author: Hill :

text:
    Paraport Theatre Leasing Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102062.
    Promulgated April 8, 1941.

      Glarenee B. Innis, Esq., for the petitioner.

      Byron M. Goon, Esq., for the respondent.
   OPINION.

Hill :

This proceeding is for the redetermination of deficiencies in income tax for the years 1936 and 1937 in the amounts of $2,512.64 and $2,838.13, respectively. The sole issue for decision is whether or not petitioner is entitled, under section 26 (c) (1) of the Revenue Act of 1936, to a credit in the amount of its entire current adjusted net income for purposes of surtax computation, by reason of a written contract executed by it prior to May 1, 1936, restricting the payment of dividends in the taxable years.

Petitioner is a corporation, organized under the laws of the State of Delaware on January 24, 1933, and is duly qualified to do business in the State of Oregon. Its business consists of the operation of a moving picture theatre on leased premises.

At December 31, 1935, and at all material times thereafter, petitioner’s authorized capital consisted of 2,000 shares of common stock of the par value of $50 each, divided into 1,500 shares of class A and 500 shares of class B stock. With respect to the rights and privileges of the two classes of shares, the certificate of incorporation provided:

The holders of the Glass A stock and the holders of the Class B stock shall have the same powers and rights without preference between the classes or the shares in the classes except as qualified, limited and restricted as follows:
(1) When any shares of both classes of stock shall have been issued and shall be outstanding one director, or if the number of directors authorized by the By-Laws is more than three, one-quarter of such authorized number (a fraction to be considered as a whole) shall be elected by the majority vote of the holders of Glass B stock voting separately. All other directors when any shares of both classes shall have been issued and shall be outstanding, shall be elected by a majority vote of the holders of the Class A stock voting separately.

There were no other provisions with respect to the rights and privileges of the shares of stock of the corporation, and no change in the rights and privileges of either class of stock has been made since December 31,1935.

At the beginning of the year 1936 there were outstanding 15 shares of class A stock, all owned by the Evergreen State Amusement Corporation, and 5 shares of class B stock, owned by Paramount Pictures, Inc. On September 25,1937, the 5 shares of class B stock were acquired by the Evergreen State Amusement Corporation.

As of November 10,1933, the Portland Paramount Corporation (an Oregon corporation) and petitioner entered into a lease contract whereby the former corporation leased to petitioner the property known as the Paramount Theatre in Portland, Oregon, for a term commencing on November 10, 1933, and ending on October 31, 1943. Petitioner immediately went into possession of the property upon execution of the contract and has since operated the theatre thereunder.

Section 1 of article ix of the lease of November 10, 1933, reads as follows:

Section 1. It is expressly understood between the parties hereto that the Lessee is a corporation with a total authorized capital stock of One- Hundred thousand Dollars ($100,000.00) of which not more than One thousand Dollars ($1,000.00) shall have been paid in as of the date hereof. The Lessee hereby covenants and agrees that at least Fifty-five thousand Dollars ($55,000.00) shall 'be paid in as follows:
(a) Twenty-five thousand Dollars ($25,000.00) out of the first seventy-five per cent. (75%) of the net profits of the corporation;
(b) Twelve thousand five hundred Dollars ($12,500.00) out of the next fifty per cent. (50%) of the net profits;
(c) Seventeen thousand five hundred Dollars ($17,500.00) out of the next thirty-three and one-third per cent. (33½%) of the net profits.
Said capital not to be disbursed in dividends, salaries, or loans to affiliated companies during the term of this lease and the determination of net profits to be made on the basis of reasonable salaries.

During tbe taxable years petitioner kept its books and made its income and excess profits tax returns on the accrual and calendar year bases.

For the year 1936, petitioner reported a net income and normal tax net income, computed under sections 21 and 13 of the Revenue Act of 1936, respectively, in the amount of $24,583.60. It reported and paid for that year a normal tax of $2,835.87. Petitioner computed its earnings and profits for 1936, under section 115 (a) (2), in the amount of $21,747.73; it paid cash dividends in that year of $250 per share, or a total of $5,000, and paid $30.59 surtax on undistributed profits.

For the year 1937, petitioner reported a net income and normal tax net income under sections 21 and 13, respectively, in the amount of $36,231.17, and paid a normal tax of $4,350.05. It reported no excess profits tax. For 1937 petitioner reported earnings and profits of $31,881.12 computed under section 115 (a) (2); it paid cash dividends in that year of $625 per share, or an aggregate of $12,500, and reported and paid $47.57 surtax on undistributed profits.

The issue in this case involves the application to the foregoing facts of the provisions of section 26 (c) (1), quoted supra. There is no contention that subdivision (2) of that section applies, since the contract relied on did not require the earnings and profits of the taxable years to be paid or irrevocably set aside for the discharge of a debt. The precise question is whether or not the contract of November 10,1933, whereby petitioner leased the Paramount Theatre in Portland, Oregon, from the Portland Paramount Corporation for a period of approximately 10 years (the operation of which theatre in the taxable years constituted petitioner’s sole business) was (1) a written contract executed by petitioner prior to May 1,1936, within the meaning of the statute, and (2) which expressly prohibited the payment of dividends by petitioner during the years before us to the extent of the undistributed profits in controversy.

Respondent makes the contention that petitioner is not entitled to the credit provided in the statute, without attempting to point out in his brief any tenable basis therefor. Respondent cites and quotes from a memorandum opinion of the Board dated December 3, 1940, in the case of Pittsburgh Gut Flower Go., holding in substance that a corporate bylaw, charter, or resolution does not constitute a contract within the purview of section 26 (c). Respondent’s argument is wholly beside the point. Petitioner bases its claim for credit solely on the written contract of November 10, 1933, which must be construed independently of any corporate action subsequently taken to carry out the terms thereof by petitioner.

The contract in question was executed by petitioner prior to May 1, 1936; it contained provisions expressly dealing with the payment of dividends, and prohibited the payment thereof by petitioner during the taxable years to the extent of the amounts of the undistributed earnings. Thus, we think it meets the requirements of the quoted statute. Cf. Oregon City Manufacturing Co., 43 B. T. A. 212, in which we denied a credit claimed under section 26 (c) (1) because the contract there did not contain a provision expressly dealing with the payment of dividends. Since petitioner at the time of the execution of the contract had a paid-in capital of only $1,000, it is obvious that the purpose of the provisions requiring petitioner to capitalize its earnings to the extent specified was to provide security for the benefit of the lessor and insure performance of the contract by petitioner.

[Respondent presents one further contention, which, in substance, is to the effect that, whether or not the contract prohibited the payment of cash dividends by petitioner, there was nothing in the provisions of the lease which prohibited petitioner from distributing its net income for the taxable years in the form of stock or bonds of the corporation.

This contention, so far as it relates to the payment of dividends in bonds, requires but little discussion. The payment of dividends in bonds, based on accumulated earnings, would have effectively dissipated the security provided for the benefit of the lessor and would have been a plain attempt at evasion of the prohibitory provision of the contract.

Also, in our opinion, the payment of dividends in stock of the corporation, under the facts disclosed here, would not have met the statutory requirements and would have availed petitioner nothing. Petitioner can not be denied the credit provided in section 26 (c) (1) because it was not prohibited from declaring a stock dividend unless it could have declared a stock dividend which would have constituted taxable income to its shareholders.

Section 115 (a) of the 1936 Act defines the term “dividend” as meaning any distribution made by a corporation to its shareholders in money or other property out of earnings or profits of the taxable year or out of earnings accumulated after February 28, 1913. Subdivision (f) of the same section provides that a distribution made by a corporation to its shareholders in its stock, or rights to acquire its stock, shall not be treated as a dividend to the extent that it does not constitute income to the shareholder within the meaning of the Sixteenth Amendment.

It is now settled law that the payment of a stock dividend in new shares of common stock, which confer no different rights or interests than did the old shares, does not constitute the receipt of income by the stockholder. In such case, the new certificates plus the old represent the same proportionate interest in the net assets of the corporation. But a stock dividend which gives the shareholder an interest different from that represented by the old shares is taxable as income under the Sixteenth Amendment. Koshland v. Helvering, 298 U. S. 441; John M. Keister, 42 B. T. A. 484; Frank J. and Hubert Kelly Trust, 38 B. T. A. 1014.

As pointed out in the Kelly Trust case, the interest of a common stockholder consists of proportionate rights in the income of the corporation, in the powers of control, and to the proceeds of liquidation upon dissolution; to which must be added the right to transfer all incidents of ownership collectively but not individually. It is this last element which furnishes an important and basic reason for the holding that a stock dividend paid to common stockholders in preferred stock constitutes taxable income because the interest of a stockholder after such a dividend becomes “to some extent transferable in parts where before it could be disposed of only as a whole.”

In the present proceeding, petitioner was without authority to issue preferred stock. Its authorized capital consisted only of common shares, designated as class A and class B, but neither was preferred over the other as to dividends nor interest in the net assets, and both carried voting rights, although in different proportions. The class A stockholders had the right to elect three-fourths of the directors and the class B stockholders could elect one-fourth of the directors. If petitioner had declared a dividend payable in either or both classes of common stock, since it was authorized to issue such stock in the ratio of three shares of class A to one share of class B and only to the stockholders of those respective classes, the stockholders would not have acquired any new or different interest in the corporation, and such dividends would therefore not have been taxable to the stockholders as income under the Sixteenth Amendment.

