co., 38 B. T. A. 1430; affd. (C. C. A., 5th Cir.), 111 Fed. (2d) 366; affd., 311 U. S. 272; and Oregon Mutual Life Insurance Co. (C. C. A., 9th Cir.), 112 Fed. (2d) 468; affd., 311 U. S. 267. The view taken by the Board and the courts in the cited cases to the effect that the reserves in question are reserve funds required by law within the meaning of section 203 (a) (2) of the Bevenue Acts of 1932 and 1934 was affirmed by the Supreme Court in the recent case of Helvering v. Oregon Mutual Life Insurance Co., supra. On authority of that case, and of the other cases referred to, this issue is determined in favor of the petitioner.

3. Should there be included in petitioner’s gross income the accrued interest on mortgage loans on real estate voluntarily deeded to the petitioner, mortgagee, in lieu of foreclosure proceedings, where value of the property was (1) less than the principal amount of the loan and charges, and (2) less than the principal amount of the loan «and charges plus accrued interest ?

During 1932, 1933, and 1934, the petitioner acquired certain real estate upon which it held mortgages as security for loans and advances theretofore made and then in default. The properties were voluntarily deeded to the petitioner in lieu of the institution of foreclosure proceedings. During 1932 six parcels of property were so deeded to the petitioner. In one case the value of the property at the date the deed was given was less than the principal and charges. In the other five cases the value of the property was in excess of tbe principal and charges but not in excess of the principal and charges and accrued interest.

During 1933 the owners deeded six parcels of land to the petitioner under like circumstances. In two cases the value of the property at the date of the deed was less than principal and charges and in the other four cases the value of the property was less than the principal and charges and accrued interest.

During 1934 the owners of 30 parcels of property deeded the mortgaged property to the petitioner under like circumstances. In 11 cases the value of the property at the date of the deed was less than principal and charges and in the other 19 cases the value was less than the principal and charges plus accrued interest.

The petitioner, making its returns on a cash receipts and disbursements basis, did not report any of the amounts of accrued interest in its returns. In determining the deficiencies herein the respondent has added to petitioner’s income all of the interest accrued on the mortgage loans at the time the properties were acquired by the petitioner, amounting to $14,837.06 in 1932, $26,845.49 in 1933, and $77,630.87 in 1934. The petitioner now concedes that it is taxable on a portion of such interest, that is, to the extent that the value of each parcel of real estate exceeded the principal amount of the loan and charges against it. It contends, however, that it is not chargeable with any interest over and above such excess value, if any. The accrued aggregate interest in the transactions referred to above exceeded such excess values by the amounts of $2,846.02 in 1932, $7,619.88 in 1933, and $46,601.98 in 1934. Those are the amounts which the petitioner now contends were erroneously included in taxable income.

The petitioner’s contentions are in line with the decision of the United States Circuit Court of Appeals for the Eighth Circuit in Helvering v. Missouri State Life Insurance Co., 78 Fed. (2d) 778, reversing 29 B. T. A. 401. The court held in that case that a mortgagee does not receive any of the accrued interest on a mortgage loan where the property is voluntarily deeded over or surrendered by the mortgagor and its value at the time is not in excess of the principal amount of the loan. That case was followed by the Board in Manhattan Mutual Life Insurance Co., 37 B. T. A. 1041. See also Commissioner v. Vandeveer, 114 Fed. (2d) 719.

A distinction was made in Helvering v. Missouri State Life Insurance Co., supra, between cases where the mortgaged property is surrendered to the mortgagee and where it is purchased by the mortgagee at a forclosure sale for an amount equal to the principal of the loan plus the accrued interest. It was held that in the latter case the mortgagee receives payment of the accrued interest. This view was adopted by the Supreme Court in Helvering v. Midland Mut. Life Insurance Co., 300 U. S. 216; reversing Midland Mut. Life Insurance Co. v. Commissioner, 83 Fed. (2d) 629, which was in disagreement with Helvering v. Missouri State Life Insurance Co., supra, on this point. We think that the distinction between the two types of transaction was well made in Helvering v. Missouri State Life Insurance Co., supra, and that the decision of the Supreme Court in Helvering v. Midland Mutual Life Insurance Co., supra, is not in point in the instant case.

We hold that the petitioner is taxable only upon so much of the accrued interest on the mortgage loans in question as was represented by the excess of the value of the real estate which it acquired by voluntary deed over the principal amount of the loans and proper charges.

4. In this issue the question presented is whether the taxes and expenses incident to the operation of certain farm properties are deductible under section 203 (a) (6) above. Also indirectly involved is the question of whether the income realized from the sale of produce from these properties is includable in gross income.

During the years 1932 and 1933 the petitioner operated certain real estate properties, ordinarily referred to as “farm properties”, which it had acquired through foreclosure or by voluntary deeds. Petitioner held and operated these properties during the years in question because it could not find a sale for them at a satisfactory price. During each taxable year such properties produced income from the sale of farm and orchard produce in the amounts of $1,590.26 for 1932 and $1,619.04 for 1933.

The taxes on the real estate and the expenses incident to the operation of the properties amounted to $3,751.83 in 1932 and $3,455.14 in 1933.

In its income tax returns for 1932 and 1933 the petitioner reported the amounts received from the sale of produce in gross income and deducted the taxes and expenses incurred in operating the properties. In his determination of the deficiencies herein the respondent has excluded the amounts received from the sale of produce from gross income and has disallowed the deduction of the taxes and expenses.

Section 203 (a) (6) above provides specifically for the deduction of “Taxes and other expenses paid during the taxable year exclusively upon or with respect to the real estate owned by the company.” However, section 203 (b) places a limitation upon the deductions allowable under section 203 (a) (6) and (7). It provides:

(b) Rental Value oe Real Estate. — Tbe deduction under subsection (a) (6) or (7) of tbis section on account of any real estate owned and occupied in whole or in part by a life insurance company, shall be limited to an amount which bears the same ratio to such deduction (computed without regard to this subsection) as the rental value of the space not so occupied bears to the rental value of the entire property.

These provisions of the statute (sec. 245 (a) (6) and (7), and (b), of tbe 1921 and 1924 Acts) were under review by the Supreme Court in Helvering v. Independent Life Insurance Co., 292 U. S. 371, and Rockford Life Insurance Co. v. Commissioner, 292 U. S. 382. In the former case it was held that the statute was not unconstitutional in that it requires a life insurance company to report in gross income the rental value of the portion of its office building which it occupied in order to claim a deduction for the expenses chargeable to the building. In the latter case it was held that the deduction for depreciation allowable under section 203 (a) (7) of the 1928 Act (the same as the 1932 and 1934 Acts was limited under section 203 (b), in the case of furniture and fixtures, to the depreciation on furniture and fixtures used in connection with the company’s “investment business.” The term investment business was used in reference to activities productive of taxable income from interest, dividends, and rents. In its opinion the Court said:

* * * In reason the cost of depreciation, like other items of expense to be deducted, ought to be limited to that related to the income taxed. Allowance of deduction of expenses incurred for the correction of premiums or in respect of other income not taxed would be hard to justify. In absence of specific declaration of that purpose, Congress may not reasonably be held to have intended by that means further to reduce taxable income of life insurance companies.
There is adequate evidence that Congress intended to limit deductions of expenses to those related to the taxed income. Helvering v. Independent Life Insurance Co., supra. In the reports of committees having in charge the act of 1921 in which first appeared the language under consideration, section 203 (a) (7), it it said: “The proposed plan would tax life insurance companies on the basis of their investment income from interest, dividends, and rents, with suitable deductions for expenses fairly chargeable against such investment income.” Section 203 (a) (5), by restricting deductions to investment expenses, indicates purpose to exclude those not related to investment income. Section 203 (b), by condition imposed, similarly restricts deductions of real estate expenses. The language under consideration opposes deduction of unrelated expenses and is in harmony with the construction for which the commissioner contends. * * *

Assuming that the rule as to deductions for depreciation allowable under subsection (a) (7)' applies equally to deductions for taxes and other expenses under subsection (a) (6), our question is whether the taxes and expenses here under consideration are related to petitioner’s investment income from interest, dividends, and rents.

That the proceeds from the sale of farm and orchard produce are in no sense “interest”, “dividends” or “rents”, is too plain for argument. Consequently such proceeds are not includable in petitioner’s gross income. It follows under the ruling of the Court in Rockford Life Insurance Co. v. Commissioner, supra, that the expenses incurred in producing this income are not related to “investment income” and must be excluded from the deductions.

