author: Aeundell:

text:
    Crossett Timber & Development Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 62294, 67775.
    Promulgated January 10, 1934.

      Donald Brotone, O.P.A., for the petitioner.

      Frank B. Schlosser, Esq., for the respondent.
   OPINION.

Aeundell:

The respondent has determined deficiencies in income tax for the fiscal years ended November 30, 1929 and 1930, in the respective amounts of $4,040.36 and $2,230.24. Only a portion of the deficiency for each year is in controversy. All of the issues relate to sums received or paid out by petitioner in connection with gas-producing properties which it owned and which were leased to others. The proceedings were consolidated, and the facts stipulated.

The first issue is whether petitioner is entitled to a depletion deduction in respect of an amount of $20,173.57 received in 1929 under the circumstances herein set forth. Petitioner in 1923 acquired lands in Louisiana theretofore owned by another corporation and on which the predecessor corporation had granted oil and gas leases in 1921. The separate identities of petitioner and its predecessor are immaterial and we will speak of them indiscriminately as petitioner or lessor; likewise the original and successor lessees will be termed, without distinction, as the lessee.

In connection with the original lease of the lands in 1921 an operating agreement was entered into between the lessor and the lessee under which the lessor was entitled to certain oil royalties and a gas royalty of one cent per thousand cubic feet of gas taken and marketed from wells drilled prior to January 1, 1928, with an increase of one fourth of one cent each five-year period thereafter. In the eighth article of the operating agreement it was provided that of all gas sold, used or furnished by ” the lessee “ one-third will be drawn from lands owned b'y ” the lessor. No oil wells have been brought in on the property covered by the agreement, but gas wells have been brought in and the petitioner received in the years 1924 to 1928, inclusive, the royalties agreed upon for all gas withdrawn from wells drilled on its lands. In 1929 a dispute arose as to whether the lessee had complied with the provisions of the eighth article of the operating agreement during the years 1926, 1927, and 1928. The petitioner contended that, because of more intensive drilling by the lessee on its own lands adjacent to those of the petitioner, less than one third of the total gas marketed had been produced from petitioner’s properties, in violation of the terms of the operating agreement. The controversy was not carried to the courts, but was settled by the payment to the petitioner by the lessee on September 12, 1929, of $20,173.57. This amount was computed by taking one third of the total production from all wells controlled by the lessee both on its own lands and those of the petitioner and multiplying by the royalty rate due the petitioner under the agreement. From the sum thus attained, a deduction was made for royalties paid to the petitioner during the years 1926, 1927, and 1928. The respondent has included the sum of $20,173.57 in the taxable income of petitioner for the taxable year 1929, but has allowed'no deduction for depletion with respect to this amount.

Petitioner claims it is.entitled to a depletion deduction of 27½ percent of the amount of $20,173.47 received in 1929. The respondent’s position is that the money so received was not a royalty payment, but damages for breach of contract, and not subject to a depletion deduction. The depletion deduction permitted by the statute applies to “ income from the property ”, section 114 (b) (3), Revenue Act of 1928, and may be taken in respect of both royalties and bonuses. Murphy Oil Co. v. Burnet, 287 U.S. 299. Clearly the sum here involved was not a payment of royalties. In the words of the stipulation filed, “ the petitioner received in the years 1924 to 1928, inclusive, the royalties specified * * * for all gas withdrawn from wells drilled on its lands.” Nor, in our opinion, was it a bonus. A bonus is consideration paid by the lessee “ for the right which he acquires to enter upon and use the land for the purpose of exploiting it.” It is consideration for the lease.” Burnet v. Harmel, 287 U.S. 103. See Lizzie H. Glide, 27 B.T.A. 1264. Here the lessee had acquired the lease and operating agreement several years before, and it is to be assumed that any bonus required had been paid. At least the payment made in 1929 was neither demanded nor received as a bonus or any other consideration for the lease. It was demanded and paid, not for the right to enter upon and drill the lands, but as a penalty for failure to do so; it was not. income from the property, nor “ income derived from the extraction of the oil ” or gas from the property (Palmer v. Bender, 287 U.S. 551), but was in the nature of damages for the lessee’s breach of contract in failing to exploit the property. The taxing statute makes no provision for the deduction in such cases of allowances for depletion, and we sustain the respondent’s refusal to permit a deduction.

The next two issues may be considered together, having to do with petitioner’s portion of the cost of drilling wells on what may be termed a 50-50 basis. The operating agreement between lessor and lessee provided that the lessee should notify the lessor where it proposed to drill, whereupon the lessor could elect to participate in the drilling. Upon election made by the lessor to participate as to any well it was to “ be drilled at the joint expense ” of the lessor and lessee, the lessor to “ advance one-half of the cost of drilling as the work progresses.” It was further provided in the same (the fifth) article of the agreement that:

If the grantor gives notice of its election to participate and the well is brought in as a gas well, then, and in that event, the grantor shall ipso facto relinquish all rights of ownership in said well, but the grantee shall pay to the grantor a royalty of one cent per thousand cubic feet in addition to the royalties hereinbefore specified under the same terms and conditions as herein above provided.

Under these provisions of the-agreement petitioner elected to participate in the drilling of four wells which were brought in as gas wells. Two of them were drilled in 1929 and two in 1930. As to each of them petitioner paid its one half of the costs as follows:

xm 1930
$5, 095. 00 $7, 203. 35 Cost of physical equipment.
6, 077. 95 7, S42. 99 Intangible expenditures_
11,172. 95 15,100. 34 Total.

Petitioner considered that it had a right of election under article 243 of Regulations 74, and deducted the above amounts in its 1929 and 1930 returns, which deductions were disallowed by the respondent. Petitioner now concedes that the cost of physical equipment, $5,095 for 1929 and $7,263.35 for 1930, was properly capitalized by respondent, but contends that the amounts are subject to depreciation. No depreciation has been allowed by the respondent. The proper rate of depreciation, if allowable, is stipu] ated.

As the result of petitioner’s election to participate in the drilling of four wells and its payment of one half of the drilling costs, it received during 1929 and 1930 the additional royalties provided for in the operating agreement.

In order for the petitioner to prevail on the question of depreciation it must meet the burden of establishing ownership of depreciable property. Frank Holton & Co., 10 B.T.A. 1317; National Electric Ticket Register Co., 17 B.T.A. 42; Leggett & Platt Spring Bed Co. v. Crooks, 34 Fed. (2d) 492; Iten Biscuit Co., 25 B.T.A. 870. The contract under which petitioner paid some of the drilling costs provided that as to any well in which it participated it should “ ipso facto relinquish all rights of ownership in said well.” This would indicate that petitioner acquired no property right in the four wells in question, and there is nothing in the record to establish any other view of the matter. True, it is stipulated that the cost of physical equipment paid by petitioner has been properly capitalized by respondent, but it does not follow that such capital costs are subject to depreciation. The respondent’s view is that the cost borne by petitioner represents cost of the additional royalty of one cent per thousand cubic feet of gas to which petitioner became entitled by reason of its participation. If so, its capital outlay will be recovered through depletion deductions from the additional royalties which it appears from the stipulation have been allowed by the respondent.

The remaining portion of costs borne by petitioner in the drilling of the four wells has been allocated to what are for convenience termed “ intangible drilling and development costs.” T. D. 4333, C.B. XI-1, p. 31. Under the cited Treasury decision and under the Commissioner’s regulations, intangible costs may, “ at the option of the taxpayer, be deducted as a development expense or charged to capital account returnable through depletion.” See W. R. Ramsey, 26 B.T.A. 277. These provisions, in our opinion, are not applicable to one in the position of this petitioner. It was not engaged in drilling wells for itself. The lessee drilled the wells and under the contract it became the owner of them. The substance of the arrangement between petitioner and the lessee was that petitioner reimbursed the lessee for expenses incurred by the latter. The consideration for petitioner’s expenditures was the increased royalty it was to receive. The sums so paid, like those allocated to physical equipment, are part of the cost of royalties and subject to recoupment through deductions for depletion which, for the taxable years, have been allowed by the respondent.

The final issue is whether the amount of $6,279.16, received by petitioner in 1930 as advance royalties under minimum royalty provisions of a contract, constitutes income.

In 1929 petitioner entered into an agreement with the lessee of its lands, modifying the operating agreement of 1921. The 1929 agreement provided for a specified minimum production of gas and concomitant minimum royalties for the twenty-year period from 1929 to 1948. In the event of shortage of production in any year the difference between the royalty on the gas produced and the minimum royalty is to be paid to petitioner on or before January 15 of the following year, and, if this occurs and in a subsequent year there is an excess over minimum requirements, the royalty payments for shortages in prior years are to be applied to the excess. If, after adequate and reasonable development, the properties will not produce the minimum requirements the lessee is to be relieved of paying advance royalties on shortages, and if at the end of the twenty-year period the properties have not produced a specified amount of gas per year — in either event — petitioner will be required to pay back to the lessee all advance royalty payments, with interest at 6 percent.

In 1929 the lessee did not produce the minimum requirements and on February 7, 1930, it paid to petitioner $6,279.16 as advance royalties on the 1929 shortage. Petitioner has retained the amount so received and recorded it on its books as a liability to the lessee. The lessee has not subsequently taken sufficient gas from petitioner’s properties so that it could apply any part of the $6,279.16 as royalty on gas actually produced. The respondent has added the amount of $6,279.16 to petitioner’s taxable income for the year 1930, and has allowed a depletion deduction with respect thereto of 27½ percent.