[Respondent erred in denying the credits claimed by petitioner.

Decision will be entered for petitioner.

       SEC. 26. CREDITS OF CORPORATIONS.
      *******
      (c) Contracts Restricting Payment of Dividends.—
      (1) Prohibition on payment of dividends.—An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. * * *


source: Caselaw Access Project

author: TURNER:

license: Public Domain

text:
    E. P. Adler, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97988.
    Promulgated April 8, 1941.

      Edward 8. Bentley, Esq., and Oliford Yewdall, O. P. A., for the petitioner.

      Angus B. Shannon, Esq., for the respondent.
   OPINION.

TURNER:

The petitioner contends that he is entitled to the deductions of $11,554.09 and $657.50 in 1936 and 1937, respectively, either as bad debts or as losses. Respondent contends that the amounts are not allowable deductions either as bad debts or as losses.

In the early part of 1933 the petitioner was liable as endorser on 11 notes of Airways, totaling $26,278.51, which were held by the bank. The bank also held certain collateral of the petitioner as security for the payment of the notes. Within a few weeks after he took charge of the bank’s affairs and when several of the notes had become due and the remainder would be due within a few weeks, McCulloch, after ascertaining that Airways was insolvent and unable to make payment and that the petitioner was solvent and able to make payment, conferred with the petitioner respecting the petitioner’s making payment of said notes. In order to avoid having to make present payment of his liability as endorser on the notes and in order to reduce if possible the amount he would eventually have to pay on them, the petitioner entered into an agreement with McCulloch whereby an extension of the time of payment was granted for four years, the city leasing Airways’ airport for a four-year period at sufficient annual rental to liquidate the notes, with interest, during that period and the petitioner agreeing with McCulloch to guarantee that the lease would be kept in full force and effect throughout the four-year period and that Airways would not default in the performance of its covenants thereunder. McCulloch knew and the petitioner knew that, since the rentals payable to the city under the lease were to be paid to the bank and applied on the notes of Airways, Airways would be deprived of necessary operating funds. The petitioner in performance of his agreement with McCulloch thereafter furnished, through the Times Co., the custodian of his funds, all the necessary operating funds required by Airways to perform its covenants under the lease. The petitioner was able to obtain reimbursement from the city of such funds furnished Airways during 1933 and 1934, but was not reimbursed from any source for the funds furnished during 1935,1936, and 1937.

This is not the usual type of case where the endorser claims the right to deduct as a bad debt the amount paid by him to the creditor of the principal debtor pursuant to liability as endorser and recovery can not be had from the principal debtor. Instead, it is a case of an endorser who, realizing that the principal debtor, unassisted, is and will continue to be unable to make payment of its indebtedness, but with some financial assistance in carrying on its operations will be able to pay its indebtedness in full, but will not be-able to make repayment of such assistance, renders, under a guaranty agreement with the creditor, financial assistance to the principal debtor, with a view to avoiding having to make present payment of his liability as an endorser and reducing to a minimum the amount of loss he would sustain thereon, and claims the right to deduct the amount of the assistance thus rendered. In the former type of case it has been held that the endorser was entitled to the claimed deduction of the amount so paid. E. A. Roberts and Wife, 36 B. T. A. 549; Daniel Gimbel, 36 B. T. A. 539; Mrs. R. L. Wheelock, 28 B. T. A. 611; Cornelia Ann Cunningham, Executrix, 16 B. T. A. 244. In John P. Dillon, 9 B. T. A. 177, the taxpayer, a stockholder of a bank, was liable thereto as a guarantor on certain notes held by the bank and considered to be uncollectible. The taxpayer, without in any wise being subrogated to the bank’s right to collect on the notes but in order to be relieved of his liability as a guarantor, paid the bank $28,000 in 1921. The amount was held to be an allowable deduction as a loss from the taxpayer’s income for 1921. In Henry Adamson, 17 B. T. A. 17, the taxpayer was an endorser on notes and a guarantor of accounts of the corporation in which he was a stockholder. In 1922 he advanced the corporation $1,000 with which to pay the interest on its indebtedness, taking the corporation’s note for the amount thus advanced. In so doing the taxpayer knew the corporation was insolvent and that the note was worthless; however he considered that he was making a partial payment of his losses. Since the taxpayer was an endorser on notes and a guarantor of accounts of the corporation, it was held that the $1,000 constituted a deduction allowable to the taxpayer in 1922 as a loss sustained in that year. The purpose of the payment of the amounts involved in the Dillon and Adamson cases was either to relieve the taxpayers of or reduce the amount of their liability on the indebtedness of others for which they were liable. While in the instant case the payments made by the petitioner were to parties other than the bank to whom he was directly liable, yet the purpose and effect of such payments were the same as in the Dillon and Adamson cases and in our opinion fall into the same category as deductible losses. This, however, does not mean that the petitioner is entitled to deduct for 1936 the $5,081.94 paid during 1935.

During 1983 and 1934 the city made reimbursement to the petitioner of the operating deficit of Airways which he had paid during those years. The legality of such action on the part of the city was questioned and in 1935 a special act was enacted by the state legislature, ratifying the payments but granting no authority to the city for making any such payments in the future. During 1934 new city officials were elected who were not sympathetic with any projects supported by the petitioner or the Times Co. and at the close of 1935 they had made no provision for any payment of the operating expenses of Airways, despite the fact that the petitioner apparently had been very active in his efforts to get those officials to do so. Since the city was not obligated and apparently was without authority to pay any part of the operating deficit of Airways, and since there was no basis for expecting a recovery of it from Airways, we are of the opinion that the amount paid by the petitioner through the Times Co. during 1935 represented a loss sustained by him during that year and was deductible as such for that year. The amounts paid during 1936 and 1937 represented losses sustained in those years respectively and were deductible as such in those years.

On brief the petitioner contends that, since Airways was dissolved and its affairs wound up in 1937 and he received nothing with respect 1 o his stock, he is entitled to a deduction for that year of a loss of $1,000 representing the cost of 10 shares of stock in Airways. The petitioner made no assignment of error in his petition respecting the loss on stock owned by him in Airways. Consideration will not be given to issues which are not raised by the pleadings. See Citizens National Trust & Savings Bank of Los Angeles, Executor, 34 B. T. A. 140, and cases there cited. In this connection, however, it is to be observed that the petitioner’s failure to raise the issue in his petition has not resulted in any detriment to him, since his testimony as well as that of McCulloch indicates that as early as the first part of 1933 Airways was insolvent and its stock was worthless.

Decision will Toe entered wider Rule 50.


text:
    Johnson County Realty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96314.
    Promulgated April 8, 1941.

      Perry W. Shrader, Esq., for tbe petitioner.

      Gene W. Reardon, Esq., for the respondent.
   OPINION.

ToRner : Among the deductions allowed by the statute for the purpose of determining net income is the deduction for taxes, section 23 (c) of the Revenue Act of 1936, but it has been held that in the case of a purchaser of real estate, taxes outstanding against the property at the time of purchase do not as to such purchaser retain the character of taxes, but constitute a part of the cost of the property. Merchants Bank Building Co. v. Helvering, 84 Fed. (2d) 478; Helvering v. Missouri State Life Insurance Co., 78 Fed. (2d) 778; Lifson v. Commissioner, 98 Fed. (2d) 508; Walsh-McGuire Co. v. Commissioner, 97 Fed. (2d) 983; Crown Zellerbach Corporation, 43 B. T. A. 541; California Sanitary Co., Ltd., 32 B. T. A. 122; Texas Coca-Cola Bottling Co., 30 B. T. A. 736. Further, there seems to be no question that if the date of purchase preceded the date of accrual of such taxes the purchaser is entitled to deduct the taxes when accrued or paid, dependent upon the method used by him in reporting his income, and the parties here agree that the date of accrual is controlled or determined by the law of the state where the land is situated.

Under the Iowa Code, property is listed and valued in January and, after opportunity for the adjustment of the values by the proper board or commission, the levy is made by the county board of supervisors at its September session. The tax list is then prepared and delivered to the county treasurer on or before December 31 and the taxes become due and payable on January 1 of the year following that for which they are levied.

In Lowell H. Chamberlain, 43 B. T. A. 259, we concluded that under the Iowa statutes and the decisions of the supreme court of ■that state, Gates v. Wirth, 181 Ia. 19; 163 N. W. 215, and Iowa Wesleyan College v. Knight, 207 Ia. 1238; 224 N. W. 502, real property taxes accrue in September, when they are levied by the board of supervisors. It would appear therefore that the taxes on the real estate in question accrued in September and at that time became an obligation outstanding against the property in the hands of the petitioner’s vendor, and if there were nothing further, wre should conclude, in line with the previously decided cases, that the payment by the petitioner of the taxes here in question constituted payment on the purchase price of the property and not the payment of taxes within the meaning of the statute. In section 7204, however, the Iowa Code provides that as “against a purchaser” the lien for taxes against the real estate purchased “shall attach * * * on and after the 31st day of December in each year.” In the instant case the petitioner purchased the real estate in question on December 28, 1935. He paid the taxes in 1936 and since he reports his income on the cash basis, claims the right to deduct for that year the amount so paid.

In Nunngesser v. Hart, 122 Ia. 647; 98 N. W. 505, the question before the court was whether the vendor or vendee of certain real property was liable for the taxes thereon for the year 1900. The court said:

As between vendor and vendee, tax liens attach to real estate on and after December 31 in each year. Code Section 1400 (now 7204) : Taxes on real estate are required to be paid by the owner, and the question at once arises, who was the owner of the property in controversy, within the meaning of the statute, on January 1, 1901.

