author: Disney:

text:
    Samuel A. Neidich, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 77905.
    Promulgated November 18, 1938.

      Ruby R. Vale, Esq., and John A. Gonlin, G. P. A., for the petitioner.

      W. Frank Gibbs, Esq., J. E. Marshall, Esq., and George F. James, Esq., for the respondent.
   OPINION.

Disney:

The petitioner contends that he received the Underwood stock in a nontaxable reorganization, to which Underwood was a party. Ho argues that the provisions of the agreement of January 3, 1929, among Underwood, the New Jersey corporation, and himself are consistent with the verbal agreement had with Wagoner in December 1928; that, interpreting the written agreement in the light of the previous undertaking, there were only two corporate parties to the plan, namely, Underwood and the New Jersey corporation. The effect of petitioner’s argument is to ask us to ignore the part the Delaware corporation played in the transaction, and consider the plan as one in which there was nothing more than a transfer of assets of the New Jersey corporation directly to Underwood for stock of Underwood. The contention of the respondent is that the intention of the parties is evidenced by the terms of the January 3, 1929, agreement and that the transaction as finally agreed upon and carried out did not make Underwood a party to a reorganization.

It was stipulated that at the December 26, 1928, meeting, Wagoner and petitioner entered into a verbal agreement for the acquisition by Underwood of “the business and assets of the New Jersey corporation” in exchange for 21,005 shares of common stock of Underwood, subject, however, to the understanding that the “verbal agreement would be made the subject of a written contract.” Wagoner, testifying from notes made by him at the time the verbal understanding was reached, testified that the agreement Avas for Underwood to acquire the business of the New Jersey corporation by an exchange of Underwood stock for assets or stock of the New Jersey corporation, as payment might be recommended by counsel for Under-Avood. Upon being consulted a few days later by Wagoner, counsel for Underwood suggested that the transaction take the form set out in the agreement executed as of January 3, 1929, and the proposal was accepted by Wagoner and petitioner, as representatives of their respective corporations. While the finance committee of Underwood was aAvare of the negotiations being carried on with the petitioner, Wagoner’s actions were at all times subject to the approval of the board of directors of Underwood.

The method originally agreed upon by the individuals for acquiring control of the business of the New Jersey corporation was abandoned in favor of one calling for the transfer of the property of the New Jersey corporation directly to a new corporation, to be organized and wholly owned by Underwood, in exchange for Underwood common stock, delivered directly by Underwood to the New Jersey corporation. The new plan was made the subject of a written contract, as contemplated by the agreement previously entered into between the individuals, and thereafter, pursuant to authority granted by the boards of directors of the corporations concerned, an agreement embodying the terms of the final understanding was duly executed. This agreement was the only one authorized by Underwood and the New Jersey corporation and to it Ave must look for the intention of the parties concerned. “The plan of reorganization was the contract made and performed.” Watts v. Commissioner, 75 Fed. (2d) 981; affd., 296 U. S. 387.

The written agreement is inconsistent Avith the oral understanding. The original understanding did not provide for ownership of assets of the New Jersey corporation by a new corporation, Avhereas the only plan to which the corporations concerned ever became a party provided in unambiguous terms for the transfer of the assets directly to a new corporation for stock of UnderAvood. The point in Helvering v. Tex-Penn Oil Co., 300 U. S. 481, cited by the petitioner, was whether it was proper to look through the form of certain documents to determine the actual fact respecting the payment of certain consideration. The fact here is that Underwood and the New Jersey corporation, by the only binding contract ever entered into between them on the subject, agreed to the transfer of the assets of the latter to a new corporation for stock of the former.

The conduct of the New Jersey corporation and Underwood was in accordance with the terms of the January 3, 1929, agreement. Upon the organization of the Delaware corporation by Underwood, the New Jersey corporation transferred its assets to the Delaware corporation, for which Underwood received from the Delaware corporation $300 cash, which had been acquired from Underwood or its representatives for stock, and 4,190 shares of Delaware corporation stock. The Delaware corporation also assumed certain liabilities of the New Jersey corporation. As consideration for the transfer by the New Jersey corporation to the Delaware corporation, Underwood, in accordance with the January 3, 1929, contract, delivered to the New Jersey corporation, 21,005 shares of its common stock, which stock was subsequently distributed to petitioner and in part by him to other stockholders of the New Jersey corporation. Upon the completion of the transaction, petitioner held stock of Underwood, Underwood held all of the stock of the Delaware corporation, and the Delaware corporation owned all of the assets of the New Jersey corporation.

Petitioner seeks to distinguish the case from Groman v. Commissioner, 302 U. S. 82; Helvering v. Bashford, 302 U. S. 454; A. W. Mellon, 36 B. T. A. 977; and Gilbert D. Hedden, 37 B. T. A. 1082. We fail to observe any material distinguishing features. In the Groman case, the Glidden Co. contracted with stockholders of an Indiana corporation for the organization of an Ohio corporation to be owned by the Glidden Co., and for the acquisition by the Ohio Corporation of all of the stock of the Indiana corporation in exchange for cash and preferred stock of the Ohio and Glidden companies. In the Bashford case the stock and assets of three corporations were transferred to a new corporation, in exchange for which the stockholders of the three corporations received cash, common stock of the new corporation, and common and preferred stock of Atlas. In the Mellon case, part of the assets of a corporation was, in pursuance of a contract with the Bethlehem Steel Corporation, transferred directly to subsidiaries of Bethlehem, in exchange for common stock and bonds of Bethlehem. It was held that the Glidden and Atlas companies and the Bethlehem Steel Corporation were not parties to reorganizations and that the securities the respective petitioners received in those corporations were subject to tax. In the Hedden case, in accordance with a contract with the Bethlehem Steel Corporation, substantially all of the assets of the Hedden Iron Construction Co. were transferred to two subsidiaries of Bethlehem in exchange for cash and bonds of Bethlehem, delivered directly by Bethlehem to the Pledden Co. Following the Groman, Bashford, and Mellon cases, and refusing to follow Schuh Trading Co. v. Commissioner, 95 Fed. (2d) 404, upon the ground that it could not be distinguished from the Groman and Bashford cases, we held that Hedden’s gain should be recognized.

The petitioner emphasizes the fact that the Delaware corporation was a wholly owned subsidiary of Underwood and that, as a nominee or transferee of Underwood to receive the assets of the New Jersey corporation, the Delaware corporation should be disregarded in the transaction. He claims that under the circumstances Underwood was the purchaser. Like facts were present in the Mellon and Hedden cases, and Michigan Steel Corporation of New Jersey, 38 B. T. A. 435, and in the Bashford case the Court concluded that such circumstances were not enough to take the case out of the rule. The Court said:

Any direct ownership by Atlas of Peerless, Black Diamond, and Union was transitory and without real substance; it was part of a plan which contemplated the immediate transfer of the stock or the assets or both of the three reorganized companies to the new Atlas subsidiary. Hence under the rule stated, the aboye distinctions are not of legal significance. The difference in the degree of stock control by the parent company of its subsidiary and the difference in the method or means by which that control was secured are not material. The participation of Atlas in the reorganization of its competitors into a new company which became a subsidiary did not make Atlas “a party to the reorganization.” The continuity of interest required by the rule is lacking.

The respondent’s action in taxing petitioner on the gain derived from the receipt of 18,177 shares of common stock of Underwood is sustained. Having so concluded, we find, in accordance with a stipulation of the parties, that petitioner in 1929 realized a taxable capital gain of $1,224,704.66 from the receipt of the Underwood stock and an ordinary gain of $142,555 upon the subsequent sale in 1929 of 3,000 shares of the stock.

Decision will be entered wider Rule 50.


source: Caselaw Access Project

author: Smith:

license: Public Domain

text:
    Western Water, Light and Traction Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91272.
    Promulgated November 18, 1938.
    IF. F. Mehrlioh, Esq., and M. J. Sporrer, Esq., for the petitioner.

      O. R. Marshall, Esq., for the respondent.
   OPINION.

Smith:

This proceeding is for the redetermination of deficiencies in petitioner’s income tax for 1934 and 1935 in the respective amounts of $655.46 and $938.33. The sole issue presented is whether the petitioner and its wholly owned subsidiary, the Iowa Terminal Co., were affiliated during the taxable years 1934 and 1935 and privileged to file consolidated returns for those years.

The parties have filed a written stipulation of facts which, in so far as material to our consideration of the issue presented, are substantially as follows:

The petitioner is a corporation, organized under the laws of Maine, with its principal office at Chicago, Illinois. During 1934 and 1935, it was a holding company, deriving all of its income from interest on bonds, mortgages, notes, and other properties, and from dividends on stocks of domestic corporations.

During 1934 and 1935 the petitioner owned all of the outstanding capital stock of the Iowa Terminal Co., an Iowa corporation, hereinafter called the Terminal Co., consisting of 5,000 shares of common stock of a par value of $100 per share.

Also, during 1934 and 1935, the petitioner held outstanding 6 percent first mortgage notes of the Terminal Co. in the face amount of $277,651.21 which had matured on October 1, 1928. This indebtedness represented moneys advanced to the Terminal Co. by the petitioner in prior years.

