author: Littleton:

text:
    Lamb Lumber & Implement Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 14242.
    Promulgated March 9, 1927.
    The evidence sustains petitioner’s claim for a deduction from gross income for 1921 of certain amounts of debts ascertained to be recoverable only in part and charged off in part within the year.
    If. A. Burhe, Esq., for the petitioner.
    If. F. Gibbs, Esq., for the respondent.
    The Commissioner determined a deficiency of $620.63 for the calendar year 1921. Petitioner claims that the Commissioner erred in refusing to allow as a deduction from gross income the sum of $7,304.32, representing that portion of certain debts falling due within the year which it ascertained could not have been recovered and which it charged off within the year.
    FINDINGS OF FACT.
    Petitioner is a North Dakota corporation with principal office and place of business at Whitman. During the calendar year 1921 certain accounts and notes due petitioner by various farmers became due and were not paid. These debts represented amounts due petitioner for farm equipment, supplies and grain sold and for threshing. Petitioner held various classes of real estate and chattel mortgages as security for these debts, which fell due during the year 1921, and particularly in October, November, and December of that year. Petitioner’s officers were personally acquainted with all of the debtors, knew their financial status, and had full and complete knowledge of the amount and character of the property which they owned and the market price or value of the same.
    During 1921 petitioner endeavored through the personal efforts of its officers to obtain payment of the amounts due it, without success. At the end of the year the debtors, all of whom were farmers, were without funds, due to the marked decline in the market for their farm products; they had already reached the limit of their credit and were unable to borrow money. They -were heavily in debt to banks, persons, and concerns other than petitioner. The only means bjr which petitioner could hope to recover any amount on the debts due it was to foreclose its mortgages on land, farm implements, horses and cattle, which mortgages in no individual case would have satisfied the debt due. Petitioner’s officers made a personal investigation of the condition of the property on which it held mortgages and, based upon their knowledge of the amount which could be obtained from the sale thereof and upon their experience as a result of previous sales - of similar property on foreclosure, petitioner determined that certain debts due it were recoverable only in part, and charged such debts off in part within the year as follows:

    These debtors were grain farmers. They had very little live stock. The market value of land did not exceed $20 an acre; good farm horses and good cows sold for from $20 to $50 each. There was practically no market for farm implements. Gang plows and drills in first-class condition were sold at from $20 to $30 each, and old and worn equipment sold at prices much below this figure. The persons above mentioned were engaged in farming upon a small scale. Some of them held real estate in their own names which was heavily encumbered; others were tenant fanners: The machinery and equipment owned by them, on which 'petitioner held chattel mortgages, was old and worn and their horses and cows were old and of .little value. The real estate mortgages held by petitioner were second, third, and fourth mortgages, and the amount of the prior mortgages held by others exceeded the market-price or value of the land. Petitioner’s judgment as to the portion of the debts that it could not recover was fully warranted by the facts known to it at the time, and subsequent events proved that the amounts charged off were conservative. In many cases petitioner recovered far less than it had estimated at the end of 1921 that it would.
    Those portions of the debts listed above which petitioner charged off at the end of 1921 were worthless.
   OPINION.

Littleton:

Section 213 (a) (5) of the Revenue Act of 1921 provides that in computing net income there shall be allowed as deductions debts ascertained to be worthless and charged off within the taxable year; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part.

The only means open to petitioner for recovery of any amount in respect of the debts hereinbefore listed was the foreclosure of the mortgages held by it. In many cases the property was subject to prior mortgages in amounts in excess of the value thereof. The facts known' io petitioner at the end of 1921 showed that the debts, to the extent (hat they were charged off, were worthless and unrecoverable and that legal action to enforce payment would not have resulted in the satisfaction of the debts to the extent that they were retained upon the books. The evidence is in detail and goes fully into all the facts and circumstances surrounding each debt, and from a consideration thereof the Board is of the opinion that the total amount claimed by petitioner was properly ascertained to be worthless and charged off within the year and that the Commissioner erred in refusing to allow a deduction of that'amount. Petitioner exercised reasonable and sound business judgment in ascertaining that these debts were recoverable only in part and in charging off the balance. In the Appeal of Egan & Hausman Co., 1 B. T. A. 556, the Board said:

In adjusting their accounts and debts business men are called upon to use sound business judgment and prudence and' are justified in eliminating from their assets such accounts and debts as are past due and which they are satisfied that they can not realize upon within some reasonably determinable period. They do not have to await uncertain and future events, nor are they called upon to wait until some turn of the wheel of" fortune may bring their debtors into affluence.

The debtors whose accounts are here involved were engaged in farming upon a small scale. They raised grain and had very little live stock. They had no income except in the fall of the year. For several years prior to 1920 farmers in this community had been fairly ' prosperous; financial conditions were good, values were inflated, and credits were extended generally and freely. Practically every mercantile business and bank held real estate and chattel mortgages far in excess of the sound value of the property. These were taken to protect credits extended on the basis of "the inflated values and in keeping with the trend of the times. The decline in property values and of prices of farm products came in the winter of 1920 and,continued downward during 1921. Farmers who had held grain for higher prices saw the price drop-below the cost of production. Land and farm property values dropped tremendously and continued to go down throughout the year 1921. Many farmers were heavily in debt and were completely wiped out. Only a few were solvent. The debtors listed herein were hopelessly insolvent at the closing months of 1921. There were men with families facing a North Dakota winter with little, if any, funds. There was no market for farm property and they had none that they could sell. Their property was mortgaged for a great deal more than the amount for which they could have sold it. There was no demand or market for the notes and mortgages which petitioner held. To have resorted to legal action with the necessai-y disproportionate expense in each case would have been folly. Had each debtor voluntarily turned over to petitioner the property on which it held the mortgage, it would have suffered a greater loss by accepting it. The cost of labor was high. The expense of moving and caring for the machinery and of caring for and feeding the live stock through a long winter would have exceeded their worth. There was no prospect that the property could be sold, if at all, for any better price in the spring of 1922. The fact is, if the property had been offered for sale in the fall or winter of 1921, or the spring of 1922, petitioner would have recovered far less than the amounts which it retained upon its books when making the charge-off here claimed as a deduction. The farmers carried on as best they could. There were many foreclosures and there was a great deal of used farm equipment on the market. Those few farmers who were in a sound financial condition were forced to retrench. They were making no profits and could not afford to increase their equipment beyond their immediate needs. Especially were they unwilling to invest in old and worn-out equipment and in live stock. The amounts which petitioner retained upon its books as being recoverable represent more than it could have recovered if it had enforced collection.

Judgment will be entered for the petitioner upon the issue raised on 20 days’ notice, under Rule 50.


source: Caselaw Access Project

author: SteRnhagen:

license: Public Domain

text:
    Simon Agency, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 2318, 11378.
    Promulgated March 9, 1927.

      B. P. Munns, Esq., and J. Q. Weisbach, Esq., for the petitioner.

      L. 0. Mitchell, Esq., for the respondent.
    This proceeding involves deficiencies of $780.29 and $1,262.60 for 1918 and 1919, respectively, arising from the Commissioner’s refusal to grant the petitioner personal service classification.

      FINDINGS OF FACT.
    The petitioner during 1918 and 1919 was an Illinois corporation with its principal office in Chicago, conducting a theatrical agency. Its capital stock was $2,500. John Simon, Irvin Simon and Burt W. Cortelyou were the sole stockholders, each owning one-third of the stock. These three men were regularly and actively engaged in the business. Each drew a salary of $75 a week during 1918 and $100 a week during 1919 when the earnings of the business justified it, and less at other times. The petitioner had two booking agents, two stenographers, a telephone operator, and an office boy. The only physical property owned by the petitioner was its office equipment, upon which it paid a personal property tax of about $11 a year. It owned a $500 Swift & Company bond which it put up as collateral securing the payment of rent on its offices. This bond was later absorbed by the rent which was applied against it during the last six months of the lease.
    Petitioner arranged engagements or “ bookings ” for actors. For this service it received from the actors 5 per cent of the salaries received under the contracts negotiated for them by the petitioner. If any actor or actors were referred to the petitioner by a Hew York booking, office it was necessary to divide the commission with that office. This was the petitioner’s only source of income.
    Petitioner often advanced money to actors to pay traveling expenses and hotel bills, taking an I O U as evidence of the indebtedness. The amounts loaned varied. . Sometimes it was more than $100, sometimes less. Ho interest was charged on these loans. The petitioner was called upon to advance money for traveling expenses ten or eleven times a week.
    The theatrical season lasts about thirty-five to forty weeks each year and the petitioner received commissions from about one hundred acts throughout the theatrical season.
    There were some transactions in the purchase and sale of stocks, as to which petitioner claimed losses. Its books of account are lost.
   OPINION.

SteRnhagen:

The evidence is not sufficiently clear to establish that capital was not a material income-producing factor. Apparently one of the features of the business was the financing of actors. That loans were regularly made is clear, although it does not appear how much they amounted to or how they were related to income. It can not be inferred whether the business could be carried on or the income earned without any capital, or more specifically whether in fact it was. There were transactions in stocks as to which the evidence is not clear.