The respondent relies on the more recent case of Moore v. Central National Bank & Trust Co., 210 Ia. 1020; 229 N. W. 666, claiming that the real property there in question was sold on December 11, 1928, but that it was there held that the 1928 taxes on the property were the taxes of the vendor. While in that case the agreement of purchase was entered into in December, the court’s decision turned on the fact that the sale was not completed until March 1929, and, in holding that the taxes in question for the year 1928 were the taxes of the vendor, the court reaffirmed the rule laid down in Nunngesser v. Hart, supra. To the same effect is Clinton v. Shugart, 126 Ia. 179; 101 N. W. 785.

In tbe instant case the sale was completed and petitioner became the owner of the real estate in question on December 28, 1935, and under section 7204, supra, the lien for the taxes against such real estate attached as to him some three days later on December 31. In the light of that provision, it is our conclusion and we so hold, that the liability for the 1935 taxes against the real estate purchased by petitioner and paid by him in 1936 was as to petitioner a liability for taxes. Nunngesser v. Hart, supra. Cf. Commissioner v. Plestcheeff, 100 Fed. (2d) 62; Lifson v. Commissioner, supra; Commissioner v. Rust Estate, 116 Fed. (2d) 636; and T. H. Banfield, 42 B. T. A. 769. Since the petitioner reports his income by the cash method and the taxes in question were paid in 1936, they are deductible in determining his income tax liability for that year.

Decision will be entered for the petitioner.

       Secs. 7106, 7115; 7122, 7129, 7137, 7140, 7141, 7145, 7147, 7171, and 7210, Iowa Code, 1935.

         7204. Lien Between Vendor and Purchaser. As against a purchaser, such liens shall attach to real estate on and after the 31st day of December in each year.


author: Turner:

text:
    Valparaiso Grain & Lumber Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99865.
    Promulgated April 8, 1941.

      Harold Johnson, Esq., for the petitioner.

      Gene W. Reardon, Esq., for the respondent.
   OPINION.

Turner:

The respondent determined deficiencies in income and excess profits taxes for the fiscal year ended June 30,1937, in the respective amounts of $80.81 and $20.92. The question presented is whether the respondent erred in computing the amount of patronage dividends excludable from petitioner’s gross income.

The case was submitted upon a written stipulation of facts, the pertinent parts of which read as follows:

1. The petitioner is a corporation, incorporated under the laws of the State of Nebraska, with principal offices at Valparaiso, Nebraska. The return for the period here involved was filed with the Collector for the District of Nebraska.
* * * * * * . *
4. The net income as shown by the petitioner’s books before the deduction for patronage rebates and before any adjustment for depreciation disallowance of $263.70 was made for the taxable year ended June 30, 1937 was in the amount of $2,437.36.
5. The respondent disallowed certain items of depreciation as a deduction from income of the petitioner for the taxable year ended June 30, 1937, and in the amount of $263.70, which disallowance is proper and thereby increases the net income for the taxable year ended June 30, 1937.
6. Before the deduction for patronage rebates and after the adjustment for the disallowed depreciation set out in paragraph 5 hereof, for the taxable year ended June 30, 1937, the net income as shown by petitioner’s books was $2,701.06 and its taxable net income was $2,956.93 (the difference of $255.87 representing an income tax payment to the United States which is an unallowable deduction).
7. In October, 1936, petitioner declared and paid to its stockholders, on its outstanding capital stock of $20,000.00 cash dividends of $1,200.00. The by-laws of petitioner provide for the payment of fixed dividends on its capital stock before any distribution of patronage rebates can be made.
8. The patronage rebate to member stockholders of said petitioner was based on the wheat purchased from said member stockholders which was 39.66% of the total wheat purchased.
9. The petitioner declared and paid to its member stockholders $923.50 for the taxable year ended June 30, 1937, as patronage rebates; $575.72 was claimed therefor on its return for said year, but only $490.74 was allowed as a deduction by the respondent for patronage rebates in computing the petitioner’s Income Tax and Excess Profits Tax liability for the taxable year ended June 30, 1937.

The petitioner is not a cooperative association exempt from Federal income tax within the 'meaning of section 101 (12) of the Revenue Act of 1936, and it does not so contend. See Producers Creamery Co. v. United States, 55 Fed. (2d) 104; and Farmers Union Cooperative Co., Guide Park, Nebraska, 33 B. T. A. 225; affd., 90 Fed. (2d) 488. It does contend, however, that the sum of $923.50 distributed to its member stockholders constituted rebates or patronage dividends on business done with such members during the year and should be treated as a part of the cost of the goods sold in determining the corporate net income for the taxable year. I. T. 3208, C. B. 1938-2, p. 127. See also Home Builders Shipping Association, 8 B. T. A. 903; Anamosa Farmers Creamery Co., 13 B. T. A. 907; Farmers Union Co-operative Association, 13 B. T. A. 969. The respondent is in agreement on the proposition that true patronage dividends should be treated as part of the cost of goods sold, but takes the position that only a part of the said sum of $923.50 may be regarded as having been paid from profits realized on business done with members and that the remainder represented a distribution from profits realized on business done with nonmembers.

Of the business done during the taxable year, 39.66 percent was done with members and 60.34 with nonmembers, and, there being no segregation of the business done with members from that done with nonmembers, we accordingly assume that the profits were realized on the business done with members and nonmembers, according to the same percentages. From the profits realized the petitioner, according to its bylaws, was required to pay a fixed .dividend on its capital stock before making any rebate to its members. During the taxable year petitioner paid ⅝ fixed dividend of $1,200, as required by the bylaws, and thereafter distributed to its member stockholders $923.50 on the basis of the business done with the members, which amount was in fact less than 39.66 percent of the total net profits for the year from all sources. It is petitioner’s contention that the fixed dividend must be considered as having been paid wholly out of the profits realized on business done with nonmembers, leaving the profits realized on business done with members available for distribution to member stockholders “as patronage dividends”, and, since the $923.50 so distributed to members was less than the percentage of total profits attributable to the business done with members, the full amount should be excluded as further cost of goods sold. The respondent contends that the amount of the patronage dividend paid to member stockholders should be computed in accordance with his earlier ruling found in A. it. K. 6967, C. B. III-l, 1924, p. 287. The effect of respondent’s contention is that the fixed dividend was paid out of the unsegregated profits and must be considered as having been paid out of profits realized on business done with members and nonmembers in the same proportions that the business done with members and nonmembers, respectively, bore to the total business for the year, and that the patronage dividend thereafter paid to members is an amount equal to that part of the profits on business done with members left available for such distribution after payment of the fixed dividend.

The burden is on the petitioner to show error in the respondent’s determination and this the petitioner has failed to do. Had there been no business with nonmembers the profits on the business done with members would have been completely exhausted in the payment of the fixed .dividend and no amount would have been available for distribution as patronage dividends. We can see no more reason therefore for concluding in a case such as we have here that the fixed dividend was paid wholly out of profits realized on the business done with nonmembers rather than wholly out of profits, to the extent thereof, from business done with members. So far as we know, business was done with member stockholders and nonmembers on exactly the same basis and we have assumed that the profits were realized from members and nonmembers alike. The method of computation used by the respondent prorates the payment of the fixed dividend to the profits realized from the two sources according to the amount of business done with each and treats as the amount available for payment of patronage dividends that part of the profits arising from business done with members that is left undistributed after payment of the fixed dividend. This method of computation is in our opinion fair and reasonable and its use is accordingly sustained.

In making his determination, the respondent made certain other adjustments, including an adjustment of depreciation and the disal-lowance of a deduction claimed with respect to an income tax payment to the United States. The parties have agreed on the proper method for giving effect to those adjustments.

Decision will be entered wnder Rule 50.


author: Sternhagen:

text:
    William Hamilton Lawrence, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100364.
    Promulgated April 9, 1941.

      Clark J. Milliron, Esq., for the petitioner.

      Arthur L. Murray, Esq., and Lon H. Moss, Esq., for the respondent.
   OPINION.

Sternhagen:

The Commissioner determined a deficiency of $1,-609.88 in war excess profits tax for 1917. Petitioner contends (1) that he is not taxable on his distributive share of income of Philippine partnerships derived from practicing law in the Philippine Islands; and (2) that, if he is taxable, the deficiency is barred by the statute of limitations. The facts are stipulated.

Petitioner, a citizen of the United States, now residing in San Francisco, California, was, during the years 1902 to 1918, engaged in the practice of law in Manila, Philippine Islands, as a member of successive partnerships. The income of the partnerships was derived exclusively from professional services performed in the Islands. Petitioner and the partnerships kept their accounts on the cash basis.

Petitioner’s net income in 1917 was:

Salaries, wages and commissions---⅜1,220.00
Share of profits of law partnership of 1917_ 44, 888. 56
Share of profits of law partnerships prior to 1917_ 6,137.11
1*52,245.67 .

This was equivalent to $26,122.84. He duly filed an income tax return for 1917 with the collector of internal revenue of the Philippine Islands. Data necessary and sufficient for the preparation of a war excess profits tax return appeared on the income tax return. Petitioner filed no war excess profits tax return. The Commissioner prepared such, a return and so advised the taxpayer in the deficiency notice of July 21,1939. This return showed net income of $26,122.67, and a deficiency was determined of $1,609.83.

