author: Arundell:

text:
    Arthur H. Fleming, Petitioner, v. Commissioner of Internal Revenue, Respondent. Marjorie Fleming Lloyd-Smith, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 4502, 7017, 4449, 7103.
    Promulgated April 19, 1927.
    1. Distributions made to petitioners as beneficiaries under trusts, the income of which consisted of royalties from mining properties, held, to be income and taxable to the life beneficiaries.
    2. Beneficiaries under the trusts held not entitled to depletion on account of removal of ore from properties forming a part of the corpus of the trusts.

      Ralph W. Smith, Esq., E. ‘Goudge, Esq., and E. E. Tooley, C. P. A., for the petitioners.

      A. Colder Machay, Esq., for the respondent.

      These proceedings involve deficiencies in income taxes as follows:

    There are three questions presented by the pleadings. They are: (1) Whether distributions made to petitioners as beneficiaries under trusts, the income of which consisted of royalties for the use of mining properties, are taxable as income; (2) whether petitioners are entitled to deductions for depletion of the iron ore in the properties forming the corpus of the trusts; (3) whether the Commissioner correctly computed the depletion he allowed.
    By the terms of his will Eldridge M. Fowler, who died on November 7, 1904, created two trusts, designated herein for convenience as the Fowler Mining Trust and the Fleming Mining Trust.
    The material portions of the will relating to the Fowler Mining Trust are as follows:
    PARAGRAPH; XIII
    I give, devise and bequeath one-half of all my real estate and interest in real estate situate in the Counties of Cook, Lake, St. Louis and Itasca, in the State of Minnesota, and one-half of all my mineral rights, rights in minerals, ores and fossils, mineral reservations and surface rights in said Counties of Cook, Lake, St. Louis and Itasca, in said State of Minnesota, and one-half of all my stock in corporations owning mines, mineral lands or mineral rights in said State of Minnesota and in mining corporations and corporations engaged in mining in said State; excepting, however, my real estate situate in the City of Duluth in said State, to my daughter I-Cate when she shall arrive at the age of forty-five years if she shall live so long, with the power to dispose thereof by will at any time before she shall arrive at the age of forty-five years; and if she shall die intestate as to such property before arriving at the age of forty-five years, then to her child or children, * * * and if she shall leave no child or children * * * then the one-half thereof to my wife, Margaret B. Fowler, * * * and the remaining one-half thereof to my granddaughter Marjorie Fleming, when she shall arrive at the age of forty years, * * * and if my said wife shall not survive my daughter Kate, then the whole thereof to my granddaughter Marjorie Fleming when she shall arrive at the age of forty years, * * *.
    Subject, however, to the following trust viz: My wife Margaret B. Fowler, my son-in-law Arthur H. Fleming, my daughter Clara H. Fleming, my daughter Kate Fowler, provided she has attained her majority at the time of my decease, and if not, then when she attains her majority, and my nephew Harold F. McCormick, and their successors in trust, shall, until it shall be ascertained in whom the absolute title to said property so devised and bequeathed is vested, hold in trust said property so devised and bequeathed for the purposes herein expressed.
    I — They shall have full charge, possession and control of said property so devised and bequeathed; they may make mining or other leases and change leases in existence at the time of my decease, as they may deem best; they shall collect all royalties, dividends, rents and income from said property and do all things necessary to preserve the same * * *.
    The property embraced in the Fleming Mining Trust consisted of the remaining one-half of that described in Paragraph XIII of the will. This property, subject to a trust in terms the same as the Fowler Mining Trust, was given by the terms of the will as follows:
    * * * To my granddaughter Marjorie Fleming, when she shall arrive at the age of forty years, if she shall live so long, with the power to dispose thereof by will at any time before she shall arrive at the age of forty years; and if she shall die intestate as to such property before arriving at the age of forty years, then to her child or children, and to the issue of any deceased child or children her surviving, such issue of any deceased child or children to take the parent’s share by right of representation; and if she shall leave no child or children, nor issue of any deceased child or children, her surviving, then to my daughter Kate, when Kate shall arrive at the age of forty-five years, if she shall live so long, and if she shall die before arriving at the age of forty-five years, then to the child or children and to the issue of any deceased child or children of my said daughter Kate, if she shall leave any her surviving, such issue of any deceased child or children to take the parent’s share by right of representation; and if my said daughter Kate shall leave no child or children nor issue of any deceased child or children her surviving, then to my heirs forever.
    The will provided for the distribution of the income of the trusts, after payment of taxes and expenses, in the following proportions:

    At the time of the death of the testator certain of the mining properties in which he had an interest, namely those known as Fayal No. 2, Fayal No. 3, Adams, Spruce, and Cloquet, were under lease to the Minnesota Iron Co., a corporation, for a period of 50 years from January 1, 1902. These properties, hereinafter called the consolidated properties, had previously been leased to various parties, the previous leases being acquired by the Minnesota Iron Co. The lease to the Minnesota Iron Co. will hereinafter be designated the consolidated lease.

      The consolidated lease provided that the ore mined and shipped by the lessee should be graded into first and second grades, with royalties per ton on the first grade ore as follows:
    Cents per ton.
    First 13 years (January 1, 1902, to December 31, 1914)- 30
    Next 7 years (January 1, 1915, to December 31, 1921)- 37
    Next 5 years (January 1, 1922, to December 31, 1926)- 42
    Balance of term (January 1, 1927, to December 31, 1951)- 45
    Royalties on second grade ore were fixed by the lease at 15 cents per ton less than those on the first grade and the amount to be considered second grade was fixed at certain percentages of the total output.
    Subsequent to the death of the testator the trustees of the Fleming and Fowler Mining Trusts gave leases under various dates on three other pieces of property in Minnesota forming a part of the corpus of the trust.
    The properties leased under the consolidated lease consisted of five parcels containing iron ore and located on what is known as the Mesaba Range near Eveletli, Minn. Of these properties three are mined by the open pit method and two by underground mines. At March 1, 1913, about 35 per cent of the ore was available by open pit mining and it was known then that the stripping area would be greatly extended. About 60 per cent of the available ore will eventually be recovered by open pit mining. The mines are located on land that is from 100 to 200 feet above the general level of the surrounding country and there was no danger in 1913 of the mines being flooded. There was no fire hazard in the open pit mines and little if any in the underground mines, as the air in them was moist, which made the timbers noninflammable. There was no danger from gas, fire damp, or underground explosions in any of the mines operated under the consolidated lease, nor was there any danger of cave-ins, due to careful methods of operation.
    • The ore in the consolidated properties was close to the surface and easily mined. The mining operations have been so conducted as to take out some of both the high grade and the low grade ores. The produce has been exceedingly uniform, varying only from a low of about 59.71 per cent to a high of 60.23 per cent.
    The lessee, the Minnesota Iron Co., is a subsidiary of the United States Steel Corporation, and is a responsible company from the standpoint of the payment of royalities being assured during the life of the lease.
    In 1913 royalty rates for bodies of ore inferior in quantity and quality to those of the consolidated properties ranged from 60 cents to $1 per ton.

      Reasonable estimates, as of March 1, 1913, of the ore reserves of the consolidated properties, the rate of mining and the expected royalties, are as follows:
    Tons.
    Total ore in mines, first and second grade_ 53, 455, 468
    Second grade ore in mines_ 7,107, 078
    Rate of mining per year for 22 years, first and second grade- 2, 429, 794
    Rate of mining per year for 22 years, second grade ore_ 323, 049
    Expected gross royalties_$20, 899, 276. 00
    Less 3 per cent for expenses_ 626, 978.29
    Net expected royalties_ 20, 272, 297. 77
    By applying to the net expected royalties of $20,272,297.77 under the consolidated lease, the Hosltold formula factors of G per cent interest rate and 4 per cent capital redemption rate, the Commissioner determined the fair market value as of March 1, 1913, of the ore reserve in the consolidated properties, for depletion purposes, to be $10,287,970.24.
    Reasonable estimates as of March 1, 1913, of the ore reserves, the life of the mines, and the expected royalties from the other properties of the mining trusts are as follows:

    By applying to the net expected royalties from these properties the Hoskold formula factors of 6 por cent interest rate and 4 per cent capital redemption rate, the Commissioner determined the fair market value as of March 1, 1913, of the ore reserves for depletion purposes, to be as follows:
    Eayal No. 1-$618,437.69
    Park Lot No. 1- 25,291.09
    Park Lot No. 2- 94,644.30
    Cloquet No. 2- 67,408.65
    Meadow Mine_ 34, 291.98
    The rate of interest on commercial investments on March 1, 1913, was about 4y2 per cent.
    In determining the deficiencies involved in these appeals the Commissioner allowed to the petitioners deductions for depletion of the mines, based on the March 1, 1913, value of the interests of the trusts therein computed by the application of Hoskold’s formula as above set forth. In the answers to the petitions the Commissioner avers that he erred in allowing any deduction for depletion.
   OPINION.

Arundell:

The petitioners contend that the royalties they received as beneficiaries under the mining trusts constituted a distribution of the corpus of the trusts and as such constituted property acquired by gift or bequest and are not taxable. That royalties from mining ore are income and not the return of capital has been settled ever since the decisions in Stratton's Independence v. Howbert, 231 U. S. 399; 34 Sup. Ct. 136; and Von Baumbach v. Sargent Land Co., 242 U. S. 503; 37 Sup. Ct. 201. The Supreme Court has also held that income from a trust created by a will is taxable to the beneficiary. Irwin v. Gavit, 268 U. S. 161; 45 Sup. Ct. 475. The latter case arose under the Act of October 3, 1913, which, like the acts here involved, excluded from income “the value of property acquired by gift, bequest, devise, or descent” but included the income from such property. After quoting part of the 1913 Act the court said :

The language quoted leaves no doubt in our minds that if a fund were given to trustees for A for life with remainder over, the income received by the trustees and paid over to A would be income of A under the statute. It seems to us hardly less clear that even if there were a specific provision that A should have no interest in the corpus, the payments would be income none the less, within the meaning of the statute and the Constitution, and by popular speech. In the first case it is true that the bequest might be said to be of the corpus for life, in the second it might be said to be of the income. But we think that the provision of the act that exempts bequests assumes the gift of a corpus and contrasts it with the income arising from it, but was not intended to exempt income properly so-called simply because of a severance between it and the principal fund. No such conclusion can be drawn from Eisner v. Macomber, 252 U. S. 189, 206, 207. The money was income in the hands of the trustees and we know of nothing in the law that prevented its being paid and received as income by the donee.
* * * * * * *
* * * This is a gift from the income of a very large fund, as income. It seems to us immaterial that the same amounts might receive a different color from their source. We are of opinion that quarterly payments, which it was hoped would last for fifteen years, from the income of an estate intended for the plaintiff’s child, must be regarded as income within the meaning of the Constitution and the law.