Petitioner concedes that the $6,279.16 received in 1930 constituted advance royalty ” but contends that it should not be included in income because of its liability to repay it either through application to subsequent production in excess of minimum requirements or in caslr in the event of demonstrated inability of the field to produce to minimum. Jamison Coal do Cokee Co., 24 B.T.A. 554; modified, 67 Fed. (2d) 342, and Hutchinson Coal Co., 24 B.T.A. 973; affd., 64 Fed. (2d) 275, cited by petitioner, do not sustain its views. In those cases the taxpayers were the lessees, and the question was whether the amount paid by the lessees, representing the difference between the minimum royalties and the royalties on coal actually mined, was deductible currently as an expense or was a capital expenditure under which the lessee acquired an equity in property. As these cases now stand, one being modified and the other affirmed by the circuit court, they hold that the entire minimum royalties paid are deductible currently. The converse of these holdings would require that sums so paid and treated as royalties by the' lessee should be included in income of the lessor. Bankers Pocahontas Coal Co., 18 B.T.A. 901; affd., 55 Fed. (2d) 626, and 287 U.S. 308, and Louis Werner Saw Mill Co., 26 B.T.A. 141, expressly hold that minimum royalties are taxable income to the lessor. The only difference between these latter cases and the one before us is the provision here under which the petitioner may eventually be required to repay a part of the royalties received. The conditions, however, which might require repayment were conditions subsequent and did not prevent petitioner’s unfettered use of the money in the year of receipt. In Brooklyn Union Gas Co., 22 B.T.A. 507; affd., 62 Fed. (2d) 505, litigation arose under which the taxpayer was required by court order to impound a portion of the moneys received. On the question of the year in which such moneys represented taxable income it was held that they were income in the year when earned and not in the year when the litigation was finally terminated. The principle of that case is applicable here. The contingent liability which might at some future time require repayment of some indeterminate portion of the royalties imposed no restriction upon petitioner’s use of the money currently as received. See also Consolidated Asphalt Co., 1 B.T.A. 79; Uvalde Co., 1 B.T.A. 932.

All issues are decided for the respondent.

Decision will he entered for the respondent.


source: Caselaw Access Project

author: Lansdon:

license: Public Domain

text:
    Anson Evans, Philip J. Noonan, and Walter T. Noonan, Trustees, F. R. Noonan Estate Trust, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 62664.
    Promulgated January 10, 1934.

      Thomas Gallagher, Esq., for the petitioner.

      Arthur H. Fast, Esq., for the respondent.
   OPINION.

Lansdon:

The Board is asked to settle only one issue; viz., What was the fair market value of the block of North American Creamery stock in question when it was acquired by the petitioners? The record discloses a slight confusion as to the date of such acquisition and counsel for petitioners attaches some importance to the fact that it did not physically pass to them until September 25, 1920, although the date of the decedent’s death was September 10, 1919. In contemplation of law the corpus of a testamentary trust passes to the trustees on the date of the death of the testator. Gage v. Brewster, 280 U.S. 327; Security Trust Co. et al., Trustees, 25 B.T.A. 29; affd., 65 Fed. (2d) 877. It follows that gain or loss from the subsequent disposition of the stock must be computed on the basis of its fair market value at September 10, 1919, as provided in section 113 (a) (5) of the Revenue Act of 1928.

The respondent has determined that the fair market value of the 4,250 shares of the stock of the corporation at date of acquisition was $743,750. The petitioners allege that such value was at least $1,468,375. The fact that petitioners received a 100 percent stock dividend is not material, since they sold the original and dividend shares in a single block, and we shall therefore discuss the share value on the basis of 4,250 shares. The stock in question was closely held by a family corporation and there were no sales at any time sufficiently near the basic date to establish a fair market value thereof, nor was it listed on any stock exchange. It is necessary, therefore, to consider the value of the underlying assets, the opinions of witnesses, and any other competent evidence offered by the parties.

It is stipulated that the net worth of the corporation at December 31, 1919, exclusive of good will, was $1,254,954.26, as represented by tangible assets owned at that time, and that this figure applies to September 10, 1919, the date of acquisition by the petitioners. As there were 5,000 shares of stock outstanding at that date, the value of each share, measured by the net worth of the corporation, was almost exactly $250 per share. The respondent’s determination is $175 per share and the petitioners contend for a value of $435.

The evidence discloses that in its capital stock tax returns for the fiscal years ending at June 30, 1916, 1917, 1918, 1919, and 1920, the corporation reported the value per share of its stock for such years in the respective amounts of $90, $96, $125, $143, and $188. On April 23, 1920, appraisers appointed by the probate court determined a value per share of $160, and such valuation was used in the settlement of estate taxes due to the State of Minnesota and in the Federal estate tax return which the executors filed within one year of the date of the decedent’s death. Upon audit of such return the respondent increased the reported valuation to $175 per share.

In addition to the stipulation the petitioners introduced witnesses who gave their opinions as to the fair market value of the stock in question at the basic date. P. J. Noonan, who succeeded his father in the management of the corporation, was an executor of the estate, and is a trustee and one of the petitioners here, was of the opinion that at such date the stock was worth $400 per share. Thomas A. Koden, long connected with the firm of Wells, Dickey & Co., which deals in securities of private corporations, opined that the stock was worth 15 times its average earning capacity over a period of years, or about $450 per share. His opinion is based on his general knowledge of the values of stock and on the financial condition of the corporation, but he has no special information about the creamery business. Marcus P. Angland, a member of a firm of stock brokers, was of the opinion that the stock was worth from $425 to $450 per share on the basic date. He based his conclusion on the earnings and assets of the corporation and was influenced by the fact that the stock in question was a controlling interest.

On behalf of the respondent each of the two appraisers who fixed the value of the stock at $160 per share in 1919 testified that his original estimate was based on facts considered at the time of the appraisal and that he knew of no changes in the corporation or the market that would require him to make any different estimate. Each considered the figure arrived at by the appraisal as a fair valuation as of that date. One of such appraisers is the first vice president and the trust officer of the First National Sank & Trust Co. of Minneapolis. The other is connected with the Farmers & Mechanics Bank of that city and is a practicing attorney in Minneapolis.

On the basis of the testimony summarized above and of the stipulated facts, the petitioners ask the Board to find that at September 10,1919, the stock in question had a fair market value of at least $435 per share. It is obvious that they rely largely on the concededly strong financial condition of the corporation, together with its history and undisputed success as factors in creating good will as an asset, in addition to the tangible properties. It must be borne in mind, however, that what we are concerned with is the fair market value of the stock at the basic date, rather than actual net worth of the corporation as represented by its tangible and intangible assets, less liabilities. It is clear that until after the sale thereof no one connected with the corporation regarded the stock as worth anything like the value now claimed. Nor does the sale on April 1, 1,929, corroborate the value as of September 10,1919, Avhich is now claimed. Such sale was made in a period of great commercial activity, at least six months before the now historical decline in the value of corporate stocks began. On December 31, 1919, the book value of the stock, which did not include any good will, was $250 per share. After several years of additional prosperous operation it was sold for approximately $290 per share, a price that indicates that the willing purchaser thereof paid little or nothing for the good will which petitioners contend was worth $480,813.87 at September 10, 1919. Upon due consideration of all the facts and estimates of value, we are of the opinion and find as a fact that at September 12, 1919, the stock in question had a fair market value of $250 per share.

On brief counsel for the petitioners argues strenuously that the valuations placed on the stock for capital stock and estate tax purposes are inadmissible as evidence. The Board has never considered such valuations to be conclusive, but they are evidence that must be overcome by the taxpayer claiming higher values for tax purposes in subsequent years. Williams v. Commissioner, 44 Fed. (2d) 467; affirming David Williams, 15 B.T.A. 227.

Decision will Toe entered under Rule 50.


text:
    James Cunningham, Petitioner, v. Commissioner of Internal Revenue, Respondent. Marjorie W. Cunningham, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 52005, 52006.
    Promulgated January 10, 1934.

      Henry Brack, G.P.A., lor the petitioners.

      H. D. Thomas, Esq., for the respondent.
   OPINION.

Leech : These proceedings, formally consolidated, attack deficiencies in income tax for the calendar year 1928 proposed against James Cunningham and Marjorie W. Cunningham, petitioners, in the respective amounts of $7,744.26 and $1,567.35.

Petitioners were and are husband and wife. They maintained “ long ” security trading accounts with a broker, which were both conducted by petitioner James Cunningham. The purchases and sales in the,se accounts included hundreds of such transactions and were identical, but, so far as here material, involved only the following transactions in shares of Electric Bond & Share Corporation as to each petitioner:

October 31, 1928, bought 500 shares at a cost of $56,643.75.
December 6, 1928, sold 250 shares for $40,308.75.
December 7, 1928, bought 250 shares at a cost of $37,625.00.
December 10, 1928, sold 250 shares for $35,352.50.
December 13,1928, bought 250 shares at a cost of $37,793.75.
December 12th and 13th, 1928, sold 250 shares for $37,802.50.
December 14,1928, bought 250 shares at a cost of $36,712.50.
December 20, 1928, sold 250 shares for $38,958.75.
December 24, 1928, sold 250 shares for $39,927.50.
December 31,1928, bought 250 shares at a cost of $43,312.50.
January 10, 1929, sold 150 shares for $26,719.00.
January 14, 1929, sold 100 shares for $18,071.00.

The last two sales disposed of all shares of Electric Bond & Share stock acquired by petitioners in 1928.

None of the above sales were ordered by petitioners, or either of them, as “ short ” sales, nor were any of such sales executed or recorded as “ short ” sales by petitioners’ broker.

In determining the present deficiency under the Revenue Act of 1928, section 113 (a), here pertinent, respondent applied the “first in, first out ” rule of article 58 of Regulations 74, which, within its purview, has been approved. Snyder v. Commissioner, 54 Fed. (2d) 57; affirming 20 B.T.A. 778; Skinner v. Eaton, 45 Fed. (2d) 568; certiorari denied, 283 U.S. 837. The profit on the sales made in 1928 was computed as follows:

Upon the above basis the 250 shares remaining in-each account on December 31, 1928, were the 250 shares purchased on December 31, 1928, and had a cost of $43,312.50.