A, claim for personal service classification with its special method of tax must be clearly proven and can not be loosely granted. The uncertainties in the present record defeat the petitioner’s claim, and we therefore sustain the Commissioner.

Judgment will be entered for the resfondent.


author: Marquette:

text:
    Boynton Gasoline Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 5342, 6909, 6910.
    Promulgated March 9, 1927.
    Tlie petitioner is entitled to an annual deduction from gross income for tlie exhaustion of casing-head gas contracts owned by it.

      Charles H. Garnett, Esq., for the petitioner.

      B. H. Bav/nders, Esq., for the respondent.
    These are proceedings for the redetermination of deficiencies in income and profits taxes in the amounts of $32,303.28 for the year 1918, $7,583.27 for the year 1919, and $4,557.17 for the year 1920. The only question involved is whether or not the petitioner, in computing its net income for each of the years 1918, 1919, and 1920, is entitled to a deduction as an allowance for the exhaustion of certain contracts. The several proceedings were consolidated for hearing and decision.
    FINDINGS OF FACT.
    The petitioner is a corporation organized under the laws of Oklahoma, with its principal office at Tulsa. It is and was during the years 1918, 1919, and 1920, engaged in the business of manufacturing gasoline from casing-head gas.
    In the year 1916 the petitioner’s stockholders transferred to it. without any consideration, certain casing-head gas contracts which they then owned. The life of these contracts was equal to the life of the oil properties which they covered, that is, the petitioner was entitled to the casing-head gas from these properties as long as the same was produced. It is agreed by the parties to these proceedings that the contracts had, at the time they were' acquired by the corporation, a fair market value of $100,000, and that the Commissioner allowed the corporation to include the contracts in invested capital at $100,000. They are also in accord as to the amount of the exhaustion of the contracts that occurred in each of the years 1918, 1919, and 1920. The Commissioner has reduced the petitioner’s invested capital on account of the exhaustion of these contracts but has refused to allow any deduction from gross income on account of such exhaustion.
   OPINION.

Marquette:

The petitioner contends that, in computing its net income for each of the years 1918, 1919, and 1920, it is entitled to a deduction for the exhaustion of the contracts in question. It is conceded by the parties hereto that the contracts, when acquired by the petitioner, had a fair market value of $100,000, and there appears to be no controversy as to the method of computing the exhaustion of the contracts or the amount thereof that occurred in each of the' taxable years under consideration. We are of the opinion that the contention of the petitioner is well taken and that it is entitled to the relief sought. When the petitioner acquired the contracts in question, it became possessed of an asset of the value of $100,000 and its total actual capital was increased by that amount. The assets so acquired immediately became part of the pethioner’s capital and in disposing of the assets it is entitled to recover the value thereof before it can be said to realize any taxable income. We think that no one will dispute that if the petitioner had sold those contracts the next day after it acquired them, the measure of taxable gain would have been the selling price, less $100,000. In this case the petitioner disposes of the contracts by exhausting them over a period of years, and we are of the opinion that from the amount it receives from the contracts it is entitled to a pro rata deduction for their exhaustion, based upon the value at the date acquired. In the Appeal of The Hub, Inc., 3 B. T. A. 1259, the facts were that the taxpayer on or about April 1, 1913, acquired by gift from its principal stockholders a leasehold which, at that time, had a life of fourteen years. The Commissioner refused to permit the Hub Company to include any amount in invested capital on account of said leasehold or to take any deduction from gross income for the fiscal years ending January 31, 1920, and January 31, 1921, on account of the exhaustion of the leasehold. The Board held that the leasehold in question had a fair market value of $42,000 when acquired by the taxpayer, and that the taxpayer was entitled to include that value in its invested capital, and to deduct, in computing its net income for each of the taxable years involved, an allowance of $3,000 for the exhaustion of the leasehold. The decision in that appeal, in so far as it involves the question of the deduction for exhaustion, is applicable here, and we hold that the petitioner herein is entitled, in computing its net income for each of the years 1918, 1919 and 1920, to a deduction for the exhaustion of the contracts in question. We express no opinion as to the propriety of the Commissioner’s action in including the value of the contracts in the petitioner’s invested capital, as that question has not been raised. ■ ‘ .

J%idgment will be entered on 15 days' notice, under Bule 50.


author: Maequette :

text:
    Appeal of New Orleans, Texas & Mexico Railway Co.
    Docket No. 400.
    Promulgated March 9, 1927.
    1. The petitioner in the year 1918 purchased its own bonds for less than the amount for which they had been issued. Held, that it realized no taxable gain from the transaction.
    2. That part of the 191S income tax (2 per cent) paid for the petitioner by the Director General of Railroads in accordance with the provisions of the Federal Control Act of March 21, 1918, was not income to the petitioner.
    3. The reasonable compensation of a railroad company for the use of its properties during the period of Federal control, awarded to a taxpayer keeping its accounts on the accrual basis, was income for each of the accounting periods for which the compensation was allowed, although not received until a later date.
    4. The amount paid by the petitioner on April 1, 1919, as interest on its non-cumulative debenture bonds for the period July 1 to December 31, 1918, hold to be a proper deduction in computing its net income for the year 1918.

      J. L. Lockett, Esq., for the petitioner.

      P. 8. Crewe, Esq., for the Commissioner.

      Schofield Andrews, Esq., and James Craig Peacock, Esq., as amici curiae.

    This appeal is from the determination by the Commissioner of a deficiency in income and profits taxes for the year 1918 in an amount of more than $10,000.
    FINDINGS OF FACT.
    The taxpayer is a Louisiana corporation with its principal office at Houston, Tex., and is engaged in operating railroad properties as a part of the Gulf Coast System. Its books were kept on the accrual basis.
    The taxpayer was organized on March 1, 1916, and on that date it purchased from the receiver of the Texas, New Orleans & Mexico Railroad Co. all of the property of that company, and issued as part of the purchase price $15,158,000 Jivq per cent non-cumulative debenture bonds. During the year 1918, the taxpayer purchased on the open market, and thereby retired, $1,308,750 par value of these bonds, paying therefor the amount of $655,424.52, which was $653,-325.48 less than the par value of the bonds so purchased. The Commissioner determined that the. taxpayer, as a result of the purchase of said bonds, realized income in the amount of $653,325.48, and upon audit of the taxpayer’s return for the year 1918, he increased the income reported on the return by the said amount of $653,325.48.
    In the year 1915, the New Iberia & Northern Railroad Co. acknowledged an indebtedness to the New Iberia Syndicate of $1,891,086.47. In the same year the New Iberia & Northern Railroad Co. issued to the NeAv Iberia Syndicate, in satisfaction of said indebtedness, $1)88,GOO par value of its capital stock and $2,000,000 par value of its 5 per cent first mortgage bonds. The bonds at that time had a life of 28 1/45 years. In the year 1916, the taxpayer purchased all of said stock and bonds from the syndicate and held them during the year 1918. The taxpayer and the New Iberia & Northern Railroad Co. were affiliated during that year. The difference between the par value of the stock and bonds so issued and the amount of the acknowledged indebtedness is $1,097,518.53, which the New Iberia & Northern Railroad Co. seeks to amortize over the 28 1/45-year life of the bonds; and in the consolidated return of the taxpayer and the New Iberia & Northern Railroad Co. for the year 1918, there was deducted from gross income on account of such amortization the amount of $39,174.48. The Commissioner, upon audit of the taxpayer’s return, determined that the taxpayer is entitled to amortize over the life of the bonds only $108,913.53, and he therefore disallowed $35,174.48 of the amount so deducted.
    The Commissioner, upon audit of the taxpayer’s income and profits-tax return for the year 1918, added to the income reported thereon the amount of $14,550.37, which represented that part of the 1918 income tax (2 per cent) paid for the taxpayer by the Director General- of Railroads in accordance with the provisions of the Federal Control Act of March 21, 1918.
    On December 28, 1917, the President of the United States, by proclamation dated December 26, 1917, took possession and assumed control of the taxpayer’s railroad property, and retained such possession and control during the year 1918. The taxpayer did not, after the enactment of the Federal Control Act of March 21, 1918, execute the just compensation agreement, commonly known as the standard return, authorized by that Act, but filed an application with the Director General of Railroads for compensation in excess of the standard return. Negotiations were continued until July 29, 1921, when a final settlement was signed by the taxpayer and the Director General of Railroads, in which $1,500,000 was agreed upon as the annual compensation to be paid by the United States to the taxpayer and its subsidiary lines for the use of their property.
    At the time of filing its original consolidated return for the year 1918, the taxpayer included in its gross income the amount of $1,101,-215.32, being the so-called standard return of the taxpayer and its subsidiary lines as originally certified to by the Interstate Commerce Commission. Subsequent to the execution of the final settlement agreement of July 29,1921, the taxpayer filed an amended return for the year 1918, and included in its gross income said amount of $1,500,000 in place of the $1,101,215.32 reported on its original return. The Commissioner excluded the difference between those two amounts from the taxpayer’s income for the year 1918, attributing it to the year 1921.
    The taxpayer, as hereinabove stated, issued on March 1, 1915, $15,158,000 five per cent non-cumulative debenture bonds. Approximately $13,700,000 of said bonds were outstanding during the period July 1, 1918, to December 31, 1918. The debenture under which the bonds were issued contained the following provisions:
    As to any instalment of interest on the income bonds payable on April 1, 1918, or on any semi-annual interest date thereafter, the hoard, of- directors shall wv each ease ascertain and determine in the maimer provided in this indenture the net income of the Railway Company from all sources during the six months period beginning the 1st day of July, immediately preceding any such 1st day of April and during the six months period beginning the 1st day of January immediately preceding any such 1st day of October, and, if there he such net income applicable to the payment of such interest and, to the extent that there shall he such net income, after making the deductions and reservations for additions, betterments and improvements as hereinafter provided, the hoard, of directors shall declare the same to he, and, the same shall thereupon become, clue and payable by the Railway Oompamy, provided, that no such declaration shall he made and the Railway Company shall be under no obligation to make any payment of such interest, for any one fiscal year, unless the net income of the Railway Company in such year applicable to such imymeiit to be ascertained and determined as hereinafter provided, and after reservation for additions, betterments and improvements, as hereinafter provided, shall suffice to pay at least 1% on said income bonds for such fiscal year. For the purposes of this indenture the fiscal year of the Railway Company shall be doomed to be from July 1st to and including- June 30th. (Italics ours.)
    During the six months beginning July 1, 1918, and ending December 31, 1918, the taxpayer’s net income applicable under the terms of the indenture to the payment of interest on said bonds for said period, after making the deductions and reservations for additions, betterments and improvements as in said indenture provided, was sufficient to pay interest for said period on said bonds at the rate of 5 per cent per annum, and the board of directors of the taxpayer did in accordance with said indenture, on the eleventh day of March, 1919, so declare. The interest so declared amounted to $341,153.14 and became due and payable April 1, 1919. The taxpayer, in its income and profits-tax return for the year 1919, deducted the amount of interest in computing its net income for that year. The Commissioner disallowed the deduction on the ground that said interest was a proper deduction for the year 1918 and not for the year 1919. The taxpayer now claims a right to deduct said interest in computing its net income for the year 1918.
   OPINION.