The respondent asserts that he erred in allowing depletion to the petitioners who are beneficiaries under the trust estates here involved. Whether or not this is so depends upon the construction to be given section 219 of the Revenue Act of 1918, which, as far as material here, provides:

Sec. 219. (a) That the tax imposed by sections 210 and 211 shall apply to the income of estates or of any kind of property held in trust, including— *******
(4) Income which is to be distributed to the beneficiaries periodically, whether or not at regular intervals * * *.
*******
(d) In cases under paragraph (4) of subdivision (a) * * * the tax shall not be paid by the fiduciary, but there shall be included in computing the net income of each beneficiary his distributive share, whether distributed or not, of the net income of the estate or trust for the taxable year * * *.

This section was involved in the case of Baltzell v. Mitchell, 3 Fed. (2d) 428; 5 Am. Fed. Tax Rep. 5230; certiorari denied, 268 U. S. 690. In that case it was held that a loss of a part of the capital of a trust fund does not constitute a loss to the beneficiaries even where one of them had a vested equitable remainder ” in the corpus. The court says, in part:

In considering section 219 alone and apart from the other sections of the act, it is evident that in it Congress employed words which lead to confusion of thought. It states under subdivision (d) that the income under paragraph 4 on which the tax is to be assessed and collected shall be “his distributive share, whether distributed or not, of the net income of the estate or trust for the taxable year.” The beneficiary clearly has no distributive share in the net income of the estate or trust; but he has a distributive share of income to be paid him under and in accordance with the terms of the trust, and resort must be had to them to ascertain his proportion of the income or his distributive share.

A simple example will illustrate the soundness of this holding. Suppose that in a taxable year rents in the amount of $10,000 were collected by the trustee from trust property and distributed to a sole beneficiary, and in the same year the trustee sold a part of the trust corpus at a loss of $10,000. Here the loss sustained by the trustee exactly offsets its income, yet the beneficiary, in accordance with the terms of the trust, has received $10,000 which under Irwin v. Gavit, supra, is taxable income, nor could the creator of the trust, by any direction of his, relieve the income from tax. Merchants' Loan, & Trust Co. v. Smietanka, 255 U. S. 509; 3 Am. Fed. Tax Rep. 3102. Continuing in the Baltzell case the court says:

* * * The beneficiary is not interested in the capital of the trust, but only in the income. If there are accretions to the capital, these are not distributable as income, so that the beneficiary may receive any part of them * * *,

This is in accordance with Gibbons v. Mahon, 136 U. S. 549, holding that a stock dividend on stock held in trust is an appreciation' in the capital of the trust corpus and not distributable to a life bene-fieiary. The converse of this last proposition is then set out in the Baltzell opinion as follows:

* * * And if there are capital losses they cannot be made good out of the income. The capital may be depleted by such losses; but the income for that taxable year is not.

This follows the principle that unless the trust instrument provides otherwise, a trustee can not withhold from the beneficiary any of the income to compensate for a decrease in the value of the trust property from which the income is derived. In re Chapman, 66 N. Y. S. 235; affirmed 69 N. Y. S. 1131. Similarly, where mines already opened comprise the corpus of a trust estate a life tenant may work the mines even to the point of exhaustion and enjoy the profits therefrom without being chargeable with waste. Hook v. Garfield Coal Co., 112 Iowa 210; 83 N. W. 963; In re Woodburn's Estate, 138 Pa. St. 606; 21 Atl. 16; In re McFadder's Estate, 224 Pa. 443; 73 Atl. 927; Higgins Oil & Fuel Co. v. Snow, 113 Fed. 433.

Another phase of the question here involved is treated of in the Baltzell case where it is pointed out that if losses sustained by trusts were allowed to the beneficiaries the result would be to defeat the intent of Congress as expressed in sections 210 and 211 to impose taxes on the incomes of individuals. The language of the court is as follows:

Under section 210 Congress enacted that a normal income tax “ should be levied, collected and paid for each taxable year upon the net income of every individual ” at the rates therein provided, and by section 211 that, in addition to the normal tax, a surtax should be levied, collected, and paid upon the net income of every individual.
It cannot be supposed that Congress intended that the taxes under sections 210 and 211 should be paid by an individual who was engaged in some business or gainful occupation which yielded an income upon which such tax could be levied and collected, and also provided that the beneficiary of a trust, although paid a large amount in accordance with the terms of such trust, should escape all taxation upon the amount so paid, because the trust, as such, through losses of capital, did not show a net income. The fiduciary and the beneficiary are separate taxable persons. Merchants’ Loan & Trust Co. v. Smietanka, 255 U. S. 509, 41 S. Ct. 386, 65 L. Ed. 751, 15 A. L. R. 1305.

Earlier in the opinion the court, following well-known rules of construction, says:

* * * Section 219 must be interpreted and construed as a part of the whole act, and having in mind the purpose sought to be accomplished by it. The court cannot read into the statute anything that is not there; but it must look at the whole act, having its purpose in mind, and determine whether the interpretation placed by the Treasury Department upon section 219 of the act is reasonably within its terms.

The Commissioner ever since the promulgation of Treasury Decision 2987, dated March 1,1920, adding article 347 to Eegulations No. 45, has held that for income tax purposes the distributive share of a beneficiary is not changed by either capital gains or losses or by depreciation of the corpus of the estate. This interpretation of section 219 is characterized in the Bdltsell case as “ a sensible and reasonable one, and within its scope when considered as a part of the whole act.”

Depreciation, we have held, in the Appeal of Louise P. V. Whitcomb, 4 B. T. A. 80, “ relates to capital assets. The depreciation is not in the income but in the capital, and it affects income only in that, if the depreciable assets are not replaced, the income sooner or later will cease.” It will hardly be said that depletion has any less relation to capital assets or any closer relation to income than has depreciation.

Nowhere in the Eevenue Act of 1918 is there any provision allowing deductions to beneficiaries of estates or trusts for diminution of capital, and the Eevenue Act of 1921 by sections 215(b) and 219(d) expressly provides against such deduction as is here claimed. While section 215(b) of the 1921 Act is a new provision, section 219 is merely an amendment of a similar provision in the prior act. As stated on page 16 of the Senate Finance Committee Eeport on the Eevenue Bill of 1921 (Eep. No. 275, 67th Cong., 1st sess.) :

Section 219 is amended slightly for the purpose of clarifying its provisions and making the interpretation thereof more definite and certain. * * *

That resort may be had to subsequent legislative acts for interpretive aid is shown by the case of Bailey v. Clark, 21 Wall. 284; 4 Am. Fed. Tax Rep. 4575, where the court said of a later act than the one involved:

This enactment was evidently intended to remove any doubt previously existing as to the meaning of the statute and declare its true construction and meaning. Had it been intended to apply only to cases subsequently arising it would undoubtedly have so provided in terms.

We are aware of the rule to the contrary that taxing provisions in an act may not be applied to cover an omission in an earlier act. Smietanka v. First Trust & Savings Bank, 257 U. S. 602; 3 Am. Fed. Tax Rep. 3145. But such is not the case here, for as pointed out above, section 219 was amended solely “ for the purpose of clarifying ” the provisions of the previous act “ and making the interpretation thereof more definite and certain.”

Even without resort to the Act of 1921 we think the Commissioner must be sustained in his allegation of error in allowing depletion to the petitioners, for the cases here can not be distinguished in principle from several that the Board has heretofore decided.

The first of these is Appeal of Mary P. Eno Steffanson, 1 B. T. A. 979, where the taxpayer placed her property in trust under an agreement whereby she was to receive the income for life, except for an amount to be paid to her mother, she retaining • the right to withdraw a part of the principal and a limited right to direct the investment of the principal, and the principal to be ultimately disposed of as the taxpayer should direct in her will. In 1919 the trustee sold certain property, in which a part of the trust in’incipal had been invested, at a loss and sold other property at a profit. The transaction resulted in a net loss which the taxpayer claimed as a deduction from her income for that year. The claim was disallowed, the opinion citing the Baltzell case, supra, and reading in part:

Capital losses of a trust estate are deductible only by the trust, and the' beneficiaries with life interests must report for taxation the income received by them from the proceeds without deduction of losses suffered, by the corpus of the trust estate.

In Appeal of C. D. Woodard, 2 B. T. A. 432, the petitioner had a legal one-third life estate in the estate of his deceased wife. His entire income for the year 1920 consisted of oil royalties from the estate. The Commissioner disallowed a claim for depletion and treated the entire amount of royalties received as taxable income. The Board, without an opinion, sustained the Commissioner.