Petitioners contend that each intended at all times during 1928 to maintain a “ long ” position of 500 shares of Electric Bond & Share stock and that when the above sales were made they were not intended to be sales of the 500 shares held on October 31, 1928, but were intended to be “ short ” sales to be covered by purchases at a later date at a lower price. They maintain that the following computation should be used in determining the disputed tax:

On the basis of this contention the sale of 250 shares on December 24, 1928, was still open as a “ short.” sale on December 31, 1928, and the original 500 shares acquired on October 31, 1928, at a cost of $56,643.75 were still owned. According to this position it was not until 1929 that they decided to terminate their operations in Electric Bond & Share stock and consider their “long” position as being applied against sales made on December 24, 1928, and on January 10 and 14, 1929.

Petitioners suggest a “ short ” sale differs from a “ long ” sale only in the bookkeeping entries of the broker recording the transaction. We disagree. The essence of a “ short ’’ sale is that what is sold has not yet been acquired by the seller. Thus the entire mechanics of a “ short ” sale are inconsistent with those employed in a sale of shares already held by the seller. Cf. Provost v. United States, 269 U.S. 443; Cook v. Flagg, 251 Fed. 5; Robert W. Bingham, 27 B.T.A. 186.

Petitioners base their position on what they intended. However, not only did neither of petitioners direct that the controverted sales be executed as “ short ” sales, but, so far as this record discloses, neither petitioner ever maintained a “ short ” account. Thus the fact is that the broker, unquestionably petitioners’ agent who carried out the several questioned transactions, had not the semblance of authority to execute them as other than sales of stock, already held in petitioners’ “ long ” accounts. Cf. Robert W. Bingham, supra, and cases cited therein.

In any event, we are concerned with what was actually done, not with what was intended. United States v. Phellis, 257 U.S. 156; Western Maryland Ry. Co. v. Commissioner, 33 Fed. (2d) 695. It is apparent from this record, and we so find, that when the questioned sales were made petitioners had in their “ long ” accounts shares of such stock in excess of that then sold; that the transactions here involved were sales of those securities already held by petitioners, not “ short ” sales; and that the lots of securities so sold were not identifiable. The respondent is affirmed.

Judgment will be entered for the resfondent.


author: Matthews :

text:
    Central National Bank of Lincoln, Nebraska, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 59285.
    Promulgated January 10, 1934.

      G. Petrus Peterson, Esq., and Wm. G. Dorsey, Esq., for the petitioner.

      Philif M. Glarh, Esq., for the respondent.
   OPINION.

Matthews :

A motion to dismiss this proceeding for lack of jurisdiction was filed by respondent prior to the expiration of the time for filing his answer. A hearing was had on the motion and upon consideration it was denied for the reason that under the authorities, National Bank v. Insurance Co., 104 U.S. 54; Central Natl. Bank of Missouri, 11 B.T.A. 1017, a national bank which goes into voluntary liquidation continues to exist as a body corporate, capable of suing or being sued until its affairs are completely settled.

The petitioner contends that the transaction set forth in our findings of fact was a “ reorganization ” within the meaning of the Revenue Act of 1928 and, as such, nontaxable. The pertinent provisions of the Revenue Act of 1928, which are applicable here, are set out in the margin.

Petitioner argues that, as a party to a reorganization, it exchanged its assets for 500 shares of stock in the First Rational at an agreed valuation of $110,000, plus $290,000 in cash, which under the plan of reorganization the petitioner distributed to its stockholders in liquidation. The respondent contends that the transaction was a sale by petitioner of its assets for $400,000 cash and that on such transaction a gain of $70,549.29 was realized, relying on sections 111 (a) and 112 (a), (b) (4), and (d) (1). The sum in question represents the amount agreed upon by petitioner and the First Rational in the transfer as value of petitioner’s good will. Petitioner contends in the alternative that even if this were not a reorganization, but a sale, the sum in question did not represent gain to petitioner, but the consideration paid by the First Rational for petitioner’s good will, alleged to have a value not less than this sum on March 1, 1913. Respondent in his determination allowed no March 1, 1913, value for good will.

1. We shall consider the nature of the transfer first, for, if petitioner is correct in its contention on this score, we need not trouble with the second question. The respondent-bases his contention that the transaction was a sale on the rule laid down by the Supreme-Court in Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U.S. 462. In that case all of the petitioner’s assets were transferred by a contract of sale to a corporation which paid over to petitioner about one third of the purchase price in cash and gave petitioner short term promissory notes for the balance. Petitioner distributed to its stockholders the cash received and the proceeds of the notes as they were paid. The petitioner sought to bring this within the reorganization provisions of the Revenue Act of 1926, but the Supreme Court, affirming the court below and this Board, held that short-term notes “ were not securities within the intendment of the act and were properly regarded as the equivalent of cash.” Since the petitioner exchanged its property not “ solely for stock or securities in another corporation a party to the reorganization” (§203 (b) (3)), for petitioner received cash and notes, and not for stock or securities and “ also * * ⅜ other property or money ” (within the proviso of §203 (e), the notes being obviously not “ stock ” and not reasonably to be regarded as “ securities ”), it followed that the transaction did not fall within the reorganization provisions exempting from taxation on exchanges and would therefore reflect a taxable gain. The acceptance of a contrary view, it was said, “would make evasion of taxation very easy.”

Was that the situation here? The corresponding provisions of the 1928 Revenue Act, section 112 (b) (4), (c), and (d), are identical with those of the Revenue Act of 1926.

Petitioner relies upon Stock Yards Bank of Cincinnati, 25 B.T.A. 964, where an Ohio bank, forbidden by law to purchase stock of any other bank in the state, appointed nominees, lent them cash without interest, and authorized them to buy all the capital stock, at $400 a share, of another Ohio bank. When this had been dons, the purchasing bank took over all the assets and liabilities of the selling bank and liquidated it. The Board held that, while the purchase of the petitioner bank’s stock might have been an ultra vires act under state law, the purchase by the bank’s nominees was in substance a purchase by the bank, and the transfer of petitioner’s assets to the purchasing bank, its sole stockholder, therefore, while in form a sale of assets, was nothing more than a distribution of assets by petitioner in complete liquidation. The Board did not adopt petitioner’s argument that this was a reorganization under the 1926 Revenue Act, but held for the petitioner on the ground that the transaction was nontaxable as a complete liquidation of petitioner under section 201 (c), Revenue Act of 1926, by which the petitioner received no consideration for its assets from the purchasing bank.

When we apply the analogy of that case to the present one, we find important differences. Here there was no purchase of petitioner’s stock by the First National, either directly (not permissible under the National Bank laws) or indirectly through nominees. There was executed between the two banks only one instrument, which purported to be a contract of sale and by which petitioner was to convey to the First National all its assets and First National was to assume all liabilities and pay therefor “to Central National Bank ”, not to petitioner’s stockholders, it will be noted, the sum of $400,000. Petitioner’s stockholders (the necessary two thirds) by the same instrument were required to vote for liquidation of petitioner. First National never owned in name or fact petitioner’s stock. The transfer of petitioner’s assets to the First National, therefore, can scarcely be regarded as the liquidation by the First National of property over which it exercised legal ownership and control.

We pass to the next case upon which petitioner relies, National Pipe & Foundry Co., 19 B.T.A. 242, in which this Board held the transaction a reorganization under the 1926 Act, and, the distribution of proceeds having been made by petitioner to its stockholders, nontaxable under section 203 (e) (1). In that case the petitioner corporation contracted to transfer its assets and liabilities to another new corporation, petitioner’s preferred stockholders to receive par value for their shares, and petitioner’s common stockholders to receive cash and so many shares of preferred stock in the new corporation. The cash and new shares were distributed by petitioner to its stockholders on receipt. The petitioner’s stockholders in their written contract bound themselves to receive shares and cash, as stated, of the new corporation in exchange for shares and assets of petitioner. Cf. Fred Barker, 28 B.T.A. 657, in which, under like circumstances, we held a reorganization had been effected.

To state the National Pipe & Foundry Co. case is to show its variance from the case at bar. The only contract between petitioner and the First National, as stated, binds petitioner, on its part, to transfer all its assets to the First National and to liquidate itself; on the First National’s part, to pay to petitioner $400,000 cash and assume petitioner’s liabilities. Nothing more. No obligation is imposed on petitioner’s stockholders to take any of the First National’s stock. In fact, as petitioner admits, nothing appears in this contract to indicate it was anything but an outright sale of petitioner’s assets for $400,000 cash. When wé look at the petitioner’s stockholders’ agreement of the same date, we find petitioner’s stockholders binding themselves, with respect to the projected “ merger ” and the payment to themselves of $200 a share for this stock, to vote for the sale and transfer of all of petitioner’s assets to First National and to liquidate petitioner bank. Nothing whatever is said about any obligation on the part of petitioner’s stockholders to take shares in First National. In the First National’s stockholders’ agreement, however, the stockholders of that bank bind themselves to vote an increase of 500 shares of capital stock, “to be sold to various stockholders of Central National Bank at two hundred and twenty ($220) dollars a share,” and to execute waivers of their right to purchase such additional stock, “ that such additional shares may be sold as above contemplated.”

Chapin, vice president of petitioner and vice president of the First National after the transfer, testified that an oral but binding agreement between himself and possibly other officers and directors of petitioner, on the one part, and Easterday and others representing the First National, on the other part, had been entered into by which petitioner’s stockholders Avere obligated to buy at the agreed figure of $220 a share all the new 500 shares issue of the First National’s stock. All stockholders of petitioner were given the privilege of subscribing to one share of First National stock for every 4 shares .held of petitioner’s stock. And all this stock was bought by petitioner’s stockholders, but not in the fixed proportion. In fact, of petitioner’s 40 stockholders, 17 did not subscribe to any of the First National’s stock, but the shares for which they were given the privilege of subscribing were taken by other stockholders. Chapin testified that he was the last to subscribe, and he took all the remaining unsubscribed stock in the First National, 74 shares, although he had held in petitioner only 51 shares.