Maequette :

The first question presented herein is whether or not the taxpayer realized any income as the result of the purchase by it in the year 1918 of its own bonds for less than their par value. A similar question was presented to the Supreme Court of' the United States in the case of Bowers v. Kerbaugh-Empire Co., 271 U. S. 170. The facts in that case were that the Kerbaugh Empire Co. prior to July 2, 1913, borrowed from the Deutsche Bank of Germany the amount of $1,983,000. The loan was evidenced by notes payable, as to principal and interest, in marks or their equivalent in United States gold coin at prime bankers’ rates in New York for cable transfer to Berlin. The equivalent of the loan in marks was 8,341,-337.50. On September 1, 1913, there remained unpaid 6,740,800 marks. The notes of the company then outstanding were surrendered and a new note was given for 6,740,800 marks. When that note became due it was renewed. Partial payments were made and by March 31,1915, the principal was reduced to 3,216,445 marks.

After the United States entered the war, the Deutsche Bank became an alien enemy. In 1921, on the demand of the Alien Property Custodian, the Kerbaugh-Empire Co. paid $113,688.23 in full settlement of the principal and interest owing on the notes belonging to the Deutsche Bank. Of that amount, $80,411.12 represented principal. The settlement was on the basis of 2% cents per mark. Measured by United States gold coin, the difference between the value of the marks at the time the loan was made and the amount paid to the Custodian was $684,456.18. The Commissioner held that the last named amount was income to the Kerbaugh-Empire Co. The Supreme Court of the United States, in holding that the company did not realize any income from the transaction, said:

The question for decision is whether the difference between the value of marks measured by dollars at the time of payment to the Custodian and the value when the loans were made was income.
The Sixteenth Amendment declares that Congress shall have power to levy and collect taxes on income, “ from whatever source derived ” without apportionment among the several States, and without regard to any census or enumeration. It was not the purpose or effect of that Amendment to bring any now subject within the taxing power. Congress already had power to tax all incomes. But taxes on incomes from some sources had been held to be “ direct taxes ” within the meaning of the constitutional requirement as to apportionment. Art. I, § 2, cl. 3, § 9, cl. 4; Pollock v. Farmers’ Loan and Trust Co., 158 U. S. 601. The Amendment relieved from that requirement and obliterated the distinction in that respect between taxes on income that are direct taxes and those that are not, and so put on the same basis all incomes “from whatever source derived.” Brushaber v. Union Pac. R. R., 240 U. S. 1, 17. “Income” has been taken to mean the same thing as used in the Corporation Excise Tax Act of 1909, in the Sixteenth Amendment and in the various revenue acts subsequently passed. Southern Pacific Co. v. Lowe, 247 U. S. 330, 335; Merchants L. & T. Co. v. Smietanka, 255 ü. S. 509, 519. Alter full consideration, this Court declared that income may be defined as gain derived from capital, irom labor, or from both combined, including profit gained through sale or conversion of capital. Stratton’s Independence v. Howbert, 231 U. S. 399, 415; Doyle v. Mitchell Brothers Co., 247 U. S. 179, 185; Eisner v. Macomber, 252 U. S. 189, 207. And that definition has been adhered to and applied repeatedly. See e. g. Merchants L. & T. Co. v. Smietanka, supra, 518; Goodrich v. Edwards, 255 U. S. 527, 535; United States v. Phellis, 257 U. S. 156, 169; Miles v. Safe Deposit Co., 250 U. S. 247, 252-253; United States v. Supplce-Biddle Co., 205 U. S. 189, 194; Irwin v. Gavit, 268 U. S. 161, 167; Edwards v. Cuba Railroad, 268 U. S. 628, 633. In determining what constitutes income substance rather than form is to be given controlling weight. Eisner v. Macomber, supra, 206.
The transaction here in question did not result in gain from capital and labor, or from either of them, or in profit gained through the sale or conversion of capital. * * *

The identical question here presented was before this Board in the Appeal of Independent Brewing Co. of Pittsburgh, 4 B. T. A. 870. The facts there were that the taxpayer issued its bonds at par and subsequently purchased part of them in the open market for less than their par value. We held that the transaction did not result in taxable gain.

We are of the opinion that the decisions in the above cited cases are decisive of the question presented here, and we therefore hold that the taxpayer did not realize any income as a result of the purchase by it in the year 1918 of its own bonds under the circumstances set forth in the findings of fact.

The second question is whether that part of the 1918 income tax (2 per cent) paid for the taxpayer by the Director General of Bail-roads in accordance with the provisions of the Federal Control Act of March 21,1918, constituted income to the taxpayer. This question miist be answered in the negative on the authority of Appeal of New York, Ontario & Western Ry. Co., 1 B. T. A. 1172.

The third issue presented is what amount, if any, the taxpayer is entitled to deduct in computing its net income for the year 1918, as amortization of bonds issued by its subsidiary, the New Iberia & Northern Bailroad Co.

The record herein discloses that the New Iberia & Northern Bail-road Co. had its railroad property constructed and equipped through the New Iberia Syndicate at a cost to the syndicate of $1,891,086.47, and that the railroad company in the year 1915 acknowledged the indebtedness and delivered to the syndicate in settlement thereof its capital stock of the par value of $986,600 and its first mortgage bonds of the par value of $2,000,000. Prior to the year 1918 the taxpayer purchased all of said stock and bonds from the syndicate and during the year 1918 it was affiliated with the New Iberia & Northern Bail-road Co.

During the year 1918 the taxpayer owned both the capital stock and the bonds of its subsidiary and affiliated corporation, the New Iberia & Northern Bailroad Co., and the bonds therefore constituted inter-company obligations, which we have held, in Appeal of Gould Coupler Co., 5 B. T. A. 499, should be disregarded in determining the consolidated net income of the affiliated corporations, and upon the authority of the decision in that appeal we hold that the taxpayer, in computing its net income for the year 1918, is not entitled to deduct any amount as amortization of the bonds in question.

The fourth question is whether or not the entire amount of $1,500,-000 agreed upon by the taxpayer and the Director General of Bail-roads as just compensation for the use of the taxpayer’s property during the ye'ar 1918, is income to the taxpayer for that year.

In its original income and profits-tax return for the year 1918, the taxpayer reported as its income the amount of $1,101,215.32, that being its so-called “ standard return,” as certified to by the Interstate Commerce Commission. After the settlement agreement was entered into with the Director General of Bailroads, the taxpayer filed an amended return for the year 1918, reporting therein as its income for that year $1,500,000, the amount of its annual compensation under the agreement with the Director General. The Commissioner,, upon audit of the taxpayer’s amended return, determined that so much of the amount of $1,500,000 as exceeded the amount of the “standard return ” was income to the taxpayer for 1921, the year in which the settlement was made with the Director General of Bailroads. In our opinion the taxpayer’s treatment of the amount involved herein was correct. Appeal of Illinois Terminal Co., 5 B. T. A. 15.