We think, however, that the taxes paid on the real estate on which the crops were produced fall in a different category. This real estate was acquired and held by the petitioner not for the purpose of producing nontaxable income but by reason of the default of the owners on their mortgage indebtedness to the petitioner. Real estate mortgages, particularly on farm lands, constitute one of the principal sources of investment income (interest) of many life insurance companies. Usually when it becomes' necessary through default of the mortgagor to take title to the property it is rented to a tenant and so continues to produce investment income in the form of rents. In such cases the deduction of the taxes and expenses paid on the property would not be questioned. Is this right of deduction cut off if the insurance company is unable to find a desirable tenant or purchaser and is forced to operate the property itself? As to the taxes we do not think that this would result. Taxes are an essential part of the cost of preservation of the company’s investment in the real estate, whether the property is rented, or permitted to lie idle, or operated by the company. They are unlike the expenses which are incurred entirely in the production of a marketable crop, such as the cost of fertilizer, cultivation, and harvesting. Such expenses, since not related to the production of taxable income, could not be deducted.

We hold on the facts of record that the taxes paid on the real estate in question during 1932 and 1933 are deductible from gross income and that the balance of the amounts in dispute, representing expenses incident to the production of the crops are not deductible.

5. The next question for consideration is whether the petitioner is entitled to deduct from the gross income the amounts paid to the Canada Life Assurance Co. for the use of certain securities borrowed by it from that company and pledged with the New York Insurance Department as reserves against reinsurance in respect of policies written by the Canadian company in the United States.

The facts giving rise to this issue are that during the taxable years here involved the petitioner reinsured certain risks on policies written in the United States by the Canada Life Assurance Co. The New York Insurance Department required that the reserves against such reinsured business be invested in United States securities and maintained by a company licensed to do business in that state. The petitioner was not so licensed and accordingly the Canada Life Assurance Co. invested its own funds to the amount of the required reserves in the United States securities, the rate of return on Avhich was lower than the rate of return on Canadian securities in which its funds ordinai’ily would have been invested, and permitted such United States securities to be put up on behalf of petitioner as reserve funds to protect the business so reinsured by petitioner. It was agreed between the petitioner and the Canada Life Assurance Co. that petitioner would pay to such company, in consideration of such arrangement, an amount equal to the difference between the actual rate of return on such United States securities and the average rate of return which would have been realized by the Canada Life Assurance Co. had its funds not been so invested and loaned. This difference in return, it is agreed to between the parties, approximates one-half of 1 percent per year.

Under section 208 (a) (8) above the petitioner is permitted to deduct “all interest paid or accrued within the taxable year on its indebtedness.” The petitioner contends that the amounts which it paid to the Canada Life Assurance Co. during the taxable years involved, under the arrangement described above, was interest paid on its indebtedness.

To give rise to a deduction for interest paid or accrued there must first be a money indebtedness (Old Colony Railroad Co. v. Commissioner, 284 U. S. 552), there must be interest due on the indebtedness, and the interest must be paid (if on the cash basis) or accrued (if on the accrual basis) within the taxable year. Baltimore & Ohio Railroad Co., 29 B. T. A. 368; affd., 78 Fed. (2d) 460; Pierre S. du Pont, 87 B. T. A. 1198, 1272.

What the petitioner paid to the Canada Life Assurance Co. was not interest upon an indebtedness but an amount agreed upon in return for the use of its securities. It was similar to the payment of the equivalent of dividends on borrowed stock, which has been held not to be deductible as interest. Gladys G. Terbell et al., Executors, 29 B. T. A. 44; affd., 71 Fed. (2d) 1017.

The petitioner is not entitled to the deduction of the amounts in dispute as interest paid upon its indebtedness.

6. The question involved under this issue is whether certain amounts of its investment income which the petitioner allocated to and set up in its books to the credit of a staff pension fund are to be excluded from its gross income or deducted from its gross income as interest payments.

During and prior to the taxable years involved the petitioner managed a staff pension fund for the benefit of its employees. The fund consisted of contributions by both the company and its employees and was held for the purpose of paying pensions to the employees upon their retirement. The funds comprising the staff pension fund were held by the petitioner and were commingled with and invested with its other invested assets. Each year the petitioner computed the interest earned by the staff pension fund at the average net rate of interest earned upon the mean invested assets. Such interest was credited to the fund during the taxable years in the amounts of $18,294.41 in 1932, $23,384.52 in 1933, and $33,640.81 in 1934.

During the taxable years there was paid out of the fund to employees who withdrew their shares interest in the amounts of $365.58 in 1932, $915.09 in 1933, and $1,263.95 in 1934.

In the determination of the deficiencies herein the respondent included in petitioner’s taxable income all of the interest credited to the staff pension fund and allowed the deduction of the amounts of interest paid to the employees in those years.

The petitioner contends that the amounts of interest credited to the staff pension fund should be excluded from its taxable income, either by way of an exclusion from gross income or by way of a deduction from gross income.

Any deduction of such amounts from gross income would necessarily have to be made under section 203 (a) (8) above, as “interest paid or accrued within the taxable year on its indebtedness.” There is no provision in the act governing the computation of the net income of insurance companies, similar to section 23 (q) (1932 and 1934 Acts), applicable to individuals and corporations generally, which authorizes the deduction of amounts paid by an employer to a pension trust for the benefit of the employees.

It is too plain for argument, we think, that the mere crediting of a proportional part of its investment income to the staff pension fund in its boobs was not a payment of interest on its indebtedness by the petitioner.

Even assuming that under the staff pension fund agreement the petitioner was obligated to the fund in the taxable years in approximately the amounts credited to the fund and that these amounts represented interest on its indebtedness, they would not be deductible by the petitioner reporting on the cash basis unless actually paid during the taxable years. United States v. Mitchell, 271 U. S. 9; Massachusetts Mutual Life Insurance Co. v. United States, 288 U. S. 269; United States v. Collier, 104 Fed. (2d) 420; Fred W. Leadbetter, 39 B. T. A. 629. Crediting the amounts to the fund in petitioner’s books was not a payment of the amounts. Barto Co., 21 B. T. A. 1197; Fred W. Leadbetter, supra. The entire fund, income, principal, and accretions, remained in petitioner’s possession and control throughout the taxable years, commingled with its other investment assets.

The argument is made by the petitioner that the fund constituted a legal trust entity such as is contemplated by section 165 of the 1932 and 1934 Acts which exempts such trusts from taxation.

This argument goes to petitioner’s contention that the income (interest) derived from the staff pension fund was trust income and therefore should be excluded from petitioner’s gross income.

The staff pension fund was created not by any express trust agreement, but rather by the adoption of a corporate bylaw. It was administered not by “trustees”, but by a “committee” appointed annually by the board of directors. The rules and regulations governing the administration of the fund were subject to amendment at any time by the board of directors, except that by such amendment the petitioner could not acquire any greater rights to the return of grants already credited to the fund than called for in the original agreement. The board of directors had the power to wind up the fund at any time.

We do not think that either the agreement under which it was created or the manner in which the fund was managed established any sound basis for the petitioner’s contention that the fund constituted a separate trust entity. See Merrill Trust Co., 21 B. T. A. 1409; Caxton Printers, Ltd., 27 B. T. A. 1110. Cf. Elgin National Watch Co., 17 B. T. A. 339.

Petitioner’s contentions that the amounts allocated to and credited in its books to the staff pension fund should be either excluded or deducted from its gross income are not sustained.

7. This issue is whether amounts which the petitioner credited to a “shareholders’ fund” during the years 1932, 1933, and 1934 are deductible from gross income as interest paid or accrued within the taxable years.

During the years involved the petitioner maintained and managed a shareholders’ fund such as is authorized by section 80 of the Canadian and British Insurance Companies Act of 1932, as amended, to which it credited in its books interest of $19,317.54 in 1932, $24,927.59 in 1933, and $31,479.56 in 1934.

The shareholders’ fund was commingled with and invested along with other funds of the petitioner and the amount earned thereon was computed at the average net rate of interest earned in the preceding year upon the mean invested funds of the petitioner.

In petitioner’s annual statements the shareholders’ fund is set up separately from paid-up capital and surplus and the interest credited to the fund is separate from the portions of petitioner’s profits set apart or paid to the shareholders as dividends.

In determining the deficiencies herein the respondent did not allow any deduction in respect of the above amounts credited to the shareholders’ fund.

This issue involves substantially the same question as that determined in issue 6 above. In accordance with our determination in that issue we hold that the petitioner is not entitled to the deduction of the amounts of interest credited during the taxable years 1932, 1933, and 1934 to the shareholders’ fund.