The Terminal Co. is the owner of certain terminal facilities located at Des Moines, Iowa, consisting of roads, buildings, tracks, and other equipment which during 1934 and 1935 were leased to the Des Moines & Central Iowa Railroad Co. for an annual rental of $18,000. The only activity of the Terminal Co. during the years 1934 and 1935 was the receiving of rents for its terminal properties, and its entire income consisted of rent received from its leased properties.

Balance sheets of the petitioner at December 31, 1933, 1934, and 1935, showing the principal assets, are set forth in the stipulation of facts as follows:

The Iowa Electric Light & Power Co. is an operating gas and electric utility company. It operates about 28 miles of electric railway between Cedar Eapids and Iowa City and carries both freight and passengers. It supplies gas and electricity to a number of areas in the vicinity of Cedar Eapids, Iowa. As of December 31, 1935, it served approximately 50,000 electricity consumers and over 10,000 gas consumers. Less than 10 percent of the company’s income is derived from transportation. The preferred stock of the company has preference both as to assets and dividends.

The stipulated facts contain no information as to the character of business of the Deer Lodge Farms Co.

The Des Moines & Central Iowa Eailroad Co., which, as stated above, was the lessee of the Terminal Co.’s terminal facilities in 1934 and 1935, operates about 180 miles of interurban railroad out of Des Moines. Its bonds, which the petitioner owned in 1934 and 1935, had matured in 1931 and were in default as to both principal and interest, no interest having been paid since 1926.

The Central Public Utility Corporation, a Delaware corporation, is the main holding company for a system of public utility companies controlled by Consolidated Electric & Gas Co., all of whose common stock it owns. The company is also engaged in the distribution of electricity.

The gross income of the petitioner and of the Terminal Co. for 1934 and 1935, determined on a cash receipts and disbursements basis, was as follows:

Petitioner’s total net income was $15,499.99 in 1934 and $13,468.10 in 1935, while the Terminal Co. had net losses of $6,129.88 in 1934 and $7,667.93 in 1935.

The petitioner filed consolidated income and excess profits tax returns for 1934 and 1935 for itself and the Terminal Co. and in its returns the petitioner’s net income was reduced by the net losses of the Terminal Co. The respondent in his audit of the returns has determined that the petitioner and the Terminal Co. were not affiliated within the meaning of section 141 (d) of the Eevenue Act of 1934 during the taxable years 1934 and 1935 and were not entitled to file consolidated returns for those years. Whether these companies were affiliated is the only question in issue in this proceeding.

Section 141 (d) of the Bevenue Act of 1934 is as follows:

(d) Definition of “Affiliated Geoup”. — As used in this section an “affiliated group” means one or more chains of corporations connected through stock ownership with a common parent corporation if—
(1) At least 95 per centum of the stock of each of the corporations (except the common parent corporation) is owned directly by one or more of the other corporations; and
(2) The common parent corporation owns directly at least 95 per centum of the stock of at least one of the other corporations; and
(3) Each of the corporations is either (A) a corporation whose principal business is that of a common carrier by railroad or (B) a corporation the assets of which consist principally of stock in such corporations and which does not itself operate a business other than that of a common carrier by railroad. For the purpose of determining whether the principal business of a corporation is that of a common carrier by railroad, if a common carrier by railroad has leased its railroad properties and such properties are operated as such by another common carrier by railroad, the business of receiving rents for such railroad properties shall be considered as the business of a common carrier by railroad.
As used in this subsection (except in paragraph (3) the term “stock” does not include nonvoting stock which is limited and preferred as to dividends.

Since the petitioner owned all of the common stock of the Terminal Co., the requirements of subsections (1) and (2) of section 141 (d) above are satisfied. In addition to those requirements, however, each of the companies claiming affiliation must be either (A) a corporation whose principal business is that of a common carrier by railroad; or (B) a corporation the assets of which consist principally of stock in such corporations. The respondent contends that the conditions prescribed in neither (A) nor (B) have been met. Assuming that the Terminal Co. fulfills the conditions prescribed in (A), it is clear that the petitioner does not, since, as it is stipulated, the petitioner in 1934 and 1935 was a holding company, deriving all of its income from interest on bonds, mortgages, notes, and other properties, and from dividends on stocks of domestic corporations. It remains to be considered whether the petitioner fulfills the conditions in (B).

As shown by the balance sheets set forth above, the assets of the petitioner at the close of each of the years 1933,1934, and 1935 totaled $1,475,426.29, $1,490,534.62, and $1,501,492.57, respectively. The petitioner’s investment in the capital stock of the Terminal Co., as shown by its books of account, was only $450,000. Apparently the stock was worth very little, if anything, during the taxable years. The requirement of section 141 (d) (3) (B) is “a corporation the assets of which consist principally of stock in such corporations and which does not itself operate a business other than that of a common carrier by railroad.” The phrase “such corporations” refers to those corporations specified in (A.), that is, those whose principal business is that of a common carrier by railroad. The other investments of the petitioner, besides its investment in the capital stock of the Terminal Co., do not meet the requirement of (B). The evidence is that only $450,000 of petitioner’s total assets of approximately $1,500,000 consisted principally of stock in “such corporations.”

The petitioner’s balance sheets for 1934 and 1935 show that one of its principal assets was “notes receivable” of the Terminal Co. secured by a 6 percent real estate mortgage of a book value of $277,-651.21. Petitioner’s income statements for 1934 and 1935 show that the interest which it received from the Terminal Co. on these notes, of $16,659.08 in 1934 and $14,659.08 in 1935, comprised about 80 percent of its total income. It would appear that the petitioner’s principal income-producing asset during the years 1934 and 1935 was its investment in the mortgage notes of the Terminal Co. The mortgage notes of the Terminal Co. were not the same or the equivalent of stock in that company, within the contemplation of the statute. They represented an interest entirely separate and different from the stock.

We think it plain that during the taxable years the petitioner’s assets did not consist principally of shares of stock of corporations whose principal business'was that of common carrier by railroad.

It is observed, too, that the petitioner was the owner in 1934 and 1935 of common and preferred stock, or both, of other corporations, none of which was of the class of corporations prescribed in subdivision (d) (3) above.

The respondent is sustained in his determination that the petitioner and the Terminal Co. were not affiliated in 1934 and 1935 and are not entitled to file consolidated returns for those years.

Judgment will he entered for the respondent.


author: Him:

text:
    Ruth B. Rains, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 86469.
    Promulgated November 18, 1938.

      George E. EL. Goodner, Esq., and Glair M. Senior, Esq., for the petitioner.

      B. P. ELertzog, Esq., for the respondent.
   OPINION.

Him:

On July 30, 1929, the directors of the Columbia Steel Corporation formally approved an option, theretofore executed on July 16, granting to petitioner’s husband the right to purchase from the corporation at any time within three years 20,000 shares of its common capital stock at $9 a share. The stock was then worth $16 a share. Petitioner and her husband at that time were residing in California, a community property state. The option was given to petitioner’s husband as compensation for services rendered in 1919-1922. Most, if not all, of the services mentioned were rendered prior to the time petitioner and her husband were married, and if any of such services were rendered after the marriage, it was while they were residing in Utah, a noncommunity property state.

Respondent held that, since petitioner and her husband were then residing in a community property state, the option constituted community income at the time of its receipt in July 1929, to the extent of its fair market value, which was determined to be $140,000, measured by the difference between the option price of $9 a share and the market price of $16 a share, or $7 a share on 20,000 shares of stock. Accordingly, respondent taxed to petitioner, as her portion of such community income one-half of the total, or $70,000. In computing the deficiency the respondent ignored the transaction between petitioner and her husband under the agreement of November 7, 1929, on the theory that, since the option was community property, petitioner thereby acquired nothing which she did not already own.

Petitioner asserts that respondent’s action is erroneous for the reasons (1) that the mere receipt of the option by petitioner’s husband did not constitute income to any one; (2) that the option was the separate property of petitioner’s husband, since they were not domiciled in a community property state when the services were rendered; and (3) that when she acquired a one-half interest in the option as her separate property on November 7,1929, in exchange for notes and accounts which had cost her $62,764.76 and exercised the option next day, receiving 10,000 shares of stock upon the payment of $90,000, she not only realized no gam from the transaction but sustained a loss.

The questions for decision are:

1. Was the option granted to petitioner’s husband, L. F. Rains, community property?

2. If the option was community property, did income result to the community from its mere acquisition or only upon its exercise?

3. Did petitioner realize a gain or loss in the taxable year in the exchange of property for a right under the option ?

If question No. 1 should be answered in the negative, question No. 2 becomes unimportant to a decision of the issues in this proceeding, since the income of L. F. Rains is not involved herein. We shall first consider question No. 1, namely, whether the option was community property.