The determination rests upon.the statement in the deficiency notice:

During the taxable year 1917 you were a citizen oí the United States residing in the Philippine Islands engaged in the practice of law. Tour net income from that source is held to be subject to the war excess-profits tax imposed by Title II of the Revenue Act of 1917.

There is no determination or suggestion of fraud.

Partnerships were subject to excess profits tax upon their net income, Revenue Act of 1917, sec. 201. By the same section, individuals were also subject to such tax, but members of partnerships, although subject generally to the excess profits tax, were not individually subject to such tax upon their distributive shares of the partnership income, Regulations 41, art. 41. So far as they were applicable, the regulations touched lawyers in the Philippine Islands no less than those practicing within continental United States. The Revenue Act of 1917, section 200, treated Philippine partnerships as foreign partnerships, and imposed the excess profits tax upon only the partnership net income derived from sources within the United States. The petitioner’s partnerships had no net income from sources within the United States and therefore there was no basis for an excess profits tax. The respondent is not claiming a tax upon the partnership.

The respondent claims the right to subject the individual partner to a 1917 war excess profits tax upon his share of partnership income from sources in the Philippine Islands. This would be contrary to the regulations in force at the time and consistently recognized ever since. If the regulations are to be ignored and the statute strictly applied under a revised interpretation to members of foreign partnerships, this must also be done as to members of domestic partnerships. Article 41 is equally applicable to both. Thus the tax would now be retrospectively said to apply to the distributive shares of all members of partnerships, such individual income being held now to be from trade or business, whether derived from sources in the Philippines, Porto Rico, foreign countries, or from the main part of the United States. Nothing indicates that article 41 was intended to cover only members of partnerships which had actually paid excess profits taxes, and then only to the extent of such payment. There is no foundation either in tbe statute or tbe regulations for sucb a limitation of tbe article. This new interpretation more than twenty years after the statute has been superseded would be unconscionable. The 1917 excess profits tax was the first of its kind in this country and was difficult of interpretation and application in many respects. The regulations were drawn to facilitate administration of a novel statute. Many of the administrative rulings were expressly made to adjust the statute to practical conceptions. Eegulations 41 was the vade, mecwrn of both the taxpayers and the Government. It is now too late to say that it goes beyond the administrative power. Preeminently it should be recognized as having the force of law. The Commissioner’s determination is reversed.

Since the Commissioner’s determination is reversed on the substantive ground, it is unnecessary to consider the petitioner’s contention that the statute of limitations precludes the deficiency.

Decision will he entered for the petitioner.

       Akt. 41. Individual member of partnership.—Inasmuch as a partner in his individual capacity is not considered to be engaged in trade or business with respect to his share in the profits of the partnership, he is not subject to excess profits tax thereon. Consequently, in computing his net income for purposes of the excess profits tax he need not include his share of the partnership profits.
      He shall, however, in computing his net income of class A under article 35, include any salary or compensation from the partnership for personal services (including any amount allowed to the partnership as a deduction on his account for the period prior to March 1, 1918, in accordance with article 32).

       In his appearance before the House ways and Means Committee, December 14, 1920, considering revenue revision, Thomas S. Adams, who was a member of the first Advisory Tax Board appointed under the Revenue Act of 1918, section 1301, said (p. 39) :
      “* * * I would recommend that you take the regulations, particularly for the revenue act of 1917, made carefully, conscientiously, sympathetically, and make those regulations law so that they cannot be challenged. Por instance, in obedience to the universal demands, but with a rather slender foundation in the law itself, the Treasury Department under the 1917 revenue act decided to accept consolidated returns of corporations. That was on the whole a regulation of mercy, as also of equity and business logic. It will result in a few taxpayers being called upon to pay greater taxes, and a considerable number of them paying less. If it goes to the courts, there is a strong possibility that they may say what I have said, that it was equitable and merciful and in accordance with present business keeping, but that there was not sufficient statutory foundation for it, and the courts may wipe it out.
      “I wish you gentlemen would have other experts than Treasury experts examine regulation 41, dealing with and applying to the revenue act of 1917, and ask them if it has been done both carefully and equitably and in the proper spirit, and if it is then I wish the Congress would stop further disputes, stop this continual overturning of things by new regulations and court decisions and say that that is the law for 1917, that discussion about it shall hereafter cease, and let us go on. I can conceive of no more statesmanlike action in the field of taxation than something of that kind.
      “Mr. Longworth. Is there any question that the courts might upset the various rulings as to similar corporations that were made?
      “Dr. Adams. I think a number of those rulings, Mr. Longworth, are in grave doubt.
      “Mr. Longworth. Isn’t that a highly important question ?
      “Dr. Adams. I think the whole statute is filled with difficult, ambiguous points, and all the regulations are filled with doubtful rulings.
      “Mr. Hull. In the interest of equity to the taxpayers?
      “Dr. Adams. Judge Hull can be a major witness in this, because he presided over the body that made the regulation.”
      Joseph E. Sterrett, another member of the original Advisory Tax Board, said', in a memorial pamphlet, “In Appreciation of Thomas Sewall Adams” :
      “The Treasury, in a determination to make the law work, asked a group, of which Dr. Adams became a leader, to prepare regulations for adoption by the Treasury for the administration of the new and untried Excess Profits Tax Law. This task was more than an ordinary effort at drafting of regulations; it was essentially legislation. Every step taken was submitted to and discussed with the Chairman of the Finance Committee of the Senate and with the Chairman of the ways and Means Committee of the House. These men gave their whole-hearted approval to every decision reached by this group of which Dr. Adams was a member. So much so, indeed, that in the 1918 Revenue Act Congress inserted, with retroactive effect, several of these regulations that were most open to attack if litigated under the 1917 Act.”

       See Secretary McAdoo’s statement, June 17, 1918, before the House Ways and Means Committee at the beginning of the hearings on the proposed Revenue Act of 1918; Report of the Senate Committee on Finance on the Revenue Bill of 1918, 65th Cong., 3d sess., Rept. No. 617, p. 36; T. B. R. 38, C. B. 1, p. 280; T. B. R. 49, C. B. 1, p. 284.


author: Smith: Black, Disney,

text:
    American Smelting and Refining Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 99850, 100562.
    Promulgated April 9, 1941.

      Floyd F. Toomey, Esq., for the petitioner.

      Thomas H. Lewis, Jr., Esq., for the respondent.
   OPINION.

Smith:

On July 14 and September 6, 1939, the respondent mailed to the petitioner notices of deficiency in income tax for 1936 and 1937 of $227,492.55 and $80,436.43, respectively. On August 25, 1939 (Docket No. 99850), and November 6, 1939 (Docket No. 100562), the petitioner filed petitions with this Board for a redetermination of the deficiencies, claiming that overpayments of tax had been made for each year. The respondent filed answers to the petitions on October 14 and December 11, 1939. On December 13, 1940, the petitioner lodged with the Board an amended petition in each case alleging an additional error committed by the respondent in the determination of the deficiencies, namely, that in computing undistributed net income the respondent had understated by $770,000 and $640,995.11, respectively, the dividends paid credit to which the petitioner is entitled under section 27 of the Revenue Act of 1936 and claiming larger over-payments than were claimed in the original petition. Each amended petition was accompanied by a “Motion for leave to file amended petition”, which.was granted on December 13, 1940. On January 27, 1941, the respondent filed motions to strike the amended petitions upon the ground that each was filed more than 90 days after the mailing of the deficiency notice.

The parties have stipulated, for the purpose of passing upon these motions, that refund claims for the alleged overpayments of tax for 1936 and 1937 would not have been barred by the statute of limitations if filed on December 13, 1940, the date of the filing of the amended petitions.

It is the contention of the respondent that the Board may not permit the filing of amended petitions or an amendment to petitions timely filed so as to raise a new assignment of error after 90 days from the mailing of the notice of deficiency. His contention is that a petitioner must file a petition with this Board within 90 days from the mailing of the deficiency notice and that where an amended petition or an amendment to a petition is filed after such 90-day period a new cause of action is presented which has not been timely filed. In the instant case the respondent alleges that the time for the filing of the petitions had expired before the amended petitions were tendered and that the amended petitions were not amendments of the original petitions but entirely new petitions.

In support of his contention the respondent cites Rieck v. Commissioner (C. C. A., 3d Cir.), 104 Fed. (2d) 294; certiorari denied, 308 U. S. 602; Commissioner v. Dallas’ Estate (C. C. A., 2d Cir.), 110 Fed. (2d) 743; Denholm & McKay Co., 41 B. T. A. 986; Adoph B. Spreckels, 41 B. T. A. 1204. He submits:

The cases last above cited hold that the “petition” which Section 322 (d) requires to be filed within three years from the time the tax was paid, is the petition which alleges the error and the facts which support the error relied upon. There is no reason apparent from the language of the statute that the word “petition” as used in Section 272 (a), which requires the “petition” to be filed within ninety days after the mailing of the notice of deficiency, should be held to mean something else, that is, to mean a petition which does not allege the error and the facts which support the error relied upon. * * *

At the argument of this motion counsel for the respondent stated:

The principle announced in the Rieclc case, and in the Dallas case, is that any supposed amendment which sets out new facts in support of a new claim not supported by the facts originally pleaded is not an amendment at all, but is a new petition, and that such a petition does not relate bach; to the original filing date.