Reviewed by the Board.

Decision will be entered under Rule 50.


source: Caselaw Access Project

author: Smith : Murdock,

license: Public Domain

text:
    Schuman Carriage Company, Ltd., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 90012.
    Promulgated March 12, 1941.

      Urban E. Wild, Esq., Milton Cades, Esq., and E. B. Cameron, C. P. A., for the petitioner.

      T. M. Mather, Esq., for the respondent.
   OPINION.

Smith :

The first question in issue is whether the petitioner derived a taxable gain of $23,967.68 in 1934 from the partial liquidation of Schuman Motors.

The applicable provision of the statute with regard to distributions in liquidation is section 115 of the Revenue Act of 1934, which reads in material part as follows:

SEO. 110. DISTRIBUTIONS, BT CORPORATIONS.
* * * * * * *
(c) Distributions in Liquidation. — Amounts distributed in complete liquida- I tion of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, [ but shall be recognized only to the extent provided in section 112. Despite the I provisions of section 117 (a), 100 per centum of the gain so recognized shall be[ taken into account in computing net income. * * *
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(i) Definition op Partial Liquidation. — As used in this section the term! “amounts distributed in partial liquidation” means a distribution by a corporation! in complete cancellation or redemption of a part of its stock, or one of a series! of distributions in complete cancellation or redemption of all or a portion of its| stock.

In Fred T. Wood, 27 B. T. A. 162, 166, the Board stated:

* * * There must be a manifest intention to liquidate, a continuing purpose to| terminate its affairs and dissolve the corporation, and its activities must be directed and confined thereto. It contemplates an impairment of capital or a) retirement of outstanding stock, though a distribution, if one of a series of dis-| tributions in liquidation, may be a liquidating dividend even if it, of itself, dnes[ not impair capital. * * *

In Horn & Hardart Baking Co. v. United States (U. S. Dist. Ct., E. Dist. Pa.), 34 Fed. Supp. 89, it was said:

* * * The fact that a resolution to dissolve has not been adopted at the tim(| of distribution does not of itself prevent a distribution from constituting liquidating dividend, the determining element being whether the distribution was made with the intent to maintain the corporation as a going concern or with the intent to liquidate the business. * * * [Italics ours.]

See also Frelmort Realty Corporation, 29 B. T. A. 181, 189; Ward M. Canaday, Inc., 29 B. T. A. 855, 361; affd., 76 Fed. (2d) 278; certiorari denied, 296 U. S. 612; Rollestone Corporation, 38 B. T. A. 1093, 1105; Holmby Corporation, 28 B. T. A. 1092; affd., 83 Fed. (2d) 549.

As indicated above, in Horn & Hardart Baking Co. v. United States, supra, a resolution to dissolve or to pay a liquidating dividend is not necessary if the facts show an actual liquidation.

It is the contention of the respondent herein that, inasmuch as the petitioner was the sole stockholder of Schuman Motors and received the cash collections of that corporation during 1934, and that after 1934 the activities of Schuman Motors were greatly curtailed, it must be held that there was a partial liquidation of Schuman Motors in 1934.

We do not think that this position can be sustained. The officers of Schuman Motors testified that it was not their intention or the intention of the petitioner prior to 1938 to liquidate' Schuman Motors. There is no reason to question their testimony. Schuman Motors surrendered its Studebaker agency in 1934. It was not dissolved, since it was expected that it would obtain another agency and continue in active business.

The petitioner throughout 1934 and until 1938 acted as fiscal agent for its subsidiary the same as it had prior to 1934. The activities of Schuman Motors were greatly lessened after it canceled its Studebaker agency, but such activities continued until 1938.

Schuman Motors declared and paid “a special dividend” on December 21, 1934. This was paid, however, out of earned surplus. It was not a liquidating dividend. Cf. Helvering v. Edison Securities Corporation (C. C. A., 4th Cir.), 78 Fed. (2d) 85.

The Schuman Motors did liquidate in 1938. It was clearly taxable in that year upon the gain resulting from that liquidation. In Walker Products Corporation, 30 B. T. A. 636, we held in a comparable case that a loss sustained on the final liquidation was a legal deduction from gross income. This is the converse of that situation.

Upon the entire record we are of the opinion that the respondent erred in his determination that the petitioner realized a taxable gain of $23,967.68 in the year 1934 from the partial liquidation of Schuman Motors.

The second question in issue is whether the respondent erred in adding to the interest income reported by the petitioner for 1934 the amount of $4,787.04. This amount was added to the net income for the purpose of placing the petitioner upon an accrual basis with respect to its interest income, the other items of income and expense being reported upon the accrual basis. On brief, the respondent claims that the amount which should have been added to the interest income reported is $5,012.04. The computation by which this amount is arrived at is not shown.

It will be noted from our findings that over a long period of years prior to 1984 the petitioner’s books of account were kept and its income tax returns made upon the accrual basis except as to interest income. The respondent’s agents examined the returns filed for all the years prior to 1934 and, although fully aware of the manner in which the books of account were kept and the returns were made, accepted the returns without placing the interest income upon the accrual basis. The respondent has determined, however, that for the year 1934 the interest income item should be upon the accrual basis and that for 1934 there should be added to the interest collections in 1934 the amount of $4,187.04.

It is the petitioner’s contention herein that, since it has requested no change in the method of reporting its income and has made no change in its bookkeeping methods, the respondent was not authorized to place its interest income upon the accrual basis; secondly, that if the interest income is to be reported on the accrual basis, only the amount of interest which accrued during the calendar year 1934 should be taken into account.

Section 41 of the Eevenue Act of 1934 provides in part:

The net income shall be computed upon the basis of the taxpayer’s annual accounting period * * * in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. * * »

In Hygienic Products Co., 37 B. T. A. 202; affd. (C. C. A., 6th Cir.), 111 Fed. (2d) 330, the Board said:

* * * The hybrid system of accounting is not proper, Massachusetts Mutual Life Insurance Co. v. United States, 288 U. S. 269; Maine Dairy Co., 4 B. T. A. 375; Niles Bement Pond Co. v. United States, 67 Ct. Cls. 693; affd., 281 U. S. 357; John I. Chipley, 25 B. T. A. 1103; Coatesville Boiler Works, 9 B. T. A. 1242; and Edwards Drilling Co., 35 B. T. A. 341, on appeal to 5th C. C. A.; and the system used being predominantly the accrual method, the respondent was clearly justified in setting up petitioner’s income on that basis. The return on its face showed that petitioner has chosen to use such basis. It should not complain because the respondent has done so. * * *

Approval by Congress for the filing of returns upon the accrual basis was first provided for in the Kevenue Act of 1916, section 8. In United States v. Anderson, 269 U. S. 422, the Court said that the purpose of permitting taxpayers to file returns upon the accrual basis was “to enable taxpayers to keep their books and make their returns according to scientific accounting principles, by charging against income earned during the taxable period, the expenses incurred in and properly attributable to the process of earning income during that period.”

The Board is not insensible to the fact that many taxpayers keeping their books of account and making their returns on the so-called accrual basis do not accrue every item of income and every item of expense which might be accrued, although the aim of the accrual system is to reflect the net income earned during a given period. The accrual system is often not employed to its full extent. This is especially so in the case of small businesses and of small items of income and expense. Thus, we find that in the case of smaller corporations interest income upon notes receivable and accounts receivable is often not computed at the end of the taxable period and taken into account. It is not worth while to make such computations and the net income over a period of years is substantially the same whether such interest income is reported upon a cash basis or upon the accrual basis. We also find that in many cases taxes are deducted from gross income and paid and many other items of expense are claimed and allowed as deductions when paid, although the total expense is not strictly allocable to the taxable period. Thus, it is common for a taxpayer on the accrual basis to treat as an expense of the taxable year the full amount of the premium paid on a three-year fire insurance policy and the full amount paid for supplies purchased, although the supplies may not all be consumed during the taxable period. Where the accrual system is more fully developed the prepaid insurance is carried as an asset at the end of the taxable year as are also the supplies on hand. It is also to be noted that the respondent in his regulations recognizes that there are certain overlapping items, both of income and expense, which do not materially distort the income, and he has ruled that they may be included in the year in which the taxpayer, pursuant to a consistent policy, takes them into his accounts. Article 43-2, Regulations 86. He has also provided in article 41-3 as follows:

Methods of accounting. — It is recognized that no uniform method of accounting can be prescribed for all taxpayers, and the law contemplates that each taxpayer shall adopt such forms and systems of accounting as are in his judgment best suited to his purpose. Each taxpayer is required by law to make a return of his true income. He must, therefore, maintain such accounting records as will enable him to do so. * * *

The courts have generally recognized the fact that under the provisions of the income tax law the respondent has a large discretion as to whether the method of accounting employed by a taxpayer correctly reflects his income. See Hardy, Inc. v. Commissioner (C. C. A., 2d Cir.), 82 Fed. (2d) 249; Niles Bement Pond Co. v. United States, 67 Ct. Cls. 693; affd., 281 U. S. 357. Where his discretion is not abused the courts will sustain his determination.