If the right under the option had its inception within the period of the domicile of L. F. Rains and petitioner in California the option was community property; otherwise, it was the separate property of L. F. Rains. Petitioner contends that such right had its inception in the performance of the services for which compensation was provided by the option. Respondent contends that the inception of the right lay in the granting of the option, or, in other words, that the right to such compensation was created by the option and that theretofore there was no such right, incipient or otherwise. Admittedly the option was granted pursuant to an arrangement to compensate L. F. Rains for services rendered by him to the Columbia Steel Corporation at a time prior to the intermarriage of L. F. Rains and petitioner, or at least prior to their residence in a community property state. Such services constituted the consideration and the only consideration for the option. From the time of the organization of the Columbia Steel Corporation it appears to have been understood between L. F. Rains and the other directors thereof, as individuals, that he was to have an additional amount of stock in the corporation as compensation for such services, but that prior to the granting of the option there was no action by the corporation to this effect. The form and amount of compensation which he claimed were not determined prior to the granting of the option and prior to that event he had no legally enforceable right to such compensation. The directors of the corporation, recognizing the value of his services to the corporation and that he had not been adequately compensated therefor, gave Eains the option, thereby determining the method of compensating Eains for such services and binding the corporation to the terms thereof. Thus ivhat had been previously a mere moral right to compensation was made a legal right. But this action did not change the fact that the consideration for the option was the performance of services by Eains in the period 1919-1922 and that hence the inception of the right under the option was the performance of such services while Eains was domiciled in Utah, a noncommunity property state. The right to the compensation provided by the option being separate property of Eains in its inception, the compensation when received was likewise separate property.

If we should agree with respondent’s contention and hold that the granting of the option was the inception of the right to compensation provided thereunder, then, it must also be held that such right did not flow from the performance of such services and consequently there was no valuable consideration for the option and that it was a gift to Eains. In such event the option and the compensation provided thereunder would be the separate property of Eains. It is unnecessary to cite authority to the point that under the law of every community property state a gift to one of the spouses of a marital community is the separate property of such spouse. Either the option was given to L. F. Eains in consideration of services rendered in 1919-1922 while he was domiciled in the State of Utah, or it was given without valuable consideration and was therefore a gift to him. In either event the option was the separate property of L. F. Eains, since the inception of a property right fixes the character of the title thereto. Cf. W. L. Honnold, 36 B. T. A. 1190; Sara R. Preston, 35 B. T. A. 312; Albert J. Houston, 31 B. T. A. 188; Gouverneur Morris, 31 B. T. A. 178; Helen N. Winchester, Administratrix, 27 B. T. A. 798; John M. King, 26 B. T. A. 1158; affd., 69 Fed. (2d) 639.

We hold, therefore, that the option was the separate property of L. F. Eains and not the community property of himself and petitioner. In view of this holding it is unnecessary to consider question No. 2, hereinabove stated, since the petitioner, not having any community interest in the option, received no income as a result either from the mere acquisition of the option by L. F. Eains or from its exercise in the purchase of corporation stock.

But our holding that petitioner realized no income from the acquisition of the option by her husband, L. F. Eains, or from the purchase of stock under the option, does not dispose of the issue affecting the tax liability of petitioner Herein. We still Have to consider question No. 3 above stated, namely, whether petitioner realized a gain or loss in the taxable year in the exchange of property for a right under the option. The latter question is one apart from the acquisition of the option by L. F. Bains and the purchase of the stock thereunder. Petitioner, in acquiring assignment of an interest in her husband’s option, exchanged property for property and it is upon that transaction that we must redetermine the deficiency determined against her by respondent.

Petitioner exchanged property which cost her $62,764.76 for a right under her husband’s option to purchase 10,000 shares of the common stock of the Columbia Steel Corporation at the price of $90,000. However, the cost of the property which she exchanged for the right under the option must be reduced by the amount of $7,099.24 to arrive at the basis to be used in computing her gain or loss, for the reason that the record discloses that the property, consisting of notes and accounts, transferred by petitioner to her husband under the agreement, as consideration for one-half interest in the option, included $7,099.24 representing royalties which accrued to petitioner in 1928 and were not reported by her as income for that year. The correct basis, therefore, for computing petitioner’s gain or loss on the transaction is $55,665.52. Cf. Pearl A. Long, 35 B. T. A. 479; affd,, 96 Fed. (2d) 270; George N. Crouse, 26 B. T. A. 477; Searles Real Estate Trust, 25 B. T. A. 1115; Henry V. Poor, 11 B. T. A. 781; affd., 30 Fed. (2d) 1019; Bothwell v. Commissioner, 77 Fed. (2d) 35; Larkin v. United States, 78 Fed. (2d) 951.

The cases last above cited are predicated upon the general principle that a taxpayer can not take as a deduction the loss of a gain which has not been reflected in income. For example, in the Poor case, sufra, the taxpayer deducted from gross income as a bad debt the full amount of a judgment embracing $484.21 interest which had at no time been included in his reported income. The Board applied the principle stated, notwithstanding the taxpayer kept his books on a cash receipts and disbursements basis, and the uncollected interest, therefore, was properly excluded from his gross income.

In the instant case, petitioner is not seeking to deduct directly from gross income the amount of the uncollected royalties, and if such a deduction were claimed, it would not be allowable under the doctrine referred to. However, petitioner is attempting to attain the same result by including the amount of the royalties in the basis to be deducted in computing gain or loss from the exchange of her receivables for an interest in the husband’s option. If so included, such amount would reduce the taxable gain or increase the deductible loss.

Substantially the same principle has been applied and the same results obtained in analogous situations based upon slightly different reasoning. In William Merriam Crane, 27 B. T. A. 360; affd., 68 Fed. (2d) 640, the petitioner owned certain realty which had been leased to an insurance company. The lessee made improvements of substantial value in 1920 which were to revert to the lessor upon termination of the lease. Petitioner sold the property in 1927, and contended that in computing gain or loss on the sale he was entitled to deduct the depreciated cost of the improvements, although he had never reported any part of such cost or value in his income. We denied the deduction on the ground that an income item is not, for tax purposes, converted into a capital asset, having a cost basis, until it is first taken into income. In our opinion we said:

Furthermore, he [taxpayer] is not in a position to charge himself with any amount of increase in capital value as he might have been had he first taken some part of the increase into income. Prior to the sale he never recognized the receipt of any benefit from the expenditures made by his lessee. Until he has recognized the receipt of the asset, he can not set up capital value for it.

In Commissioner v. Farren, 82 Fed. (2d) 141, the taxpayers in 1918 each received shares of stock in an oil company as compensation for services rendered. Although taxable as income for 1918, no return was made for that year, on the theory that no income was derived until the stock was sold. The stock was sold in 1926, and the taxpayers contended they were entitled to deduct the value of the stock when acquired, notwithstanding such value had not been returned as income. The deduction was disallowed.

In Long v. Commissioner, 96 Fed. (2d) 270, affirming 35 B. T. A. 479, the court held that the worthless obligation of a husband to pay alimony was not deductible as a bad debt, since there was no cost basis of the debt sought to be deducted.

In Alamo National Bank of San Antonio, Executor, 36 B. T. A. 402; affd., 95 Fed. (2d) 622, the petitioners were the sole stockholders of a corporation from which they received a Coca-Cola franchise in 1921 as a liquidating dividend, but did not include in their income for that year any amount on account of the receipt of the franchise. They sold the franchise in 1931, and we held they were not entitled to deduct any value for the franchise as a basis for computing gain from its sale.

Petitioner acquired her option right on November 7, 1929, and on November 8, 1929, purchased 10,000 shares of Columbia Steel Corporation stock for $90,000 in the exercise of such right. [Respondent contends that the contract of November 7, 1929, between petitioner and her husband was effective as of October 31, 1929, and that the latter date should be taken as the basic date for computing gain or loss. If such latter date be taken as the effective date of such contract, petitioner derived gain from the exchange ,whereas, if November 7, 1929, be taken as the effective date of the contract, she sustained a loss. Such difference in results flows from the fact that there was a considerable fluctuation in the market value of the stock between the respective dates. We think the date last mentioned must be used as the basic date. The contract was executed on November 7, 1929, and did not provide that it should be effective as of October 31,1929, but only that the amoimts of the various notes and accounts covered by the agreement between petitioner and her husband should be determined as of the preceding October 31. Such provisions did not fix the effective date of the contract, but merely provided a method for computing the amount of the consideration moving from petitioner to her husband.

The gain or loss realized by petitioner in the transaction is the difference between the allowable cost basis of the property exchanged for the right under the option and the fair market value of that right on November 7, 1929. Whether she realized gain or loss depends on whether the allowable cost basis was greater or less than such value. The only evidence in the record from which we may determine the fair market value of the right which petitioner acquired is that establishing the purchase price of $90,000 paid by her under the option for the stock and the market value of the stock on July 16 and 31, October 30 and 31, and November 8, 1929. Only “over the counter” sales prices of the stock are available and they varied from $15% a share on July 16 to $16 on July 31, October 30 and 31, and $14, $13⅝ and $13% high, low and close, respectively, on November 8, 1929. We have found that the fair market value of the stock on November 7, 1929, was $13% a share, or $137,500 for 10,000 shares. The evidence does not disclose any sales or quotations of the stock on November 7, 1929, but the value last above stated is indicated as the value of the stock on November 7, 1929, by the best evidence before us on this point, it being the value established by sales of the stock on the day immediately following the acquisition by petitioner of an interest in the option.

The parties hereto have proceeded on the theory that the fair market value of the right under the option is the difference between the amount to be paid for the purchase of the stock under the option and the fair market value of the stock. In the absence of evidence on this point other than that above indicated, and in view of the parties’ attitude relative thereto, we accept, for the purposes of this case, such measure of value. Therefore, the market value of the right acquired by petitioner in the option of L. F. Rains was $47,500, the difference between $90,000, the purchase price of 10,000 shares of such stock under the option, and $137,500, the fair market value of the stock on November 7, 1929. Thus we find and hold that petitioner, on November 7, 1929, exchanged property having an allowable cost basis of $55,665.52 for an option right of the fair market value of $47,500 and thereby sustained a loss in the amount of $8,165.52.