The last question herein is whether the amount of $341,153.14, paid by the taxpayer oh April 1, 1919, as interest on its non-cumulative debenture bonds for the period July 1 to December 31, 1918, is deductible from gross income for the year 1918 or the year 1919. In our opinion this interest is a proper deduction for the year 1918.

The indenture under which the bonds were issued provided that the net income of the taxpayer for the period July 1 to December 31, 1918, after providing for certain additions, improvements. and betterments, should be applied to the payment of interest on such bonds and that the board of directors should so declare, the company, however, being under no obligation to make any payment of said interest unless the net income 'for the fiscal year, after providing for such additions, betterments and improvements, was sufficient to pay at least 1 per cent interest on said bonds for said fiscal year. The interest in question is, and the indenture under which the bonds were issued so provided, interest for the period July 1 to December 31, 1918, and if the net income for that period was sufficient for the payment of interest under the terms of tbe indenture, it was the duty of the board of directors so to declare. Whatever the income of the taxpayer was from July 1 to December 31, 1918, all of it had been earned on or before December 31, 1918, and every event had occurred and every condition was present, on or before the latter date, that determined its liability to pay interest on its bonds for that period. The board of directors was required to ascertain and determine the amount of the net income, if any, but their action could not in any way change or affect- the liability of the company to pay interest if the liability had in fact accrued. If the income was sufficient, the interest was owing, if the income was not sufficient, the interest was not owing. The ascertainment and determination of the board of directors was a mere administrative action involving no discretion. If the taxpayer’s books of account at the close of the period showed its net income sufficient to pay interest-on the bonds in accordance with the terms of the indenture, it was mandatory upon the board of directors so to declare and order the interest paid. The interest in question, in our opinion, accrued in the sense of owing, on December 31, 1918, and was therefore a proper deduction in computing the taxpayer’s net income for the year 1918.

Judgment will be entered on 15 days’ notice, under Rule 50.

SterNi-iageN dissents in part.


author: Phillips:

text:
    Appeal of The Hof Brau Co.
    Docket No. 6134.
    Promulgated March 10, 1927.
    1. Salaries, disallowed l>y the Commissioner, allowed as a deduction.
    2. The Commissioner decreased invested capital by the amount of additional tax claimed by him to he due, but not yet assessed and in dispute in another proceeding before the Board. In the absence of any evidence of the correct tax liability for such prior year, the action of the Commissioner is approved.

      W. W. /Spalding, Esq., for the petitioner.

      Arthur E. Murray, Esq., for the Commissioner.
    Taxpayer appeals from the determination by the Commissioner of a deficiency of $4,593.18 in income-and profits taxes for the fiscal year ended October 31, 1920. The issues involve the disallowance by the Commissioner of salaries of officers, a reduction of invested capital for income and profits taxes of earlier years, and. the reduction of current earnings by the amount of a tentative tax in computing the deduction from invested capital for dividends paid during the year. Two other issues raised were abandoned.

      BINDINGS OB BACT.
    The taxpaj^er is a California corporation with its principal office in San Francisco.
    In the return of the taxpayer for the taxable year there was deducted from gross income $36,000 for salaries paid to the two executives, L. H. Hirsch and H. L. Hirsch. Of this amount, $8,374.10 was disallowed by the Commissioner. The salaries, $1,500 per month to each of the two executives, were duly authorized by the board of directors prior to the beginning of the taxable year. The stock holdings in the appellant company were as follows: From November 1, 1919, to April 19, 1920, L. H. Hirsch, 349 shares; H. L. Hirsch, 650 shares; W. P. Caubu, 1 share; and from April 20, 1920, to October 31, 1920, L. H. Hirsch, 1 share; H. L. Plirsch, 1 share; W. P. Caubu, 1 share; W. P. Caubu, trustee for Elizabeth M. Hirsch, 997 shares. IT. L. Hirsch is the father of L. H. Hirch; Elizabeth M. Hirsch is the wife of H. L. Hirsch and the step-mother of L. PI. Hirsch.
    In 1920 the taxpayer was conducting a restaurant in the basement of the Pacific Building, Fourth and Market Streets, San Francisco. The name, originally, was the Hof Brau Restaurant, now known as “ The States.” The business was operated by Mueller & Company up to and including 1910. Under the Mueller management the restaurant was unsuccessful and it was not until it was taken over by the appellant company, in 1912, that financial success came to it. The Hof Brau then became a family restaurant whose specialty was the serving of good food at reasonable prices, with the attendant feature of music but no cabaret or dancing. The executives, Messrs. Hirsch, conceived the idea of increasing the business of the restaurant through a new form of advertising, e. g., the introduction and popularizing of abalone, reindeer meat, and the meat of other game animals. Under the Hirsch management, the business of the restaurant developed until it became one of the largest west of Chicago. During the taxable year the floor space of the restaurant was 30,000 square feet, with a seating capacity of 1,200 people. The number of customers served during the year was 853,660. The sales of the year were $890,463.70, made up as follows: Restaurant proper, $800,837.25; soft drinks, ice cream, etc., $79,850.55; and cigar stand, $9,775.90. There were approximately 150 employees, with an annual pay roll of $214,823.25. The hours of business extended from seven in the morning to one o’clock the following morning.
    H. L. Hirsch, the father, has had thirty years experience in the restaurant and hotel business and during that period has acquired the reputation of being one of the most successful restaurateurs of the country. His special task was that of satisfying the public with the service and food of the Hof Brau Restaurant. With his son, he also determined the policies of the company, employed and trained the help, and solved its daily problems as they arose. His affiliation with a large number of societies and clubs enabled him to have their banquets and dinners at the Hof Brau Restaurant. He was the president of the appellant company.
    L. H. Hirsch, the son, who has had fifteen years experience in the restaurant business, had charge of “ the back end of the house which is known as the operating end, the office and the production end,” including the kitchen. He had charge of the buying of the food and general supervision over all departments of the kitchen. His also was the duty of seeing that the records of the company were properly kept. He was the secretary of the company.
    Each of the officers devoted his entire time to the business. The hours of their service were from ten in the morning until one the following morning, seven days of the week. Sunday was one of the busiest days of the week for the officers, owing to the increased volume of custom on Sunday afternoon and evening. Their duties were so exacting as to deprive them largely of any home life. In the taxable year here involved, two special problems required solution by the officers. The first of these, the labor problem, which became very acute in 1920, required tact and patience. The second of these, prohibition, involved changes of policy and a well-balanced revision of prices to meet the changed conditions due to prohibition on the sale of wines and beer, which had theretofore been sold by the company in connection with its restaurant business. Both of these problems were solved successfully. Prior to prohibition there were five restaurants in the City of San Francisco of the same general type as the Hof Brau. Of these the Hof Brau alone survived.
    For the fiscal year ended October 31, 1919, taxpayer paid its executive officers $41,700, of which $36,000 was allowed as a deduction by the Commissioner. For the fiscal year ended October 31, 1920, taxpayer paid its officers $36,000, of which $8,374.10 was not allowed as a deduction by the Commissioner. After payment of such salaries, net income for 1919 was $28,278.83 and for 1920 it was $11,498.84.
    In computing the invested capital there were deducted the following amounts: for taxes of 1919, prorated from their due date, $9,020.53; for additional taxes of 1918, $9,564.24. The additional taxes for 1918 were not assessed prior to or during the taxable year. The correct amount of the 1918 tax liability is in dispute in another proceeding pending before the Board.
    On January 5, 1920, the appellant paid a dividend of $29,271.01. The Commissioner determined that the earnings of the current year were $25,096.22. He computed a tentative tax thereon of $5,776.18, and reduced the earnings available for dividends to $19,320.06. Pie prorated this amount and thereby determined the earnings from November 1, 1919, to January 5, 1920, available for the payment of the dividend to be $3,483.94. Ho subtracted this amount from the dividends paid on January 5, 1920, and thereby determined that the difference, $25,787.07, was paid from earnings of prior years. This amount of $25,787.07 he deducted from invested capital for the balance of the fiscal year after January 5,1920, by prorating such amount on the basis of a full year, thereby reducing invested capital by $21,136.94.
   OPINION.

Phillips:

The petitioner claimed as a deduction salaries paid to its two principal officers in the amount of $36,000. The Commissioner disallowed $8,374.10 as excessive. The salary paid was authorized by the directors prior to the beginning of the taxable year.

While the salaries paid by the petitioner to its officers were large, they do not appear to be excessive when consideration is given to the character of the services performed and their importance to the corporation. These officers were required to devote substantially all of their waking hours, seven days a week, to the business. Not only did they so manage the restaurant in the face of labor troubles and the loss of revenue from its bar that it survived when its competitors were forced "to close; they show a profit of $11.50 per share on the capital stock. Furthermore, the amount paid is the same as was allowed by the Commissioner in the previous year and, in view of all the circumstances, we see no good reason why it should be regarded as excessive for 1920. We therefore reverse the action of the Commissioner with respect to the disallowance of the portion of this salary in issue.