Ill his deficiency notice the respondent gives as the reason for placing the petitioner’s interest income upon the accrual basis the following:

Tour books of account were kept and your return was rendered on the accrued basis. (Schedule 1-A (b) of Revenue Agent’s report).
You state in your brief, page 13 (b), that although your accounting has been on the accrual basis, you have made an exception in respect of your interest income which has been recorded when, and as, received, and that this practice has been followed consistently since your business began in 1901.
In this connection, you are advised that it has been held that:
<<* * * a system of accounting- having been adopted by a taxpayer, such system will determine when, and in what manner his income shall be taxable.” Appeal of Clarence Schock, (1 B. T. A. 528, 530).
“Where a relatively small part has been on the cash basis, it must be held that the income should have been reported on the accrual basis.” (Niles Bement Pond Co. v. United States, 67 Ct. Cl. 693, affirmed 281 United States 357; Cumulative Bulletin VIII-2, pp. 320, 321).
“Minor deviations from the method in keeping the books are not sufficient to cause the books to be placed on another basis.” (M. D. Rowe, 7 B. T. A. 903; Prentice Hall — 1937—#6060).
In view of the foregoing it is held that the interest accrued on your books in 1934 is taxable in that year.

It is evident that what the respondent means by the last quoted sentence is that there shall be included in the interest income for 1984 the amount of the interest collections in that year plus the uncollected interest at December 31,1934-, which, as shown by an exhibit attached to the deficiency notice, was determined to be $4,187.04. We think that it is immaterial that the stipulated facts in this case show that the petitioner has never recorded in its books of account interest accrued but only interest collected. The question in issue upon the pleadings is whether the respondent erred in adding to the interest income reported the amount of $4,787.04.

It seems clear to us that the respondent made the adjustment in the petitioner’s interest income for 1934 because in his opinion the method of accounting employed by the petitioner did not clearly reflect its income for that year.

The second argument of the petitioner is that, if its interest income for 1934 is to be reported upon the accrual basis, there should be taken into gross income on account of interest only $12,286.40, which is the stipulated amount of interest which accrued over the 12-month period ended with December 31, 1934. The petitioner states that it included in interest income its interest collections for 1934, which were in the amount of $13,354.33, and it insists that no greater amount of interest income should be included in the gross income.

It is the respondent’s position that if the uncollected interest at the end of 1934 is not taken into income in 1934, the year in which the respondent has adjusted the petitioner’s interest income to an accrual basis, it will never be taken into income.

A case presenting a situation somewhat analogous to that presented by the instant proceeding is Hardy, Inc. v. Commissioner, supra. In that case the taxpayer prior to 1926 had made its returns upon a cash basis. It was engaged in a merchandising business. In 1926 the taxpayer asked permission of the respondent thereafter to make returns upon the accrual basis. The respondent advised it that no such permission was necessary, inasmuch as the nature of its business required it to make returns upon the accrual basis, and he amended the return filed on the cash basis for 1925 to the accrual basis and added to the gross income on such basis the amount of the accounts receivable outstanding at the beginning of the year. The action of the respondent was sustained by the Board. The Board’s decision was affirmed by the United States Circuit Court of Appeals for the Second Circuit upon the point involved, Hardy, Inc. v. Commissioner, supra. The court pointed out that, unless the accounts receivable at the beginning of the year were included in the gross income for 1925 and returns were thereafter to be made upon the accrual basis, the taxpayer’s income included in the accounts receivable would never be reflected in the returns of net income made by the taxpayer. The court observed : “There is no provision in the law which permits their escape from taxation, if received.”

Of course, it may be that for all years prior to 1934 the petitioner has reported as large an amount of interest income as it would have reported if interest income had been reported on the accrual basis. We have no knowledge upon this point. The facts, are, however, that there was an amount of accrued interest income upon the petitioner’s books of account at January 1,1934, which had never been returned for taxation. Manifestly, this amount must be included in the gross income of some year. The failure of the petitioner to make its returns consistently upon the accrual basis may place it in an unfortunate position. But for this situation the petitioner is alone to blame.

As indicated above, the respondent on brief contends that the amount which he should have added to the interest income returned is $5,012.04. Of this amount only the item of $4,187.04 is contested. We hold that the respondent did not err in adding to the interest income reported the amount of $5,012.04, which consists of the $4,787.04 item contested, and the $225 item not contested.

Reviewed by the Board.

Decision will be entered under Rule 50.

Leech dissents on the first point.

Murdock,

dissenting: The majority opinion, I believe, reaches an incorrect result on both issues. The Commissioner determined that the petitioner realized a profit in 1934 from the partial liquidation of its wholly owned subsidiary, Schuman Motors. The determination is supported by the following evidence: Schuman Motors’ only business, the distribution of Studebaker cars, was terminated in 1984, when it gave up the Studebaker franchise and completely closed out its stock of cars; it then had no further business purpose, no employees, and practically no assets except the amount owed it by the petitioner; it dissolved a few years later without ever again engaging in any business; it declared a special dividend of $20,000 at the end of 1934 and could have declared a larger one in the full amount owed it by the petitioner ; and the petitioner, at all times material hereto, had custody of all assets of Schuman Motors, was its agent in all business transacted, kept its books, handled all of its financial transactions through the petitioner’s own bank account, and controlled Schuman Motors completely. The evidence that there was no resolution to dissolve and no complete dissolution until later is not necessarily inconsistent with the determination of the Commissioner that there was a partial liquidation in 1934. W. F. Kennemer, 35 B. T. A. 415; affd., 96 Fed. (2d) 177. The self-serving testimony of officers that they did not intend to dissolve Schu-man Motors but intended to use it for a new purpose later is not sufficient, with the other evidence, to show that the Commissioner erred.

The second issue has really two parts — (a) whether the taxpayer must report its interest for 1934 upon an accrual basis, and (b) if it must use the accrual basis, whether any amount in excess of the interest which actually accrued during the year may be included in interest for 1934. I agree with the majority that interest must be reported upon an accrual basis. The interest which actually accrued in 1934 has been stipulated to be less than the amount reported on the cash basis and less than $18,141.37, the amount which the Commissioner has included as interest for 1934. Consequently, unless some adjustment is to be made to correct an error of the petitioner in failing to report for taxation interest which accrued in prior years, the change from the cash to the accrual method of reporting interest will really benefit the taxpayer. The Commissioner has not made claim for any increase in the deficiency. It must be remembered that the taxpayer has not requested permission to change its method. The change is entirely involuntary upon its part. The case of Hardy, Inc. v. Commissioner, relied upon in the majority opinion, was one in which the taxpayer asked permission to change and, of course, the Commissioner had a right to make the necessary adjustments under such circumstances. But the adjustment was made there for the earlier year of change. Thus, the holding of the majority is without adequate authority to support it. Not only is there an absence of any request to change from the method which the taxpayer has guilelessly used, but the Commissioner has known for years that the taxpayer was using that inconsistent method. The Commissioner may not arbitrarily choose 1934 as the year in which to make up for possible errors of the past. Grauman’s Greater Hollywood Theater, Inc., 37 B. T. A. 448; Sugar Creek Coal & Mining Co., 31 B. T. A. 344; Tide Water Oil Co., 29 B. T. A. 1208; Bank of Commerce, 10 B. T. A. 73; Cooper-Brannan Naval Stores Co., 9 B. T. A. 105. Cf. S. Rossin & Sons, Inc. v. Commissioner, 113 Fed. (2d) 652; Williams Land Co. v. United States, 31 Fed. Supp. 154.

Van Fossan, Turner, and Mellott agree with this dissent.


author: Disney:

text:
    The Metal Specialty Company, a Corporation Organized and Doing Business under the Laws of the State of Ohio, Este Ave. & B. & O. Railroad, Cincinnati, Ohio, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98530.
    Promulgated March 13, 1941.