Respondent contends that petitioner’s notes and accounts were not worth face value at the time of the exchange for the option, but that fact, if true, is immaterial. Petitioner is nevertheless entitled, in computing gain or loss on the exchange, to use the adjusted cost basis, which is clearly established by the record.

The deficiency will be recomputed by eliminating from petitioner’s gross income the amount of $70,000 included therein by respondent, and by deducting from gross income the above loss of $8,165.52.

Reviewed by the Board.

Judgment will 5c entered u/nder Rule 50.

Arundele, Turner, Tyson, and Disney concur only in the result.


author: Tyson :

text:
    T. A. Johnston, Trustee, Victory Lease, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 84693.
    Promulgated November 22, 1938.

      Samuel A. King, Esq., for the petitioner.

      James H. Teatman, Esq., and M. L. R. Wade, Esq., for the respondent.
   OPINION.

Tyson :

The assignment of the Victory lease, executed by Abernathy and Kirkpatrick on December 1, 1931, constituted a conveyance of legal title to an interest in real property to T. A. Johnston, trustee. See C. A. Everts et al., Jamison Lease Syndicate, 38 B. T. A. 1039, and the authorities cited therein. The uncontradicted facts herein establish that, under the terms of a prior agreement of Johnston and Owen, Johnston, as trustee, acquired and held the title to the Victory lease during the taxable year on behalf of himself as to a one-half undivided interest therein and on behalf of John Owen as to a one-half undivided interest therein and that one-half of the oil payments reserved by the assignors of the lease would be taken out of the respective interests of Johnston and Owen in the lease.

Johnston and Owen, as the individual owners of a 7/8 interest in the Victory lease, offered to sell for cash undivided fractional interests in that lease and the well to be drilled thereon and each purchaser understood that, under an assignment, he or she would become the owner of an undivided fractional interest in real property. The assignments, duly executed, acknowledged, and delivered by T. A. Johnston, trustee, as assignor, whereby he did “bargain, sell, transfer, assign and convey all rights, title and interest of the original lessee and present owner” in and to an undivided fractional interest in the Victory lease to each purchaser, his heirs, and assigns, constituted a valid conveyance of title to an interest in real property to each of such purchasers; and this is true as between the parties despite the lack of recordation of the assignment or conveyance. See C. A. Everts et al., Jamison Lease Syndicate, supra.

At the time each purchaser became the owner of an undivided fractional interest in the Victory lease, he or she had an oral understanding that neither Johnston nor Owen would have any authority to sell or encumber his or her fractional interest; that Johnston and Owen would direct and manage the development and operation of the Victory lease and the sale of oil and gas produced therefrom; that he or she, as such OAvner, would be personally liable for his or her proportionate share of the operating expenses; that if such owner did not record his or her assignment, Johnston and Owen would collect his or her share of the gross proceeds from oil and gas sales, deduct his or her proportion of the operating expenses, and distribute his or her pro rata share of the net proceeds; and, further, that such owner of a fractional interest could, at any time, record his or her assignment and thereupon, as an owner having title of record, he or she could sign a division order and collect direct from the pipe line company his or her pro rata share of the gross proceeds. The terms of that oral understanding were carried out and, since in the instant case none of the 27 purchasers and owners of fractional interests recorded the assignments of such interests, Johnston and Owen collected the gross proceeds from the sales of oil and gas on behalf of themselves and such owners, deducted the operating expenses, disbursed to the owners their respective shares of the net proceeds, maintained books of account, and rendered an accounting to each owner. Since title of record stood in the name of “T. A. Johnston, Trustee,” up to and including 1933, all of the transactions of Johnston and Owen in regard to the Victory lease were carried out in the name of “T. A. Johnston, Trustee.” The coowners of fractional interests in the Victory lease, as a group, had no form of organization empowered to direct, control, or participate in the development or management of that lease and they never held any meetings, nor were any certificates or evidence of interest other than the above mentioned assignments ever issued to them.

The sole question presented is whether, upon the facts herein, petitioner was, during 1933, an “association” within the meaning of that word as used in section 1111 (a) (2) of the Revenue Act of 1932, and thus made subject to tax as a corporation.

In the recent case of O. A. Everts et al., Jamison Lease Syndicate, supra, and upon facts which in many respects were quite similar to those in the instant case, a similar issue was presented. The numerous authorities cited, considered, and quoted from in that opinion are equally applicable here, and we do not deem it neces sary to again enter into a lengthy discussion of such authorities. In that case, Everts, as the individual owner of a one-half interest in a Texas oil and gas lease, sold fractional interests therein, and we held that under the assignments of such interests the purchasers acquired title to an interest in real property and became tenants in common of fractional undivided interests in the oil and gas lease. On behalf of himself, as the owner of unsold fractional interests, and on behalf of the other coowners, under powers of attorney given him, Everts directed, controlled and managed the development and production operations, the sale of oil and gas produced, the collection of the gross proceeds, the payment of operating costs, and the distribution of the net proceeds, and rendered an accounting to the coowners, and we concluded that there existed merely the relation of principal and agent as between each tenant in common and Everts. We held therein that there was no aggregation of individuals or separate entity having the attributes of a corporation and that the owners of the fractional interests in the lease there involved were tenants in common in their relations with each other and did not constitute an association taxable as a corporation.

In the instant case, as in the Everts case, the assignments constituted conveyances of legal and equitable title to fractional interests in the Victory lease and the assignees became tenants in common of undivided interests in that lease. In that case, Evarts remained the individual owner of the unsold fractional interests in the lease there involved, and in the instant case, Johnston and Owen remained the individual beneficial owners of the unsold fractional interests in the Victory lease, although the record title was in T. A. Johnston, trustee. Up to and including 1983, the only fractional interests as to which legal title was held by T. A. Johnston, as trustee, were those interests beneficially owned by Johnston and Owen, and in 1934 their respective interests were assigned to them individually in conformity with their prior agreement that the lease should be paid for and owned by them individually, half and half. In the Everts case, Everts carried out all of the transactions as to development, operation, sale of oil and gas produced, and distribution of the net proceeds on behalf of himself and the other coowners of the lease there involved, and in the instant case Johnston and Owen carried out such transactions in a similar manner as to the lease here involved. In that case, as here, there was no limitation npon the personal liability as tenants in common, of the various coowners of the lease. In that case, as here, there was no meeting of the interest holders. In that case, Everts acted as an agent under a written power of attorney from each coowner which expressly delegated Everts’ powers and he carried out his various transactions in his individual name or in the name of the Everts Drilling Co., a sole proprietorship. In the instant case, up; to and including 193S, Johnston and Owen carried out expressly delegated powers under an oral understanding with each coowner, but since title of record to the lease remained in the name of “T. A. Johnston, Trustee,”' all of their transactions as to the Victory lease were carried out in that name. The bank account in which receipts from the operation of the lease were deposited was in that name and the disbursements to the coowners of fractional interests for their distributive shares were made by checks signed “T. A. Johnston, Trustee,” drawn on that account.

These latter facts are the only distinguishing ones as between the Everts case and the instant case. However, we do not regard such distinction as justifying an ultimate conclusion different from that reached in the Everts case. While Johnston and Owen acted in the name of “T. A. Johnston, Trustee” in exercising certain delegated powers in the operation of the lease on behalf of the coowners thereof and with the consent and agreement of such coowners, that fact is not determinative of the real status of Johnston or Johnston and Owen in their business relations with the coowners in such operation. The use of the word “trustee” appended to Johnston’s name can not be held to have the effect of actually making him, or Johnston and. Owen, trustee or trustees. What Johnston and Owen and the co-owners of interests inj the lease characterized the capacity in which Johnston or Johnston and Owen acted is not controlling. That capacity and the relations between the parties are controlled by the terms of the agreement creating them. Cf. Titcomb v. Richter, 93 Atl. 526; 89 Conn. 226; Witthoft v. Commercial Development & Investment Co., 268 Pac. 31-35; 46 Idaho, 313; Nowell v. Oswald, 274 Pac. 423 (Dist. Ct. of Apps. Cal.); 96 Calif. App. Rep. 536 (rehearing denied; hearing denied by Supreme Court). McLean v. Ficke, 62 N. W. 753; 94 Iowa, 283; Rowe v. Rand, 12 N. E. 377; 111 Ind. 206. Trudie T. Munger, 16 B. T. A. 168, and authorities cited therein. The relation between Johnston and Owen and the coowners of the lease herein, under the terms of the agreement between them, was that of principal and agent and not that of trustees.