Giving the full weight which the evidence justifies, therefore, to the oral agreement that petitioner’s stockholders would subscribe for the additional issue of 500 shares of the First National’s stock, and to their opinion that such subscription was “ an essential condition ” of the transfer, we still are unable to reach the conclusion from these facts for which petitioner contends, namely, that the First National paid over to petitioner $290,000 and 500 shares of its stock for petitioner’s assets and good will. The purchase by the First National of petitioner’s assets and good will for $400,000 and the subscription by some of petitioner’s old stockholders to 500 shares of the First National’s stock seem to us separable and separate transactions. Viewed in this light, it was not a reorganization, since there was no exchange of “ stock or securities ” and “ other property or money ” within the meaning of the statute.

As we are of the opinion that the transaction was a sale, in the nature of the complete sale of assets and good will by the petitioner in the Pinellas lee case, the immediate distribution by petitioner to its stockholders of the money received by it from the First National is immaterial, since section 112 (d) (1), providing that a distribution by the receiving corporation to its stockholders of “ such other property or money * * * in pursuance of the plan of reorganization ” shall result in no gain to the corporation, applies only to the case of a reorganization. There was here no distribution of anything in pursuance of a plan except cash. It may be pointed out that there was an immediate distribution by the petitioner to its stockholders of the cash received on the purchase price, and, as they matured, of the proceeds of the notes, in the Pinellas case. But this fact did not affect the Supreme Court’s view in finding the transaction a sale.

It follows that the sum representing the excess over net assets of petitioner paid to petitioner by the First National, $70,549.29, was gain to petitioner, as determined by respondent, cf. Cullen F. Thomas, 14 B.T.A. 1341, unless it represented the fair value of petitioner’s good will as of March 1, 1913, for which the First National gave consideration.

2. This brings us to the second point. Petitioner seeks by an argument based on petitioner’s average invested capital and net earnings, evidence with respect to which both before and after 1913 was introduced, and also at the time of the transfer in 1929, to show that the sum in question represented petitioner’s good will value as of March 1, 1913. Petitioner’s witness, Clarke, president of the Omaha National Bank, testified that a rule of thumb method of valuing good will of a bank in 1913 was to take 5 percent of the bank’s deposits, and by such method, the resulting computation of petitioner’s good will as of March 1, 1913, was $68,100. This rate of calculation, it was said, had become 2 or 3 percent by 1929. In such fashion is explained how the natural increase of the good will from 1913 to 1929 would be offset by changed banking conditions, so as to make $70,000 seem reasonable as good will value both in 1913 and at the time of the transfer to the First National in 1929.

For the five years next preceding the basic date, 1913, petitioner’s average invested capital (its capital stock being then $150,000) was $182,410.89, and the average annual net earnings were $16,649.50. If we take the period prior to 1913 and apply the customary Treasury rule of 8 to 10 percent on the average net tangible assets to determine what should be attributable to the intangible asset of good will, before capitalizing the remaining earnings at 15 to 20 percent to determine good will (cf. Shanley & Furness, Inc., 21 B.T.A. 146), we find, after allowing a return on tangible net assets of 9 percent ($16,416), that very little of the average earnings can be regarded as attributable to an intangible asset. No justification of petitioner’s contention results from this method. Nor do we consider the expert testimony offered by petitioner’s witness, Clarke, sufficient to show that the value of petitioner’s good will on March 1, 1913, could be determined by the 5 percent of deposits method which he suggested as a basis for determining such value.

After reviewing all the evidence, we have come to the conclusion, therefore, that petitioner has not submitted sufficient evidence to overcome the presumptive correctness of respondent’s determination as to the value of petitioner’s good will on March 1, 1918, and we hold that gain was realized by the petitioner, therefore, in the amount of $70,549.29 in the year 1929.

Reviewed by the Board.

Judgment will be entered under Bule 50.

Smith dissents.

      Sec. 112. (a) General rule. — Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.
      (b) Exchanges solely in kind.— * * *
      ⅝ ⅞ ⅜ ⅞: * * ⅝
      (4) Same — Gain os’ corporation. — No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization.
      * * * ⅞ ' * *
      (d) Same — gain of corporation. — If an exchange would be within the provisions of subsection (b) (4) of this section if it were not for the fact that the property received in exchange consists not only of stock or securities permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then—
      (1) If the corporation receiving such other property or money distributes it in pursuance of the plan of reorganization, no gain to the corporation shall be recognized from the exchange, but
      ⅜ ⅜ $ ⅜ ⅜ ⅜ ⅜
      (i) Definition of reorganization. — As used in this section and sections 113 and 115—
      (1) The term “reorganization” means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected.
      (2)’The term “a party to a reorganization” includes a corporation resulting from a reorganization and includes both corporations in the case of an acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation.


author: MuRdock:

text:
    Ella P. Burdick, Trustee, Estate of Joel W. Burdick, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent. The Union Trust Company of Pittsburgh, Trustee, Estate of Joel W. Burdick, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 46322, 61009.
    Promulgated January 11, 1934.

      W. W. Booth, Esq., for tbe petitioners.

      B. M. Coon, Esg., for tbe respondent.
   OPINION.

MuRdock:

The petitioner is tbe same in each case, being a trust created under the will of Joel W. Burdick. The Commissioner determined a deficiency of $7,388.76 for 1927 (Docket No. 46322) and one of $7,067.60 for 1929 (Docket No. 61009). The issues, as stated by the petitioner, are: (1) Whore the value of stock in a corporation has been appraised for estate tax purposes at the date of death of the owner and such stock is distributed by the executors to the trustees under decree of court at the appaised value, and where extraordinary dividends are thereafter declared and paid in cash, which are partly payable out of income earned by the corporation subsequent to the date of death and partly payable out of surplus accrued prior to and existing at date of death, are those portions of such extraordinary dividends which are payable out of surplus as it existed at date of death income to the trustee within the purview of the Sixteenth Amendment, or do they constitute a return of capital ?

(2) "Where a widow is entitled, under the will of her deceased husband, to a part of the income of the estate for life, in lieu of her statutory surviving spouse’s inheritance, are the payments made to her by the trustees under the will out of income of the trust deductible by the trustees under section 219 (b) (2) of the Revenue Act of 1926 and section 162 (b) of the Revenue Act of 1928?

The Commissioner allowed the payments to the widow as a deduction for 1927, but by affirmative pleadings contends that he erred in so doing and claims an increased deficiency for that year. Otherwise the issues are raised by the petitioner. Facts have been stipulated.

The decedent created a trust by his will. It included all personal property not otherwise disposed of. ITe owned at the date of his death, May 12, 1925, 1,350 shares of West Penn Steel Co. common stock which the Commissioner valued for estate tax purposes at $573,750, or $425 per share. “ The value is based on the worth of the company, selling price of the stock and other pertinent factors, and the undistributed earnings and surplus were taken into consideration.” A large part of the surplus was in cash and Government securities. The shares were a part of the trust corpus in 1927 and 1929. In each year the company declared an extraordinary cash dividend. The trust received $87,750 in 1927 and $47,250 in 1929 as its share of these dividends. The stipulation is to the effect that a certain part of each distribution was out of surplus as of May 12, 1925. The trustees retained the part paid from surplus as of May 12, 1925, for the remaindermen and distributed the other part to the life beneficiary of the trust. The probate court approved the trustees’ account in which these actions were shown and in which the amount at which they carried the stock was reduced by the amount of the dividends retained. The Commissioner included the entire amount received by the trust in each year as gross income for that year in computing the deficiencies.

The petitioner contends, on the first point, that a distinction must be made for income tax purposes between that part of each dividend which was paid out of earnings of the company accumulated after the decedent’s death and that part which reduced the surplus of the company as it existed at the date of the decedent’s death. It claims the latter part is a return of capital and to tax that as income would be not only erroneous but unconstitutional. Its argument is that the trust became a new and separate taxable entity on May 12, 1925, having capital consisting of the 1,350 shares of stock; these shares had a certain value at that time based upon several pertinent factors, one of which was the earned or accrued surplus as of that date; this surplus became capital of the trust; any dividend paid to the trust out of this surplus reduced the “ intact ” value of the shares as part of the trust corpus, substituted cash for that value and amounted to no more than a conversion of capital; this part of the dividends was not income to this particular taxpayer; any attempt to tax it would be unconstitutional as a direct tax on property without apportionment, and furthermore would amount to double taxation, since an estate tax had been collected on this same item as part of the value of the shares at the date of the decedent’s death.

The trust and the decedent are different taxable entities, as contended. The estate tax did not fall upon this taxpayer. Thus the same thing is not being taxed twice to the same taxpayer. Cf. Elizabeth W. Boykin, 16 B.T.A. 477. The income and estate tax statutes are different, may impinge and may work some hardships in certain cases. Cf. Ernest M. Bull, Executor, 7 B.T.A. 993; Fannie E. Lang, 23 B.T.A. 854; affd., 61 Fed. (2d) 280. Even if double taxation occurs it is not unconstitutional. It is merely a result to be avoided where the statutes are not clear.

The situation here resembles closely that which results when stock is sold or given away. The seller may be subject to a tax on his profit and the donor to a gift tax. Tet the purchaser and donee have to report dividends thereafter received regardless of whether or not they come from surplus theretofore accumulated. If the whole amount distributed to the present taxpayer is not income, it would seem that similar distributions would likewise be a return of capital to the purchaser and the donee in the examples above given. This would make the administration of the revenue acts extremely difficult, if not impossible. Cf. Gibbons v. Mahon, 136 U.S. 549. How. ever, if the petitioner’s theory is correct, the result must follow, regardless of difficulties of administering the revenue acts.