      Gharles W. Baker, Jr., Esq., for the petitioner.

      Paul A. Sebastian, Esq., for the respondent.
   OPINION.

Disney:

This proceeding involves income tax for the fiscal year ended September 30,1937, in the amount of $7,152.09, in which amount the respondent determined deficiency. The question is whether there was error in the denial of a credit of $29,017.36 claimed under section 26 (c) (1) of the Revenue Act of 1936. All facts were stipulated and are found by us as so stipulated, by reference. Except for reference to petitioner’s return for the taxable year, copy of which is made a part ■of the stipulation, and reference to the disputed item of credit claimed, and exhibits attached to the stipulation, it recites, as follows:

Three: That Fred J. Flach during Ids liftirae owned 450 shares oí the 700 outstanding shares of common stock of The Metal Specialty Company of Cincinnati, Elaine Carew Plach, his wife, owned 50 shares, Vernon B. Chase owned 75 shares, Fred Moore owned 75 shares, and Hem-y C. Yeiser, Jr., owned 50 shares:
That Fred J. Flaeh was the president and head of the Metal Specialty Company;
That Fred Moore was in charge of manufacturing, and Vernon B. Chase was in charge of sales;
Four: That on January 7, 1934, Elaine Carew Flach, wife of Fred J. Flach, was killed in an automobile accident, and Fred J. Flach died two days later on January 9, 1934, of the same cause, leaving two daughters, Betty Carew Flach, a minor aged 17 years, and Elaine Flach Tietig, wife of Arnold Tietig, in., aged 22 years.
That Ben E. Tate, B. W. Lamson, H. E. Coombe, were business men and close personal friends of Fred J. Flach who went on the Board to maintain the status ■quo, and were acting on behalf of the Flach interests.
Five: That by reason of his death a reorganization became necessary and a certain method of reorganization of The Metal Specialty Company was proposed, and in order to carry out said plan of reorganization, Arnold Tietig, m. purchased the shares of stock owned by Henry C. Yeiser, Jr. Thereupon on the 24th day of May, 1935, at a special meeting of the Board of Directors of The Metal Specialty Company, a resolution was adopted providing for a plan of reorganization and providing for the amendment to the articles of incorporation of The Metal Specialty Company, a copy of the minutes of said meeting being hereto attached and expressly made a part of this stipulation and marked Exhibit “B”.
8ia>: And thereupon on June 25,1935, at a meeting of the stockholders wherein all the stockholders were present in person or by proxy, the proposed plan of reorganization was approved and adopted, and they unanimously adopted the resolution of amendment to the articles of incorporation and all of the stockholders signed said minutes in person or by proxy, a copy of said iminutes being hereto attached and marked Exhibit “C”; and thereafter within a few days of the meeting, all persons who signed by proxy signed in person.
Seven: That thereupon on the 27th day of June, 1935, a certificate of amendment to the articles of incorporation of The Metal Specialty Company was filed with the Secretary of State. A copy of said amended articles of incorporation is hereto attached and expressly made a part hereof and marked Exhibit “D”;
That certificates for the first and second preferred and common stock in pursuance of said reorganization were issued to all the stockholders as set forth in the reorganization, and all certificates of both first and second preferred stock then or thereafter issued were issued upon the same form of stock certificate hereto attached and expressly made a part hereof, marked Exhibit “E”, and all certificates of common stock then or thereafter issued were issued upon the form of stock certificates hereto attached and expressly made a part hereof and marked Exhibit “F”.
Fight: All the stockholders thereupon surrendered the stock certificates held by them prior to the reorganization and accepted new certificates in accordance with the agreement of reorganization. On July 20, 1935, 787% shares of common treasury stock was sold to Fred Moore and 787% shares of common treasury stock was sold to Vernon B. Chase. Later, prior to May, 1936, forty-one (41) shares was issued by the company to others not parties to the reorganization.

The minutes of the special meeting of the petitioner’s directors, held May 24, 1935, and referred to as Exhibit B in the fifth paragraph of the stipulation, supra, recited in part:

After providing for the payment of cumulative dividends on the preferred stock and before any dividends are declared, paid or set aside to or for other stockholders, the directors shall set aside from the remaining surplus earnings five (5%) percent on the first Ten thousand ($10,000.00) Dollars surplus earnings or less, ten (10%) percent upon the next Five thousand ($5,000.00) Dollars surplus earnings or less, fifteen (15%) percent upon the next Ten thousand ($10,-000.00) Dollars surplus earnings or less, and twenty-five (25%) percent upon the next Ten thousand ($10,000.00) Dollars surplus earnings or less, and fifty (50%) percent upon all surplus earnings over and above Thirty-five thousand ($35,-000.00) Dollars, and such additional sums as the Board of Directors may consider advisable, as a sinking fund to be held and used for the redemption of the preferred stock, and for no other purpose. * * *

This provision, the petitioner contends is a clause restricting the payment of dividends, under section 26 (c) (1) of the Kevenue Act of 1936. The argument is that, having been first passed by the board of directors, and then approved and agreed to at a stockholders’ meeting where all stockholders were present in person or by proxy and all stockholders signed the minutes, the statute was satisfied, since, it is contended, the contract was executed by the company “in the actual doing of that which was required to put this agreement into effect; the company filed with the secretary of state the amendment to the charter of the company on June 27, 1935”; and the stock was exchanged. Thus it is argued there was an agreement between the corporation and all parties signatory thereto, in writing, prior to May 1, 1936, and expressly dealing with payment of dividends. Petitioner stresses the fact that it is not claiming that either the charter or the statement on the stock certificates is a contract under the revenue act, but that the contention is that “the agreement in writing contained in the minute book of both stockholder and director meetings is the contract in writing and within the provisions of Section 26 (c) 1 of the Eevenue Act of 1936.” The petitioner points out that the new stock was not issued proportionately to the old, in some instances, that therefore the matter was arranged by contract and could not have been arranged merely by corporate action, that the company on its part executed the contract by delivering to the secretary of state the certificate of amendment and charter, and that when the stockholders turned in their old stock and received the new stock, and the corporation issued new certificates, a contract was fully executed by all parties.

In our opinion, petitioner’s contention can not be sustained. So far as emphasis is laid upon the fact of signature of all stockholders upon the corporate resolution, we held in Thibaut & Walker Co., 42 B. T. A. 29, that a contract expressly dealing with payment of dividends, between four sole stockholders of a corporation, to which contract the corporation was a party, did not bind the corporation not to pay dividends. The element of agreement between the stockholders we therefore consider not determinative under the statute. Considering the corporate resolutions: In Helvering v. Northwest Steel Rolling Mills, Inc., 311 U. S. 46, the Court, construing the same section herein involved, said:

* * * The natural impression conveyed by the words “written contract executed by the corporation” is that an explicit understanding has been reached, reduced to writing, signed and delivered. True, obligations not set out at length in a written contract may be incorporated by specific reference, or even by implication. But Congress indicated that any exempted prohibition against dividend payments must be expressly written in the executed contract. It did this by adding a precautionary clause that the granted credit can only result from a provision which “expressly deals with the payment of dividends.”
That the language used in section 26 (c) (1) does not authorize a credit for statutorily prohibited dividends is further supported by a consideration of section 26 (c) (2). By this section, a credit is allowed to corporations contractually obligated to set earnings aside for the payment of debts.8 [It is not considered necessary to quote footnote here.] That this section referred to routine contracts dealing with ordinary debts and not to statutory obligations is obvious— yet the words used to indicate that the section had reference only to a “written contract executed by the corporation” are identical with those used in section 26 (c) (1). There is no reason to believe that Congress intended that a broader meaning be attached to these words as used in section 26 (c) (1) than attached to them under the necessary limitations of 26 (c) (2).

In the light of the breadth of the above language, we consider it to apply here, though the Court was discussing the corporate charter (which it held not to satisfy the statute) and not a corporate resolution, as here. The Court plainly meant to hold that this section “referred to routine contracts dealing with ordinary debts.” Obviously, we have here no routine contract dealing with ordinary debts, for herein the petitioner must for a contract rely upon corporate minutes, and for execution of the alleged contract by the corporation, particularly required by the statute, must rely upon delivery of the certificate of amendment and charter to the secretary of state.