While Johnston and Owen acted under the name of “T. A. Johnston, Trustee,” in performing their delegated authority in carrying out the actual operation of the lease on behalf of each coowner no trust, as a concrete entity, separate and apart from the individual interest holders, was created, for each coowner remained the individual owner of his or her interest as tenant in common of real property and could have, at any time, recorded his or her assignment, signed a division order, and received his or her pro rata share of the gross proceeds direct from the pipe line company. In Helvering v. Coleman-Gilbert Associates, 296 U. S. 369, the Supreme Court said that the five individual owners of realty who there formed a combination to conduct their joint business enterprise and to avoid partition of their undivided interests in the realty, had been coowners of realty, but they preferred to become associates under their indenture of trust, and through a trust entity they secured centralized management, continuity, limited liability, and shares of beneficial interest constituting personal property, and that, thus, they had created an “association” taxable as a corporation. Here, the coowners of undivided interests in the Victory lease have continued, throughout the taxable year, to be the individual coowners of interests in real property and as such entitled to receive their respective pro rata shares of proceeds from the production of oil and gas therefrom. Here, we do not find an aggregation of individuals or an entity having attributes analogous to those of a corporation.

Upon the facts herein, we conclude that there did not exist, during 1933, an “association” taxable as a corporation within the meaning of the applicable statute. C. A. Everts et al., Jamison Lease Syndicate, supra, and the authorities cited therein.

Decision will be entered for the petitioner.


author: Kern:

text:
    Daniel J. Gallery and Robert B. Chittenden, as Co-Administrators with the Will Annexed of the Estate of John J. McCarthy, Deceased, and Daniel J. Gallery, Robert B. Chittenden and Marion I. McCarthy, Trustees of the McCarthy Family Trust, Dated May 22, 1928, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91196.
    Promulgated November 22, 1938.

      Forest D. SiefJcin, Esq., and Joseph W. Cwarnings, Esq., for the petitioners.

      R. F. Staubley, Esq., for the respondent.
   OPINION.

Kern:

Respondent has determined a deficiency of $155,587.54 in Federal estate tax by including in decedent’s gross estate the full stipulated fair market value (as of the day of decedent’s death), $1,066,-791.67, of the corpus of a trust settlement made by decedent on May 22,1928, for the benefit of himself, his wife, and three children. The grounds taken by respondent in his deficiency notice are that the transfer was made (1) in contemplation of death under section 302 (c), and (2) to take effect in possession and enjoyment at or after death, under section 302 (d) of the Revenue Act of 1926, as amended. The petitioners returned as part of the gross estate of decedent one-third of the amount of the trust corpus, on the ground, apparently, that decedent’s control of one-third of the trust income during life justified the inclusion of a proportionate amount of the corpus in the gross estate, but now pray that the amount so paid, $28,591.05 be declared an overpayment and refunded.

1. We may take the broadest ground, contemplation of death, first, and dispose of that. The inducement clause of the trust indenture recites that the trust settlement was made since the settlor was “desirous of making proper provision for his family and giving them an immediate enjoyment of the property now owned by him.” No testimony was adduced at the hearing, and we have only the stipulated facts and such inferences as we may draw from them. They set out “that the deceased, John J. McCarthy died in Chicago, Illinois, on July 21, 1935, at the age of sixty-five years. The deceased at the time of executing the trust of May 22,1928, was in good health for a man of his years, and the execution of the trust was not prompted by any condition of body or mind, which would have led him to believe that death was imminent or near at hand, or that he expected to die within the reasonably distant future.”

The trust instrument required the annual distribution of the trust income to the decedent’s wife and his three children to the extent of four-sixths of the total, one-sixth being reserved to the decedent, and the last one-sixth to be accumulated or distributed by the trustees in their discretion, and might, upon the direction of the two other trustees (the decedent being himself a trustee) be paid to decedent. We think that these provisions support the declaration in the inducement clause that the trust was to make “proper provision for his family” and give them “immediate enjoyment of the property”; purposes which are associated with life and not with death. United States v. Wells, 283 U. S. 102; Becker v. St. Louis Union Trust Co., 296 U. S. 48; Constance McCormick, Executrix, 38 B. T. A. 308.

Nor do the stipulated facts point to any other conclusion. The Supreme Court, in Wells’ case, supra, pointed out that it is “the thought of death, as a controlling motive prompting the disposition of property that affords the test.” We can not well find the thought of death as the controlling motive here, when all we know is that the decedent at the time of the transfer was 58, was “in good health for a man of his years”, and made the transfer without expecting death either as “near at hand” or as something “within the reasonably distant future.” If the stipulation means anything, we think it must mean that the thought of death itself did not closely impinge on the decedent’s consciousness at the time, but that, being 58, he knew that he could not live, say, more than 35 years more. The actual motive of the transfer is lacking then, except in so far as it may be inferred from all the circumstances. They indicate a motive connected with life; present provision for his family. We think that the dominant motive of death has not been proved, and that we can not infer the existence of such a controlling motive, as respondent would have us do, from decedent’s age, from the size of the transfer (which, if excluded from the decedent’s estate, would leave less than $15,000), or from the fact that the beneficiaries of the trust were the natural objects of the decedent’s bounty. Constance McCormick, Executrix, supra. Nor does the fact that the benefit of the income and, later, of the corpus of the trust would continue after the settlor’s death affect the conclusion. Cf. Shukert v. Allen, 273 U. S. 545. The transfer must have a direct relation to the death of the settlor, either by reason of his motive in making it or by reason of the time when its possession and enjoyment will become effective.

2. We pass then to respondent’s contention that the transfer was to take effect in possession and enjoyment at or after death, under section 302 (c) of the Revenue Act of 1926. It is obvious that under the Supreme Court’s decision in May v. Heiner, 281 U. S. 238, the decedent’s retention of control over one-third of the income for life would not bring the trust corpus in whole or in part within this section, and respondent confesses in his brief that the amendments to this section on March 3, 1931, and thereafter can have no retroactive application. Hassett v. Welch, 303 U. S. 303.

Respondent attempts, however, by an elaborate argument to show that the transfer was “intended to take effect as to the right to the possession or enjoyment at or after death” because death of any one of the children before that of the survivor of decedent and his wife might divest that child’s interest; and argues that the transfer is not complete until the “succession” is complete; until, in other words, the beneficiaries’ interest is indefeasibly vested. Respondent says therefore that “the only interest, if any, that may be properly excluded from the gross estate, from the standpoint of the transfer taking effect after death, is the interest in said four-sixths part of the trust corpus for the period of the life expectancy of decedent’s widow, as of the date of decedent’s death.”

The short answer to this whole contention is that the Federal estate tax is a “transfer”, not a “succession” tax; it is laid on the decedent’s right to transfer his property at death, not on the heir’s or devisee’s right to inherit or take. The incidence of the two types of tax is wholly different in effect. See Stebbins v. Riley, 268 U. S. 137. To illustrate this profound difference we need cite only the Supreme Court’s decision in Nichols v. Coolidge, 274 U. S. 531, in which in circumstances not dissimilar to those here a transfer in trust was considered and adjudged not taxable under the Federal estate tax, and the Court’s decision in Coolidge v. Long, 282 U. S. 582, in which the same transfer was considered under the Massachusetts succession tax. The full discussion of the question in the latter case by the four dissenting judges makes comment unnecessary, but the earlier Massachusetts succession tax case of Saltonstall v. Saltonstall, 276 U. S. 260, illustrates the principle, and the later Massachusetts succession tax case of Binney v. Long, 299 U. S. 280, confirms the difference in the nature of the two classes of taxes. If the gift has passed out of the hands of the settlor and is beyond recall from the beneficiaries named, the Federal estate tax will not concern itself with whether or when the gift shall vest indefeasibly in the beneficiary.

The fact that there have been written into the procession of Federal estate tax statutes euacted since 1916 provisions which recognize the substance of control which a power may exercise over even fully executed, as well as over executory, transfers by no means affects the principle, as respondent appears to think, that the Federal estate tax is laid on the transfer from the dead to the living, and not on the receipt by the living from the dead, of the property passing. Such are the provisions dealing with the powers of revocation and of appointment. They require, to escape taxability, only that the donor shall have completely loosened his grip on the thing before death, not that the heir’s or devisee’s hold shall have been made fast.

3. We turn now to respondent’s final contention, that the transfer to the extent of one-fifth was intended to take effect at or after death under section 302 (c) and (d), since the decedent, it is said, had a right to revoke the trust and revest so much of it in himself. The relevant portion of section 302 (d) is as follows:

To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power, either by the decedent alone or in conjunction with any person, to alter, amend or revoke * * *.

Article 1 of the trust constituted the decedent, his wife, and E. B. Chittenden, who was not a beneficiary, trustees. Article 2 gave the trustees “every power, right and privilege with respect to the trust property enjoyed by the prior owner not inconsistent with the specific terms of the trust.” The same article further provided that “the powers of the trustees heremider may be exercised upon the consent of the majority of them.” Article S provided that “the trust may be altered or amended in any of its provisions, except that no change shall operate to revest title to more than one-fifth of the principal of the trust estate in John F. McCarthy * * The power in the decedent to control until his death one-fifth of the trust corpus is, therefore, obvious and comes within the language of the statute which speaks of a power to alter, amend, or revoke exercisable “either by the decedent alone or in conjunction with any person.”