Under the provisions of law creating this Board and prescribing procedure before it, a taxpayer is permitted to appeal to it for the redetermination of a deficiency in tax determined by the respondent. Section 272 (a), Revenue Acts of 1936 and 1938, and the same section of the Internal Revenue Code. The Board is given authority to prescribe “rules of practice and procedure” in the performance of its duties. Sec. 1111, Internal Revenue Code. Under such authority the Board has prescribed Rule 17 of its Rules of Practice, which reads in material part as follows: “The petitioner may, as of course, amend his petition at any time before answer is filed. After answer is filed, a petition may be amended only by consent of the Commissioner or on leave of the Board.” This rule has been in effect in substantially the same form during the entire existence of the Board. Amendments to petitions have been allowed as a matter of course when made prior to the filing of an answer and leave has generally been granted by the Board to file an amended petition or an amendment to the petition when request therefor has been made after the filing of an answer.

The courts have gone even further than the Board in permitting amendments to original petitions filed. See Chicago Railway Equipment Co. v. Blair (C. C. A., 7th Cir.), 20 Fed. (2d) 10; International Banding Machine Co. v. Commissioner (C. C. A., 2d Cir.), 37 Fed. (2d) 660; Excelsior Motor Manufacturing & Supply Co. v. Commissioner (C. C. A., 7th Cir.), 43 Fed. (2d) 968; Geuder, Paeschke & Frey Co. v. Commissioner (C. C. A., 7th Cir.), 41 Fed. (2d) 308, 312, Alameda Park Co. v. Lucas (App. D. C.), 37 Fed. (2d) 805. In Internationad Banding Machine Co. v. Commissioner, supra, the court held that the Board erred in denying a motion to conform the pleadings to the proof where evidence had been received at the hearing without objection from Government counsel showing an error committed by the respondent in the determination of the deficiency which had not been pleaded. In no case has a decision of the Board been reversed by the courts, so far as the Board is able to determine, where the Board has permitted an amendment to the pleadings which raised a new assignment of error. The Board has not been criticized even for permitting such amendments. In fact it has been reversed where it failed to permit an amendment. This statement is limited, of course, to amendments relating to the redetermination of a deficiency.

The respondent plainly misconstrues the opinions of the courts in the Riech and Dallas’ Estate cases. The facts in the Rieck case were that upon the basis of the original petition filed the Board found a deficiency in tax of $3,173.50. Upon the basis of the amended petition the Board found that there was no deficiency in tax, but an overpayment instead. The Board held that, since the original petition was filed within two years from the date of the payment of the tax, the amendment to the petition filed more than two years after the date of the payment related back to the date of the original petition and that the overpayment was refundable. The court reversed the Board upon this issue upon the ground that the statute was specific that a claim for the refund of an overpayment of tax had to be filed within two years from the date of the payment and that there could not be an amendment of such claim raising a new assignment of error after the statute of limitations had run. The court’s decision was based upon United States v. Andrews, 302 U. S. 517, and United States v. Garbutt Oil Co., 302 U. S. 528, 529. The court held that, since the statute was specific upon this point, a taxpayer appealing to this Board could not get the benefit of an amendment to his petition made more than two years after the tax was paid for the purpose of obtaining a refund. The court said:

* * * The cited cases rule that an untimely claim cannot be brought within the two year limitation by calling it an amendment of a claim filed in time unless the amendment was properly allowed and that it is not properly allowed if based “on a new and unrelated ground,” which by itself alone would be barred by the Statute.

The court therefore held that the Board erred in determining a refundable overpayment in that case. It did not hold that the amendment to the petition was invalid for the purpose of determining the deficiency. Under the mandate of the court the Board entered its decision with the approval of the Commissioner that there was no deficiency in tax, but an overpayment instead, which was barred by the statute of limitations.

Precisely the same facts were present in the Dallas' Estate case. Under the mandate from the court the Board entered its decision, not that there was a deficiency, but that there was an overpayment of tax, which was barred by the statute of limitations.

In Denholm & McKay Co., supra, the Board held:

On consideration of the opinions of the Circuit Courts of Appeal of the two cited cases [Rieck v. Commissioner, supra, and Commissioner v. Dallas’ Estate, supra], we hold that an amended petition raising a new issue, filed more than three years after the payment of the tax, does not relate back to the time of filing of the original petition for the purpose of applying section 322 (d) of the Revenue Act of 1934, as amended by section 809 (a) of the Revenue Act of 1938.

That we reached a similar conclusion in Adolph B. Spreckels, supra, is apparent from the second paragraph of the headnote to our report, which reads in part:

2. Prior to determination of deficiency, petitioner filed a claim for refund of taxes paid, on the ground that he had not taken deduction for stamp taxes paid. In determining the deficiency, the stamp taxes were allowed as deduc-. tions, but other items resulted in determination of a deficiency. Stipulations show an overpayment of tax. At the hearing, more than three years after the last payment of tax, an amendment was filed, the effect of which was to claim, on new grounds, refund of overpayment. Held, the claim of overpayment is barred by limitations. Sec. 322 (d), Revenue Act of 1934; * * *

We are of the opinion that there is no merit in the respondent’s contention that the Board erred in granting the filing of amended petitions more than 90 days after the dates of the mailing of the deficiency notices.

In point of fact the contention made by the respondent in this case was passed upon by the Board in Bancitaly Corporation, 34 B. T. A. 494, where the Board stated at page 496:

The respondent’s motion, filed on October 24, 1934, to strike the amended petition in Docket No. 59674 from the record, on the ground that the same states a new cause of action and was filed- more than two years subsequent to the payment of the tax and more than 60 days subsequent to the mailing of the notice of deficiency, which motion was 'taken under advisement at the hearing on the merits of the case, is denied.

Cf. Producers Oil Corporation, 43 B. T. A. 9.

The opinions of the courts and of the Board in the cases relied upon by the respondent go only so far as to say that the Board may not determine the refund of an overpayment of tax where the refund is based upon an amendment to a petition filed after the statute of limitations has run. It appears, however, from the stipulations of counsel in this case that the statute of limitations relative to the finding of overpayments of taxes for 1936 and 1931 is a three-year period and that the amended petitions were filed within such period. Therefore, the principle of law enunciated in the Riech and Dallas’ Estate cases has no application to these proceedings.

Orders will be entered denying the respondent’s motion.'

Reviewed by the Board.

Black,

concurring: I concur in the result reached by the majority opinion. I do not do so, however, because I think that Rieck v. Commissioner; Commissioner v. Dallas’ Estate; Denholm & McKay Co.; and Adolph B. Spreckels, mentioned in the majority opinion were rightly decided. My judgment is to the contrary and I stated my reasons in a dissenting opinion in the Denholm & McKay Co., case. I shall not repeat here the words of dissent which I wrote in-that case, but I respectfully refer to it for a more detailed statement of my views.

The gist of my dissenting opinion in the Denholm & McKay case was that in a proceeding filed with the Board of Tax Appeals contesting a deficiency determined by the Commissioner, the cause of action is the deficiency. Therefore, it is my opinion that in the above cited cases the courts and the Board are wrong in applying the same rule to amended petitions filed with the Board of Tax Appeals as is applied to claims for refund which are filed with the Commissioner of Internal Revenue. It is my view that an amendment to the petition which contains a new assignment of error does not set up a new cause of action, but merely has to do with the one already before the Board. I think that such an amendment, when, filed by permission of the Board, “relates back” for all purposes to the time of the filing of the original petition, and that the above cases are in error when they hold that such amendments are tantamount to the filing of new petitions.

If my views in this respect are wrong and the cases to which I have referred are right, then I think there is strong support for the Commissioner’s motion in the instant case. But, for reasons which I have stated, I do not think the above cited cases were correctly decided.

I, therefore, concur with the majority opinion in its conclusion that the Commissioner’s motion should he denied.

Mellott and HaeRon concur in the above.

Disney,

dissenting: I dissent. In Edward E. Rieck, 35 B. T. A. 1178, we considered the question to be “what constitutes a ‘cause of action’ in cases involving the determination of the income tax liability of taxpayers”, and cited Peruna Co., 11 B. T. A. 1180, where we said: “In the present case, as in Eastman Gardiner Naval Stores Co., supra, petitioner had one right of action in the sense that term is used in the cases cited. This was its right to petition this Board for a review of its income tax liability for certain years as finally determined by the Commissioner.” We concluded: “It follows that if the amendment to the petition in the instant proceeding did not set up a new cause of action, and we do not think it did, then it relates hack and is effective from the date the original petition was filed.” The Circuit Court of Appeals, Third Circuit, agreed with us that the question was properly stated by us, saying:

* * * The real question thus becomes, as formulated in the opinion of the Board, “what constitutes a cause of action in cases involving the determination of the income tax liability of taxpayers.”

The court disagreed with our view that in the case presented no new cause of action was set up in the amended petition. The statute of limitations as to refund; claims had run, and the case was reversed. It appears from the above that the cause of action is set forth in the petition filed with the Board. Though in the Riech case the reversal was because of the fact that the claim for refund was set up by amended petition, after the running of the statute of limitations prescribed for such claims, nevertheless the opinion is based upon the fact of a new claim, not originally set forth in the petition, and in my opinion the thought is equally applicable to the 90-day limitation after deficiency notice. A new refund claim upon, specific grounds is not covered by an original claim upon other specific grounds. United States v. Garbutt Oil Co., 302 U. S. 528; United States v. Andrews, 302 U. S. 517, Therein the Court found “the analogies of pleading” helpful, though not to be slavishly followed. We here have a cause of action pleaded within a prescribed period, setting forth a specific claim of overpayment, and a distinctly different claim thereafter asserted. I think the rule usually applicable to pleadings applies here, that the amendment sought does not merely better state the original cause of action, but states a cause of action not germane to the original, and that such amendment should not be permitted after the 90-day period.