In Davison-Joseph Campau Realty Co., 41 B. T. A. 675 and in Atlas Supply Co., 43 B. T. A. 324 we held that a corporate bylaw is not “a written contract executed by the corporation” covered by the statute. In the latter case we referred to legislative history of the statute where the requisite contract of a corporation was referred to as one “entered into with its creditors.” This is to the same effect as the statement in Northwest Steel Rolling Mills, Inc., supra. We see no essential difference, so far as here pertinent, between a bylaw and a stockholder’s resolution. Both are merely matters of internal management of a corporation, adopted, that is, agreed upon, by those individuals owning and controlling the corporation. They reflect agreements of the stockholders inter sese, but not agreements of the corporate entity with, others, within the intendment of the Federal revenue act. We think a routine contract with creditors was intended to be covered by the statute, and not some intramural arrangement made by the stockholders of the corporation providing for a sinking fund for retirement of preferred stock.

■ We conclude and hold that the respondent did not err in denying the credit claimed, under the provisions of section 26 (c) (1) of the Revenue Act of 1936.

Decision will be entered for the respondent.

       SEC. 26. CREDITS OE CORPORATIONS.
      In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax—
      *******
      (c) Contracts Restricting Payment of Dividends.—
      (1) Prohibition on bayment of dividends. — An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account.


author: Van Fossan:

text:
    Agnes I. Fox, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100157.
    Promulgated March 13, 1941.

      Jacob >Schápiro, Esq., and Harold Wiscn, Esq,, for the petitioner.

      F. S. Gettle, Esq., for the respondent.
   OPINION.

Van Fossan:

The only issue for our determination is whether or not petitioner is entitled to a deduction for interest paid in the taxable year on sums paid to insurance companies which were denominated by petitioner as interest accrued on policy loans prior to assignments to petitioner of the policies upon which the loans had been made.

Petitioner contends that the mere fact that she paid more than the current year’s interest to the insurance companies in the taxable year is immaterial, since she was on the cash basis. She maintains that by virtue of being a beneficiary under the policies she had an equity in the policies before they were assigned to her and hence was entitled to deduct interest due but not paid in prior years but paid as indicated in the facts in the taxable year. She urges that in any event respondent erred in limiting her deduction for interest paid to those amounts accruing after assignment of the policies to her. In regard to this contention she asserts that she is entitled to deduct at least those amounts of interest paid which became payable after her acquisition of the policies. Respondent argues that petitioner’s payment of interest which accrued prior to the assignment of the policies to her is not deductible because it was paid upon the obligations of another. He contends that the overdue interest which the insurance companies had added to principal of the various loans ceased to be interest and became principal so that neither petitioner nor her husband can obtain a deduction for interest paid by payment in a later year of the amounts which had previously been added to the principal by the insurance companies. We sustain the respondent.

Upon the addition of the overdue intei’est to the principal of the loans by the insurance companies the interest due lost its character as interest and became principal. This was not a mere bookkeeping device since interest immediately began to run upon the amounts added to principal. We are of the opinion that amounts paid by petitioner luring the taxable year claimed to represent past-due interest which rad been added to principal of the policy loans did not constitute “in-:erest paid” within the meaning of the statute. Nor is it material that several of the insurance companies issued statements to petitioner in he taxable year indicating that the companies had withdrawn “interest” from principal and again treated it as interest. After the amounts lave been added to principal the fact that the insurance companies .re willing to designate payments as interest will not give such pay-aents the characteristics necessary for deductibility under the statute. Ve hold that petitioner is not entitled to deduct the amounts paid upon he policy loans which had been added to the principal of the loans y the insurance companies.

There remains the question of the deductibility of those amounts paid y petitioner to the companies in the taxable year which related to iterest on the policy loans becoming payable after February 29,1986, íe date on which the policies were assigned to petitioner. Respond-lt has allowed petitioner a deduction for interest on the loans which jcrued after February 29, 1936, and which was paid by petitioner in Le year 1936. He denies that petitioner may deduct interest which jcame due after February 29, 1936, but which is allocable to the jriod before the date of assignment of the policies to petitioner.

Petitioner argues that she may deduct interest which accrued ■fore the date of assignment because she had an equity in the policies v virtue of being the named beneficiary before the policies were Signed to her. She urges that under New York law the interest 1 a beneficiary of a policy of life insurance is protected and that she bad acquired sufficient ownership in the policies before the assignment to permit her to treat the policy loans as her obligations. Whatever petitioner’s equity in the policies before their assignment to her may have been, we can not ignore the fact that petitioner’s husband was the person who borrowed on the policies. It was he who had the obligation to pay interest and the obligation continued until the date of assignment to petitioner. Proration must be made as of that date.

In Harvey M. Toy, 34 B. T. A. 877, we stated:

The statutory deduction for interest (Revenue Act of 1928, sec. 23 (b), supra) is limited to amounts chargeable against tlie taxpayer qua interest (Automatic Sprinkler Co. of America, 27 B. T. A. 160) upon bis indebtedness. Morris Plan Co. of Binghamton, 26 B. T. A. 772. * * *

The quoted statement is applicable here. Only those amounts which may be considered interest on petitioner’s indebtedness are deductible. The amounts paid by petitioner in the taxable year which were al-locable to the period during which the loans were clearly the obligations of her husband are not deductible by petitioner as interest paid. Helen B. Sulzberger, 33 B. T. A. 1093; Colston v. Burnet, 39 Fed. (2d) 867; certiorari denied, 287 U. S. 640.

We hold that respondent was correct in disallowing petitioner’s deduction of amounts paid to the insurance companies which were attributable to interest accrued on the loans prior to February 29 1936.

Deeision will be entered for the respondent


author: KeRn:

text:
    Florence H. Watkins, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100640.
    Promulgated March 13, 1941.

      John W. Windhorst, Esq., for the petitioner.

      Luden W. Shaw, Esq., for the respondent.
   OPINION.

KeRn:

As has been stated already, the issues in this controversy concern the prepaid dividends on the preferred stock and the prepayment of the interest on the note which was issued in place of the preferred stock certificates. The dividends due on the stock in the years 1936 and 1937 were paid to the trustees in the years 1935 and 1936, respectively, but were not distributed by them to the life beneficiary of the trust until 1936 and 1937. The interest on the note for the year 1938 was paid to the trustees in 1937 but was not distributed to the life beneficiary until 1938. The question presented is whether such items of income to the trustees are “to be distributed currently” within the meaning of section 162 (b) of the Revenue Acts of 1934 and 1936, set out in the margin, and, therefore, to be included in the taxable income of the life beneficiary in the years in which they were received by the trustees, although not actually distributed until subsequent years.

The decisive consideration is whether the amounts received by the trustees were paid to them as current income or whether they should be considered advances of income for succeeding years. Sental income, for instance, paid in advance to a trustee may not be distributed currently to the life beneficiary but must be held by the trustee and distributed periodically to the persons entitled thereto in each period when the rent would normally be paid. Johnson v. Collamore, 271 Mass. 521; 171 N. E. 717. On the other hand, a so-called “annual consideration payment” in the nature of a bonus to assure continued tenure after the expiration of a current lease is not treated as advance rental, but as current income distributable in the year of receipt. Thalia W. Malcom, 36 B. T. A. 358; affd., 97 Fed. (2d) 381. Likewise, ordinary dividends are distributable in full to the life beneficiary living at the time of declaration and are not apportionable between such beneficiary and the remainderman. Adams v. Adams, 139 Mass. 449; N. E. 746.

We must determine, first, under which of the foregoing rules the dividends fall. The dividends paid in December of 1935 and 1936 were, in a sense, ordinary dividends. They were not ordinary, however, in the sense of having been earned at the time of declaration and payment. The stock upon which they were paid was preferred stock paying 6 percent annual dividends and no more. For both 1935 and 1936 the full 6 percent had been paid and the stockholder was entitled to no more. When an extra payment was made in December of each year it was in the nature of an advance payment, analogous to the advance payment in Johnson v. Collamore, supra, rather than a payment for current use of property as in the Malcom case, supra. Whether the trustees properly treated the dividends as income in the year of receipt is not before us for decision. As to the beneficiary, we are of the opinion that, in view of the dividends being advance payments, she was not entitled to them in the year of payment and they were, therefore, not currently distributable.

The situation with respect to the interest paid in December 1937 is different from that as to the dividends. From the terms of the note on which the interest was paid it is clear that no interest on the principal was ever intended to be paid to the remainderman. The note recites that the interest is to continue until the principal is paid. The latter event was to take place “on or before December 31, 1943, or in the event of the prior death of Florence H. Watkins”, the petitioner. Clearly all interest payments were for her sole benefit. And, since the remaindermen had no right to them, even contingently, we must conclude that the interest payment made on December 31, 1937, was currently distributable to the petitioner. Regardless of the fact that it was not distributed to petitioner until 1938, the entire amount is income taxable to the petitioner in the year 1937, since it was distributable to her in that year.