Petitioners, in their contention that the one-fifth of the property transferred to the trust was not includable in the gross estate, pursuant to section 302 (d), rely strongly on the case of White v. Poor, 296 U. S. 98. However, that case differs from the instant case in that there the trust instrument did not contain any power to revoke, amend, or alter the trust, but merely provided that the trustees should have the power to terminate the trust, and in that there the settlor became a trustees having, together with the other trustees, the power of terminating the trust, not by virtue of any provision in the instrument by which she had created the trust, but by virtue of her election^ as trustee to fill a vacancy caused by the resignation of one of the original trustees designated by the settlor, the election being made by the surviving trustees with the approval of all of the beneficiaries. In the instant case the trust instrument, as we have pointed out, provided that the trustees should have the right to amend and alter, and further provided that the settlor should be one of the trustees, pursuant to which provision the decedent did act as trustee. Therefore, the case of White v. Poor, supra, is not authority for the petitioners’ contention in the instant case. The case of Helvering v. City Bank Farmers Trust Co., 296 U. S. 85, is in. point, and the broader principles stated in that case should apply here.

The case of Reinecke v. Smith, 289 U. S. 172, although dealing with an income tax problem arising under another section of the revenue acts, contains reasoning which, by analogy, supports our conclusion.

The trust corpus, to the extent of the one-fifth portion revocable by the decedent jointly with one of the two other trustees, was properly includable in decedent’s gross estate.

We hold, therefore, that there was an overpayment to the extent that the tax originally paid exceeds the tax due as computed in accordance with our opinion.

Decision will be entered under Rule 50.


author: Keiín:

text:
    Estate of Michael I. Pupin, Deceased, Varvara Pupin Smith, Administratrix, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92177.
    Promulgated November 22, 1938.

      Harry W. Forbes, Esq., for the petitioner.

      Stanley B. Pierson, Esq., for the respondent.
   opinion.

Keiín:

This proceeding involves an alleged deficiency of $2,764.90 in estate tax, of which $2,056.91 is in dispute. The facts are undisputed; and the proceeding was submitted on the pleadings without hearing, under Rule 30.

The decedent, Michael I. Pupin, died on March 12, 1935, leaving policies of insurance upon his life aggregating, with post-mortem dividends, $101,122.20, of which $50,000 was payable to Columbia University, an exempt educational institution, and $51,122.20 was payable to decedent’s daughter, Yarvara Pupin Smith, who became administratrix of his estate. These insurance policies were duly reported in the estate tax return filed for the estate of the decedent, and $61,122.20 of such insurance (the amount in excess of $40,000) was included in the gross estate shown in the return.

In the deductions claimed in the return for charitable and similar gifts, the full $50,000 of insurance payable to Columbia University was included, making the net taxable insurance $11,122.20. That was the amount by which the insurance payable to the nonexempt beneficiary exceeded the statutory exemption of $40,000. The respondent held that the statutory exemption of $40,000 should be prorated and $19,778.05 thereof allocated to the insurance payable to Columbia University, thereby reducing the charitable deduction from $50,000 to $30,221.95 and increasing the net taxable estate by $19,778.05, the effect being to include $30,900.25 of the insurance in the net taxable estate, instead of $11,122.20. The additional estate tax claimed by reason of such adjustment is $2,056.91, which is the only amount in dispute.

The pertinent sections of the statute are section 302 (g) and section 303 (a) (3) of the Revenue Act of 1926, which we have set out in the margin.

The question presented by this proceeding seems to have been first considered in John E. McKelvy et al., Executors, 31 B. T. A. 1206. In that case we approved the apportionment method followed by the respondent as outlined in E. T. 2 XII-2 C. B. 280. However, that case was reversed by the Circuit Court of Appeals in McKelvy v. Commissioner, 82 Fed. (2d) 395, and in its opinion therein the court fully considered the question involved in this case. Under the authority of that case, therefore, we find for the petitioner.

Decision will ~be entered wnder Rule 50.

       Sec. 302. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
      *******
      (g) To the extent of the amount receivable by the executor as insurance under policies taken out by the decedent upon his own life; and to the extent of the excess over $40,000 of the amount receivable by all other beneficiaries as insurance under policies taken out by the decedent upon his own life.
      Sec. 303. For the purpose of the tax the value of the net estate shall be determined— (a) In the case of a resident, by deducting from the value of the gross estate— *******
      (3) The amount of all bequests, legacies, devises, or transfers, to or for the use of the United States, any State, Territory, any political subdivision thereof, or the District of Columbia, for exclusively public purposes, or to or for the use of any corporation organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, including the encouragement of art and the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private stockholder or individual, or to a trustee or trustees, or a fraternal society, order, or association operating under the lodge system, but only if such contributions or gifts are to be used by such trustee or trustees, or by such fraternal society, order, or association, exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals. The amount of the deduction under this paragraph for any transfer shall not exceed the value of the transferred property required to be included in the gross estate.


author: Muiídock :

text:
    The Minneapolis Security Building Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 82131.
    Promulgated November 22, 1938.

      Oswald Maland, Esq., for the petitioner.

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

Muiídock :

The Commissioner determined a deficiency of $671.22 in the petitioner’s income tax for the fiscal year ended June 30, 1933. The first issue is, How should the cost of the leasehold be amortized, i. e., should the cost be recovered by deductions spread over the remaining term of the lease, or over the shorter life of the building on the leased premises, or should a part of the cost be spread in the one way and a part in the other. The only other issue is whether or not the petitioner is entitled to deduct $3,256.82 paid into the “Depreciation Fund”, as provided in the lease. The Commissioner has claimed an increased deficiency on the ground that he computed deductions for exhaustion of the leasehold upon an excessive basis. The parties have agreed upon the correct basis and the petitioner has no objection to the adjustment claimed by the Commissioner except as is set forth in its contention under the first issue. The facts have been stipulated and the Board adopts the stipulation as its findings of fact.

The petitioiier acquired the unexpired portion of a 99-year lease just prior to the beginning of the taxable year. The lease then had 94 years and 11 months to run. The property subject to the lease was a tract of land, located in the business district of Minneapolis, Minnesota, completely covered by an office building. The lessor was the owner of the land and building at the time the lease was originally executed. The building was 25 years old at the time the lease was acquired by the petitioner and had a remaining life of 30 years. Its value at that time was $705,600, while the value of the land was $293,000. The petitioner’s basis for gain or loss and for exhaustion of the leasehold was $258,130.51. The income which the petitioner received from tlie leased premises consisted entirely of rentals received from tenants of the office building. The petitioner, as lessee, was required to pay $55,000 a year as rental to the lessor. The lessee was required to maintain the improvements on the leased premises and was permitted but not required to remove and replace the building under certain circumstances. It also had an option to purchase the leased premises on or before June 1, 1978, for the sum of $1,050,000.

The Commissioner contends that a reasonable allowance for exhaustion of the leasehold for this fiscal year is computed by taking that part of the cost of the lease which bears the same ratio to the total cost of the lease as the twelve months of the fiscal year bear to the total unexpired period of the lease at the beginning of the fiscal year. The petitioner contends that a reasonable allowance for exhaustion of the lease is one-thirtieth of its cost, because that cost must be recovered over the remaining useful life of the building. It contends in the alternative that some portion of the cost of the leasehold should be apportioned to the building and recovered over the useful life of the building. There is no evidence relating to this question except what has been already outlined, together with the terms of the lease. The entire record does not indicate any sound reason for computing the deduction or any part of it with reference to the life of the building, rather than with reference to the unexpired portion of the lease. The petitioner does not have an exhaustible interest in the building. Neither had its predecessor, the original lessee. Weiss v. Wiener, 279 U. S. 833. Cf. Cogar v. Commissioner, 44 Fed. (2d) 554. The exhausting property which it owns is the leasehold. There is present no justification for concluding that the useful life of that leasehold will be less than its unexpired term. The method advocated by the Commissioner is the usual method (Regulations 77, arts. 130 and 201) and its use has been approved in a great many cases. Hotel De France Co., 1 B. T. A. 28; Grosvenor Atterbury, 1 B. T. A. 169; Roth Hotel Co., 1 B. T. A. 1111; Columbia Theatre Co., 3 B. T. A. 622; Automatic Exposition Co., 11 B. T. A. 1397; Coronado Realty Co., 24 B. T. A. 1022; City National Bank Bldg. v. Helvering, 98 Fed. (2d) 216, affirming 34 B. T. A. 93. If its use here does not result in a reasonable allowance for exhaustion of the leasehold, at least that fact has not been shown by the petitioner. Some of the cases above cited involved similar long term leases. The capital outlay of the petitioner for the lease will be returned by the method which the Commissioner seeks to apply. United States v. Ludey, 274 U. S. 295.

The petitioner during the fiscal year deposited $3,256.82 in the “Depreciation Fund” pursuant to the provisions of article five of the lease. The deposit was made by delivering to the lessor certain land trust certificates which the petitioner liad acquired during tlie year at a cost of $3,256.82 and which were accepted by the lessor in lieu of that amount of cash. The certificates were carried on the petitioner’s balance sheet at the end of the year as an asset under the heading of “Securities in depreciation fund.” The petitioner did not claim any deduction on its income tax return for the fiscal year on account of this deposit and the Commissioner has not allowed any deduction in determining the deficiency. The amount contained in the depreciation fund did not amount to $750,000 at the time the stipulation was entered into.

Article five is entitled “Depreciation Fund”, and contains the statement that depreciation of the premises and the amount of damages to the lessor in case of default will be incapable of exact determination and, in order to avoid the necessity of approximating such amounts, to guarantee the payments to be made by the lessee and to indemnify the lessor against all liabilities in connection with the demised premises, “The Lessee agrees to create and maintain in the hands of the Lessor a special fund to be known as the ‘Depreciation Fund’ under the following terms and conditions and for the uses, benefits and purposes hereinafter set forth, to-wit:”

(a) The lessee agrees to “deposit” $7,500 with the lessor during each year until the Depreciation Fund shall amount to $750,000 as hereinafter provided.