Aenold agrees with this dissent.


author: Van Fossan :

text:
    Estate of Lucy S. Schieffelin, Title Guarantee and Trust Company and Benjamin G. Bain, Executors, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99961.
    Promulgated April 9, 1941.

      H. F. Matheis, O. P. A., for the petitioners.

      Allen T. Akin, Esq., for the respondent.
   OPINION.

Van Fossan :

The issue is whether taxes paid by the decedent, the mortgagee, either before or after foreclosure, should be included in the debt due to her in computing her gain or loss from the foreclosure transaction, or should be added to the cost of the property purchased by her, thus creating an increased base for the computation of future gain or loss upon its disposition.

The petitioners contend that section 23 (k) of the Revenue Act of 1934, as interpreted by Regulations 86, article 23 (k) -3, is controlling and should be applied whether the taxes and assessments are paid before or after the mortgagee acquires the property. They maintain that the taxes and water rates, whether paid or accrued, properly form a part of the debt due to the mortgagee and should be recognized in computing gain or loss on the foreclosure transaction.

The petitioners quote section 251-6, Real Property Law of the State of New York, in support of their position. The provisions in the mortgage agreement, as well as the interpretation thereof embodied in the law, grant the mortgagee the right to pay all taxes, assessments or water rates which may become liens against the mortgaged property, if the mortgagor fails to do so, and all amounts so paid serve to increase the mortgagee’s investment in the debt secured by the mortgage. This privilege or right is obviously given in order to protect the mortgagee’s investment. If he avails himself of that right his investment is enlarged by the amount so paid and upon foreclosure the augmented debt becomes the base of computing his gain or loss.

The taxes on the Third Avenue property were paid by the decedent prior to her acquisition of it upon foreclosure. Thus, pursuant to contractual and statutory provisions, they became a specific obligation of the debtor to her, secured by the same character of lien and mortgage as that which secured the original mortgage indebtedness. The base of her investment was thereby enhanced. The amount of the taxes is a factor in determining the decedent’s gain or loss upon the foreclosure of the Third Avenue property and hence the petitioners’ contention is sustained.

The taxes accrued on the Oceanic Avenue property present a different situation. They were not paid until the taxable year following the date of the foreclosure. The petitioner did not exercise her right to pay the taxes prior to foreclosure and consequently to increase her investment in the mortgage debt secured by that property.

In Minnie M. Coward, 39 B. T. A. 1158 (affirmed as to the point at issue, 110 Fed. (2d) 125), we said:

It is well settled that if the purchaser of real estate pays taxes thereon which have accrued prior to the date of purchase, such payments are an additional cost of the property to the purchaser and are therefore not deductible by him as his taxes.

In Lifson v. Commissioner, 98 Fed. (2d) 508, the court stated:

When one purchases land which is subject to a lien for taxes, the subsequent payment of those taxes by the purchaser does not constitute an allowable deduction from gross income, for the reason that the taxes accrued while the land was in other ownership and the payment of them is merely a payment of a part of the cost of acquiring the property.

See Merchants Bank Building Co. v. Helvering, 84 Fed. (2d) 478, and other similar cases.

In the cases from which the above excerpts are quoted the issue was the deductibility of taxes as such, but the principles there set forth are equally applicable to the situation here. As to the Oceanic Avenue property, therefore, the taxes and water rates due thereon at the time of the foreclosure sale and paid by the decedent in the following taxable year constituted additional cost of the property purchased and form no part of the computation of the decedent’s gain or loss upon foreclosure.

Decision will he entered under Rule 50.

       SEC. 23. DEDUCTIONS PROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:
      *******
      (k) Bad Debts.—Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts); * * *

       Aet. 23 (k)-3. TJnoollecUble deficiency upon sale of mortgaged or pledged property.— If mortgaged or pledged property is lawfully sold (whether to the creditor or another purchaser) for less than the amount of the debt, and the mortgagee or pledgee ascertains that the portion of the indebtedness remaining unsatisfied after such sale is wholly or partially uncollectible, and charges it off, he may deduct such amount (to the extent that it constitutes capital or represents an item the income from which has been returned by him) as a bad debt for the taxable year in which it is ascertained to' be' wholly or partially worthless and charged off. In addition, if the creditor buys in the mortgaged or pledged property, loss or gain is realized measured by the difference between the amount of those obligations of the debtor which are applied to the purchase or bid price of the property (to the extent that such obligations constitute capital or represent an item the income from which has been returned by him) and the fair market value of the property. The fair market value of the property shall be presumed to be the amount for which it is bid in by the taxpayer in the absence of clear and convincing proof to the contrary. If the creditor subsequently sells the property so acquired, the basis for determining gain or loss is the fair market value of the property at the date of acquisition.

        Mortgagor to pay all taxes, assessments or water rates.

      A eonvenant “that the mortgagor will pay all taxes, assessments or water rates and in default thereof, the mortgagee may pay the same” must be construed as meaning that until the amount hereby secured is paid, the mortgagor will pay all taxes, assessments and water rates which may be assessed or become liens on said premises, and in default thereof the holder of this mortgage may pay the same and the mortgagor will repay the same with interest, and the same shall be liens on said premises and secured by the mortgage.


author: TueneR :

text:
    L. M. Bryan, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100378.
    Promulgated April 9, 1941.

      Charles W. Wingett, Esq., for the petitioner.

      Gene W. Reardon, Esq., for the respondent.
   OPINION.

TueneR :

The respondent determined a deficiency in petitioner’s income tax for the year 1937 in the amount of $234.12. From the notice of deficiency it appears that the petitioner on his return claimed a deduction of $2,766.73 as the amount of loss sustained during the taxable year in the operation of a fish hatchery. The deficiency results from the disallowance of that deduction to the extent of $1,959.49.

The facts were stipulated as follows:

1. In 1931 petitioner established a fish farm in Scotts Bluff County, Nebraska, for the purpose of propagation and culture of trout together with his other business activities. He built artificial open ponds upon his land and at the end of the first year a lot of fish were lost.
2. During the first few years storms contaminated the waters and many fish were lost. In the spring of 1934 the ponds were contaminated from poison meat (feed) and dead fish were hauled away by the wheelbarrow load. The estimated loss was 10,000 fish.
3. No actual count of the fish was ever made since it would be impracticable to make an actual count as it would result in a 10% loss through handling. No adjustment to inventory wasi made prior to the taxable year 1937 either for sales or for losses sustained.
4. As a result of said losses petitioner arbitrarily wrote down closing inventory in the amount of $2,000 representing an estimated loss whieh was reflected as a deduction in computing loss from operations. The petitioner had no fixed method of counting the fish nor did he ever make an actual count thereof.
5. The petitioner’s records indicate that an inventory was set up as follows:
INVENTORY
6.In the deficiency letter, a copy of which is attached to the amended petition and made a part hereof by reference, the Commissioner disregarded inventories in computing net income or loss from petitioner’s operation of said fish ponds, resulting in an additional deductible loss of $411.55 for 1936 and a reduction of $1,959.49 in the amount of loss claimed in the petitioner’s income tax return for 1937.

The petitioner claims to have computed his loss from the operation of the fish hatchery by the use of inventories. According to the stipulation the inventories from 1931, when the hatchery was established, through 1936 were nothing more than the accumulated totals of all purchases of fish and eggs plus the cost of feed and a portion of the sums paid for labor and other expenses from the date of establishment to the dates of the respective inventories. No physical inventory was ever taken and no adjustment was ever made to eliminate from inventory the fish sold during any year and prior to December 31, 1937, no adjustment was made for fish lost during any year, although according to the stipulation dead fish were hauled away by the wheelbarrow load in the spring of 1934. It is also to be noted that no allowance for adjustment of inventories was ever made to include fish raised at the hatchery, except possibly through the addition to inventory at the end of each year of the amount expended for feed and a portion of the sums paid for labor and other expenses.

According to the notice of deficiency the respondent determined that “the net income of a fish hatchery can not be properly computed on the basis of inventory” and determined the amount of petitioner’s net loss by taking the difference between gross sales and the total of purchases of fish, eggs, feed, cost of labor and other expenses, repairs, and depreciation. Eeconciliation of the amount of loss disallowed with the loss claimed by petitioner was shown in the deficiency notice by disallowing petitioner’s arbitrary write-down of inventory amounting to $2,000 and adjusting the depreciation claimed.

The petitioner contends that the use of inventories in the fish hatchery business is proper and that the loss from the fish hatchery as computed by him and deducted on his return is correct. The respondent adheres to his determination that the net income of a fish hatchery can not be properly computed by the use of inventories and that in any event there is no basis of fact for the allowance of the arbitrary write-down in the closing inventory in the amount of $2,000, which, as noted in the reconciliation contained in the deficiency notice, accounts for the loss deduction disallowed.