Petitioner has conceded that an adjustment made by the respondent in the amount of $40, which was added to her gross income for the year 1935 is correct, and, consequently, this amount is no longer in issue. As to the refund for the year 1937 in the amount of $10.31, there has been no explanation or proof offered by the petitioner on this issue and, therefore, we disallow the claimed refund.

Decision will be entered under Bule SO.

       SEC. 162. NET INCOME.
      The net income of the estate or trust shall be computed in tbe same manner and on the same basis as in the case of an individual, except that—
      ‡ * >lc $ # 4 *
      (b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. * * *


author: Smith :

text:
    Elliott B. Smoak, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100036.
    Promulgated March 13, 1941.

      Frank B. Mwrdoeh,, Esq., for the petitioner.

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

Smith :

In his deficiency notice in this proceeding the respondent states:

(a) You have treated as capital gains to the extent limited by Section 117 (a) of the Revenue Act of 1936, the payments made to you in 1936 (and 1937] by the Ex-Gell-0 Aircraft and Tool Corporation, successors to the American Paper Bottle Company, and included in net income 60 percent of the amount received. It is held that there was no sale or exchange of a capital asset within the meaning of Section 117 (a) of the Revenue Act of 1936, and that the full amount of the payments should be included in your gross income. * * *

At the hearing counsel for the respondent stated:

* * * It is the Government’s position, however, that there was no sale of a contract. There was a termination or cancellation of a contract as the result of which Mr. Smoak received income in 1936 and 1937. It is our position that the income so received is ordinary income, and not capital gain.

The petitioner alleges that the respondent erred in his determination that the amounts received by him in 1936 and 1937 from the Ex-Cell-0 Aircraft & Tool Corporation were not from the sale of a capital asset. We limit our discussion to the issue raised.

Section 117 (b) of the Eevenue Act of 1936 defines “capital assets” as meaning:

* * * property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.

In support of his contention that the gains realized by the petitioner in 1936 and 1937 were not from the sale of capital assets, the respondent relies upon the following cases: George K. Gann, 41 B. T. A. 388; Thurlow E. McFall, 34 B. T. A. 108; Doyle v. Commissioner (C. C. A., 4th Cir.), 102 Fed. (2d) 86, affirming 37 B. T. A. 323; and Escher v. Commissioner (C. C. A., 3d Cir.), 78 Fed. (2d) 815.

By the agreement of April 23, 1936, the petitioner transferred to the Ex-Cell-0 Aircraft & Tool Corporation all of the rights inuring to him from the original contract with the American Paper Bottle Co. He relinquished his exclusive right to develop the sales territory allotted to him, the right to all royalties from future sales within that territory, and his right to the future royalties to be paid by existing licensees. He transferred also his office files and records and the good will which he had built up over the course of two years. This was much more than the assignment of a mere contractual right to receive royalties in the future. The petitioner had a going agency business. He sold all of the assets of that business, with all of his rights under the agency contract to the Ex-Cell-O Aircraft & Tool Corporation.

In Dudley T. Humphrey, 32 B. T. A. 280, the Board held that a partner’s sale of his interest in a partnership engaged in buying and selling securities constituted the sale of a capital asset. If the sale by a partner of his interest in a partnership is the sale of a capital asset, where the partner has been a member of a firm for more than two years, a fortiori, the sale of an agency business held for a period of more than two years is likewise a sale of a capital asset.

We think that the cases cited by the respondent in support of his contention that the petitioner did not sell a capital asset are not in point. The cases of Thurlow E. McFall, supra, and George K. Gann, supra, involved the cancellation of unexpired employment contracts by the terms of which the employee was bound to perform services before he was entitled to any compensation. The right held by the employee was only a conditional right to receive something in the future. The relinquishment of that right to compensation for future services was held not to be a sale of property within the contemplation of the capital gains provisions of the revenue acts. The' cases of Doyle v. Commissioner, supra, and Escher v. Commissioner, supra, are not factually similar to the instant proceeding. In Doyle v. Commissioner, supra, an attorney, upon the liquidation of his firm, accepted a certain sum in exchange for his interest in fees to be received. It was held that the amount received was merely a commutation of the fee later to be received. It'was for personal services performed and constituted taxable income. In the Escher case a similar ruling was made with respect to the sum received by an attorney under a contract providing for the payment of a proportion of the amount recovered by his client in lieu of a claim for past services and compensation for services to be rendered.

What the petitioner sold was an agency business. Since he had owned the agency for a period of more than two years at the date of sale, it was a capital asset.

The action of the respondent in including in petitioner’s gross income for each of the years 1936 and 1937 the full amount received from the Ex-Cell-0 Aircraft & Tool Corporation is reversed.

Decision will he entered under Bule 50.


author: Black :

text:
    Oliver N. Hardy, Petitioner, v. Commissioner of Internal Revenue, Respondent.

      Docket Nos. 97525, 98044, 98999.
    Promulgated March 13, 1941.

      A. Galder Machay, Esq., and Benjamin W. Shipman, Esq., for the petitioner.

      Samuel Taylor, Esq., and Franh T. Horner, Esq., for the respondent.
   OPINION.

Black :

The sole issue which we have to decide in these proceedings is largely a question of fact, namely, whether petitioner and his wife did actually annul and cancel the 1933 written property settlement agreement prior to the beginning of the taxable years involved, and supersede it with an executed oral agreement.

At the outset it should be noted that under the laws of California where petitioner and his wife were domiciled, they had a right to entei into such an agreement as they did on September 6, 1933, regardless of whether they were living together or whether they were living apart and later became reconciled; and that so long as such an agree ment was in full force and effect petitioner’s earnings would be hi¡ separate property and would all be taxable to him. Civil Code of California, secs. 158 and 159; Howard G. Hickman, 27 B. T. A. 807 affd., 70 Fed. (2d) 985; Marshall v. United States, 88 Ct. Cls. 393 26 Fed. Supp. 474; certiorari denied, 308 U. S. 597; ZaSu Pitts Woodall, 38 B. T. A. 97; affd., 105 Fed. (2d) 474; certiorari denied, 30 U. S. 655; Van Every v. Commissioner, 108 Fed. (2d) 650; certiorari denied, 309 U. S. 689; Estate of J. Harold Dollar, 41 B. T. A. 869; F. Eldred Boland, 41 B. T. A. 930; Sparkman v. Commissioner, 112 Fed. (2d) 774; Ina Claire v. United States, 34 Fed. Supp. 1009; McKay on Community Property, 2d ed., sec. 1318. Furthermore, it should be noted that, notwithstanding the provision in the 1933 agreement that it could “only be changed, altered or vacated by the express written agreement, signed and acknowledged by both parties”, the 1933 agreement could have been changed, altered or vacated by an “executed oral agreement” of the parties. Civil Code of California, sec. 1698; 17 Corpus Juris Secundum, Contracts, sec. 377. Cf. Treadwell v. Nickel, 228 Pac. 25; Klein Norton Co. v. Cohen, 290 Pac. 613. On these propositions of law, we understand the parties to be in agreement.

There was no written agreement which in any way canceled or even modified the herein material provisions of the 1933 agreement other than the 1937 agreement referred to in our findings. If petitioner is to prevail, his proof must show that there was an executed oral agreement between himself and his wife prior to the beginning of the taxable years here involved which did away with the 1933 agreement or at least that provision of the 1933 agreement contained in the sixteenth paragraph wherein the parties agreed that “any and all properties that the respective parties shall acquire on and after the date hereof shall be and the same is hereby declared to be the separate property of the party by whom it is acquired.” It is well to bear in mind that there was a provision contained in the 1933 agreement stating that the parties are not only desirous of effecting a settlement of their property rights, “but expressly intend that this agreement will continue in full force and effect in the event that their respective differences can be composed and a reconciliation whether permanent or otherwise, take place.” This latter provision was no doubt placed in the 1933 agreement for the purpose of avoiding the application of such cases as Sargent v. Sargent, 106 Cal. 541; 39 Pac. 931; In re Jones’ Estate, 118 Cal. 499; 50 Pac. 766; In re Martin's Estate, 137 Pac. 2; Brown v. Brown, 170 Cal. 1; 147 Pac. 1168; and In re Boeson's Estate, 255 Pac. 800, which cases stand for the authority that property settlement agreements are sometimes set aside where the acts, conduct, and relations of the parties thereafter are of such a character as to justify the conclusion that the parties intended and agreed orally to annul and cancel the same. In other words, it is apparent that the parties to the 1933 agreement wanted to guard against any future contention by either party that they had orally agreed to rescind the 1933 agreement with the hope of proving such contention by showing evidence of a reconciliation. Evidently as a further guard against any such future contention, they put in the provision that the 1933 agreement could only be changed, altered, or vacated by an express written agreement to that effect. While it is our opinion that it was possible to annul and cancel the 1933 agreement by means of an executed oral agreement to that effect, we think the burden was on petitioner to prove the existence of such an executed oral agreement, and we think he has failed to do so.