(b) The lessor will pay interest on any money in its hands belonging to the fund at such rate as interest is paid on funds in checking-accounts in trust companies in Cleveland, Ohio, and will invest and reinvest available funds, subject to the request and approval of the lessee, “in obligations of the United States of America or in undivided fractional interests in the fee of the demised premises.” The interest and income shall be credited to and become a part of the fund until the fund shall amount to $750,000 as hereinafter provided.

In the event the Lessee exercises its option to purchase the demised premises as hereinabove provided, the Lessor shall, on receipt by him of the option price, pay and deliver to or upon the order of the Lessee, all moneys and/or investments then held by him in said Depreciation Fund.

(c) Further deposits shall cease whenever and as long as the fund (takinginvestments at their market or face value, whichever is lower) shall amount to $750,000, and thereafter the income from the fund, exclusive of capital gain, shall be paid to the lessee.

(d) The lessee may make deposits in securities.

(e) The lessor may withdraw sums from the fund sufficient to pay the lessee’s obligations in case the latter fails to make prompt payments in accordance with the lease.

(f) The lessee is to pay all taxes on the fund or the income therefrom.

(g) Said Depreciation Fund and the investments included therein shall be and remain the property of the Lessee, pledged, transferred and deposited, to and with the Lessor, however, for the purposes herein set forth, and without any right in the Lessee to use, claim or enjoy the same except to the extent and in the manner herein specifically set forth. Upon the termination of this Lease by the expiration of its term, said Fund and the investments included therein shall, without further act or deed by the Lessee, belong to and thereafter be and remain the property of the Lessor in the same manner as is in such cases made and provided with respect to the demised premises, and shall be and constitute liquidated compensation to the Lessor on account of the depreciation in the value of the demised premises during the Lessee’s occupancy thereof, and upon the happening of such event the Lessee does hereby sell, convey, assign, transfer and set over unto the Lessor all the right, title or interest of the Lessee in said Fund. Upon the termination of this Lease on account of the default of the Lessee hereunder, said Fund and the securities included therein shall belong to and thereafter be and remain the property of the Lessor in the same manner as if in such case provided with respect to the demised premises, and shall be and constitute liquidated compensation to the Lessor on account of the depreciation in the value of the improvements on the demised premises during the Lessee’s occupancy thereof and liquidated compensation to the Lessor for damages resulting from such default, and upon the happening of such event the Lessee does hereby sell, convey, assign, transfer and set over unto the Lessor all the right, title or interest of the Lessee in said Fund. Until the happening of such event as under the provisions of this Lease shall give the Lessor the right and title to said Fund or the right to have recourse thereto, the Lessor shall have only a contingent interest therein as in this Lease provided.

There is a provision elsewhere in the lease that the lessee, upon exercising the option and paying the purchase price of $1,050,000, “shall be entitled to all moneys and/or investments in the Depreciation Fund held by the lessor under the provisions of this lease, and all insurance moneys then in the hands of the Trustees for Insurance hereinafter named.”

Another provision is that the lessee shall maintain and keep the improvements in good condition, keep the improvements insured, and have the use of any insurance proceeds necessary to restore the premises. If the premises are taken for public use, such appropriation is to constitute an election on the part of the lessee to exercise its option, and upon payment of the option price the lessee is to have all awards, together with the depreciation fund and insurance. The lessee is to pay all taxes. The lessee, while not in default, has the right to remove improvements for the purpose of replacing them with other improvements upon putting up proper security to protect the lessor. Any building erected is to be a proper one for the location, and is to cost not less than $1,000,000. Improvements are to immediately become a part of the realty.

No improvements were made by the petitioner.

The petitioner contends that it is entitled to deduct the amount of $3,256.82 under section 23 (a) of the Revenue Act of 1932, either as additional rent or as an ordinary and necessary expense. That section provides for the deduction of all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including “rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.” The annual payment of $55,000 which the petitioner was required to make to the lessor was clearly rental for the use of the property during the taxable year. But the amount here in question was quite different. It was not paid to the lessor absolutely for the use of the property during the taxable year. It was not paid to the lessor absolutely for any purpose. It was not paid at all. Neither did it represent an accrual. Instead, it was deposited with the lessor to be made a part of a fund which still belonged to the lessee. The right of the lessor to that fund was entirely contingent and depended upon the possibility of a default by the lessee in some payment or upon the failure of the lessee to exercise its option on or before June 1,1918. The petitioner would recover possession of the fund upon exercising the option and purchasing the property. Meanwhile, the fund remains as prop-ertjr of the lessee, forming a guarantee to the lessor. The fund may possibly go to the lessor in the future. It may go to the lessor piecemeal in order to make up payments on which the petitioner has defaulted. Deductions for such possible use of the fund will have to be determined in the light of the circumstances under which the use is made. Cf. Estate of George E. Barker, 13 B. T. A. 562; Virginia Iron Coal & Coke Co., 37 B. T. A. 195. The fund may go to the lessor in its entirety on June 2, 1978, but, if so, that will be the first date upon which the exact nature of the payments can be determined. Meanwhile, the petitioner is not entitled to deduct deposits in the fund. If, as may happen, the fund is returned to the petitioner, then the impropriety of the allowance of any deduction as an ordinary and necessary expense would clearly appear.

Although no further reason is necessary for disallowing this deduction, nevertheless there are other reasons why it may not be allowed. Section 23 (a) allows a deduction for rents or other payments required to be made as a condition to the continued use of property only in case the taxpayer has not taken and is not taking title to the property and has no equity in the property. The lease agreement provides expressly that the fund and the investments included in it shall be the property of the lessee, and it further provides that those funds may be invested in “undivided fractional interests in the fee of the demised premises.” The record does not show whether or not any of the fund has been invested in such fractional interests. But regardless of whether or not such investments have been made, nevertheless they may be made, and under such circumstances no deduction would be proper under section 23 (a).

Decision will be entered uruler Rule 50.


author: S'ternhagen :

text:
    Wagegro Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 82077.
    Promulgated November 22, 1938.

      William R. Green, Jr., Esq., and Jerome R. Hellerstein, Esq., for the petitioner.

      Philip M. Clark, Esq., for the respondent.
   OPINION.

S'ternhagen :

1. The petitioner, in accounting on its return for the gain from the sale of the Yosemite shares, used the installment basis recognized in the Revenue Act of 1932, section 44 (b). The Commissioner refused the use of the installment basis and included in petitioner’s income for the fiscal year ended May 31, 1933, the difference between the “proceeds of sale of stock $850,000” and the “cost and other expenses of sale” $156,627.06, as “profit from sale $693,-472.94.”

In our opinion, the petitioner is clearly entitled to use the installment basis. This was a “casual sale of personal property for a price exceeding $1,000”, in which “the initial payments did not exceed 40 percentum of the selling price.” The $750 fee paid by the purchaser in discharge of the vendor’s obligation to the law firm must be regarded as part of the purchase price. McInerney v. Commissioner,, 82 Fed. (2d) 665; Corona Flushing Co., 22 B. T. A. 1344. The fact is that, as provided in the original offer and acceptance, the purchaser paid the fee in discharge not of its own obligation, but in discharge of petitioner’s obligation to the law firm. This was tantamount to a payment from the purchaser to the seller, and must be so treated. See Law of Federal Income Taxation, Paul and Mertens, vol. 1, § 912. Its use to discharge what might be called a “selling expense” of the seller does not alter the fact that it was a prescribed part of the consideration of the sale and that it was in effect received by the seller in the year of sale, thus fulfilling the statutory definition of an “initial payment.” In Regulations 77, article 352, the rule is laid down that:

* * * Commissions and other selling expenses paid or incurred by the vendor are not to be deducted or taken into account in determining the amount of the “initial payments,” the “total contract price,” or the “selling price.”

This applies in its terms to the treatment of amounts paid by the vendor and has no relation to amounts received, actually or constructively, by the vendor from the purchaser. We are here considering not the treatment to be applied to the $750 as paid by the vendor to the lawyers, but as received by the vendor from the purchaser. The dual conception of the direct payment by the purchaser to the vendor’s obligee which the law recognizes for other income tax purposes must be preserved here as well. The rule of article 352 appears to have been applied without contest to the $677.06, and perhaps it should be applied also to the $750 payment constructively made by petitioner to the law firm. But as a part of the consideration constructively received by petitioner for the sale, it must be regarded as an initial payment of the installment sale.

Since there was what the statute recognizes as an initial payment, it is not necessary to decide the question, elaborately argued, whether the “installment basis” may be used if no payment whatever is received in the year of sale.

2. The Commissioner disallowed the deduction taken by the petitioner on its return of $16,500 as compensation paid to its officers. The petitioner assails the disallowance and has undertaken to support the deduction by proving that the payment was made and that the amount was no more than reasonable compensation for the services which were performed. To this end it offered the oral testimony of Wallace Groves and George Groves. It can not be said, however, that the evidence establishes that the amounts paid were no more than reasonable, the defect of evidence being in an inadequate description of the services performed. The Commissioner, presumably after an investigation of the facts, held that there was no evidence before him to show that the amounts were paid for services rendered. There is, however, in the present record uncontradioted evidence that the payments were made and also some evidence that some services were performed. The disallowance of the entire deduction may not, therefore, be sustained.