On the record' as it stands, it is not necessary to determine the question whether the income of a fish hatchery may be properly computed by the use of inventories, since the facts show that the so-called inventory used by petitioner is not in reality an inventory. Up to December 31, 1937, it does not purport to show anything but the accumulated cost of fish and eggs purchased from the date the hatchery was established plus the cost of feed and a part of the sums paid out for labor and other expenses. An inventory has been defined as “an itemized list of goods or values, with their estimated worth; specif., the annual account of stock taken in any business”, Webster’s New International Dictionary, and as “a detailed list of articles or property; a list or schedule of property, containing a designation or description of each specific, article;' an itemized list of the various articles constituting a collection, estate, stock in trade, etc., with their estimated values. * * *”, Black’s Law Dictionary. In the instant case there was no physical or other count. While a book inventory may be maintained, the purpose of the inventory is to show goods on hand as of a given date, whether the inventory be on cost or market, and in order to accomplish that purpose the book inventory must show proper credits for goods used, transferred, sold, or lost since the last inventory, as well as charges for goods purchased during the period, and under article 22 (c)-2 of Regulations 94 it is required that the balances shown by book inventories should be verified by physical inventories at reasonable intervals and adjustments made as indicated by such physical count. Here the so-called inventory still includes the cost of fish sold from 1931 through the taxable year and no allowance was made for losses until December 31, 1937, when the arbitrary write-down of $2,000 was made, although heavy losses were incurred in 1934 through the death of fish. In short, the so-called inventory by means of which the petitioner has sought to compute the amount of the loss sustained by him in the operation of the fish hatchery is no inventory at all, but merely a record of certain expenditures less, in the case of 1937, the arbitrary write-down for losses, and its use without proper adjustments can be of no assistance in reaching the correct result as to profits realized or losses sustained. The petitioner has failed to offer any facts which might form the basis for making the necessary and proper adjustments to reflect a true and proper inventory and in fact has not shown that a proper inventory can be taken in the business in which he is engaged. We are accordingly of the opinion that the respondent did not err in disregarding the so-called inventories used by the petitioner.

We are also of the opinion that the respondent’s alternative argument to the effect that the petitioner in no event is entitled to the $2,000 loss reflected by the arbitrary write-down in that amount to cover fish lost from death or other cause is well taken. The only losses shown by the record were losses sustained in 1934 and not in the taxable year, and, even if the petitioner’s inventory should otherwise be accepted as proper, restoration of the $2,000 write-down would be required.

Decision will be entered for the respondent.


author: Steknhagen:

text:
    Percival Parrish, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103406.
    Promulgated April 9, 1941.

      Charles 8. Jacobs, Esq., and William R. Spoford, Esq., for the petitioner.

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

Steknhagen:

The petitioner claims to have been the head of a family in 1936, and demands the personal exemption of $2,500 allowed by the Revenue Act of 1936, section 25 (b) (1). The term “head of a family” is not defined in the act, but its scope is to some extent indicated in the regulations, and these have been frequently adopted as the pattern for construction.

Petitioner, recognizing a moral or legal obligation, supported and maintained his aged mother and sisters, who had no other means of support. They were not in the same household, but the circumstances explain this and show it to be entirely reasonable. Clearly petitioner, whose established business was in Philadelphia, could not reasonably be expected to live with his mother in Newport; and his mother and sisters, having lived for more than fifty years in Newport, could not reasonably be required to live with him in Philadelphia. Where the separate homes are thus justified, they do not preclude the statutory exemption, Estate of Grace Adams Howard, 42 B. T. A. 449; Hassard Short, 39 B. T. A. 567; William Lee Tracy, 39 B. T. A. 578; Meier S. Block, 37 B. T. A. 945; Olive Ross, 37 B. T. A. 928, although an unjustified separation may do so, cf. Henry P. Kishner, 42 B. T. A. 456; Claude S. Rucker, 42 B. T. A. 32. The fact that petitioner was the sole support of the Newport household may itself be fairly regarded as giving him the right to exercise family control, and the suggestions which he occasionally made of household economies and the consultation as to financial matters, although very slight, are some indication that some control was recognized—enough in a harmonious family to have significance. Cf. Sidney Williamson Kirtland, 39 B. T. A. 959.

The determination is reversed.

Decision will be entered for the fetitioner.

       Art. 25-4. [Regulations 94.1 Personal exemption of head of family.—A head of a family is an individual who actually supports and maintains in one household one or more individuals who are closely connected with him by blood relationship, relationship by marriage, or by adoption, and whose right to exercise family control and provide for these dependent individuals is based upon some moral or legal obligation. In the absence of continuous actual residence together, whether or not a person with dependent relatives is a head of a family within the meaning of the Act must depend on the character of the separation. If a father is absent on business, or a child or other dependent is away at school or on a visit, the common home being still maintained, the additional exemption applies. If, moreover, through force of circumstances a parent is obliged to maintain his dependent children with relatives or in a boarding house while he lives elsewhere, the additional exemption may still apply. If, however, without necessity the dependent continuously makes his home elsewhere, his benefactor is not the head of a family, irrespective of the question of support. A resident alien with children abroad is not thereby entitled to credit as the head of a family. As to the amount of the exemption, see article 25—3.

        Estate of Grace Adams Howard, 42 B. T. A. 449; Meier S. Block, 37 B. T. A, 945; Alfred E. Fuhlage, 32 B. T. A. 222, dismissed, 79 Fed. (2d) 998.


text:
    Neils Schultz, Petitioner, v. Commissioner of Internal Revenue, Respondent. Ellen Schultz, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 100440, 100441.
    Promulgated April 9, 1941.

      Robert B. Gaylord, Esq., for the petitioners.

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

Steknhagen:

1. The Commissioner denied the petitioner’s claim that the Millbrae profits were capital gains and held that the profits were ordinary gains because the property was “held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business”, Revenue Acts of 1934 and 1936, sec. 117 (b). This is true, as shown by the evidence upon which the finding has been based, A. R. Calvelli, 43 B. T. A. 6. The petitioner suggests that this opinion be withheld until decision on review of Florence H. Ehrman, 41 B. T. A. 652 (on appeal C. C. A., 9th Cir.). However, that case is distinguishable and would not require a decision upholding the petitioner’s contention even if the Board’s decision should be reversed. This is not to be expected, see Welch v. Solomon, 99 Fed. (2d) 41; Richards v. Commissioner, 81 Fed. (2d) 369. The petitioner acquired his interest in the land and the venture for the sake of the profit to be derived from its exploitation. He bought it and held it primarily for sale to customers and not to deal with as a whole or as an investment. The Commissioner’s determination is sustained.

2. The Commissioner held that the profit received by petitioner as his share of the proceeds of sales of lots in the Marina tract was not capital gain. The evidence establishes and the finding has been made that the property was held by petitioner and his associates primarily for sale to customers in the ordinary course of trade or business. The Commissioner’s determination was correct. There is no reason to debate whether the group constituted a partnership, for that is irrelevant; and it is also unimportant whether petitioner may have been in the real estate business completely or only to some extent. The question is whether the evidence shows that the property from which the particular income was derived was within the description of the statute, Thompson Lumber Co., 43 B. T. A. 726. We hold that it was within the statutory exception to the definition of capital assets. The determination is sustained.

3. The Fillmore Street property was treated by the Commissioner as within the definition of a capital asset, the loss on the sale of which was limited to $2,000, The evidence shows, however, that the petitioner’s interest was acquired by him as an incident of his business and for the purpose of sale for a profit. Although it was, for the time being, rented and yielded an income, this was not the primary purpose for which it was acquired or held. It was conveyed to avoid foreclosure and a deficiency judgment. This was a sale, Helvering v. Hammel, 311 U. S. 504, but not of a capital asset. The loss is deductible without the limit of capital losses. The determination is reversed.

4. The petitioner on his returns deducted $11,011.81 for 1935, $18,595.62 for 1936, and $17,035.57 for 1937, as “rent, repairs and other expenses,” $1,571.20, $1,947.05, and $1,379.65, respectively, were called “general expenses.” The Commissioner disallowed $1,178.40, $1,428.47, and $1,034.74 of these amounts because they were “not substantiated.” In other words, he allowed about one-fourth of the amounts deducted as general expenses. All that the evidence shows is petitioner’s general statement of how the amounts were spent. Presumably the Commissioner had as much information as this when he made the determination and was unable to verify it. It can not be said that petitioner’s reiteration on the witness stand gives the claim any greater support. This is not like the situation in Cohan v. Commissioner, 39 Fed. (2d) 540, for the Commissioner has not disallowed the entire deduction. He has recognized that “something was spent”, and has made presumably “as close an approximation” as he could. There is nothing upon which the Board can base a different or greater approximation. The determination is sustained.

5. The Commissioner reduced the deduction for depreciation of furnishings of the Pennwell Apartments by $619.57, $610.64, and $621.96, respectively. For no reason stated in the deficiency notice, he apparently adopted a computation based on the depreciation already deducted for the prior years, a remaining life of six years for the furnishings on hand, and a life of ten years for the current additions, thus allowing deduction of $66.24, $75.17 and $77.59, respectively.

We can find no justification for the Commissioner’s disallowance. As shown by the evidence, six or seven years is not too short an estimated life for the furnishings of these apartments as a basis for a reasonable allowance for depreciation. This should properly include the cost in 1931 of the refrigeration system, irrespective of whether that system may for some legal purposes be regarded as part of the realty. The amounts deducted by the petitioner in the years in question are shown to be reasonable. The determination is reversed and the deductions taken by the petitioner are sustained.