In the Appeal of George M. Studebaker, 2 B. T. A. 1020, there was involved a testamentary trust under which testator’s wife and three children were named and qualified as trustees. The trust was to continue during the life of testator’s wife or until a disagreement should thereafter arise among the remaining trustees, with the remainder then to the three children or their heirs. During the existence of the trust, the income, after payment of a specific amount to the wife, was to be divided equally among the three children. After the death of their mother the children during the years 1918, 1919, and 1920 continued the operation of the property comprising the corpus of the trust. In each of those years losses were sustained in the operation of the trust property and the children in filing individual returns each claimed as a deduction one-third of such loss. It was held that such deductions were not' allowable, the opinion reading in part:

Acts done by the taxpayers in their individual capacities and those performed by them as trustees are separate and distinct, and losses sustained by them as trustees can not be' claimed as losses sustained as individuals. [Citing Baltzell v. Casey, 1 Fed. (2d) 29.]

The Appeal of Henry Stoddard, 3 B. T. A. 79, holds, without opinion, that a beneficiary under a revocable trust, the beneficiary being also the creator of the trust, is not entitled to deductions for the years 1919, 1920, and 1921 on account of losses on the sale by the trustees of securities forming a part of the trust corpus.

In the Appeal of Helene B. McConnell, 3 B. T. A. 260, the taxpayer was a life tenant under a testamentary trust, the corpus of which consisted of a brewery. The taxpayer claimed deductions for the years 1918, 1919, and 1920 for the exhaustion of her estate due to lapse of time and for impairment of the value of her estate due to the advent of prohibition. It was held that such deductions as were claimed are allowable only in respect of property used in trade or business and that the right of the taxpayer to share in the income of the estate was not such property.

The Appeal of Louise P. V. Whitcomb, 4 B. T. A. 80, involved a testamentary trust for the life of testator’s wife and two children with remainder over to grandchildren, if any, and if none, then to Harvard College. The Commissioner allowed the trustee deductions for the exhaustion of the depreciable assets of the trust corpus, for the years 1919 to 1920 inclusive, but denied any deduction therefor to the life tenants. The decision in that case followed that in Baltzell v. Mitchell, supra, and approved the action of the Commissioner.

In the Appeal of Elizabeth M. Abell, 4 B. T. A. 87, the taxpayers were life tenants and trustees under a testamentary trust and one of them was a remainderman. In the years 1919 and 1920 the trust estate sustained losses on sales of securities held as capital assets of the trust. The beneficiaries in filing returns reported their proportionate shares of the income of the trust as reduced by the losses sustained. The Commissioner added to the incomes of the beneficiaries their proportionate parts of the losses. The Board on the authority of the decision in the Appeal of Louise P. V. Whitcomb, supra, sustained the action of the Commissioner.

In the Appeal of Sophia G. Coxe, 5 B. T. A. 261, the taxpayer was a life tenant under a will and had no interest in the principal or remainder of the estate. It was there held that such beneficiary is not entitled to deductions for the year 1919 on account of losses sustained by the estate on the sale of securities.

One case, the Appeal of Julia N. De Forest, 4 B. T. A. 1059, contains language which might be construed to take a contrary view. The basis of that decision, however, is found in the last paragraph of the opinion, wherein it is stated:

* * * Where it is shown, as it was here, that it was the beneficiary who created the trust for himself and that he is also the remainderman, we find no justification for the conclusion that he may not get the benefit of the allowance for the exhaustion of his property temporarily and for convenience only in the hands of a trustee to collect the income and pay it to him. We think in cases of this character the separate entity of fiduciary and beneficiary should be ignored and that the petitioner should be allowed a deduction for the exhaustion of her interest in the patent.

In the De Forest appeal the trustee was designated merely as an instrumentality for the purpose of collecting the income and paying it over to the same persons who had theretofore owned the patents and continued to own them beneficially to the same extent. In such situation it was unnecessary to either overrule or reconsider what the .Board had already held to be the law in the appeals hereinbefore set out.

Under authority of Baltzell v. Mitchell, supra, and previous decisions of the Board herein set forth at length, we conclude that the Commissioner erred in allowing depletion to the petitioners in the present case.

The third question presented is whether the Commissioner has allowed sufficient depletion on the basis of the March 1, 1913, value fixed by applying the so-called Hoskold formula of a 6 per cent remunerative rate and a 4 per cent capital redemption rate to the expected royalties under the mining leases. As we have held above that the petitioners are not entitled to deductions for depletion, the question whether the Commissioner properly computed the depletion allowance falls by the way and requires no decision.

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


source: Caselaw Access Project

author: Milliken :

license: Public Domain

text:
    J. Percival Smith and Claude Hamilton, Executors, Estate of James P. Smith, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7750.
    Promulgated April 19, 1927.
    Commissions, payable to a trustee oí a trust fund, winch has been administered by the executor, are not deductible under section 403(a) (1) oí the Revenue Act of 1918, as administrative expenses allowable under the laws of New York.

      Charles J. McDermott, Esq., for the petitioners.

      John F. Greaney, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in estate taxes in the amount of $1,216. The petitioners contend that the Commissioner erred in refusing to allow the following deductions:
    (1) Administration and attorney’s fees in the amount of $3,136, in connection with ancillary proceedings in the State of California.
    (2) Trustees’ commissions amounting to $33,329.86. .
    (3) Two • New York state tax items of $131.81 and $34.47, respectively.

      (4) An allowance of $500 to W. T. Collins, for services as special guardian.
    At the hearing, the respondent confessed error as to items (1) and (4), and petitioners withdrew their allegations with respect to item (3), stipulating that this item should not be deducted. This leaves open for consideration only item (2).
    FINDINGS OF FACT.
    James P. Smith died testate, August 7, 1921, domiciled in the State of New York. The petitioners are the executors of his will. The estate has been allowed, as deductions, all amounts paid or due the executors in consideration of their executorial duties. There is no controversy as to this deduction. On dates not shown by the record, the executors paid and transferred to themselves and the Bankers Trust Co., as testamentary trustees under the will of James P. Smith, property of the value of .$557,831.64. Thereafter, on July 31, 1925, the Surrogate’s Court of the County of New York allowed each of the three trustees, out of the trust fund, as commissions for receiving the fund, the sum of $5,441.52 or a total of $16,324.56. These amounts were paid by the trustees to themselves, individually, on August 6, 1925. The trustees claim that under the laws of New York they will be entitled, upon the termination of the trust, to a commission for paying over the fund, an amount which, when added to the amounts paid August 6, 1925, will make their entire commission $33,529.86, the amount claimed as a deduction.
   OPINION.

Milliken :

Section 401 of the Bevenue Act of 1918, imposes a tax “ upon the transfer of the net estate of every decedent,” dying after the passage of the Act. Section 402 sets forth what is included in the gross estate. Section 403 provides the method of ascertaining the net estate by allowing certain deductions from the gross estate. Subdivision (1) of paragraph (a) of that section, grants the following deduction: “ Such amounts for * * * administration expenses * * * as are allowed by the laws of the jurisdiction * * * under which the estate is being administered * *

Under the decisions of the courts of New York, double commissions are allowable to the same persons acting as executors and trustees under the same will, only when they have terminated their duties as executors and have entered upon their duties as trustees. Olcott v. Baldwin, 190 N. Y. 99; 82 N. E. 748, and cases cited. Thus the courts of New York recognize that the executors of a will and the trustees of a testamentary trust created by the same will, represent distinct and separate entities.

While the New York Courts have held that, in ascertaining the value of transfers under the state inheritance tax law, the commissions of trustees, in situations similar to this case, should be allowed as deductions in the nature of administration expenses, see In re Vanneck's Estate, 175 App. Div. 363; 161 N.Y.S. 893; In re Nichols’ Estate, 120 Misc. 228; 198 N.Y.S. 896; In re Moller’s Estate, 110 Misc. 184; 179 N.Y.S. 768; In re Garcia’s Estate, 101 Misc. 387; 167 N.Y.S. 168; In re Shields’ Estate, 68 Misc. 264; 124 N.Y.S. 1003, a reading of the cases discloses that the deduction was made in each case, not from the gross estate of the decedent but from the trust fund. In this case, no part of the trustees’ commissions was paid by the executors out of the gross estate of the testator, but the whole amount was paid by the trustees to themselves, out of the trust estate.

No case has been cited and none has been found which holds that in New York commissions of trustees are a part of the administration expenses of a decedent’s estate. What has been decided is that such commissions are deductible under the New York inheritance tax statute, which prescribes a method of computing the tax quite different from that provided by the Kevenue Act of 1918. The tax imposed by section 401 of that Act attaches to the estate before distribution, and with certain exceptions which it is not necessary to enumerate, is a tax upon the estate as a whole. Section 403 should be read in connection with section 401 and section 402. The deductions allowed by section 403 are those which pertain to the estate, the transfer of which is taxed by section 401 and which is described in section 402. That estate is the estate of the decedent and the “ administration expenses ” mentioned in section 403 are those expenses which are incurred in transmitting that estate to the beneficiaries, one of which, in this case, is the trust. The deductions allowed by section 403 are those which, under the state law, affect the estate as a whole and as a distinct entity. Cf. New York Trust Co. v. Eisner, 256 U. S. 345, and Keith v. Johnson, 271 U. S. 1.

We find no error in the action of the respondent in refu&ing to permit the petitioners to take as a deduction the commissions of the trustees, which were not paid by them as executors nor out of the corpus of the estate.

Judgment mil be entered on 10 dayI notice, under Bule 50.


author: Marquette:

text:
    Appeal of J. M. and M. S. Browning Co.
    Docket No. 1037.
    Promulgated April 19, 1927.
    1. License agreements for the use of patents are intangible property. The right to receive royalties thereunder is likewise intangible property and when paid into a corporation for a nominal consideration can not be included in invested capital under section 326(a) (3) of the Revenue Act of 1918.
    2. The fair market value as of January 2, 1915, of the right to receive royalties under certain license agreements, and the manner of computing the deduction for the exhaustion thereof, determined.
    3. The petitioner accepted a lump sum in lieu of the royalties which would be payable under contracts owned by it. Held, that the amount so received constituted income.
    4. Under the facts herein the petitioner is entitled to special assessment.

      Leo H. Hoffman, Esq., and Forest D. Siefkin, Esq., for tlie petitioner.