It does not follow, however, that because the evidence shows that some services were performed it must be held that the entire amount paid was properly deducted. To establish the deductibility of salaries over the Commissioner’s adverse determination the taxpayer must prove not only that the salaries Avere paid, but also that they Avere reasonable compensation for the services performed. Becker Brothers v. United States, 7 Fed. (2d) 3; Doernbecher Manufacturing Co., 30 B. T. A. 973, 983; affd., 95 Fed. (2d) 184; East St. Louis Finance Co., 34 B. T. A. 1085. This is especially true where the alleged salary is paid by a corporation to one who owns all of its shares, and also, although perhaps to a slightly less degree, as to a salary paid by such a corporation to the brother of the principal shareholder. Under such circumstances the mere statement by the two brothers that they believed the amounts to be commensurate Avith the value of their services, even though not contradicted, is not per se determinative of its deductibility. Neither of the brothers testifieo with any accuracy as to the specific services which he rendered tc the value of their services, even though not contradicted, is not per se determinative of its deductibility. Neither of the brothers testified with any accuracy as to the specific services which he rendered to this corporation during the year in question, and the general language in which their activities for the corporation were described establishes finding, howeA'-er, is required in recognition of the evidence that some services were performed, “bearing heavily * ⅛ ⅛ upon the taxpayer whose inexactitude is of his own making.” Cohan v. Commissioner, 39 Fed. (2d) 540, 544. The finding has been made, therefore, that $3,000 is “a reasonable allowance for salaries or other compensation for personal services actually rendered” to the petitioner. So much may be deducted, and the Commissioner’s disallowance as to the rest is sustained.

Decision will be entered wnder Rule SO.


author: SteRnhagen : Disney,

text:
    Sydney R. Wrightington, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91371.
    Promulgated November 22, 1938.

      Sydney R. Wrightington, Esq., pro se.

      Paul E. Waring, Esq., for the respondent.
   OPINION.

SteRnhagen :

The Commissioner determined deficiencies in petitioner’s income tax of $4.83 for 1934 and $49.72 for 1935. The petitioner seeks to overcome these deficiencies by showing that income which he received as Town Counsel of Lexington, Massachusetts, is exempt from tax. The facts are contained entirely in a written stipulation. The amounts of petitioner’s income which are brought in question are $850 received by him as salary in 1934 and $887.50 received by him as salary in 1935 from the municipality for general services as town counsel, such services being described in section 3 of the town bylaws as the drafting and approval of town documents and giving legal advice and opinions to town officers. Other amounts received by the petitioner for services incident to litigation he does not here put in issue.

The question whether salary paid by a county, town, or other subdivision of a state to counsel regularly employed, as distinguished from amounts sporadically paid for specific services, is subject to Federal income tax has been considered in several cases, and until recently the decisions have held the salary to be exempt. Helvering v. Curren, 90 Fed. (2d) 621; Commissioner v. Schnackenberg, 90 Fed. (2d) 175; Commissioner v. Hindman, 88 Fed. (2d) 44; Commissioner v. Coughlin, 87 Fed. (2d) 670; United States v. Butler, 49 Fed. (2d) 52; Burnet v. Livezey, 48 Fed. (2d) 159; Blair v. Matthews, 29 Fed. (2d) 892; Wilkins v. Moore, 24 Fed. Supp. 670. Eecently, in Ewart v. Commissioner, 98 Fed. (2d) 649, and Commissioner v. Emerson, 98 Fed. (2d) 650, the Circuit Court of Appeals for the Third Circuit held that because New Jersey township attorneys were independent contractors they were not free from tax upon their fixed compensation. Metcalf & Eddy v. Mitchell, 269 U. S. 514. The Board has recognized immunity in Jeremiah Wood, 31 B. T. A. 1141; Martin P. O'Connor, 35 B. T. A. 402; and W. Frank Carter, 36 B. T. A. 60; and denied it in Clark McK. Whittemore, 35 B. T. A. 757.

The Commissioner argues in this proceeding that Helvering v. Gerhardt, 304 U. S. 405, overruled these earlier decisions and puts an end to the immunity unless it can be shown not only that the services for which the compensation was received are essential to the preservation of the state government, but also that the Federal tax upon the individual operates as a burden upon the state. The Gerhardt case, however, was directed to the question of immunity of employees of the New York Port Authority, who were held not to be engaged in such governmental functions as were indispensable to the continued existence of the state. The functions there considered were in this respect quite different from those to which the services of the present town counsel were an incident. Such services covered the entire field of existence and activity of the town, touching it at every point where the law might operate upon it. In every sense the petitioner was engaged in performing an inherent and traditional function of government.

It is said, however, that the petitioner has not met the second test of immunity, in that he has not shown that the imposition of the Federal tax upon him operates to burden the state. If this means that he has not introduced primary evidence of an actual burden during the particular years in question, the statement is correct. It is difficult to believe, however, that the Gerhardt opinion must be read as requiring such a showing to support every claim of immunity which is made under the established doctrine that the Federal Government may not by taxation interfere with the free operation of the governmental functions of the states. Collector v. Day, 11 Wall. 113. To read it as meaning this would logically lead to the conclusion that even the statutory compensation of the governor of the state may be taxed by the Federal Government unless evidence is introduced the preponderance of which shows that such tax operates in fact as an interference with the carrying on of the state’s essential govermnental functions or those which are indispensable to its existence as a state. Such a burden of proof would practically nullify the constitutional doctrine itself, for it is hard to conceive how the burden could be discharged by any individual officer or employee of a state. We are unable to conclude that the decision in the Gerhardt case may be carried so far. See Robert McCarthy Bullington, 38 B. T. A. 754.

Since the petitioner was not an independent contractor, Helvering v. Curren, supra, and the compensation in question was received for services incident to the town’s existence and governmental operations, the immunity from Federal tax is, in our opinion, estabished.

Reviewed by the Board.

Judgment will be entered wider Rule 50.

ARNOLD dissents.

Smith, dissenting:

In Helvering v. Gerhardt, 304 U. S. 405, it was said:

The basis upon which constitutional tax immunity of a state has been supported is the protection which it affords to the continued existence of the state. To attain that end it is not ordinarily necessary to confer on the state a competitive advantage over private persons in carrying on the operations of its government. There is no such necessity here, and the resulting impairment of the federal power to tax argues against the advantage. The state and national governments must co-exist. Each must be supported by taxation of those who are citizens of both. The mere fact that the economic burden of such taxes may be passed on to a state government and thus increase to some extent, here wholly conjectural, the expense of its operation, infringes no constitutional immunity. Such burdens are but normal incidents of the organization within the same territory of two governments, each possessed of the taxing power.

It seems to me that the principle upon which the Gerhardt case was decided was that immunity from Federal income tax of the salary and wages of officers and employees of a state depends upon whetlaer the imposition of the tax puts a substantial burden upon the state. Absent evidence of such burden the tax attaches.

I think the opinion of the Supreme Court in the Gerhardt case overrules the principle of Collector v. Day, 11 Wall. 113, and “a century of precedents,” as stated by Mr. Justice Butler in his dissenting opinion.

In the instant proceeding there is no evidence that the imposition of the Federal income tax upon the petitioner’s salary was a substantial burden upon the State of Massachusetts or the town of Lexington.

Disney,

dissenting: I think that in the light of Helvering v. Gerhardt, 304 U. S. 405, rehearing denied October 10, 1938, the question here presented requires our reexamination, and that, so reexamined, the answer is a denial of the immunity upheld by the majority opinion.

The burden of taxation passed on to the state or subdivision by reason of taxation of this employee is theoretical, not actual. The tax is not discriminatory, and overrefinement of plausible, but unsound theory, instead of a weighing of reality, is in my opinion the basis of claim of immunity. Collector v. Day, 11 Wall. 113, adopted what appeared to be a well balanced reciprocal treatment of state and national government, but which neglected the sound distinctions between taxation by a state and by the United States, made by Chief Justice Marshall in McCulloch v. Maryland, 17 U. S. 315, and reverted to and relied upon in Helvering v. Gerhardt, supra; and Collector v. Day, supra, has in turn been strained to apply to situations beyond its scope, until fact is made to subserve formula and, because of a certain symmetry in theory of reciprocal relations between nation and state, a class of immunity has been created which wars with the idea of equality of taxation inhering in the income tax law and the Constitution. Too much emphasis, I think, has been placed upon the idea of separate sovereignties and the fear of encroachment of one upon the other in the tax field. The dichotomy in the governance of the citizen of the United States does not cut so deeply. Nation and state should not be treated as wholly independent sovereigns. They are interdependent, and nowhere more so than in the tax realm. The employee of the state is a citizen of the United States, subject to its laws. Bealization of this interdependence and the pragmatic nature of income tax dictates that we should realize that there is in plain fact no burden upon the operation of state government because of nondiscriminatory Federal income tax upon those who administer it in the indirect manner of the employee who is petitioner here. Though the function performed by him be essentially governmental, I think the burden upon state is essentially chimerical, not factual.

Oppee agrees with this dissent.