On the other hand, the evidence convinces us that the 1933 agreement continued in full force and effect until the written agreement of April 14, 1937. Even then it was not abrogated by the latter agreement, but was merely modified and changed in certain material respects, and as modified it continued in full force and effect. It was not changed or modified in respect to the sixteenth paragraph fully set out in our findings of fact.

We consider it unnecessary to rehearse in this opinion the facts upon which we base our conclusion. We have stated the facts fully in our findings of fact. Upon these facts we hold that the Commissioner did not err in his determination that in the taxable years involved in these proceedings the earnings of petitioner were his own separate property and taxable entirely to him. If taxpayers do not wish to be bound by such agreements they should not enter into them. Cf. ZaSu Pitts Woodall, supra.

Decision will be entered for respondent.


author: Mukdock :

text:
    William J. McCormack, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 88920, 96054.
    Promulgated March 13, 1941.

      Milton J. Levitt, Esq., for the petitioner.

      George B. Sherriff, Esq.., for the respondent.

       This point was not decided in Commissioner v. Krebs, 90 Fed. (2d) 880, mentioned in the Beclc case.

   OPINION.

Mukdock :

The income of these trusts for the year 1934 is taxable to the petitioner upon authority of Helvering v. Clifford, 309 U. S. 331. The slight differences between this case and the Clifford case are immaterial and do not serve to distinguish the two cases. Commissioner v. Berolzheimer, 116 Fed. (2d) 628; Helvering v. Hormel, 111 Fed. (2d) 1; Penn v. Commissioner, 109 Fed. (2d) 954. Thus, it is unnecessary to decide whether or not the income would be taxable to the petitioner under section 167 (a) of the Revenue Act of 1934.

The only other issue for decision relates to gift taxes for 1936. The income actually distributed under the trusts is not involved in this issue. The question is, Were there for the first time in 1936 completed gifts of the amounts accumulated in these trusts, which accumulated amounts were to be held for and turned over to the beneficiaries when they became twenty-one years of age? The parties have agreed upon the amount of the accumulated income in each trust. The parties agree that the petitioner made gifts through the medium of these trusts. The fact that the income is taxable to the grantor is, of course, no reason for holding that the accumulations could not be the subject of a taxable gift in 1986. The petitioner contends, however, that the gifts were completed prior to 1986 and nothing happened in 1936 which would be subject to tax as a gift in that year. We have come to the conclusion that the gifts of the accumulated income were complete for the first time in 1936. This conclusion can be supported on each of two grounds. The first is that there was to be no gift unless the beneficiaries survived the trusts and the second is that the petitioner retained the power during the continuance of the trusts to expend all of the income of the trusts and thus avoid the gift .of any accumulations.

The only provision for a transfer by gift of the accumulations under either trust is in that part of paragraph ii, which provides that the “accumulations, if any”, are to be held for the beneficiary, “if” the trust does not terminate by the death of the beneficiary. There is no express provision disposing of the accumulated income of either trust in case of termination by the death of the beneficiary. Thus, following the principle of inelusio unius est exclmio alterius, there was to be no gift in either trust unless the beneficiary survived the trust. In case the trust was terminated by the death of the beneficiary, the accumulated income, like the corpus of the trust, was to go back to the petitioner. The gift tax applies only to consummated gifts, absolute transfers. Since it was not apparent prior to the termination of these trusts that the beneficiaries would be alive, and therefore entitled to take the accumulations, obviously, they, as donees, should not be personally liable for the gift tax under section 510 of the Revenue Act of 1932 until 1936, when the trusts terminated while they were still alive. There was not a completed gift of the accumulated income until the trusts terminated, but there was a completed gift of the accumulated income of each trust at that time. Carl J. Schmidlapp, 43 B. T. A. 829; Margaret White Marshall, 43 B. T. A. 99; Marrs McLean, 41 B. T. A. 1266; Emily Trevor, 40 B. T. A. 1241; William T. Walker, 40 B. T. A. 762; Lorraine Manville Gould Dresselhuys, 40 B. T. A. 30. Cf. Helvering v. Hallock, 309 U. S. 106; Klein v. United States, 283 U. S. 231; Sanford v. Commissioner, 308 U. S. 39; Hughes v. Commissioner, 104 Fed. (2d) 144; Hesslein v. Hoey, 91 Fed. (2d) 954; certiorari denied, 302 U. S. 756; Van Vranken v. Helvering, 115 Fed. (2d) 709.

The second reason why the gifts of the accumulated income were not complete until 1936 is based upon the retained power of the petitioner to determine whether or not there would be any accumu-.ations at the termination of the trusts. There was no way of de-;ermining, prior to the termination of the trusts, how much of the income the petitioner would see fit to expend or distribute and how much he would permit to accumulate. The decision to use or accumulate the income of these trusts was not required to. be made annually. Thus, even though at the end of any particular year some income remained undistributed, nevertheless, there was no assurance that it would not be expended or distributed later. Although the petitioner anticipated that a substantial amount of the income would be accumulated and although his expectations may have been reasonable ones, still, there was no certainty that there would be accumulations and there was no way of determining how much the accumulations might amount to in dollars at the end of the trusts. The petitioner had extremely broad powers to decide whether or not he would expend or distribute the income; that is, he could use the income in any way that he deemed “necessary and proper for the maintenance, education and well-being” of the beneficiaries. The Commissioner argues that this gave him the power to use all of the income up to the very last moment of the life of the trusts to discharge his own obligation to support and maintain his minor children and, consequently, there was no completed gift of any accumulated income from the petitioner to the children until the termination of his power to use that income. Clearly, he could have used much more of the income than he did use. An indication of his power in this connection is found in the fact that the amount which he actually distributed to the mother of the children in 1932 was more than! he deemed necessary for their needs during the remaining life of the trusts. Furthermore, there was always the possibility that the income of the trusts might be completely exhausted by some unforeseen need, as for example an expensive illness.

A transfer in trust by a father merely for the purpose of using such of the income as might be necessary for the support of his minor child during infancy would not be a taxable gift, since the father would part with nothing. Martin Beck, 43 B. T. A. 147. He would simply have provided that a part of his income was to be used to discharge his own obligation. But if a father directed that the income of a trust should be accumulated during the minority of his child and paid over to the child at maturity, there would be at the creation of the trust a completed gift of an estate for years in the trust property. See cases above cited. The present trusts have some of the characteristics of each of the hypothetical trusts just mentioned. But since it was impossible to say in 1931, when these trusts were created, whether or not there would be any accumulated income upon termination of the trusts, there was no taxable gift of the accumulations at that time. There was at that time no absolute transfer of the donor’s dominion and control over the subject matter. Emily Trevor, supra. There is, however, some analogy between this case and those cases holding that the termination of the power of a grantor over trust property gives rise to a completed gift. Cf. Hesslein v. Hoey, supra; Burnet v. Guggenheim, 288 U. S. 280; Sanford, v. Commissioner, supra. The gifts of the accumulations were not complete until 1936, when the powers of the petitioner over those accumulations ceased.

We have assumed for the purposes of this decision that the trusts were valid and enforceable under the laws of New York and that the beneficiaries had vested interests in whatever income might be produced during the terms of the trusts. Yet, for the reasons already given, it does not follow that there was any completed gift in 1931 of the accumulated income, as that income was actually disclosed at the termination of the trust. Cf. Marrs McLean, supra. The cases of Estate of Giles W. Mead, 41 B. T. A. 424, and Jack L. Warner, 42 B. T. A. 954, are not in point. The Board held in those cases that, annual payments of income to beneficiaries of trusts subject to change-were not taxable gifts in the year of payment. The trust deeds in those cases provided for annual payments of income to beneficiaries and it was upon that point that our decisions rested. Here the trustee was not required to make distributions annually or to do anything else upon an annual basis, but could accumulate or distribute, at any time and in any amount as he saw fit.

Decision will be entered wnder Rule 50'..