The petitioner seeks to support its contention by stating two principles; one, that the cost of a capital investment must be restored to a taxpayer from “ the proceeds ” before there is a gain taxable as income; the other, that which constitutes corpus of an estate is not thereafter subject to an income tax. The revenue acts provide for the return of capital before gain or profit is taxed. The courts have very generally applied such a rule. But it has no bearing upon our question of what is a taxable dividend. It would be an important rule if the trust had disposed of the stock or had received a liquidating distribution. The value of the stock on May 12, 1925, would have to be subtracted from the amount received before there would be any gain taxable to the trust. But no contention is made that these distributions were in liquidation of the corporation nor is the trust being taxed upon a sale of the stock. It still owns the stock and for all we know the value of the stock may be greater now than it was on May 12, 1925. Cf. In re Waterman’s Estate, 279 Pa. 491; 124 Atl. 166.

The surplus of the corporation was not a part of the corpus of the trust until it was distributed through the declaration and payment of these dividends. Cf. Lynch v. Hornby, 247 U.S. 339; Peabody v. Eisner, 247 U.S. 347. Prior thereto the trust had only the indirect interest of a stockholder in the surplus of the corporation. Eisner v. Macomber, 252 U.S. 189. These distributions did not return capital to the trust. They were dividends and income under the express provisions of the revenue acts. Section 201 and 213(a) of the Revenue Act of 1926 and sections 22(a) and 115 of the Revenue Act of 1928. As such they have been included in the gross income of the trust. A distribution in cash of a surplus of a corporation is a sufficient realization of income by the stockholder to be taxable as income under the Sixteenth Amendment. These distributions were in cash and were made from earnings or profits accumulated since February 28, 1913. The taxpayer still has its stock and that stock still carries its original basis for gain or loss. That basis measures the capital which must be returned to the taxpayer tax free before gain is recognized upon the disposition of the stock. In the meantime dividends may be subjected to tax constitutionally. They have no basis except as surplus on March 1, 1913, and unimpaired capital may be bases. Subject to these restrictions, they are income. There is no further restriction that they must not include distributions of surplus as of the date the taxpayer acquired his stock.

The petitioner seems to contend that this conclusion can not be reached because of a rule of law in Pennsylvania. The courts of that state have held that the part of an extraordinary dividend paid from extraordinary accumulations of surplus of a corporation on hand when the decedent died must be held for the remainderman as corpus of the trust and may not be distributed by the trustees to a life beneficiary. See, however, Gibbons v. Mahon, supra. This rule lias an effect in Federal income taxation and may not be disregarded. Where it applies, a life beneficiary would not have to include that part of the income of the trust in his income and the trust would not be entitled to deduct the amount from its gross income. Section 219 (b) (2) and (3) of the Revenue Act of 1926. Section 162 (b) and (c) of the Revenue Act of 1928. But this is the extent of the effect of this Pennsylvania rule. It settles the question of property rights in the distribution. The Federal law controls -as to what is a taxable dividend and as to what is taxable as income, if there is any conflict. Cf. Wear v. Commissioner, 65 Fed. (2d) 665. The second rule stated, if it be a correct statement of a general rule, is inapplicable because, as we have already said, the surplus of the corporation was never a part of the corpus of the trust prior to the declarations of these dividends. We do not understand that the Pennsylvania courts hold differently. But if they do, the subject is not one as to which their decisions are binding upon the Federal Government in the imposition of its income taxes.

The payments of a part of the income of the trust made to the widow under the will in lieu of her statutory rights are deductible from the petitioner’s income. Helvering v. Butterworth, 290 U.S. 365.

Decision will be entered under Bule 50.


author: Smith:

text:
    L. Elmer Wood, James E. Osborn, John S. Brayton, Administrators for Estate of Solomon Woodward, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 43971.
    Promulgated January 11, 1934.

      Franje J. ATbus, Esq., and Ja/mes V. Ciblin, C.P.A., for the petitioners.

      C. A. Bay, Esq., and Prew Savoy, Esq., for the respondent.
   OPINION.

Smith:

The respondent has determined a deficiency in the decedent’s income tax for the calendar year 1924 of $9,672.44. The question in issue is whether the decedent received taxable income from a dividend upon his preferred shares of stock which he elected to receive in the form of additional preferred shares to the extent of $28,100.

The decedent in 1924 was a substantial stockholder in the Woodward Iron Co., a Delaware corporation engaged in business in Alabama. Under date of June 20, 1924, the board of directors of the company passed a resolution providing in part that:

Whereas, The total authorized capital stock of the Woodward Iron Company is now Thirteen Million Dollars, divided into 130,000 shares, each share being of the par or face value of $100.00, all of which stock has been issued and is outstanding, of which stock one hundred thousand shares is common stock, and of which stock thirty thousand shares is preferred cumulative dividend bearing stock, entitled to dividends payable quarterly, at the rate of 6% per annum, and
Whereas, The cumulative and unpaid dividends on the said preferred stock up to July 1st, 1924, will amount approximately to Four Hundred and Five Thousand Dollars, and the company has accumulated net earnings more than sufficient to pay and discharge all dividends in arrears on said preferred stock up to July 1st, 1924, but has been using said net earnings as a working capital, and
Whereas, The Board of Directors deem it advisable and to the interest of the company and all of the stockholders thereof that dividends and arrears of dividends on the preferred stock should be paid from the net earnings of the company up to April 1st, 1924, and contemporaneous the working capital of the company should be kept intact by sale of the preferred stock of the corporation which would necessitate an amendment of the certificate of incorporation or charter of the company, increasing the authorized capital stock of the company in the amount of Four Hundred and Five Thousand Dollars, and
Whereas, In order to sell the increased stock at par, in the opinion of the Board, it will be necessary to issue said stock as preferred stock, entitled to Cumulative Dividends, at the rate of 7% per annum, payable quarterly, from April 1st, 1924, and other than the rate of dividends in all respects on an equality with the preferred stock heretofore issued by the company and outstanding,
Therefore Be It Resolved :
1. — -That the Board of Directors hereby declare it is advisable and to tile interest of the company and the stockholders thereof, for the certificate of incorporation or charter of the company, to he amended.

It was further provided that the corporation should amend its charter so as to increase its capital to the extent of $405,000 by the Issuance of $4,050 additional shares of class A preferred stock. The resolution then provided:

3. — That a meeting of the stockholders of the company be and the same is hereby called to be held at the office of the company, at Woodward, in Jefferson County, Alabama, on the 8th day of July, 1924, at 12:00 o’clock Noon, for the consideration of the proposed amendment, and said meeting shall be called and held upon such notice as the corporation’s charter or by-laws provide.
4. — That if at said meeting, or any adjournment thereof, the stockholders in person' or by proxy, holding a majority of the common stock entitled to vote and represented at said meeting, and the stockholders holding a majority of the preferred stock entitled to vote and represented at said meeting, .vote in favor of said proposed amendment, the judges and officers of the company shall make all certificates, file all papers, and do all things required by law to effectuate the' amendment of the certificate of incorporation, or charter of the company, as proposed by the board and approved by the stockholders.
5. — That IT. E. Curtis and Frank E. Carlton, Jr., are hereby appointed judges to conduct the vote, as required by law, at said meeting, or any adjournment thereof.
6. — That in the event the charter is amended as herein recommended by the Board, the officers are authorized to sell the entire authorized amount of Class “A” preferred stock, and each stockholder of the company holding common and or preferred stock, shall be entitled to subscribe to the new or class “A” preferred stock, at any time within 30 days from the date the charter is amended, each subscriber to pay to the corporation, within 40 days from the amendment to the charter One Hundred Dollars per share (the par value of each share being One Hundred Dollars) and earned dividends thereon from July 1st, 1924, on the shares allotted to subscribers. All subscriptions shall be subject to the rights of the corporation to allot to the subscribers ratably a less number of shares than the number subscribed for, if the total number of shares subscribed for exceeds the total number of shares authorized to be sold, such rights to reduce the allotment, however, to apply only to such number of the shares subscribed for as represent an excess over the above number of shares to which the subscriber would be entitled to subscribe on the basis of one share of new stock for approximately 32 shares of old stock (common and preferred) held.
If the total authorized issue of Class “A” preferred stock is not subscribed for, the officers may sell the unsubscribed-for part of said stock, at par, and accrued dividends, from July 1st to date of sale, provided, however, that no part of Class “A” preferred stock shall be sold on subscriptions of stockholders or otherwise, unless all of said stock is sold.
7. — In the event all of said “ Class A ” preferred stock is sold to stockholders, subscribers, or other persons, then after such sale is consummated, the officers of the company are authorized and directed to pay the stockholders of preferred stock issued by the company, accrued and unpaid dividends on the preferred stock up to and including dividends due July 1st, 1924, from the earnings of the company.

A letter was then sent to each and all of the stockholders of the Woodward Iron Co. under date of June 24, 1924, which provided in part:

If the amendment is adopted, the directors deem it advisable if all of Class “A” preferred stock can be sold at par, and earned dividends from July 1, 1924, to the time of the sale, to then pay from the net earnings of the company the dividends on the now existing preferred stock to April 1, 1924, the surplus of the company being kept intact by proceeds of sale from the Class “A” preferred stock. If Class “A” preferred stock is sold, each stockholder will be given the privilege, within a time fixed, to subscribe for and purchase Class “A” preferred stock on approximately the basis of one share of Class “A” preferred stock for each thirty-two shares of all other stock owned by subscribers and issued- by the company. The officers of the company being given the power to sell all or any portion of the Class “A” preferred stock not subscribed for by stockholders at par and earned dividends as above stated.
The Federal War Revenue Act imposes a tax of ten cents on each proxy. Unless advised by you to the contrary, we shall consider the return of the attached proxy, properly signed by you, as authority to us as your agent to affix and cancel the necessary revenue stamp in your behalf without expense to you.