The issue raised with reference to the reduction of invested capital by additional taxes for 1919 prorated from their due date must be decided adversely to the taxpayer under the provisions of section 1207 of the Revenue Act of 1926. See Appeal of Russel Wheel & Foundry Co., 3 B. T. A. 1168. It appears further that the Commissioner has reduced invested capital for 1920 by an additional tax for .1918 determined by him but not yet assessed and which is the subject of another proceeding before the Board. At the time the hearing was had in this appeal, this second proceeding was not yet at issue, no motion was made to postpone the consideration of the present hearing until the two proceedings could be consolidated, nor was any evidence offered with respect to the tax liability for the prior year. The presumption is in favor of the correctness of the Commissioner’s determination and a showing merely that the tax liability is in dispute is insufficient to enable the Board to determine affirmatively that there is any error in the Commissioner’s computation.

The third issue involves the reduction of invested capital by reason of the payment of a dividend during the taxable year. In determining how much of such dividend was paid from earnings of the current year and how much from surplus accumulated in prior years, the Commissioner reduced the earnings of the current year by a tentative income and profits tax thereon. Upon the ground that the income and profits tax does not accrue and become a liability from day to day, the Board decided, in the Appeal of L. S. Ayers & Co., 1 B. T. A. 1135, that earnings of the current year to the date of declaration of the dividend were not to be reduced by such a tentative tax in determining what portion of dividends were paid from such earnings. The question hero involved is controlled by that decision.

Decision will he entered on W days' notice, wider Rule 50.


author: Smith:

text:
    Canton Art Metal Co., Petitioner, v. Commissioner of Internal Revenue, Respondent. Canton Steel Ceiling Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 7111, 7112.
    Promulgated March 10, 1927.
    1. Where bonuses are authorized to be paid to the officers and employees of a corporation and the amount to be paid to each employee and officer is determined prior to the close of the year, they are deductible from gross income in income-tax returns, even though no entry is made upon the books of account until the succeeding year.
    2. A reS&Srve for bonuses charged monthly upon the petitioners’ books of account held, not to be deductible from gross income where the amount to be paid to individual employees and officers was not determined until long after the close of the taxable year.

      'William Simpson, Esq., and John E. 0. Feller, Esq., for the petitioners.

      J. H. Byrne, Esq., for the respondent.
    These are proceedings for the redetermination of deficiencies in income and profits taxes as follows:
    Canton Art Metal Co.:
    1018_-_$14,828.46
    1919_ 1, 853. 77
    Canton Steel Ceiling Co.:
    1918_.,_!_ 2,199. 61
    1919_ 334. 01
    - Total_ 18,715.85
    These two proceedings were consolidated for the purpose of hearing and decision. The respondent held the petitioners' to be affiliated within the purview of section 240 of the Revenue Act of 1918. The only questions presented for the determination of the Board grow out of the refusal of the respondent to allow as deductions from gross income in income-tax returns certain bonuses paid by the Canton Art Metal Co. for the years 1918 and 1919.
    FINDINGS OF FACT.
    1. The Canton Art Metal Co. is a corporation organized under the laws of the State of Ohio, with its principal office and place of business in Canton, and has been in existence for more than twenty years. It is engaged in the manufacture of steel filing cases, desks, special work for banks, public offices, etc., and steel ceilings, heating and ventilating apparatus, gear guards, etc.
    2. On February 18, 1918, the board of directors of the company in meeting assembled, by unanimous vote of the entire board, adopted a resolution which reads as follows:
    Moved by .Tolm W. Yohe, seconded by J. S. Shanks, that bonuses shall be paid out of the earnings of the year 1918 and each year thereafter in such amounts and to such officers and employees as the president shall direct.
    3. In November, 1918, one Eckis, then bookkeeper of the company, was instructed by the president that a total of $10,000 would be paid as a bonus for the year 1918 and was also advised of the amounts which should be credited to each of the individuals on the basis of a $10,000 bonus. Eckis advised at least two of the employees, namely, C. E. Saint and Arthur W. Streckert, who were still in the service of the company, of the fact that a bonus was to be paid and of the amount each would receive for the year 1918. He did not, however, make any book entries in 1918 relative to the bonus. In February or March, 1919, accountants called in to audit the books of the company presented a statement of the business to the president who then, for the first time, learned that no entries had been made upon the books of the bonus which was to be paid. He then ordered such entries to be made, which was done.
    4. At about the same time A. B. Clark, president of the company, which was then enjoying a very profitable business, ordered that a bonus of $35,000 be sot up on the books of the company for the year 1919 in monthly installments of $3,500 each, beginning in March, 1919, and continuing throughout the year, which order’was carried out. The amount of $3,500 a month was charged to general expense of the two factories operated by the company and credited to a “ reserve for bonus.”
    5. Of the bonus set up for the year 1918, $1,971 was paid to six employees on April 2, 1919, $2,000 was paid to another employee on May 5,1919, and $420 was paid to another employee in equal amounts on June 10 and December 24, 1919. On April 15, 1919, there was passed, to the credit of W. W. Clark, vice president and secretary of the conqpany, who with A. B. Clark constituted the principal stockholders, $1,G09; the remaining $4,000 of the reserve was credited to A. B. Clark on May 7, 1919.
    6.Out of the reserve for bonus set up for the year 1919 in the amount of $35,000, payments were made to different employees during the year 1920 in the amount of $2,650. Credits were made to different employees up to December 31, 1920, of $1,700. On December 31, 1920, there was credited to different officers and employees $15,400. The balance of the $35,000 was credited as follows:
    June SO, 1921, factory employees_$1,500

    March 12, 1923, Alfred Bowers_ 300
    April 13, 1923, Alfred Bowers_ 500
    September 16, 1923, A. B. Clark_ G, 475
    September 16, 1923, W. W. Clark_ 6,475
    7. The capital stock of the Canton Art Metal Co. as of December 31,1918, was divided into 1,500 shares common stock and 1,000 shares preferred stock. A. B. Clark owned 240 shares and W. W. Clark owned 401 shares common stock. Neither owned any of the preferred stock. The authorized salary of each for the year 1918 was $4,800 and for 1919 it was $6,000. Out of the reserve for bonus set up for the year 1919 in the amount of $35,000 there was paid or credited, during the years 1920 to 1923, to A. B. Clark $13,425, and to W. W. Clark $11,125.
    8. Although the business of the Canton Art Metal Co. for the year 1918 and for the first eight or ten months of 1919 was profitable, business became very much depressed at the end of 1919 and the company suffered a large inventory loss for 1919, the result being that its return for that year, after the deduction of $35,000 for bonuses, showed a loss. The company was not during most of the year 1919 in a position to pay to its officers and employees the amount set up in its reserve for bonuses.
    9. The petitioners kept their books of account upon the accrual basis. In the audit of their returns the respondent disallowed the deduction from gross income of the $10,000 claimed as a bonus paid to officers and employees for 1918, and $35,000 similarly claimed for 1919. The deficiencies result in part from such disallowances.
    10. The practice of adding $3,500 per month to a reserve for bonus was continued during the year 1920 until $35,000 for the year-had been set up. At the close of 1920, $25,275 of the amount so set up was credited back to general expense.
   OPINION.

Smith:

The only question for our decision is the deduction from the gross income of the consolidated returns of $10,000 for the year 1918 and $35,000 for the year 1919. The petitioners contend that these amounts were authorized by the board of directors of the Canton Art Metal Co., that officers and employees knew of the intention of the company to pay bonuses for those years and, so far as the year 1919 is concerned, that the bonuses were actually charged upon the books during the year.

We think that the bonus authorized by the board of directors in 1918 is a legal deduction from the gross income of that year. The evidence shows that the president of the company determined the amount of the bonus and instructed the bookkeeper to charge the same upon the books of account, and to credit the various employees therewith. Certain employees of the company had been advised of the bonus to be paid them. Although the evidence as to the communication of the amount to be paid to each employee is somewhat vague, we are of the opinion that the corporation had a liability of $10,000 for bonuses at the close of 1918. Appeals of American Express Co., 2 B. T. A. 498; Josiah Wedgwood & Sons, Ltd., 3 B. T. A. 355; Block & Kohner Mercantile Co., 4 B. T. A. 673.

We think that a different situation exists with respect to the payment of bonuses for the year 1919. A. B. Clark testified that about Christmas of 1919 he determined the amount of the bonus to be paid to the several employees, but the accounting records would indicate that there was no actual liability of the petitioner to pay bonuses for the year 1919 and we think that the fact that only $2,650 of the $35,000 sot up as a reserve for bonus for 1919 was paid during the year 1920 argues very strongly that there had been no clear determination of the amount of the bonus to be paid. It was not until some time in 1921 that $1,500 of the amount set up was paid to the factory employees, and not until 1923 that a large part of the bonuses reserve was credited to officers and employees.