      A. H. Fast, Esq., for the Commissioner.
    This appeal is from the determination of a deficiency in income and profits taxes for the year 1918 in the amount of $319,746.33. The questions involved are:
    (1) The value on January 2, 1915, of certain contracts acquired by the petitioner on that date from J. M. and M. S. Browning.
    (2) The amount of the allowance, if any, to which the petitioner is entitled for the -year 1918 on account of exhaustion or obsolescence of the contracts acquired on January 2, 1915, from J. M. and M. S. Browning.
    (3) Whether or not the amount of $750,000 received by the petitioner in the year 1918, as payment for the relinquishment by it of its right to royalties under the contracts mentioned, was taxable income.
    (4) Whether or not the petitioner is entitled to have its tax liability for the year 1918 computed under sections 327 and 328 of the Revenue Act of 1918, and if it is entitled to have its liability so computed, what comparatives should be used.
    FINDINGS OF FACT.
    (1) The petitioner is a corporation organized in the year 1908 under the laws of Utah, with its principal office at Salt Lake City. It is an investment company and its activities have at all times consisted solely in holding stocks, bonds, real estate, notes receivable, depositing accounts, special accounts and savings accounts, receiving and investing the income from the property so held, and receiving royalties on certain contracts hereinafter referred to. The capital stock of the corporation is and was during the years involved herein, closely held, being owned by members of the Browning family. J. M. Browning and M. S. Browning were stockholders of the corporation and were also president, and general manager and secretary, respectively.
    (2) On January 2, 1915, J. M. Browning was and had been for many years, an inventor of automatic firearms. At that time, he and his brother, M. S. Browning, were the owners of numerous patents covering automatic pistols, machine guns and other automatic firearms, invented by J. M. Browning, the use of which patents had been granted to certain manufacturers of firearms upon a royalty basis. On January 2, 1915, J. M. and M. S. Browning assigned to the petitioner their rights to royalties under certain contracts by the following instrument:
    January 2, 1915.
    Assignment oe Agreement.
    In consideration of One Dollar, we hereby assign and transfer to the J. M. and M. S. Browning Company all contracts between ourselves, or either of us, made with the Colts Patent Firearms Mfg. Company, Remington Arms Company or their successors, J. Stevens Arms and Tool Company, Fabrique Na-tionale d’Armes de Guerre, or their successors, for the payment of royalties on patents.
    J. M. Browning
    M. S. Browning.
    The contracts covered by the assignment set forth were as follows:
    Contracts wfith the Colts Patent Fire Arms Manufacturing Co., hereinafter called the Colts Company.
    (a) Contract dated July 24, 1896 (Exhibit A-l)
    (b) Contract dated January 11, 1902 (Exhibit A-2)
    (c) Contract dated April 6, 1903 (Exhibit A-6)
    (d) Contract dated November 13, 1899 (Exhibit A-7)
    Contracts with the Remington Arms Co., hereinafter called the Remington Company.
    (a) Contract dated December 23, 1903 (Exhibit A-8)
    (b) Contract dated June 11, 1904 (Exhibit A-9)
    (c) Contract dated March 20, 1914 (Exhibit A-10)
    (d) Contract dated August 6, 1914 (Exhibit A-ll)
    Contracts with the Fabrique Nationale d’Armes de Guerre, Societe Anonyms, hereinafter called the Belgian Company.
    (a) Contract dated July 7, 1897 (Exhibit A-12)
    (b) Contract dated December 8, 1903 (Exhibit A-13)
    (c) Contract dated January 4, 1913 (Exhibit A-14)
    (d) Contract dated July 29, 1909 (Exhibit A-15)
    Contracts with the J. Stevens Arms & Tool Co.
    (a) Contract dated June 12, 1906 (Exhibit A-16)
    (b) Contract dated November 10, 1913 (Exhibit A-17)
    ' These contracts were all similar in that they gave the rights to the several companies to manufacture and sell certain of the many patented firearms invented by J. M. and M. S. Browning. They also, with one exception, gave to the various companies, the use of any and all improvements which might be made by J. M. and M. S. Browning on the particular arms covered by their respective contracts. The exception existed in the case of the contracts with the J. Stevens Arms & Tool Co. Its contract dated June 12, 1906, (Exhibit A-16) was modified by the contract of November 10, 1913, (Exhibit A-17) so as to exclude therefrom the rights to inventions thereafter made. These contracts, with the exception of the contract with the J. Stevens Arms & Tool Co., were for the life of the patents set forth therein, and of any patents that might thereafter be granted to J. M. and M. S. Browning for improvements on the inventions covered by the existing patents.
    (3) The contracts (Exhibits A-l and A-2) between J. M. Browning and M. S. Browning, of the one part, and the Colts Company of the other part, dated July 24, 1896, and January -11, 1902, gave the exclusive right to the Colts Company to manufacture, use, and sell certain automatic pistols invented by J. M. and M. S. Browning, and all improvements thereafter made on such automatic pistols, in consideration of certain royalties to be paid on the pistols manufactured and sold. The contracts covered the following arms:
    .380 caliber automatic pistol
    45 caliber automatic pistol
    38 caliber automatic pistol
    32 caliber automatic pistol
    25 caliber automatic pistol
    22 caliber automatic pistol
    The patents which had been granted prior to January 2, 1915, and which were covered by the contracts of July 24, 1896, and January 11, 1902, (Exhibit A-l and A-2) were:

    The royalties paid on the contracts of July 24, 1896, and January 11, 1902, for the years 1908 to 1921, inclusive, were:

      (4) The contract (Exhibit A-6) between J. M. and M. S. Browning and the Colts Company, dated April 6, 1903, gave the Colts Company the exclusive right to manufacture, use, and sell certain machine guns invented by J. M. and M. S. Browning, and all improvements that might thereafter be made on such machine guns, in consideration of certain royalties to be paid on the arms manufactured and sold. The patents covered by this contract were:

    Application No. 125,504, dated October 13, 1916, was made for an improved machine gun and a patent, No. 1,293,021, was issued thereon on February 4, 1919. Application No. 183,841, for a patent on a machine gun rifle, was made on August 1, 1917, and a patent, No. 1,293,022, was issued on February 4, 1919. These patents fell within the provisions of the contract of April 6, 1903 (Exhibit A-6).
    The royalties paid on the contract of April 6, 1903, (Exhibit A-6) during the years 1908 to 1921, inclusive, were as follows:

    (5) The contract (Exhibit A-7) dated November 13, 1899, between J. M. and M. S. Browning, and the Colts Company, gave the Colts Company the exclusive right to manufacture, use, and sell a belt loader for machine guns invented by J. M. and M. S. Browning, and to all improvements that might thereafter be made on such belt loader, in consideration of certain royalties to be paid on the loaders manufactured and sold. The patents on the belt loader had not been granted at the time the contract was entered into, but an application had been made for a patent thereon, and it was issued on October 23,1900, being Patent No. 660,244. The royalties paid during the years 1908 to 1917, inclusive, on the contract of November 13, 1899, (Exhibit A-7) were:

      (6) The contract (Exhibit A-8) between J. M. and M. S. Browning, and the Remington Company, dated December 23, 1903, gave the Remington Company the exclusive right to manufacture, use, and sell certain automatic shotguns invented by J. M. and M. S. Browning, and all improvements thereafter made on such automatic shotguns, in consideration of certain royalties to be paid on the arms manufactured and sold. Tire patents which had been granted prior to January 2, 1915, and which were covered by the contract of December 23, 1903, were as follows:
    Number. Dated.
    659, 507- October 9, 1900
    689, 288- December 17, 1901
    710, 094_ December 30, 1902
    730, 870_ June 16, 1903
    812, 326_ February 13, 1906
    The royalties paid on the contract of December 23, 1903, (Exhibit A-8) during the years 1908 to 1921, inclusive, were:

    (7) The contract (Exhibit A-9) between J. M. and M. S. Browning, and the Remington Company, dated June 11, 1904, gave the Remington Company the exclusive right to manufacture, use, and sell certain automatic rifles invented by J. M. and M. S. Browning, and to all improvements thereafter made on such automatic rifles, in consideration of certain royalties to be paid on the arms manufactured and sold. The patents which had been granted prior to January 2, 1915, and which were covered by the contract of June 11, 1904, (Exhibit A-9) were as follows:

    The royalties paid during the years 1908 to 1921, inclusive, on the contract of June 11, 1904, (Exhibit A-9) were:

      (8)The contract (Exhibit A-10) between J. M. and M. S. Browning and the Eemington Company, dated March 20, 1914, gave the Eemington Company the exclusive right to manufacture, use, and sell a certain 22 caliber automatic rifle, invented by J. M. and M. S. Browning, and to all improvements thereafter made on such automatic rifle, in consideration of certain royalties to be paid on the arms manufactured and sold. The patents granted prior to January 2, 1915, covered by the contract of March 20, 1914, (Exhibit A-10) were as follows:
    Number. Dated.
    1,065,341_June 24, 1913.
    1,065,342_June 24, 1913.
    1,202,024_January 6, 1914.
    An application for a patent on the automatic rifle covered by the contract of March 20, 1914, was made on August 18, 1914, and Patent No. 1,202,024 was issued thereon on October 24,1916.
    Manufacture of the rifle covered by the contract of March 20, 1914, (Exhibit A-10) was begun in the year 1917, b'ut because of the outbreak of war, manufacturing operations were suspended in order to make manufacturing facilities available for wartime arms. At the end of the year 1921 royalties had been paid on the contract of March 20, 1914, as follows:
    1917-$11,360.75
    1921- 14, 789.27
    (9) The contract (Exhibit A-ll) between J. M. and M. S. Browning and the Eemington Company, dated August 6, 1914, gave to the Eemington Company the exclusive right to manufacture, use, and sell certain repeating shotguns invented by J. M. and M. S. Browning, and to all improvements that might thereafter be made on such repeating shotguns, in consideration of certain royalties to be paid on the arms manufactured and sold. No patent had been issued at the time this contract was entered into, but application for a patent had been made on November 26, 1913, and the patent was issued June 15,1915, being Patent No. 1,143,170. Because of the expansion of manufacturing facilities during the war period, manufacture of the arms covered by this contract was not begun until after the war period.
    (10) The contracts (Exhibits A-12 and A-15) between J. M. and M. S. Browning, and the Belgian Company, dated July 7, 1897, and July 29, 1909, gave to the Belgian Company the exclusive right to manufacture, use, and sell certain automatic pistols invented by J. M. and M. S. Browning, and to all improvements that might thereafter be made on such automatic pistols in consideration of certain royalties to be paid on the arms manufactured and sold. It is impossible to determine from the record what patents covered by these contracts had been granted on January 2, 1915, or when the patents existing on that date expired. During the years 1908 to 1921, inclusive, royalties were paid on these contracts as follows:

    In August, 1914, the factory of the Belgian Company was seized and taken over by the Germans and was not restored to its owners until the year 1918, so that there were no royalties paid on the contracts of July 7, 1897, and July 29, 1909, (Exhibits A-12 and A-13) or on the contracts of December 8, 1908, and January 4, 1913, (Exhibits A-13 and A-14) hereinafter described during the years 1915 to 1918, inclusive.
    (11) The contract (Exhibit A-13) between J. M. and M. S. Browning and the Belgian Company, dated December 8, 1903, gave the Belgian Company the exclusive right to manufacture, use, and sell a certain automatic rifle and shotgun, invented by J. M. and M. S. Browning, and to all improvements that might thereafter be made on such automatic rifles and automatic shotguns, in consideration of certain royalties to be paid on the arms manufactured and sold. From the record it is impossible to determine what patents covered by this contract had been granted on December 8, 1903, or when the patents existing on that date expired. The automatic shotgun covered by this contract corresponds to the automatic shotgun covered by the contract of December 23, 1903, with the Remington Company, referred to above, and the automatic rifle corresponds to the automatic rifle covered by the contract with the Remington Company dated June 11, 1904. Royalties paid during the years 1908 to 1921, inclusive, on the contract of December 8, 1903, (Exhibit A-13) were as follows:

    (12) The contract (Exhibit A-14) between J. M. and M. S. Browning and the Belgian Company, dated January 4, 1913, gave the Belgian Company the exclusive right to manufacture, use, and sell a certain 22 caliber automatic rifle invented by J. M. and M. S. Browning, and all improvements that might thereafter be made on such 22 caliber automatic rifle, in consideration of certain royalties to be paid on the rifles manufactured and sold. It is impossible to determine from the record what patents covered by this contract corresponded to the automatic rifle covered by the contract of March 20, 1914, (Exhibit A-10) with the Eemington Company. The royalties paid on the contract of January 4, 1913, during, the years 1913 to 1921, inclusive, were:

    (13) The contracts of June 12, 1906, and November 10, 1913, (Exhibits A-16 and A-l7) between J. M. and M. S. Browning and the Stevens Company, gave the Stevens Company the exclusive right to manufacture, use, and sell certain repeating shotguns invented by J. M. and M. S. Browning in consideration of certain royalties to be paid on the guns manufactured and sold. The contracts did not, however, give to the Stevens Company the right to improvements on such shotguns that might thereafter be made by the Browning Company. The patents which had been granted prior to January 2,1915, and which were covered by the contracts of June 12, 1906, and November 10,1913, (Exhibits A-16 and A-TT) were as follows:
    Number. Da tea.
    550, 778. December 3, 1895.
    577, 281. February 16, 1S97.
    781, 765. February 7, 1905.
    864, 609. August 27, 1907.
    The royalties paid during the years 1909 to 1921, inclusive, on the contracts of June 12, 1906, and November 10, 1913, (Exhibits A-16 and A-l!) were:

    (14) The Colts Patent Firearms Manufacturing Co., the Eeming-ton Arms Co., and the J. Stevens Arms Co., were on January 2, 1915, had been for many years prior to that date, and were subsequent thereto, large, conservative, and amply financed concerns with consistent records of stability and ability to carry out their undertakings, and occupied a predominant position in the firearms manufacturing business in the United States. The Colts Company’s factory was the only one in the United States equipped to manufacture machine guns in quantity at the beginning of the year 1915. The Fabrique Na-tionale d’Armes de Guerre occupied the same position in the firearms field in Europe that the Colts, Remington, and Winchester companies did in the United States.
    (15) The 45 caliber automatic pistol which was covered by the contracts of July 24, 1896, and January 11, 1902, (Exhibits A-l and A-2) between J. M. and M. S. Browning, and the Colts Company, was adopted as the official side arm of the United States Army in the year 1911 or 1912.
    (16) The machine gun became a proved military weapon about 1898, and tactics and improvements in guns after that time and up to the time of the World War, made it fairly certain that the machine gun would play a major part in modern warfare. The first weeks of the World War made known to the Allies the superior equipment of the Germans in regard to machine guns, and their own need for them in large quantities. Inquiries were made of various gunmakers in the United States as to their ability to produce machine guns, but the possibilities of quantity manufacture in the United States were limited to the Colts factory, that being the only factory capable of large-scale production in the United States. Furthermore, no machine gun could be considered that had not completed a period of testing and experimentation. The machine guns invented by the Brownings were adapted to quantity production and required practically no handwork in finishing and less precision in manufacturing. The inventions of J. M. Browning and M. S. Browning were tested and experimented with fully before application was made for patents, and the machine guns made under the Browning patents were much cheaper to make than the Vickers, the Lewis, or the Maxim machine guns, and were superior in simplicity of design, sureness of function, and durability.
    The Colts patent machine gun covered by the contract of April 6, 1903, (Exhibit A-6) had been manufactured and sold by the Colts Company for many years prior to the second day of January, 1915. The average annual production of the said Colts machine gun for the years 1909 to 1913, inclusive, and the average annual demand for said gun during the said period, was approximately 40 guns per year. During the last five months of the year 1914 the Colts Company received orders for 2,188 Colts machine guns. These orders emanated from many and various sources, among which were Canada, Spain, Belgium, France and England. On January 2, 1915, there was a reasonable expectation and certainty that 100,000 Colts machine guns would be ordered during the war.

      On December 10, 1915, the Colts Company entered into a written contract with the Marlin Arms Corporation, whereby the Marlin Corporation was given the right to manufacture and sell the Colts machine gun. By the terms of the contract the Colts Company was to receive $100 per gun for the first 5,000 guns manufactured, out of which the taxpayer herein was to receive $45 per gun. After the first 5,000 guns the Colts Company was to receive $75 per gun until it had recejved $1,500,000, out of which $75 per gun the taxpayer was to receive $45.
    (17) The Browning heavy machine gun which, as above stated, came within the provisions of the contract of April 6, 1903, (Exhibit A-6) between the Brownings and the Colts Company, was completed in the latter part of the year 1914, and the War Department and the Colts Company knew of its existence and that it fell within the provisions of Exhibit A-6. However, it was not manufactured and put on the market until after the United States entered the World War. Application for a patent on this machine gun was made October 13, 1916, but at the request of the War Department the patent was held up and was not issued until February 4, 1919.
    (18) During the month of September, 1917, the United States Government placed'an order for 15,000 water-cooled Browning machine guns with the Remington Arms-Union Metallic Cartridge Co. of Bridgeport, Conn., and an order for 5,000 Browning aircraft machine guns, and 20,000 Browning automatic rifles with the Marlin-Rockwell Corporation of New Haven, Conn. In October, 1917, the United States Government placed an order for 25,000 Browning automatic rifles with the Winchester Repeating Arms Co. of New Haven, Conn. In December, 1917, an additional order for 10,000 Browning aircraft guns was placed with the Marlin-Rockwell Corporation. About the same time a contract for Browning aircraft guns was also given to the Remington Arms-Union Metallic Cartridge Co.
    On October 31, 1917, at the suggestion of representatives of the Ordnance Department of the United States Army, J. M. Browning and M. S. Browning, representing the taxpayer, met with certain officials of the Ordnance Department, for the purpose of arriving at an adjustment of the rights accrued to the taxpayer and others by reason of contracts entered into by the United States Government and certain manufacturing concerns in regard to firearms upon which J. M. and M. S. Browning held patents and in which the taxpayer had a royalty interest by reason of the contracts herein-before mentioned. These manufacturing concerns had no rights covering the firearms which they had contracted to manufacture, such rights being held by the Colts Company. The Government desired to place its contracts where it saw fit and requested the taxpayer, in lieu of all rights accrued or to be accrued during the period of the war, to accept a certain definite sum. It was thereupon agreed that the taxpayer should receive $150,000 in cash in lieu of its right to royalties during the period of the war under the contract with the Colts Company (Exhibit A-6). A written contract to that effect was entered into by the taxpayer and the United States Government and on March 28, 1918, the taxpayer was paid the amount of $750,000 in accordance with the contract. Pursuant to the said contract, further orders were placed by the United States Government with other manufacturers for machine guns and machine rifles covered by the Browning patents. When the Armistice was signed, orders had been placed by the United States Government with various arms factories for 288,174 Browning machine rifles and 110,000 Browning heavy machine guns, which would have netted the taxpayer at the established royalty rates of $25 and $50 for the machine rifle and machine gun, respectively, the amount of $12,704,350. After the Armistice the United States canceled orders for 37,000 Browning-heavy machine guns, 186,000 Browning machine rifles, and 1,300 tank machine guns.
    During the year 1918 the United States accepted 56,608 Browning-heavy machine guns, 2,816 Colts machine guns, 580 Browning aircraft machine guns, 38 Marlin aircraft machine guns (Colts), 4 Browning tank machine guns, 1,470 Marlin tank machine guns (Colts), and 69,960 Browning machine rifles.
    (19) On January 2, 1915, the fair market values of the rights to receive royalties under the contracts hereinabove mentioned, were as follows:

    (20) On the known facts, on January 2, 1915, the contracts involved herein would expire on the following dates:

    The petitioner corporation was, as hereinbefore stated, organized in the year 1908. However, the books of the corporation were not opened until the year 1914. When the books were opened in the year 1914, all tile assets owned by the petitioner at that time, including stocks, bonds, cash and real estate, were entered thereon, and a record of the assets was thereafter kept in an accurate manner. There is nothing in the record to show that the values given to such assets on the books of the petitioner in 1914 were other than their cost to the petitioner.
    The books of the petitioner were, during the year 1918, kept on the cash receipts and disbursements basis.
    The petitioner in its income and profits-tax return for the year 1918, reported a gross income of $381,313.98, of which $345,403.67 was from royalties, and a net income of $189,110.63. No part of the amount of $750,000 received by the petitioner from the United States in the year 1918, as set forth in paragraph 17 herein, was included in the return. In computing its invested capital for the year 1918 the petitioner included the contracts involved herein as paid-in surplus in the amount of $3,000,000. The Commisisoner, upon audit of the petitioner’s return for the year 1918, increased the income reported therein by the said amount of $750,000 received by it from the United States. He also determined that while the contracts mentioned were very valuable, their value at January 2, 1915, could not be ascertained, and that the petitioner was not entitled to include any amount in its invested capital on account of said contracts, or to any deduction from gross income as an allowance for the exhaustion of the contracts. He also determined that since the value of the contracts could not be determined, an abnormality in invested capital and income existed within the meaning of section 327 of the Revenue Act of 1918 and he therefore computed the tax liability under the provisions of section 328 of the Revenue Act of 1918, and arrived at a rate of profits taxes as to net income of 27.85 per cent.
   OPINION.

Marquette:

It may be stated at the outset that the several contracts involved herein are license agreements, authorizing the licensees to make and sell certain firearms covered by patents owned by J. M. and M. S. Browning, and as to the Brownings, the right to receive royalties thereunder. We have heretofore held in the Appeal of Dwight & Lloyd Sintering Co., 1 B. T. A. 179, that license agreements for the use of patents are intangible property within the meaning of the Revenue Act of 1917. In that appeal we said:

The taxpayer relies upon article 811 of Regulations 45 in support of its position that the license agreements were tangible property. That article of the regulations provides that most contracts are intangible property and that a contract may be regarded as tangible only after a full statement as to its exact nature and a showing to the satisfaction of the Commissioner that it relates to rights in tangible property to such an extent that its value arises chiefly therefrom. This article, however, does not support the position of the taxpayer in this case, as the license agreement’s do not relate to the machines to such an extent that they derived their chief value therefrom.
Patents, under the Revenue Act of 1917, are not treated as intangibles nor yet specifically as tangibles; the license agreements are one step removed from the patents. They amounted to no more than licenses in the ordinary meaning of that word or privileges to use the processes and mechanism protected by the patents. As such they are intangibles. The article of the regulations above referred to is not authority for holding that contracts or agreements which derive their chief value from patents are tangible assets.

The taxes involved in this appeal are for the year 1918 and they arise under the Revenue Act of 1918. By section 325 (a) of that Act, patents are specifically called intangible property; and as we have held that, under the Revenue Act of 1917, which does not expressly denominate patents intangible property, license agreements for the use of patents are intangibles, we are of the opinion that agreements of that nature are also clearly intangible property under the Revenue Act of 1918. The right to receive, royalties thereunder is likewise intangible property. The petitioner, therefore, by the assignment to it of the contracts mentioned, acquired intangible property.

It may also be stated, without extended discussion, that regardless of the value of the several contracts on January 2, 1915, the date they were acquired by the petitioner, it is not entitled to include that value or any part thereof in its invested capital for the year 1918. The contracts were paid in to the petitioner corporation by the Brownings without any consideration therefor except the nominal consideration of one dollar, and under the decision of this Board in the Appeal of Herald-Despatch Co., 4 B. T. A. 1096, they may not be included in invested capital under section 326(a) (3) of the Revenue Act of 1918. See also Appeal of Shope Brick Co., 5 B. T. A. 1042. This leaves for consideration the questions as to the value of the contracts on January 2,1915, the amount of the deduction to which the petitioner is entitled in computing its net income for the year 1918 as an allowance for the exhaustion of the contracts; whether or not the amount of $750,000 received by the petitioner from the United States Government in the year 1918 was income, and whether or not the petitioner is entitled to special assessment for the year 1918, and if so, what comparatives should be used.

We have carefully considered the evidence presented relative to the value on January 2, 1915, of the several contracts in question and we are of the opinion that it establishes that they had a fair market value on that date at least equal to the amounts set forth in the findings of fact. The values we have found for the contracts with the Colts Company (Exhibits A-l, A-2, A-6 and A-7) are, to our minds, established by the testimony of Samuel M. Stone, president of the Colts Company. He testified that on January 2, 1915, it was known that there would be a great demand for machine guns, due to the fact that the World War was then being waged; that no machine gun could be considered that had not completed a long period of testing and experimentation; that the Colts machine gun was admirably adapted to quantity production and the Colts Company was the only manufacturer of machine guns in the United States; and that a demand for at least 100,000 Colt machine guns could readily be seen. On the machine gun contract he placed a value of at least $3,000,000. He also testified that he was familiar with the prior earnings of the automatic pistol and belt loader contracts (Exhibits A-l, A-2 and A-l), and that considering the royalties paid prior to January 2, 1915, and the facts known on that date as to probable future demand, he considered Exhibits A-l and A-2 were worth at least $350,000, and A-l was worth at least $60,000. On cross-examination he testified that the Colts Company on January 2, 1915, would have paid $350,000 for the petitioner’s rights under Exhibits A-l and A-2, if the Brownings had been inclined to sell.

The fair market values of the contracts with the Eemington Company (Exhibits A-8, A-9, A-10 and A-ll) are sufficiently established, to our minds, by the testimony of C. L. Eeierson, president of that company. He testified that he was familiar with the contracts, the royalties paid thereon prior to January 2, 1915, and with ivhat was considered the probable future demand on January 2, 1915, of the guns covered by these contracts, in the light of the experiences of his company with the sale of guns of that sort, and conditions as they then existed. He also testified that as a matter of fact the Eemington Company paid to the petitioner on Exhibit A-8, subsequent to January 2, 1915, $104,000 more than the amount he testified to as the fair market value of the contract on that date. While the values placed on Exhibits A-10 and A-ll appear too high, in view of subsequent events, he testified that on January 2, 1915, it was believed by the Eemington Company that there would be yearly sales of at least 50,000 of the guns covered by Exhibit A-10, and from 8,000 to 10,000 of the guns covered by Exhibit A-ll, and that he considered his estimate conservative, in view of manufacturing costs at January 2, 1915. However, he computed the fair market value of these contracts as the total amount of royalties that might reasonably be expected to be paid over the life of the contracts without any allowance in order to arrive at the discount value of these future royalties on January 2,1915. In view of that fact and the further fact that values of these contracts were more or less speculative, we have not allowed the full values testified to by Reierson but have reduced them to the amounts shown in the findings of fact.

There is not sufficient evidence before us from which we can determine the values of the Belgian contracts (Exhibits A-12, A-13, A-14 and A-15). Also, as we have stated in the findings of fact, it is impossible to determine from the evidence what patents were covered by these contracts, or when they expired.

We find, from the evidence, that the contracts with the Stevens Company had a fair market value of $20,000 on January 2, 1915.

Having fixed the January 2,1915, value of the contracts acquired by the petitioner from J. M. and M. S. Browning, we must next determine the amount of the deduction to which the petitioner is entitled for the year 1918 as an allowance for the exhaustion of these contracts. The Commissioner contends that it is impossible to determine when the contracts will expire; that they became more valuable from year to year, since they covered any improvements and patents that might thereafter be invented or taken out by Browning, and that, therefore, the petitioner is not entitled to any deduction for the exhaustion thereof. The petitioner contends that each contract should be considered as expiring with the expiration of the latest patent covered by that contract existing on January 2, 1915, or the patent that might thereafter be issued on inventions made on or before that date. We agree with the petitioner’s contention. To hold that the Brownings might make other inventions or take out other patents, which would extend the life of the contracts, would be to enter the realm of pure speculation and that we should not do. As far as the evidence discloses, no patents covered by the contracts herein were taken out subsequent to January 2, 1915, except on guns which were in existence on that date and which were known to come within the scope of the contracts. We therefore hold that the contracts severally expired on the dates set forth in the findings of fact.