The minutes of a special meeting of the stockholders held at Woodward, Alabama, on. July 8, 1924, show that the amendment to the corporation charter recommended by the board of directors under date of June 20, 1924, was adopted. The charter was accordingly amended.

Under date of July 26, 1924, a letter was sent by the Woodward Iron Co. to Mr. S. Woodward, c/o B. M. C. Durfee Trust Co., Fall River, Mass.,” reading as follows:

Referring- to communication sent you under date of July 18th, 1924, our records show past-due dividends on preferred stock standing in your name amounting to $28,107.00.
To assure payment of past-due dividends under the plan adopted by the íitoekliolders, it is necessary that the entire issue of 405,000 shares of Class “A” Preferred Stock bo sold. It is therefore suggested that the holders of Preferred stock subscribe for the entire issue of Class “A” Preferred Stock.
If only Preferred Stockholders subscribe for the new issue, your quota figures 281.07 shares. This being less than 281.50 shares, it will simplify matters if you will subscribe for only 283. shares, in which, case check for $7.00, will be sent you to cover past-due dividends in excess of $28,100.
If any of the holders of Common Stock exercise their rights and subscribe for their quota of Class “A” Preferred Stock, your subscription for the new stock will, of course, be reduced in proportion.
Please advise us if this meets with your approval.

The decedent elected to receive 281 shares of class A preferred stock in part payment of the dividend due him, and within the year 1924 received the stock and a chock for $7. In his income tax return for 1924 the decedent did not report any taxable income from the receipt of the $28,100 class A preferred stock, contending that the same represented a stock dividend to him. In the audit of the decedent’s return the respondent added to the net income reported $28,100, representing the par value of the class A preferred stock thus received by the decedent, and determined the deficiency accordingly.

At the time of the payment of the $405,000 dividend on or about October 1, 1924, the Woodward Iron Co. had approximately 300 stockholders, including both common and preferred stockholders. A few of the preferred stockholders elected to receive cash, although a great majority subscribed for and received additional shares of preferred stock in payment of their dividend.

The income tax return of the Woodward Iron Go. for 1924 .shows that the company had cash on hand at the beginning of the year of $1,193,560.51, and at the close of the year of $1,334,730.82. At the hearing of this proceeding it was stipulated that the cash on hand during the year 1924 held by the Woodward Iron Co. was approximately $1,300,000. It was further stipulated that the Woodward Iron Ce. “ actually declared a cash dividend in the amount of $405,000 and actually voted it on its minutes.”

In this proceeding the petitioners contend that the dividend in question received in the amount of $28,100 was a stock dividend and not a taxable cash or property dividend. In making thi,s contention they rely upon United States v. Mellon, 281 Fed. 645; United States v. Davison, 9 Fed. (2d) 1022; Eisner v. Macomber, 252 U.S. 189; and Jackson v. Commissioner, 51 Fed. (2d) 650. In the Mellon, Davison, and Jackson cases the courts held that under the circumstances which obtained therein the stockholders did not receive taxable income from the receipt of additional shares. The facts showed that the corporations were not in possession of funds with which to pay the dividends declared and that it was not within the contemplation of either the corporation or the shareholders that the dividends should be paid in cash. In Eisner v. Macomber, supra, it was held that a stockholder receiving a stock dividend did not receive taxable income.

We are of the opinion that the facts in the proceeding at bar are substantially different from those which obtained in any of the cases above referred to. The Woodward Iron Co. desired to pa'y off the accumulated preferred dividends. It declared a cash dividend for that purpose and each of the preferred stockholders, according to the stipulation, had an option to receive either cash or additional shares of preferred stock. Clearly the dividend that wag declared was not a stock dividend. It was a cash dividend. As we stated in Tillotson Mfg. Co., 27 B.T.A. 913:

* * * N0t every dividend in stock is a stock dividend, Peabody v. Eisner, 247 U.S. 347; United States v. Phellis, 257 U.S. 156, nor is every stock dividend a dividend in stock, Harry A. Brown, 26 B.T.A. 901; cf. W. Q. Wright, 10 B.T.A. 806. Indeed a dividend declared in cash has been held to be in substance a tax-free stock dividend. United States v. Mellon, 279 Fed. 910; 281 Fed. 645; United States v. Davison, 1 Fed. (2d) 465; 9 Fed. (2d) 1022; Irving Trust Co. v. United States, 44 Fed. (2d) 246; cf. W. J. Hunt, 5 B.T.A. 356; George T. Smith, 21 B.T.A. 782. * * *

See also Joseph Paper, 29 B.T.A. 523.

Judgment will be entered for the respondent.


text:
    Annie C. Atwood, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 57390.
    Promulgated January 11, 1934.

      Bussell L. Bradford, Esq., and George H. Graven, Esq., for the petitioner.

      Allin H. Pieree, Esq., and Irving M. Tulla,r, Esq., for the respondent.
   OPINION.

Smith:

The first contention of the petitioner is that the administration of the estate of Eugene Atwood was completed on March 31, 1928, and that no part of the income of the estate which was received by the executors prior to that date and paid over to the petitioner afterwards is taxable to the petitioner. In making this contention the petitioner relies, first, on article 863 of Regulations 74, which provides in part:

* ⅜ ⅜ a pel.j0(j 0f administration or settlement of the estate ” is the period required by the executor or administrator to perform the ordinary duties pertaining to administration, in particular the collection of assets and the payment of debts and legacies. It is the time actually required for this purpose, whether longer or shorter than the period specified in the local statute for the settlement of estates. * * *

The petitioner submits that all of the outstanding accounts receivable had been collected by the executors prior to March 31, 1928, all the ante mortem, debts had been paid, and all that remained to be done was the payment of the inheritance tax to the State of Connecticut and accounting and legal fees, commissions to executors, and other small items. The decree of the probate court clearly shows, we think, that the administration of the estate was not completed on March 31, 1928. It distinctly sets forth that the executors had filed with the court a “partial administration account”; that a “ partial account was ” accepted on the fourteenth day of April 1928; and that the executors were ordered to retain in their possession certain assets for the purpose of paying and discharging such other and further costs, charges, and expenses as might be incurred in the completion of the administration of the estate. It is further to be noted that the executors in their income tax return for 1928 did not file a return for the period from January 1 to March 31, 1928, inclusive, but filed a return for the calendar year 1928 and by doing so obtained the deduction from gross income of the inheritance tax paid to the State of Connecticut in the amount of $194,337.73 on May 10, 1928. From these facts we conclude that the estate was in the process of administration and settlement during the entire year 1928, the same as the executors considered it both by their accounting and reporting.

The petitioner further contends that inasmuch as the executors in their 1928 income tax return for the estate accounted for its total income to March 31, 1928, she should not be subject to any income tax in respect of such income when paid over to her in 1928. This contention is made by virtue of article 864 of Regulations 74, which provides in part:

⅜ * ⅞ Where tlie tax has been paid on the net income of an estate or trust by the fiduciary, the net income on which the tax is paid is free from tax when distributed to the beneficiaries.

This article must be read in the light of section 162 of the Revenue Act of 1928, which, so far as material, provides' as follows:

SEC. 162. NET INCOME.

The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that—
* * * ⅛ * ⅜ *
(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 tlie fiduciary to the beneficiaries, and tlie 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. * * *
(c) In the case of income received by estates of deceased persons during the period of administration or settlement of the estate, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary or accumulated, 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 properly paid or credited during such year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir, or beneficiary.

The legal situation presented upon this point has been resolved by the Supreme Court in Helvering v. Butterworth, 290 U.S. 365. In that case the Court observed:

Is a widow who accepts the provisions of her husband’s will and receives part or all of the income from an established trust in lieu of her statutory rights a beneficiary within the ambit of the statute? We think she is. It is unnecessary to discuss her rights or position under other circumstances. We are dealing with a tax statute and seeking to determine the will of Congress.
When she makes her election the widow decides to accept the benefits of the will with the accompanying rights and liabilities. In no proper sense does she purchase an annuity. For reasons satisfactory to herself, she expresses a desire to occupy the position of a beneficiary and we think she should be so treated.

The income from the estate and trust paid over to the petitioner m 1928 was in the total amount of $540,267.11. The stipulation filed in this case is to the effect that of this amount $171,331.92 represented income that had been collected by the executors of the estate in years prior to January 1, 1928, to wit, 1926 and 1927, and said sum had been reported by the executors on their returns and taxes paid thereon. Such amount is not subject to income tax in the hands of the petitioner, under the provisions of article 864 of Regulations 74. The balance constitutes taxable income.

Reviewed by the Board.

Judgment will be entered under Rule SO.


author: Leech :

text:
    Charles E. Pearsall & Son, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 50816.
    Promulgated January 16, 1934.

      Bernhard KnoTlenb&rg, Esq., and R. E. Lee, Esq., for the petitioner.

      Arthur Olarh, Esq., for the respondent.
   opinion.

Leech :

Petitioner is a New York corporation now in dissolution. The petition herein was filed through Mabel E. Pearsall and Arthur R. Pearsall, its trustees in dissolution. Chapter 787 of the 1923 Corporation Law of New York State provides that a corporation in dissolution shall remain in existence for the purpose of suing and being sued in winding up its affairs. Its directors are trustees in charge of its liquidation.

Deficiencies were determined for years and in amounts as follows.

1925-$962.92
1926- 56. 52
1027- 44. 32
1928- 94.85

These deficiencies in tax the respondent has increased by 25 percent delinquency penalties, computed upon petitioner’s entire tax, as follows:

1925_ $377.78
1926- 475. 99
1927-1 261.29
1928---• 289. 70

Petitioner does not contest the correctness of the tax deficiencies asserted in the total amount of $1,158.61, but questions the delinquency penalties in the total of $1,404.76.