The evidence indicates that the “ reserve for bonus ” set up on the petitioners’ books of account for 1920 was only the title under which a part of its surplus Avas carried. We think that the evidence shows no actual liability on December 31, 1919, on the part of the petitioners for the payment to their officers and employees of a bonus for 1919.

The year 1920 is not before us and we express no opinion as to the right of the petitioners to deduct from the gross income of 1920 amounts paid or credited to employees in 1920 out of the reserve for bonus standing upon their books of account at the time of such payment or credit.

Judgment mil be entered on 15 days' notice, under Bule 50.


author: Tettssell:

text:
    Charles F. Pearce, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5606.
    Promulgated March 10, 1927.
    Income on- cash receipts and disbursements basis determined.

      Charles F. Pearce, Jr., pro se.

      J. W. Fisher, Esq., for the respondent.
    The Commissioner, in his letter dated June 29, 1925, has asserted a deficiency in the income tax of this petitioner for the calendar year 1922, in the amount of $151.14.
    The petitioner alleges that the Commissioner erred in that the amount of income on which the deficiency tax is based represents income not received during the calendar year 1922.
    FINDINGS OF FACT.
    Charles F. Pearce, Jr., an individual residing- at Glencoe, Ill., was, during the year in question and also for the years prior and subsequent thereto, employed by the Burton-Dixie Corporation of Chicago, on the basis of a salary and bonus. Pearce had an oral agreement with the corporation that after the close of each year he was to receive a cash bonus amounting to a certain percentage of the net profits of the department of the business in which he was engaged. Neither Pearce nor the corporation knew what the amount of the bonus would be until the books had been closed for the year.
    For the years prior to 1922 and up to the year 1925, the corporation closed its boobs as of December 31 of each year, but the closing entries were never actually made prior to February of the succeeding year, for it owned a large warehouse in Detroit and all the necessary inventories and information could not be secured prior to that time.
    For the year ended December 31, 1922, the corporation actually closed its books some time during February, 1923, and thereafter paid Pearce a cash bonus in the amount of $1,363.05. At the same time the corporation credited to Pearce’s account a stock bonus amounting to $926.32.
    The stock bonus account, the only account Pearce had with the corporation, was carried on the books in accordance with an agreement, made in 1917, between Pearce and the corporation, to the effect that if Pearce remained in the employ of the corporation for a period of eight years he should receive a certificate of stock and that each year an amount designated as a stock bonus should be credited to his account in payment for the stock. It was further agreed that if Pearce left or was discharged from the corporation within the eight-year period, he should not receive the certificate of stock nor any part of the amounts credited .to the said account. In accordance with this agreement the certificate of stock was issued to Pearce in 1925.
    Pearce actually received during the year 1922 all the salary due him for that year, in the amount of $5,825, and also a cash bonus of $102.55 for the year 1921. The total of these two amounts, $5,727.55, was the only income actually received during 1922 by Pearce, who kept his books on a cash receipts and disbursements basis, and the said amount was reported in his income-tax return for that year and the tax thereon paid.
   OIUNION.

Tettssell:

The total amount of the deficiency is based upon the Commissioner’s inclusion in petitioner’s 1922 income of amounts representing cash and stock bonuses which were not received by petitioner nor ascertainable in amount by him during the taxable year 1922.

Under the authority of the Appeal of M. E. Farr, 3 B. T. A. 110, holding that a taxpayer on a cash receipts and disbursements basis may be taxed only on the amount of income actually received during the taxable year, and under authority of the Appeal of Anthony Schneider, 3 B. T. A. 920, holding that stock received as a bonus or additional compensation is income in the year in which the certificate therefor is actually issued and delivered, there is no deficiency in tax for the year 1922.

Judgment will be entered for the petitioner.


author: Teussell:

text:
    George C. Jones, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 4864.
    Promulgated March 10, 1927.
    Losses resulting from worthlessness of corporate stock allowed.

      Wilbur D. Shaw, Esg., for the petitioner.

      John W. Fisher, Esg., for the respondent.
   Teussell:

This proceeding was brought for the redetermination of a deficiency for the year 1923 in the amount of $511.26. The petitioner in his return for that year' claimed a deduction from gross income of $20,000, the cost of corporate stocks which had become worthless. ’

BINDINGS OF FACT.

In the year 1900, A. N. Drake, B. B. Ballard, and this petitioner organized a Minnesota corporation with common capital stock of $25,000, and began a business at Minneapolis of making and dealing in farm mortgage loans, chiefly in the States of North Dakota, South Dakota, Montana, Idaho, and Wyoming. At the inception of the corporation Drake took $10,000 of the corporate stock, Ballard $10,000, and the petitioner $5,00.0. The stock was issued and paid for at par in cash.

During the period from 1900 to 1911, at various intervals, the common capital stock of the corporation was increased,.and at each time when stock ivas so increased Drake, Ballard, and the petitioner each subscribed and paid for, in cash at par, such a number of shares as maintained their original relative ownership of the total common stock of the company. The last increase of common stock was made in the year 1917, and thereafter Drake owned 800 shares, Ballard 800 shares, and the petitioner 400 shares.

During all the years from 1900 to 1920, the business of the corporation prospered and at commonly regular intervals paid substantial dividends.

The principal business- of the Drake-Ballard Co. was that of loaning money on farms in the states above mentioned. As security for these loans the corporation took first mortgages and trust deeds, securing bonds which were sold to the corporation’s customers. The greater portion of the corporation’s profits arose through the taking, in the form of a second mortgage, of what is commonly known as a “commission mortgage,” that is, if the mortgagor undertook to pay interest on the money borrowed at 8 per cent, the first mortgage ivas written as bearing interest at G per cent and the company’s commission mortgage was written as bearing interest at 2 per cent. These first mortgages were then sold to the corporation’s customers, or used as a basis for the issuance of bonds sold to such customers. The second, or commission mortgages, representing the profits of the corporation, were commonly retained by it and collections were made thereon at the regular interest-payment dates described in the first mortgages. In connection with its mortgage loan business, the company acquired some banking interests in different places, bought and sold bonds of other companies, and acted as agents in making loans for an eastern life insurance company.

The general depression in prices of products and the consequent collapse of farm land values in the grain and corn-growing States which occurred in the year 1920 was directly reflected in the business of the Drake-Ballard Co. Farmer mortgagors discontinued the paj^-ments of interest and failed to meet occurring installments of principal, and the Drake-Ballard Co. was thus compelled to fail to meet its obligations to those of its customers wlio had furnished the funds for the farm loans.

In the year 1921, the Drake-Ballard Co.’s business and its books were examined by a committee of representatives from several Minnesota banks with whom it had been doing business and who were among its creditors. The bankers advised the company’s officers that the situation was such that the company could no longer continue to carry on its business at a profit. ■ Following the receipt of the advice from its bankers, tlie company’s officers, in an effort to bolster up its fortunes, agreed to a voluntary 50 per cent assessment upon its common stock, and in carrying out this voluntary assessment the petitioner, not being able at that time to pay an assessment of $20,000, turned in an authorized cancellation of $20,000 par value of the common stock then held by him. Ballard, likewise, being unable to meet the entire assessment, paid in property valued at $15,000, and turned in and authorized the cancellation of $15,000 par value of the stock held by him. Drake conveyed to the company lands at a valuation of $15,000, and paid in cash and mortgages valued at $10,000. Common stock shares turned in by the petitioner and Ballard were reissued to Drake. The assets of the company were thus increased in the amount of $100,000, and its common stock liability remained as before. The company’s financial troubles, however, continued and grew worse through the year 1922, and, in the spring of 1923, at a meeting of the company’s stockholders, it was agreed that the company should and it then did go into voluntary liquidation.

Thereupon, a thorough investigation of the company’s books of account and a reaudit of the same was made. Such reaudit, being made as of December 31,1922, showed total assets $2,015,835.64. Of this total amount of assets, $685,856.60 represented the so-called second or commission mortgages and foreclosures of the same, against which there was set up a reserve for probable losses in an amount computed at about 14 per cent of the total. The company’s liabilities, including preferred and common stock, were then found to aggregate $2,124,559.64, indicating a deficit of $108,724.00.

On December 31, 1923, after approximately eight months of liquidation, the company’s assets were found to have been reduced by the amount of $991,986.08, while its outside liabilities, excluding capital stock and reserve, had been reduced in the amount of $810,416.95, indicating a shrinkage in its assets of $181,569.13, and at that date its total assets were carried as $1,023,849.56, and its total liabilities, including reserves and capital, were found to be $1,269,259.49, indicating a deficit of $245,409.93.

In the total of book assets as of December 31, 1923, there were yet carried a number of items which were then known to be worthless. Among these items were nineteen of the so-called second or commission mortgages of a face value of $52,579.89. The facts in reference to one of these commission mortgages are: Its face amount was $2,650; it was foreclosed on April 4, 1922, and bid in by the Drake-Ballard Co.; there was no redemption; it was subject to a first mortgage bond issue of $8,500; it covered a 200-acre tract of land in Montana which in 1923 was not worth more than $30 per acre. The title remained in that condition until 1925, when the Drake-Ballard Co., in consideration of $50, conveyed its foreclosure title to a bank which held $5,000 par value of bonds secured by the first mortgage, and at or about that time the same bank purchased the remaining $3,500 of bonds at 10 cents on the dollar. The facts pertaining to each of the other eighteen items are along substantially the same line as’above set forth.