The petitioner contends that the allowance for the exhaustion of the contracts involved herein should be computed upon the unit basis; that is, upon the quantity of guns manufactured and sold, rather than by amortizing the January 2, 1915, value of each contract over its remaining life. In the case of the war-arms contract.-;, it contends that the prewar production and the war years (1915 to 1918, inclusive) production were known at the end of the year 1918; that with the supplies of war guns on hand at the end of 1918, it might safely be assumed that the average yearly postwar production would be the same as the average yearly prewar production, and that the allowance for the exhaustion of these contracts in the year 1918 should bear the same ratio to the January 2, 1915, value of the contracts as the number of guns produced in the year 1918 bears to the total number of guns produced or estimated to be produced after January 2, 1915. In the case of the other contracts, the petitioner contends that the average yearly demand prior to 1915 may be taken as the average yearly demand over the remaining life of the contracts, and that the allowance for exhaustion of each contract in the year 1918 should bear the same ratio to the value of the contracts on January 2, 1915, as the number of guns produced in that year bears to the total number of guns manufactured and to be manufactured after January 2,1915. The method contended for by the petitioner is known as the production method, which is based upon the theory that depreciation charges should fluctuate in harmony with fluctuations in production, and is analogous to that used in computing allowances for the depletion of mines, oil wells, and timber. While this method may be the ideal one under some conditions, there are certain difficulties which stand in the way of its practical application in this case. In order to determine an allowance which bears the same ratio to the value of the asset as the production in the year for which the allowance is made bears to the total content producible, the total content must be known or capable of being ascertained with reasonable certainty. Here we know the prewar production under the contracts and the production during the war years. We are asked to assume that the average yearly postwar production under the war arms contracts will be the same as the average yearly prewar production, and that the average yearly production under the other contracts after the year 1914 will be the same as the average yearly production of the years up to and including 1914. This assumed production is at best a mere estimate arrived at by speculation. We think it is impossible to predict with any degree of accuracy, what the future production under the contracts will be. It may or may not be the same as in the prewar years, dependent upon conditions which can not be foreseen. We have declined to speculate or conjecture as to the life of these contracts, although it is entirely possible that they may be extended beyond the date of the expiration of the patents that are now in force, and wo are of the opinion that there is less reason to speculate or conjecture as to the future production under the contracts. Furthermore, as in the case of patents, the diminished value of the contracts under consideration on the last day of any accounting period, as compared to the value on the first day thereof, can not be attributed solely to the production thereunder, for the contracts did not cover any specific number of guns; rather the shrinkage in value arises from the fact that on the last day of any accounting period the contracts had one year less to run than on the first day thereof. The shrinkage in value occurs irrespective of production. We are of the opinion that the allowance for the exhaustion of the contracts herein can only be determined on the time basis, by spreading the January 2, 1915, value of each contract ratably over its remaining life after that date.

In its petition the petitioner alleged that the amount of $150,000 paid to it in the year 1918 in lieu of its rights to royalties during the war period under certain contracts with the Colts Company, was not income. At the hearing and in the petitioner’s brief that point was given no attention, but the record is not clear that the petitioner intended to abandon it. We are satisfied that the amount in question was clearly income. If the petitioner had insisted upon and received the royalties to which it would have been entitled, the amount of the royalties so received would certainly have been income. When it entered into the agreement with the United States to surrender or waive its rights to royalties and to accept $150,000' therefor, it simply accepted a definite and determined amount instead of an indefinite and undertermined amount that might thereafter be earned. What actually occurred, in the light of subsequent events, was that the petitioner accepted a lesser, determined, present income in lieu of a greater, undetermined, future income; but it was income nevertheless, and we so hold.

The Commissioner, upon audit of the petitioner’s return for the year 1918, found that the contracts involved herein were very valuable when acquired by the petitioner, but that their exact value on that date could not be determined, and that, therefore, as he was unable to determine its invested capital, the petitioner was entitled to have its tax liability computed under section 328 of the Eevenue Act of 1918, and it was so computed. The Commissioner now contends that if the Board finds the value of the contracts, no abnormality exists in capital or income and that special assessment should not be granted. The petitioner urges, however, that even if the Board is able to find the value of the contracts, it is entitled to special assessment because when the books were opened in the year 1914, the stocks, bonds, real estate and other assets owned by it at that time were not entered on the books at cost; that the cost of these assets can not now be ascertained and that it is, therefore, impossible to determine the petitioner’s statutory invested capital.

As set forth in the findings of fact, the petitioner acquired from the Brownings on January 2, 1915, the contracts involved herein, which had at that time a fair market value of $4,190,000. For the reason hereinbefore stated, the value of these contracts may not be included in the petitioner’s invested capital for the year 1918. The contracts produced, however, a large part of the petitioner’s income for that year. These conditions, we think, constitute an abnormality within the meaning of section 327 (d) of the Eevenue Act of 1918, which entitles the petitioner to have its tax liability computed under the provisions of section 328 of that Act.

The petitioner has submitted the names of several corporations which it insists are representative corporations engaged in businesses similar to .its own business, and it contends that they are proper comparatives to be used in computing the tax under section 328. The evidence presented in support of this contention does not satisfy us that these corporations are proper comparatives as claimed by the petitioner. We therefore hold that the respondent shall compute the petitioner’s tax liability for the year 1918 under section 328 of the Revenue Act of 1918, using comparable corporations as defined by that section, and that the tax so computed, upon the basis of income as herein adjusted, shall be final.

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

Sterni-iagen dissents.


author: Smith :

text:
    John J. Pascoe, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9174.
    Promulgated April 21, 1927.
    In the absence of evidence of the cost of the petitioner*’® interest in property, or the value thereof on March 1, 1913, the Board is unable to determine what amount, if any, the petitioner is entitled to deduct from gross income in its income-tax return for 1921 for exhaustion or depletion.

      M. J. Kennedy, Esg., for .the petitioner.

      Jose'pli Hcsrlacher, Esg., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income tax for the year 1921 in the amount of $407.77. The only questions in issue are (1) the right of the petitioner to deduct from gross income in his income-tax return a reasonable amount for depletion, and (2) the amount of such depletion deductible, if any.
    FINDINGS OF FACT.
    The petitioner is a resident of Ishpeming, Mich. He is a practical man, having been foreman, shift boss, miner, pump man, and engineer. In 1912 he entered into a partnership agreement with Charles D. Fournier, Jr., for the purpose of handling iron ore properties. These individuals believed that a certain quarter section in Gogebic County, Michigan, was underlaid with a vein of iron ore. Under the partnership agreement the petitioner was to endeavor to interest certain mining men and mining companies in prospecting for ore upon the tract in question. Fournier was to sbow parties interested over the property and to point out to them the petitioner’s and his own belief with respect to the trend of an ore vein. The petitioner succeeded in interesting certain mine operators in the property, one of whom was A. B. Coates, and another George P. Tweed. These individuals on November 19-, 1912, took an option for a mining license or lease. Coates and Tweed agreed to pay Fournier the sum of $1,250 in cash and a royalty of 1% cents per gross ton upon all ore mined and removed under the said mining lease and an interest in the net profits resulting to Coates and Tweed from the explorations and operations under the option for a mining lease and under the mining-lease itself amounting to a one twenty-fourth interest in the profits. The mining property in question was owned by John Hanousek and Anne Hanousek, his wife, of Bamsey, Mich. The lease to the property was executed by them in favor of Coates and Tweed and was dated March 15,1918, and recorded May 3, 1913.
    The petitioner because of his services to the partnership existing between himself and Fournier became entitled to one-half of whatever Fournier might receive out of the transaction. He thus became entitled to $625 in cash paid to Fournier on March 15, 1913, and one-half of Fournier’s interest in certain contracts made between Coates and Tweed and other parties relating to the leased property. The petitioner was compelled to bring suit to recover his one-half of the interest in such cash payment and contracts which suit was decided in favor of the petitioner. This decree was made and entered in the Circuit Court for the County of Marquette, in Chancery, February 9,1916. The decree of the court evidences the existence of a partnership between petitioner and Fournier and the one-half interest of the petitioner in all the “ moneys, profits, royalties and contracts realized and received therefrom [Hanousek transaction] by the defendaht, Charles D. Fournier, Jr.” The decree further recites that:
    * * * Defendants, A. B. Coates and George P. Tweed and the Savannah Iron Mining Company, a corporation under the laws of the State of Minnesota and the defendants, Edward J. Pearce, Charles D. Fournier, Jr. and Albert J. Rough entered into two certain contracts dated November 19, A. D. 1912 and January 15th. A. D. 1914 and that under and by virtue of said contracts and the mining leases hereinbefore referred to, the defendant, Charles D. Fournier, Jr., received the sum of twelve hundred fifty dollars ($1250.00) and that in and by said contracts it was further agreed that so long as said leases remain in force and effect the said Charles D. Fournier, Jr. should receive and be paid a royalty of one and one-quarter cents (l%c) per gross ton of twenty-two hundred forty pounds (2240 lbs.) upon all iron ore mined and removed under said mining leases upon the premises above described which amounts are payable quarterly on the 20th. days of January, April, July and October of each year for the three calendar months preceding the day of payment and that in and by said agreements relating to said mining leases the Savannah Iron Mining Company further agreed to pay to said Charles D. Fournier, Jr. an interest in the net profits resulting to said A. B. Coates and George P. Tweed and the Savannah Iron Mining Company from the explorations and operations carried on under said option for a mining lease and under the mining leases described in this decree, namely, one twenty-fourth (l/24th) interest in said profits.
    It was further provided tliat Fournier was to account to the petitioner for one-half of the payment of $1,250 with interest thereon at 5 per centum per annum from March 15, 1913, and that he should transfer and set over to the petitioner one-half of his interest in the contracts above referred to.
    Subsequent to the entering of the decree by the court, Pascoe assigned an undivided one-fourth interest of all moneys received or to be received and of all rights, profits, and privileges secured to Pascoe by the decree and by the contracts between Fournier and Coates and Tweed to M. J. Kennedy, the petitioner’s attorney. Thereafter and on September 2, 1916, Coates and Tweed and the petitioner entered into an agreement under which the petitioner assigned to Coates and Tweed all of his remaining right, title, and interest to the contracts, profits, and royalties acquired under the decree, and received from Coates and Tweed an agreement that so long as the mining leases remained in force and effect they would pay the petitioner a royalty of 1 y2 cents per gross ton upon all iron ore mined and removed under the lease. These amounts were payable quarterly and a minimum royalty of 100,000 tons per year was provided for whether the amount was mined and shipped or not.
    The agreement provided that all such payments of royalty and of minimum royalty should be made at the times and in the manner and with the same force and effect in every respect as provided in said mining lease with reference to the payment of royalty and minimum royalty. Such minimum royalty was to be computed from and began to run on July 1, 1916. The agreement further provided that all agreements contained in the contract should bind the heirs, executors, administrators and assigns of the respective parties to the contract and that the provisions contained in such contract should be construed as covenants running with the land.
    The petitioner performed no service and engaged in no business for gain for the taxable year 1921 for these royalties. The holders of the mining option and lease having acquired property of great prospective value were willing to pay Fournier for his services in bringing the property to their attention. The payment was to take the form of a royalty upon ore mined. As the ore was mined from the property the petitioner became entitled through the agreement of September 2, 1916, to receive 1 y2 cents per ton royalty.
    The decree of the court recites the leases executed by the fee owners to A. B. Coates and George P. Tweed, the agreement by the lessees, Coates and Tweed and the Savannah Iron Mining Co., to pay to Fournier and others mider two certain contracts dated November 19, 1912, and January 15, 1914, certain moneys, royalties, and profits upon all iron ore mined and removed under said mining leases from said premises.
    The mining of ore under the lease commenced in 1916. The following table shows the ore mined from the property and the year in which it was mined down to and including the taxable year 1921.
    Yew. Tons.
    1916-330,426
    1917_ 658, 325
    1018-816, 510
    1919-366,256
    1920_ 696, 554
    1921-428,112
    Total_ 3,296,183
    In February, 1914, when the drilling records were completed, the petitioner estimated the tonnage of the mine at 14,000,000 tons. The petitioner was an experienced mining man and his estimate has been verified to a large extent by subsequent exploration and development.
   OPINION.