Petitioner was organized in 1899 and was operated, prior to the taxable years here in question, by Clarence A. Pearsall, husband of Mabel E. Pearsall and father of Arthur R. Pearsall. Arthur R. Pearsall, shortly prior to the calendar year 1924, was elected secretary of petitioner. This action was taken for the reason that his father, Clarence A. Pearsall had, shortly prior to that time, suffered a stroke of paralysis and feared that in case of a second stroke there would be no one to sign checks for payrolls and other expenses, which would have to be met without delay. Arthur R. Pearsall, at the time of his election as secretary, knew nothing about the business and took no part in the management. Petitioner’s business was that of pile driving, while Arthur R. Pearsall was employed by a separate stevedoring business, operated by his father. In this latter business Arthur R. Pearsall operated a coal hoist and looked after certain of the other stevedoring equipment.

On February 12, 1925, Clarence A. Pearsall, the father, suffered another stroke of paralysis following which, except for an interval of a few days in July of that year, he was unconscious until his death in the following November.

On February 12, 1925, Arthur R. Pearsall took charge of petitioner’s business. He was without business training or experience and lacked knowledge of petitioner’s affairs. These had been handled by his father, as the business was small and did not employ a bookkeeper nor the services of an accountant.

Arthur R. Pearsall carried on the business of petitioner, his time being spent in an endeavor to keep up the work and to continue his services with the stevedoring business. Such books as petitioner maintained were kept by him and from these he determined that petitioner, after paying expenses of operation, showed no profit for the years 1925,1926,1927, and 1928, and under such conditions it was his belief that income tax returns were not required.

In 1929 petitioner received a request from its bank to supply a list of its officers and a copy of the resolution authorizing signature to its banking paper. Pearsall then realized that action was necessary toward regularly electing new officers for petitioner as nothing had been done in this respect since his father’s death. No meetings of stockholders had been held and no formal corporate action taken after that death. During this period Pearsall had merely carried on the work as best he could.

Pearsall thereupon consulted a firm of attorneys and upon looking into the matter this firm advised him that petitioner had been dissolved in 1926 by formal state action and since that time he had been acting technically as a trustee in liquidation and that it would be necessary to determine the stock ownership and get the affairs of petitioner upon some definite basis for the completion of the liquidation,

Pearsall was further informed by these attorneys that income tax returns should have been filed by petitioner for the four preceding years and the services of an accountant were at once secured. The latter, upon making an audit of petitioner’s accounts, reported a net taxable income to have been received for each of the preceding four years and income tax returns were thereupon prepared and filed and the tax shown, with interest thereon, was paid.

Upon audit of the returns, above referred to, respondent determined the deficiencies above listed and increased these amounts by 25 percent delinquency penalties under section 1103 of the Revenue Act of 1926 and section 291 of the Revenue Act of 1928, which provide that in case of any failure to make and file a return or list within the time prescribed by law the Commissioner shall add to the tax 25 per centum of its amount, “ except that when a return is filed after such time and it is shown that the failure to file it was due to a reasonable cause and not to willful neglect, no such addition shall be made to the tax.” The total amount of the deficiencies and penalties was thereupon collected by respondent under jeopardy assessments.

We think the facts amply support petitioner’s contention that the failure to file returns for the years in question was not due to willful neglect. We think this is clearly shown by the fact that Pearsall was ignorant of the requirements, but, upon learning of petitioner’s duty to file these returns, took action at once to prepare and file them, when there was no evidence that respondent had knowledge of its failure to act.

But the proposed penalty is avoided only when, in addition to the absence of willful neglect, the tardy filing is the result of reasonable cause. Rogers Hornsby, 26 B.T.A. 591.

“ Reasonable cause ”, in the quoted applicable statutory provision, means such a cause as would prompt an ordinarily intelligent and prudent business man to have so acted under similar circumstances. Cf. Smith v. Powers, 255 Fed. 582. The respondent has so construed the term in article 446 of Regulations 69 and article 1211 of Regulations 74, which provide: “ If the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return in prescribed time, then the delay is due to reasonable cause.”

Therefore, although the present facts are unusual, we can scarcely say that the petitioner’s delinquency in filing these returns for four consecutive years was the result of reasonable cause. The penalty was properly imposed. Berlin v. Commissioner, 59 Fed. (2d) 996; Rogers Hornsby, supra.

Reviewed by the Board.

Judgment will be entered for the resfondent.


text:
    Atlas Life Insurance Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 40544, 40751, 67199.
    Promulgated January 16, 1934.

      Earl W. Shinn, Esq., for the petitioner.

      Maxwell M. Maihany, Esq., for the respondent.
   OPINION.

Matthews :

The first issue for determination is whether there was error in the respondent’s exclusion from the “ reserve funds required by law”, in the calculation of the petitioner’s gross income, of amounts held by petitioner in its reserves to satisfy its obligations on coupons on certain policies of life insurance known as guaranteed premium reduction policies, where premium reduction credits evidenced by coupons had been left with the petitioner to accumulate in accordance with the provisions of the policies. The applicable statutory provisions are section 245 (a), identical in the Revenue Acts of 1924 and 1926, ánd.sectioñ 203 (a) (2) , Revenue Act of 1928.

This issue presents no novel question. It has already been carefully considered and passed upon by this Board in Standard Life Ins. Co. of America, 13 B.T.A. 13; affd., 47 Fed. (2d) 218; Reserve Loan Life Ins. Co., 18 B.T.A. 359; Western Union Life Ins. Co. v. Commissioner, 61 Fed. (2d) 207, affirming, Board’s memorandum opinion entered March 6,1932; Farmers Life Ins. Co., 27 B.T.A. 423; and Missouri State Life Ins. Co., 29 B.T.A. 401.

The instant case is in no important respect different from the situation considered in the Standard Life Ins. Co. case supra. Here the petitioner issued a nonparticipating policy bearing coupons which might be used when mature for payment of the premiums, paid-up additions to the policy, or redeemed in cash. The coupons bore interest after maturity, and, if there had been default in payment of premiums, might also be used to carry continued term insurance. The National Convention of Insurance Commissioners has a concerted practice, adopted by the Insurance Commissioner of Oklahoma, requiring the insurer to exact a higher premium on such coupon policies and to carry a proportionately higher reserve to meet these coupon obligations, both principal and interest. The petitioner did carry such additional reserves in the years in question and reported them as a special reserve in its annual report. We have no doubt that under local law (see Bunn’s Comp. Okla. Stat., Ann., 1921, vol. 2, p. 2417; §§6710, 6711), therefore, that these reserves represented undischarged obligations of petitioner and must have been set up to meet them.

In the Standard Life case we reviewed the authorities on the question whether such reserves came within the meaning of “ reserves required by law,” as used in the revenue acts, so that it is unnecessary to discuss it here. On the authority of that case, therefore, this issue is decided for petitioner.

We now pass to the issue with respect to the rental value of space used by petitioner and the rentals received by petitioner from the office building which it built on land leased for 99 years from the Tulsa board of education, the lease having been assigned by Sinclair, the original lessee, to petitioner with the lessor’s consent.

(a) The respondent included in petitioner’s gross income for 1924, 1925, 1926, and 1927 amounts equivalent to the rental value of space occupied by the petitioner in its own office building. At the hearing the parties stipulated these amounts and the amounts received by petitioner as rent from other tenants of the building, and respondent further stipulated that the latter, less deductions, were in excess, for each of the seAmral years involved, of 4 percent of the book value of the building.

In his brief respondent waives his claim that petitioner is required to include in income the rental value of the space occupied by it, in order to claim deduction for taxes, depreciation, etc., on the building, for tlie reason that the rent received from the other tenants, less deductions, is more than 4 percent of the building’s book value. This makes it unnecessary to consider the question on authority of our decision in Independent Life Ins. Co., 17 B.T.A. 757; affd., 67 Fed. (2d) 470, or to consider the arguments advanced by petitioner.

(b) Petitioner contends that the lease was an instrumentality of the state, that the building became a part of the leased land and, therefore, that the rent received from its tenants was income from a state instrumentality and is impliedly exempt from taxation under the decision of the Supreme Court in Burnet v. Coronado Oil & Gas Co., 285 U.S. 393.

Respondent contends that the Goronado case does not govern, for the reason that the land here in question was not a part of the lands lying in Oklahoma territory granted by the United States to the state to be forever held for the use and benefit of the public schools of the state; that the building from which the rents were derived was private property of petitioner, erected by petitioner with its money, and, therefore, that the rents from the building are taxable income to the petitioner.

The Goronado case involved an oil and gas lease on school lands which had been granted by the United States to the state for the benefit of the common schools. Under the rule previously approved in Gillespie v. Oklahoma, 257 U.S. 501, the Court held that the lease was an instrumentality of the state for the purpose of carrying out her duty in respect to public schools; that to tax the income of the lessee arising therefrom would amount to an imposition upon the lease itself. However, in applying the rule approved in the Gillespie case, which involved the taxation by the state of income derived from the sale of oil acquired under an oil and gas lease on Indian lands, the Court said: “We are disposed to apply the doctrine of Gillespie v. Oklahoma strictly and only in circumstances closely analogous to those which it disclosed.”

Since the Coronado decision, the Supreme Court has, in Burnet v. Jergins Trust Co., 288 U.S. 508, again had the question of the tax-ability of income derived by a lessee from an oil and gas lease on lands owned by a political subdivision of a state. Although in that case the lands had been held since 1911 and used by the city of Long Beach, California, for water supply and other purposes, the decision of the Court was not that supplying water was not a governmental function, but that the subject of the tax, namely, the net income of the trust whose operations were carried on in a private capacity, was so remote from any governmental function as to render the effect of the exaction inconsiderable as respects the activities of the city. In holding that the Gillespie and Coronado case were not authorities binding on it, the Court said:

In both of those eases the sovereign was acting as the trustee of an express trust with regard to the lands leased. In both the burden upon the public use was more definite and direct than in the present case. As said in the Coronado case, the doctrine of Gillespie v. Oklahoma is to be applied strictly and only in circumstances closely analogous to those which it disclosed. The decisions relied on can not be held to be authority upon the facts presented by this record.