In the same list of assets there was stock of the Williams County State Bank in the amount of $6,150. This bank was closed in the year 1923 and it has never been reopened. In October, 1923, a 100 per cent assessment was levied against the stockholders. The Drake-Ballard Co. has paid part of this assessment.

Among said assets there was also carried stock of the Inverness State Bank in the amount of $27,115. This bank was closed in July, 1923, and has never been reopened. A 100 per cent assessment was made against its stockholders, and the Drake-Ballard Co. has paid part of'this assessment. This bank had given a bond to Hill County, Montana, to secure dejoosits of public funds. The Drake-Ballard Co. was surety on this bond and has paid the $24,000 liability thereon.

Among the same assets there was carried stock of the Northern Loan & Credit Co. in the amount of $8,000. The Drake-Ballard Co. had been the owner of a majority of the stock of the Inverness State Bank, and prior to 1923 the State Banking Department had ordered this bank to charge off and remove from its list of assets various items of real estate and chattel mortgages. In order to satisfy the State Banking Department and keep the Inverness State Bank open for the time being, the Drake-Ballard Co. caused to be organized the Northern Loan & Credit Co., and paid $8,000 for stock in this company, and then made it a cash loan of $16,000. The Northern Loan & Credit Company then took over the rejected assets of the Inverness State Bank. These assets proved to be worthless and both the stock of the Northern Loan & Credit Co. and its note for $16,000, which was carried among the bills receivable of the Drake-Ballard Co. on December 31, 1923, were then known to be worthless.

The stated assets of the Drake-Ballard Co. on December 31, 1923, should therefore have been reduced by—

Worthless second mortgages-$52, 579.89
Less: 14% previously set up in reserve- 7, 360.18
- $45,219. 71
Bank stocks:
Williams County State Bank_ 6,150.00
Inverness State Bank_ 27,115.00
Northern Loan & Credit Co_ 8, 000. 00
-- 41,265.00
Bills receivable_ 16, 000.00
Total_ 102, 484. 71

This amount, added to the indicated deficit of December 31, 1928, makes that actual deficit $347,894.64.

The $20,000 of common capital stock of the Drake-Ballard Co. owned by the petitioner on December 31, 1923, was on that date a total loss, and was a proper deduction from gross income. The common stock of the Drake-Ballard Co. acquired by the petitioner prior to March 1, 1913, was worth par on that date. The common stock of the Drake-Ballard Co. acquired by the petitioner after March 1, 1913, was acquired for cash at par.

There is no deficiency against this petitioner for the calendar year 19%3. Judgment will be entered in due course.


author: Korngr, Chairman:

text:
    Erle M. Donalson, Executor, Estate of John E. Donalson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 1629.
    Promulgated March 10, 1927.
    Decedent transferred to a bank by endorsement a promissory note owned by him, in satisfaction pro tanto of his indebtedness to the bank. After decedent’s death makers of the note defaulted and the bank recovered judgment and payment. The note was not an asset of the decedent’s estate at the date of his death.

      Erie M. Donalson, Esq., for the petitioner.

      A. B. Marrs, Esq., for the respondent.
    The Commissioner determined a deficiency in estate tax in the amount of $149.87. Petitioner brings this proceeding for the rede-termination thereof. The tax arises under the Revenue Act of 1918.
    FINDINGS OF FACT.
    The decedent, John E. Donalson, died on December 2, 1920. The petitioner, his son, duly qualified as his executor and filed an estate-tax return showing no taxable net estate. The Commissioner made adjustments in the values of certain parcels of real estate by which adjustments the values thereof were increased. The value of the gross estate was increased correspondingly. The values determined by the Commissioner and as found by the Board are, respectively, as follows:

    Prior to his death, John E. Donalson was indebted to the First National Bank of Bainbridge in an amount in excess of $12,000. The decedent was the owner of a promissory note executed by C. D. Cowart and W. H. Van Landingham in the amount of $2,000. Prior to his death the decedent transferred and set over by endorsement to the First National Bank of Bainbridge his right, title and interest in the said chose in action in satisfaction fro tanto of his indebtedness to the bank. After the death of the decedent the makers of the note defaulted and the bank called on the decedent’s executor to protect his testator’s endorsement. The executor requested the bank to enter suit against the makers of the note which was done. The bank employed the petitioner, who is an attorney, to prosecute the suit. Judgment was secured, together with 10 per cent attorney’s fees provided in the note in case of suit for collection. The judgment was paid by the makers of the note. Petitioner made the collection, deducted his fees, and turned the proceeds of the note over to the bank. No part of the'proceeds of the collection of this judgment was taken by the executor into the funds of the estate. The indebtedness of decedent’s estate, as reported in the estate-tax return, was shoAvn as reduced.by the amount of $2,000 as the result of the action of the decedent in taking credit on his outstanding liability to the bank by the note transaction referred to occurring before his death. The executor, in making return for estate-tax purposes, did not report the Cowart and Van Landingham note as an asset of the estate. The Commissioner treated this note as an asset and included its value of $2,000 in the gross estate of the decedent.
   OPINION.

Korngr, Chairman:

The Commissioner apparently treated the proceeds of the Cowart and Yan Landingham note as an asset belonging to the estate or, on the other hand, treated the flowing of the proceeds of the note from the makers to the bank as a payment of a liability of the estate, which was to the same effect. But in so treating it, the Commissioner did not, on the contrary, increase the estate’s indebtedness which it satisfied, by the corresponding amount of $2,000. We are of opinion that the petitioner is correct in his contention that the note in question was not an asset of the estate and that the item of $2,000 was improperly included by the Commissioner in the decedent’s gross estate.

Judgment will l>e entered on 15 da/ys notice, umder Bule 50.


author: ‘ Korner, Chairman:

text:
    Richard Carney, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7027.
    Promulgated March 10, 1927.
    The fair market value of petitioner’s land on March 1, 1913, was $18,500.

      Douglas D. Felix, Esq., for the petitioner.