Smith :

Although the petitioner received $9,121.47 in royalties in the year 1921 he did not report any part of this amount as net taxable income by reason of having deducted therefrom the full amount for depletion. The deduction of the depletion was disallowed by the respondent upon the ground that—

* * * It is held by this office [Commissioner’s office] that since you [the petitioner] are neither the lessor nor the lessee and have no interest in the mining lease, no depletion is allowable. The income received from the operation of mining property is not subject to depletion deductions based upon the value of an alleged equity in the mining lease and the entire amount received by reason of the assignment of the option constitutes taxable income for the year in which received.

The petitioner submits that he is entitled to deduct from gross income in his income-tax return for 1921, a reasonable amount for depletion and submits that—

The unit value is the present worth on March first, 1913 of 1%‡, and the depletion allowance for the year is the unit value multiplied by the tonnage mined [paid for, namely, 608,058].

Section 214 of the Revenue Act of 1921 permits an individual to deduct from gross income in his income-tax return, among other items:

(8) A reasonable! allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence. In the case of such property acquired before March 1, 1913, this deduction shall be computed upon the basis of its fair market price or value as of March 1, 1913 ;
#**$$*$
(10) In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case, based upon cost including cost of development not otherwise deducted: Provided, That in the case of such properties acquired prior to March 1, 1913, the fair market value of the property (or the taxpayer’s interest therein) on that date shall be taken in lieu of cost up to that date * * *.

The basis for a deduction for exhaustion or depletion under the provisions of the Revenue Act of 1921 is the fair market price or value as of March 1, 1913, where the property was acquired before that date and the cost where acquired after that date. In the case at bar, the record discloses that the petitioner acquired his interest in the property in question as a result of services performed for a partnership. No evidence has been introduced from which the Board can determine the value at the date of acquisition of the petitioner’s interest, or at March 1,1913, assuming that petitioner had an interest on that date. Upon the record, the action of the Commissioner in disallowing any deduction for exhaustion or depletion for 1921 must be and is sustained.

Judgment will be entered for the respondent.


author: Milliken:

text:
    Shirley Hill Coal Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9304.
    Promulgated April 21, 1927.
    The amount paid by a mine owner for the cancellation of a lease to enable it to sell the mine is a part of the mine’s cost basis to be used in determining the loss resulting from subsequent sale, and not a deductible business expense.

      Frank J. ATbus, Esq., for the petitioner.

      Harold Allen, Esq., for the respondent.
    This proceeding results from the determination of a deficiency in income and profits taxes for the calendar year 1917, in the amount of $1,287.40. Error is assigned by petitioner in that the Commissioner, in computing net income for the year 1917, refused to allow as a deduction from income $50,000 paid to the Gould Coal Washing Co. for the cancellation of a lease. We have found the facts in accordance with a stipulation filed by the parties.

      FINDINGS OF FACT.
    Petitioner is an Indiana corporation with its principal office at 1350 Peoples Gas Building, Chicago, Ill. Prior to 1912, petitioner purchased certain mining properties, known as Mines Nos. 2 and 3. The depreciated cost as shown by the books of account of petitioner and as accepted as correct by the parties, is $195,092.92 less $33,333.33, representing the balance of a contract carried on its jiooks, which should have been written off, making a corrected depreciated cost of $161,759.59. In the year 1912, the mining property in question was leased by petitioner to the Gould Coal Washing & Mining Co., an Indiana corporation, for a period of 25 years. In 1917 the petitioner received an offer of $190,000 from a third party for the property. The petitioner thereupon entered into negotiations with the Gould Coal Washing & Mining Co. for the cancellation of the remaining portion of the lease on the mining property. On March 17, 1917, an agreement was entered into between petitioner and the Gould Coal Washing & Mining Co. wherebjr in consideration of the cancellation of the lease the petitioner agreed to pay and paid to the Gould Coal Washing &> Mining Co. the amount of $50,000, which fully and completely extinguished all further rights of the Gould Coal Washing & Mining Co., under the 25-year lease entered into in 1912. Immediately after the cancellation of the rights of the Gould Coal Washing & Mining Co., under the lease, in consideration of $50,000 paid to them, the petitioner sold the property for $190,000. In arriving at the gain or loss sustained by the petitioner on the sale of the property in 1917, the respondent considered the $50,000 paid by petitioner to the Gould Coal Washing & Mining- Co. for the cancellation of the 25-year lease entered into in 1912 as additional cost of the property, and added it to the book cost of $161,759.59, making a cost of $211,759.59. The respondent, in arriving at the amount of the loss sustained, determined the same as follows:
    Depreciation cost as sliown by books anti brief dated July 31, 1924_ $195,092.92 Less: Balance of contract carried on books wbicb should have
    been written off- 33,333. 33
    Corrected depreciated cost of assets- 161, 759. 59
    Additional cost of cancellation of contract- 50, 000. 00
    Corrected cost--- 211,759. 59
    Sale price_ 190,000. 00
    Revised loss_ 21, 759.59
    The March 1, 1913, value of the property sold was $214,915.63.
    The agreement between the petitioner and the Gould Coal Washing & Mining Co., covering the $50,000 paid by the former to the latter, provided as follows:

      This Indenture, executed in original and triplicate parts, between Shirley Hill Coal Company, a corporation organized and existing under and by virtue of the laws of the State of Indiana, party of the first part, and Gould Coal Washing and Mining Company, a corporation organized and existing under and by virtue of the laws of the State of Indiana, party of the second part:
    WITNESSETH :
    That Whereas said parties on the 24th day of June, 1912, entered into a certain indenture or lease recorded in Miscellaneous Record 13, Page 491, Sullivan County, Indiana, whereby the party of the first part leased to the party of the second part certain property in Sullivan County, State of Indiana, in said lease specifically described, for a term of twenty-five (25) years, commencing on the first day of July, 1912, and ending on the 30th day of June, 1937, and a certain agreement supplemental thereto; and
    Whereas it is the desire of said parties that said term be sooner terminated;
    Now, Therefore, said parties hereby agree as follows:
    1. For and in consideration of the sum of Fifty Thousand Dollars ($50,000.00) Paid by the party of the first part to the party of the second part, the receipt whereof is hereby acknowledged, the term of said lease is hereby terminated and ended on the 19th day of March, 1917, and the party of the second part hereby agrees to deliver possession of all of said leased property to the party of the first part on or before seven o’clock in the forenoon of March 19th, 1917. The option in said indenture of June 24th, 1912, to lease coal in the Number Five Vein, and the easement granted in the agreement of June 24th, 1912, supplemental to said indenture are hereby released, cancelled and determined.
    2. The party of the second part is hereby excused from the payment of the taxes for the year 1917 that became a lien on the first day of March, 1917, but is not by this agreement released or excused from the payment of rentals or royalties earned up to the 19th day of March, 1917, or from the performance of any covenants or obligations accruing prior to March 19th, 1917, under said indenture of June 24th, 1912.
    In Witness Whereof, the said Shirley Hill Coal Company has caused this instrument to be executed in its name and on its behalf by its President and Secretary, and its corporate seal to be affixed hereto, in pursuance of authority granted by its Board of Directors; and the said Gould Coal Washing and Mining Company has caused this instrument to be executed in its name and on its behalf by its President and Secretary and its corporate seal to be affixed hereto in pursuance of authority granted by its Board of Directors, this 17th Day of March, A. D. 1917.
   OPINION.

Milliken:

Petitioner contends that the $50,000 paid in 1917 to the Gould Coal Washing & Mining Co. for the cancellation of the balance of the 25-year lease entered into in 1912, was an ordinary and necessary business expense and as such, is a proper deduction from gross income for the year 1917.

In 1912, petitioner had leased its mine for a period of 25 years. In 1917, an offer was received for the mine from a third party. It was obviously necessary, in order to consummate the sale for the petitioner to have the right to possession of the mine, and to accomplish the same petitioner purchased the cancellation of the lease for the sum of $50,000, and thereupon sold the property for the sum of $190,000.

In the absence of any facts to the contrary, we must presume that petitioner sold two things for the sum of $190,000 — the title to the real estate and the right of immediate possession. To determine whether a gain or loss resulted from such sale, it is necessary to know the basis of cost for the two things sold. We know as,a fact what the cost was to petitioner of the real estate sold and the cost to it of the right to the sale of immediate possession of the property theretofore encumbered by a lease.

Counsel for petitioner has directed our attention to certain decisions in support of his contention. They relate, however, to situations where the lease of a tenant was purchased by the lessor in order that the lessor might acquire immediate possession of his property for his own use, and the cost of extinguishment of the lease was allowed as a business expense. The distinction in the case at bar is obvious. Petitioner bought and paid for the right of possession of his property in order to sell it, and did sell the very thing purchased. We find no error in the determination of the respondent.

Judgment will be entered for the resfondent.