' The facts in the instant case are even less analogous to those of the Coronado case than were the facts of the Jergins case.

The income here in question is the rent received by petitioner from tenants of its home office building, which was erected with its own money on land leased from the Tulsa board of education for 99 years.

The leased premises were not a part of the land which was granted to Oklahoma by the United States, upon its admission as a state, for the use and benefit of the public schools of that state, nor is it land which was purchased with part of the $5,000,000 which was given to the state to be held and invested for the use and benefit of the public schools. It was purchased by the town of Tulsa from the Creek Nation and thereafter deeded to the board of education. Hence, in leasing to petitioner a part of the land purchased, the state, acting through the board of education, was not acting as trustee of an express trust with regard to the land ieased, as it was in the Coronado case, supra, but as owner.

In the Coronado case the lease was not for the use of the premises for a specified rental, but one involving the depletion of a reserve. In other words, a lease under which the state and taxpayer shared the proceeds of operation. In the present case the state, through the board of education, has merely sold to this taxpayer the right to use the land for a specified period in consideration of certain payments to be made and covenants performed. The obligation of the lessee and the return to the state do not depend in any way upon the operations of the lessee. The rental specified is due and payable whether or not any space in the building is rented. The rental is fixed at an amount equal to 6 percent of the value of the premises, exclusive of improvements, and is payable annually in advance.

The terms of the lease indicate clearly that as between lessor and lessee the building was for all purposes to he treated as property of the lessee until termination of the lease, at which time the lessor agreed to purchase the building at its then cash value. Taxes were paid by petitioner on the building.- The amount of such taxes is not shown by the evidence, but the parties stipulated the amount covering taxes, depreciation, and other deductible expenses properly chargeable against the rent received. The statutes of Oklahoma provide, in chapter 57, Landlord and Tenant:

Sec. 7869. Tarnation of improvements. — All improvements put on leased, lands, that do not become a part of the realty, shah be assessed to the owner of such improvements as personal property; and the taxes imposed on such improvements shall be collected by levy and sale of the interest of such owner, the same as in all other cases of the collection of taxes on personal property.

And in chapter 84, Revenue and Taxation, it is provided:

Seo. 9583. Personal property. — Personal property, for the purpose of taxation, shall be construed to include:
* * * ⅜ * ❖ *
Second. All improvements made by others upon lands, the fee of which is still vested in the United States or this State; all improvements, including elevators and other structures, upon lands the title to which is vested in any railway company or other corporation whose property is not subject to the same mode and rule of taxation as other property.

Notwithstanding that in legal theory the building became a part of the land, it was, for all practical purposes, owned by petitioner. It was erected with petitioner’s money and represents an investment of the petitioner. It was used by petitioner as its home office building in carrying on its business. One of the necessary activities of an insurance company is the investment of its funds. That portion of the building not needed for its home office it rented to others, thus earning an income on such investment. The state has no more interest in the investment income of petitioner from its building, merely because it happens to be on land leased by the state to petitioner for 99 years, than it has in the income received by petitioner from its other investments or from its business.

We think the rule of the Supreme Court in Thomas v. Gay, 169 U.S. 264, holding the Oklahoma tax on cattle grazing in Indian lands valid, is applicable here. The Court said, at page 273:

But it is obvious that a tax put upon the cattle of the lessees is too remote and indirect to be deemed a tax upon the lands or privileges of the Indians.

And at page 275:

The taxes in question here were not imposed on the business of grazing or on the rents received by the Indians, but on the cattle as property of the lessees, and, as we have heretofore said that as such a tax is too remote and indirect to be deemed a tax or burden on interstate commerce, so it is too remote and indirect to be regarded as an interference with the legislative power of Congress.

This case was relied on by the state in the Gillespie case, supra, and Mr. Justice Holmes, in distinguishing this case said:

* * * whether this property [income from oil and gas leases on Indian lands] could be taxed in any other form or not, it cannot be reached as profits or income from leases such as those before us. The same considerations that invalidate a tax upon the leases invalidate a tax upon the profits of the leases, and stopping short of theoretical possibilities, a tax upon such profits is a direct hamper upon the effort of the United States to make the best terms that it can for its wards. Weston v. Charleston, 2 Pet. 449, 468. The taxation of cattle grazing in Indian lands held valid in Thomas v. Gay, 169 U.S. 264, 273, obviously is more remote. ⅜ * *

Under the principle of Thomas v. Gay, supra, the state could tax a building erected by a lessee on leased Indian lands, and does under section 9583 Okla. Stat., supra, and also the income received by such lessee from tenants in the building. The same rule would apply conversely to a tax by the Federal Government on the income from a building erected on state lands.

A tax on the rents received by petitioner from its tenants is no hamper upon the efforts of the state, through the board of education, to make the best terms it can. Like the state tax on cattle held valid in Thomas v. Gay, supra, it is too remote and indirect to interfere with the governmental functions of the state acting through the board of education.

Under the circumstances here present, we hold that the rent was not derived from the lease with the state, but from the building which was property of petitioner and is taxable to petitioner. Burrnet v. Jergins Trust, supra. If it be argued that a portion of the rent received from tenants of the building should be apportioned to the lease with the board of education, it is answered that all rent received in excess of that paid to the board of education represents a profit in the disposition of the lease for the time being, which is taxable under Willcuts v. Bunn, 282 U.S. 216, and Marland v. United States, 53 Fed. (2d) 907; certiorari denied, 290 U.S. 658.

Reviewed by the Board.

Judgment will be entered wider Rule 50.


text:
    Helen E. Grant, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 62029, 65577, 68324.
    Promulgated January 16, 1934.

      Bayley Kohlmeier, Esg., for the petitioner.

      G. G. Holmes, Esg., for the respondent.
   opinion.

Lansdon:

The respondent has determined deficiencies in income tax for the years 1927,1928, 1929, and 1930 in the respective amounts of $1,412.76, $1,396.35, $767.72, and $1,895.43. The only issue is whether a husband and wife domiciled in California may by contract convert the earnings of the husband from community to separate income. The several proceedings were consolidated for hearing and report. The material facts have been stipulated and may be summarized as follows:

The petitioner is the wife of Edwin J. Grant and, during each of the taxable years, resided with her husband at Beverly Hills, California. On August 1, 1927, she and her husband entered into and signed an agreement that the personal earnings of and salaries of the husband should remain his separate property and income. Such personal earnings and salaries for the last five months of 1927 and for 1928, 1929 and 1930 were in the respective amounts of $7,343.74, $18,156.48, $18,432.21 and $21,742.04. On his Federal income tax return for such years, the husband included such amounts in his gross income. The petitioner included no part thereof in her gross income reported on separate returns. Upon audit of the returns of the petitioner for the years under review, the respondent added to the gross income reported each year one half of the earnings of the husband for such year and determined the deficiencies here in controversy.

The petitioner contends that the purpose and elfect of the agreement of August 1, 1927, was to convert the earnings of her husband, otherwise community income under the laws of California, into separate income of the husband. There is no question as to the purpose of the agreement. Whether it was effective therefor is the legal question which must be decided. Under the laws of California a husband and wife residing in that state may enter into a valid contract with each other. California Civil Code, sec. 158; Wren v. Wren, 100 Cal. 276; 34 Pac. 775; Smith v. Smith, 47 Cal. App. 650; 191 Pac. 60; Gray v. Perils, 76 Cal. App. 511; 245 Pac. 221; Rayburn v. Rayburn, 54 Cal. App. 69; 200 Pac. 1064.

Petitioner contends that it is now well settled in California that a valid partition agreement between husband and wife applies not only to existing property, but also to future earnings, and prevents such earnings from becoming community property even for an instant, and relies on several decisions of the courts and of this Board to that effect. In Kaltschmidt v. Weber, 145 Cal. 596; 79 Pac. 272, the Supreme Court of California said:

And so also he may under Section 158, 159, Civ. Code, contract with her [the wife] by an agreement that her personal earnings shall be her separate property, and this may apply to future as well as past earnings, and the elfect of such an agreement will be to convert such earnings from the status of community property to that of separate property of the wife.

In Earl v. Commissioner, 30 Fed. (2d) 998, the Circuit Court of Appeals for the Ninth Circuit said:

If, as this seems to be the settled law of the State and which is recognized as such by the Board of Tax Appeals, a husband and wife may legally agree by contract that the future earnings of the wife shall be her separate property, find by virtue of such agreement they do not become the property of the community, there is no sufficient reason why they may not make a similar agreement with reference to the earnings of the husband.

The principle set out in the two decisions above cited has been applied by the Board in many proceedings heretofore decided. Edith Page Skewes-Cox, 29 B.T.A. 167; Howard C. Hickman, 27 B.T.A. 807; Francis Krull, 10 B.T.A. 1096. The authorities upon which petitioner relies support her contention unless changes in the California laws subsequent thereto establish a new rule, and this is in part at least the argument of the respondent. Prior to 1927 there was some confusion as to the exact nature of the separate interest of the spouses in community property under the laws of California. In that year the legislature enacted section 161 (a) of the Civil Code, as follows :

Seo. 161. (a) Interests in community property. The i’espeetive interests of the husband and wife in community property during the continuance of the marriage relations, are present, existing and equal interests under the management and control of the husband as is provided in sections 172 and 172(a) of the Civil Code. This section shall be construed as defining the respective interests of the husband and wife in community property.

Since 1927 the Supreme Court, in United States v. Malcolm, 282 U.S. 792, has decided that under the above section of the Civil Code of California the wife has such an interest in community income that she should separately report for Federal taxation. Manifestly, the provisions of the code, as well as the Malcolm decision, relate to community income and the taxation thereof. Under the laws of California the agreement between the petitioner and her husband changed the status of the husband’s earnings to separate income. The determinations of the respondent are reversed.

Decision will be entered for the 'petitioner.