      A. B. Marrs, Esq., for the respondent.
    Proceeding for the redetermination of a deficiency in income tax for the calendar year 1919, determined by the Commissioner in the amount of $6,587.85.
    FINDINGS OP PACT.
    Petitioner is a resident of Cocoanut Grove, Fla. Prior to the year 1913 he acquired a parcel of land on Miami Beach, in Florida, of 14.5 acres. He conveyed 1.3 acres of this property to another at a time immaterial to this proceeding, and in the year 1919 he sold the remaining 13.2 acres for $45,000. In returning his income for taxation for the year 1919, the petitioner reported a fair market value on March 1, 1913, of the land sold of $40,000. The Commissioner determined the value on the basic date to be $4,200 and restored the difference to income and, accordingly, determined the deficiency here in controversy.
    The property in question is a strip of land 200 feet wide fronting on the Atlantic Ocean. It runs back westward between parallel lines for a distance of approximately 3,000 feet. About the basic date it was bounded as follows: On the east by the Atlantic Ocean, on the north by the lands of Carl Fisher and Collins (later the Alton Beach .Realty Co.) and on the south and west by the lands of Ocean Beach Realty Co. It is situated about one and one-fourth miles north of Biscayne Avenue and the fee to the land included the riparian rights on the ocean frontage. About one-third of the east end of the land was on a ridge and was generally higher than the surrounding lands, approximately the middle third was somewhat lower, while the west third was lower still, though not lower than the contiguous lands. A portion of this western third was what is known as palmetto swamp or sand dunes. It was not mangrove swamp. The property to the west, southwest and northwest was mangrove swamp and required filling in to make it useful, at a cost of $2,000 to $2,500 per acre on the average. The east third of petitioner’s land needed no filling but, about the basic date, the lands surrounding petitioner’s property on the west, southwest and northwest were filled in to a level higher than the west third and a greater portion of the middle third of petitioner’s property. This filling necessitated the filling of that portion of petitioner’s land. The west third was filled by approximately 2 to 2y2 feet — diminishing as the filling proceeded eastward, while the middle third was filled to a depth varying from iy2 feet to C inches. The reasonable cost of the amount of filling indicated on petitioner’s tract was $5,500.
    At the basic date there was no settlement of the Miami Beach section to speak of. Collins Avenue (now Washington Boulevard) was a road but it had not been developed as such. The only practicable means of transportation between this property and the south end of the island was a boardwalk which ran from Hardie’s Casino along the ocean front to petitioner’s property. There were only four structures south of Collins’ residence, which was a mile north of petitioner’s land. Two of these structures were bathing and amusement casinos on the extreme south beach, one was the home of J. C. Gram-ling, the other was the home of A. J. Bendle, then under construction. There were no waterworks, schools, electric lights, telephones or other conveniences of urban life. The only means of communication with the mainland was by ferryboat across Biscayne Bay. This ferry line ran to the south end of the beach. The Collins bridge had been partially completed. It was finally completed in June, 1913. The Causeway had not yet been begun.
    Some time in 1912, or prior thereto, Collins had begun a development of his properties adjoining petitioner’s to the northward. As a means to this end he began the construction of a wooden bridge across Biscayne Bay from the mainland to that portion of the island now known as North Beach, in which petitioner’s property lay. Collins was unable to carry out his undertaking for lack of funds. In 1912 he interested Carl Fisher in the project. Fisher was a man of large wealth. Having become interested in the general development in that vicinity, Fisher announced and it became generally known that he would carry out such development on a large scale. Fisher took over the Collins bridge and pushed it.to completion in June, 1913. The cost of this work to Fisher was $40,000, and Collins conveyed to Fisher about 200 acres of land as reimbursement or part reimbursement for such expenditure. This was about 1912.
    Prior to the time Fisher came on the scene the principal values in real estate were to be found in the extreme south end of the island. Values were higher there than in the vicinity of petitioner’s tract. The coming of Fisher materially changed this situation and values increased rapidly.in petitioner’s vicinity. Due to Fisher’s influence,* activity in real estate development began to be apparent early in 1913. About March 1, 1913, the Ocean Beach Realty Co. purchased a tract of 500 acres adjoining petitioner on the south and running to the southward and southwestward. The purchase price was $85,000. Of this 500 acres, approximately 75 per cent was swamp land which had to be reclaimed by filling before it was fit for use; The remaining 25 per cent was ridge land along the ocean front.
    The Ocean Beach Realty Co. immediately subdivided its property and placed it on the market. The lots began to sell early in 1913 along Collins Avenue from Fifth Street to Twentieth Street. About 20 of such lots were sold at about that time. The corner lots sold for $800 each, while inside lots sold for $500 each. The lots so sold were on the portion of the company’s land which did not require any filling. These lots averaged 50 feet frontage and 150 feet depth. The company offered to give lots to persons who would build residences thereon. Seven or eight persons availed themselves of this offer early in 1913 and lots were given to them about midway between Fifth and Fifteenth Streets. On March 8, 1913, lots of similar size on corners and ocean frontage on South Beach sold for $1,000 each, while inside lots sold for about $850 each.
    In the latter part of 1912 and throughout 1913 Fisher and Collins owned the land adjoining petitioner on the north. Early in 1914 they sold this land to the Alton Beach Realty Co. for a consideration of $546,000. This purchase contemplated approximately 400 acres, or $1,365 per acre. This was the average price for the whole tract including both high land and swamp land. A less percentage of this land was swamp than of that purchased by the Ocean Beach Realty Co. This company did not subdivide and offer lots for sale in this tract until after the basic date.
    The cost of filling in the petitioner’s tract on the western two-thirds at March 1, 1913, in order to bring it to a marketable level, Avas $5,500. The fair market value of the land in question Avas $18,500 on March 1, 1913.
   OPINION.

‘ Korner, Chairman:

Various Avitnesses gave testimony tending to

prove the fair market value of the petitioner’s land on March 1, 1913. The opinion evidence was weakened by the fact that the witnesses were not able to show a very high degree of qualification as expert witnesses. Other witnesses did not offer opinions but testified -to sales in the immediate vicinity of similarly situated lands and also to sales of more or less similarly circumstanced property more distantly removed from the immediate vicinity. We have considered all the evidence and weighed it in the light of the A^arying circumstances applicable to each transaction given as a basis. Each portion of the evidence has been considered in the light of, and in relation to, the other portions of the evidence. We are convinced that considerable activity in the land market on Miami Beach had evidenced itself in the early months of the yéhr 1913 and that market values were substantial in spite of the yet undeveloped terrain. On the other hand, we are not convinced that the land had the high value claimed for it at the hearing by the petitioner of $42,000, or approximately $3,200 per acre. Even on a basis of subdivided lots at the price they were bringing a year or two later, the sum total Avould not approach such a figure. Taking into consideration all the evidence and all the factors entering into the transactions, we are convinced that the fair market value on March 1, 1913, Avas approximately $18,500, and Ave find that to be the value on that date.

Judgment will be entered after 15 days’ notice, wider Rule 50.


author: Smith :

text:
    Pittsburgh Valve, Foundry & Construction Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9089.
    Promulgated March 10, 1927.

      Walter W. MeV ay, Esq., for the petitioner.

      W. H. Lawder, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income and profits tax for the year 1920. The petitioner alleges error on the part of the respondent (1) in decreasing invested capital for the year 1920 in the amount of $14,549.35, which is the amount by which earnings available for the purchase of stock and/or for the payment of dividends were reduced by a so-called tentative tax which the respondent determined to have accrued as at the several dates upon which stock was purchased and/or dividends paid; (2) in decreasing surplus as at the beginning of the year in the computation of invested capital by $106,048.88, on account of the payment of $251,658.48 income taxes during 1920.

    FINDINGS OF FACT.
    1. In determining invested capital for 1920, the respondent indicated the correct net income for the year to be $291,099.11. From said income the respondent then deducted a tentative tax in the amount of $39,874.05. The respondent thus determined the earnings available for the purchase of stock and/or the payment of dividends to be $251,225.06. On March 31,1920, the petitioner paid a dividend in the amount of $17,250; on May 31, 1920, $5,146.50; on June 30, 1920, $17,230; August 31, 1920, $741.50; September 30, 1920, $35,073; December 31, 1920, $43,750. On June 1, 1920, the petitioner purchased its stock in the amount of $115,170, and thereafter purchased stock as follows: On June 3, $550; on June 4, $1,540; on June 10, $1,870; on. June 17, $660; on June 18, $9,900; on June 29, $99,000; on June 30, $6,270; on July 1, $14,630; on July 6, $54,340; on July 9, $2,420; on July 22, $50,050; on August 11, $5,060; on August 12, $220; on August 16, $5,500; on August 18, $2,530; on August 23, $1,111; and on August 27, $6,600. As at each of the dates of the several stock purchases and dividend payments the respondent determined the amount of current earnings available for the purchase of said stock and dividend payments, and the excess amount of stock purchased or dividend payments over the earnings available was then prorated in determining invested capital.
    2. In the determination of invested capital for the year 1920 the respondent reduced surplus as at the beginning of the year by $106,048.88, on account of the payment of $251,658.48 income taxes during 1920, covering the preceding taxable year 1919.
   OPINION.

Smith :

The respondent was in error in reducing invested capital by a tentative tax in the manner indicated in the findings of fact. Appeal of L. S. Ayers & Co., 1 B. T. A. 1135..

The Commissioner correctly reduced earned surplus in each of the years by the prorated amount of the preceding year’s income and profits tax. Appeal of Russel Wheel & Foundry Co., 3 B. T. A. 1168.

Judgment will he entered on 15 days’ notice under Rule 50.


text:
    Edward Malley Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9677.
    Promulgated March 10, 1927.

      W. E. Malley for the petitioner.

      A. H. Murray, Esq., for the respondent.
    This, proceeding involves deficiencies in income and profits tax for the fiscal years ending Jannary 31, 1920 and 1921, in the amounts of $3,588.33 and $885.27, respectively. The petitioner claims that the Commissioner erred in reducing surplus for each of the years by the computation of a tentative tax in the determination of current earnings available for the payment of dividends, and that he also erred in reducing surplus by the amount of the preceding years’ income and profits taxes prorated. . ■
    BINDINGS 03T PACT.
    Petitioner is a Connecticut corporation with principal office at New Haven. In determining the amount of current earnings available for the payment of a dividend -of .$45,000 declared and paid April 9, 1919, the Commissioner computed a tentative tax on the earnings to the date of the declaration and payment of the dividend and reduced surplus in the amount of $12,354.40, representing the excess of the current earnings available for the payment of the dividend after the computation of the tentative tax. The Commissioner likewise reduced surplus for the fiscal year ending January 31, 1921, in the amount of $18,680.23, through the computation of a tentative tax upon earnings available for the payment of a dividend of $45,000 declared and paid April 21, 1920.
    The Commissioner also reduced earned surplus for the fiscal year ending January 31, 1920, in the amount of $29,883.66 on account of the income and profits tax for the preceding year, prorated, and for the fiscal year ending January 31, 1921, he reduced surplus at the beginning of the year in the amount of $25,626.69 on account of additional income and profits tax for years prior to the fiscal year ending January 31, 1920, and in the further amount of $30,835.91 representing the amount of the income and profits tax for the preceding fiscal year, prorated.
   OPINION.

Littleton:

The Commissioner erred in reducing invested capital on account of a tentative'tax upon current earnings available for the payment of the two dividends of $45,000 on April 9, 1919, and April 21, 1920. See Appeal of L. S. Ayers & Co., 1 B. T. A. 1135.

The Commissioner correctly reduced earned surplus in each of the years by the prorated amount of-the preceding year’s income and profits tax. Appeal of Russel Wheel & Foundry Co., 3 B. T. A. 1168.

Judgment will Toe entered on 15 days’ notice, under Rule 50.