6. The Commissioner included in petitioner’s income the earnings of his minor son- These amounts were paid to the son by petitioner. It is not clear in the record how these amounts are accounted for in the returns. The deficiency notice states that a deduction of $265 was taken on the 1935 return for compensation paid by petitioner to two minor sons; that for 1936 petitioner failed to report $275 salaries or wages received by a minor son; and that for 1937 $100 was included by the Commissioner as the earnings of a minor son.

Ever since the Revenue Act of 1918, Regulations 45, article 291, through the current regulations, Regulations 103, section 19.2A-1, the regulations have consistently provided that allowances of a father to a minor child to whose services he is entitled are not deductible. This long unquestioned existence is alone a strong support for the rule. However, it is manifestly correct. There is nothing besides the payments themselves to suggest that the petitioner may have emancipated the child, and the argument to that effect can not be adopted.

The Commissioner’s treatment of the payments to petitioner’s minor son is sustained.

7. The Commissioner included in petitioner’s income $547.50 in 1936 and $1,000 in 1937, being advanced rents received. Petitioner argues that because his accounts are kept on the accrual basis and these amounts were by California custom the advance payments for the last month of the tenancy, they must be accounted for as income in the year in which that last month occurs. The argument must be rejected. The amounts, having been received by petitioner in the earlier years, were his income in those years, even though the accrual method was used, Commissioner v. Lyon, 97 Fed. (2d) 70. The determination is sustained.

Decision will be entered? imder Rule 50.


text:
    Council Bluffs Grape Growers Association, Petitioner v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98498.
    Promulgated April 9, 1941.

      John L. Peterson, Esq., for the petitioner.

      Gene W. Reardon, Esq., for the respondent.
   OPINION.

TURNER:

The respondent determined deficiencies in income tax for the years 1934 and 1935 in the respective amounts of $488.02 and $388.02, and excess profits taxes for the same years in the respective amounts of $177.46 and $117.97. The only issue is whether the petitioner is exempt from tax as a farmers’ or fruit growers’ cooperative marketing association within the meaning of section 101 (12) of the Revenue Act of 1934.

The case was submitted upon a written stipulation of facts and the facts as stipulated constitute our findings herein. •

The Council Bluffs Grape Growers Association was organized as a, corporation under chapter 390, Code of Iowa 1924, and ever since its incorporation in 1927 has had its principal place of business in Council Bluffs, Iowa. It was organized for the purpose of handling upon a commission basis fruits and products of its members and to buy, sell, and handle other commodities which may be incidental and necessary to the proper conduct of its business. Persons engaged in the production of the products or in the use or consumption of the supplies handled by or through the petitioner, including the lessors and landlords of lands used for the production of such products who receive as rent part of the crop raised on the leased premises, may become members of the petitioner association.

Under petitioner’s bylaws, which were adopted in April 1927 and were in effect during the taxable years 1934 and 1935, the manager of the association was authorized to receive and ship fruits for nonmembers. The bylaws provide that “The Association shall charge 10 per cent for selling produce handled by it and such additional charge for ice and handling as the Board of Directors may deem necessary, equitable and just with the exception of apples or pears in carload lots, then 5 per cent selling charge will be made. When 5 per cent is charged those particular fruits do not enter into refund.” The bylaws also provide that the refund which would ordinarily be paid to members of the association “shall be withheld for a period of five years beginning in 1927 and such refund for such periods shall be used to build up a cash reserve for the association to aid and assist in the proper conduct and carrying on of its business. * * * At the annual meeting of the association in January after the expiration of said five years, and at each annual meeting thereafter a refund may be ordered paid to the membership on the basis of the amount that such members would have coming for the fifth year previous to the ordering of the paying of the refund.”

Since the adoption of its articles of association the petitioner’s business has been conducted generally on a cooperative basis. The association has no capital stock, but in lieu thereof issues memberships to growers, who are required to pay a fee of $10 and annual dues of $1. All memberships are held by producers.

The petitioner transacts business for both member and nonmember patrons. “Non-member growers were not entitled to share in the corporate profits in 1934 and 1935. The earnings of petitioner in the amount of $3,250.04 in 1934 and $902.80 in 1935 were set up on the petitioner’s books as an accrued liability to member growers’ refund account and the member growers were issued unpaid refund certificates in accordance with the by-laws then in effect.”

“In 1935 the above amounts, totaling $4,152.84, were credited to working capital reserve which is shown on the petitioner’s books and income tax returns for 1934 and 1935 as ‘net worth’ account, from unpaid refund certificates. No patronage dividends were paid in cash to either member or non-member patrons for the years 1934 and 1935.”

“The petitioner only transacted business with producers during the years 1934 and 1935, and during said years about 5 per cent of the gross business of petitioner was transacted with non-member growers. No patronage dividend credit was made to non-members which might enable them to receive their proportionate share of profits for 1934 and 1935 upon becoming members.”

The main crop handled by petitioner consisted of grapes, which, prior to the agricultural depression, petitioner was able to market when packed in baskets. Since about 1933 petitioner has been able to market only a portion of the grapes so packed. Upon the repeal of national prohibition it began marketing the balance of the grapes by making them into wine. A Federal permit as a winery was granted to petitioner in 1933 and in that and subsequent years it became necessary for it “to expend large sums of capital for wine-making equipment and large funds were required in order to age the wine for three years before it could be marketed.”

On September 4, 1937, the petitioner amended its bylaws to permit nonmember patrons to participate or share in patronage dividends equally on the same basis as members.

The petitioner filed income tax returns for the years 1934 and 1935 in which it claimed exemption from the tax. The respondent denied the exemption, made certain adjustments in net income, and determined the deficiencies shown above.

In support of its contention that it has qualified as an exempt cooperative marketing association within the meaning of the act, the petitioner asserts on brief that during the years 1934 and 1935 the members and nonmembers of the association were “treated equally.” It also contends that the exemption should not be denied since the business transacted with nonmembers was “negligible.” The respondent contends that, since the nonmembers neither shared nor were entitled to share in the profits of the association during the taxable years, it did not qualify as a corporation exempt from tax.

Section 101 (12) of the Revenue Act of 1934 of the statute provides that “farmers’, fruit growers’, or like associations organized and operated on a cooperative basis (a) for the purpose of marketing the products of members or other producers, and turning back to ‘them’ the proceeds of sales, less necessary marketing expenses, on the basis of either the quantity or the value of the products furnished by them” shall be exempt from taxation. Obviously the petitioner does not qualify under the provisions of the statute quoted. Not only was it not organized for the purpose of turning back to nonmembers the proceeds from the sale of products sold for them less the necessary marketing expenses, but it did not actually turn back to nonmembers any part of such proceeds, and under its bylaws nonmembers had no right to such rebates. The petitioner argues, however, that members and nonmembers were in fact “treated equally” in that no rebates were made to either members or nonmembers “for the: years 1934 and 1935.” It further argues that the failure to make rebates was due to the accumulation of a reasonable reserve which was necessary to meet the changing conditions in the grape-growing industry resulting from the depression, and that the statute specifically provides that exemption shall not be denied to any such association “because, there is accumulated and maintained by it * * * a reasonable reserve for any necessary purpose.” In making the above argument the petitioner ignores the plain language and spirit of the statute. Congress has stated in clause (a) that in order to be entitled to exemption the association must be organized and operated “for the purpose of marketing the products” of its patrons, nonmembers as well as members, “and turning back to them the proceeds of sales, less necessary marketing expenses.” Clearly there was no purpose or intent in the organization of the petitioner to turn back to nonmembers at any time any part of the proceeds from the sale of their products, and the clause to the effect that exemption shall not be denied because of the accumulation of a reasonable reserve for any necessary purpose in no way relaxes the requirement under clause (a). To be entitled to exempt status not only must an association meet the statutory test as to purpose of organization, but it must be organized in such manner as to require the carrying out of that purpose. The petitioner here was not so organized. See Regulations 86, art. 101 (12) 1; Farmers Mutual Cooperative Creamery of Sioux Center, Iowa, 33 B. T. A. 117; Producers Creamery Co. v. United States, 55 Fed. (2d) 104; Fruit Growers Supply Co., 21 B. T. A. 315; affd., 56 Fed. (2d) 90; and Farmers Union Co-Operative Oil Co., Nelson, Nebraska, 38 B. T. A. 64. With further respect to the petitioner’s argument that members and nonmembers were “treated equally” in that no patronage dividends were paid to either member or nonmember patrons “for the years 1934 and 1935,” there is some question whether the record would support such a conclusion. According to the bylaws, the profits for any particular year could not be rebated even to members until the fifth succeeding year, and during the taxable years before us, 1934 and 1935, the only rebates permitted by the bylaws would have been from the profits realized for the years 1929 and 1930. The record is silent as to whether or not rebates were made in 1934 and 1935 for the years mentioned and, as we have already pointed out, no rebate could have been made to nonmembers under any circumstances, the bylaws not having been changed until 1937 to allow nonmembers to participate.

The respondent’s determination that petitioner is not an exempt organization is sustained.

Decision will be entered under Rule 50.


text:
    Annie Ratkowsky, an Incompetent, Douglass Newman, Hilda Matz and Irving Rogers as Committee of Her Person and Property, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101997.
    Promulgated April 10, 1941.

      Joshua Edelman, Esq., for the petitioners.

      Henry G. Ciarle, Esq., for the respondent.
   OPINION.

Van Fossan :

The first issue for our determination is whether or not incompetent is entitled to a personal exemption as head of a family in the taxable year. The .applicable provision of the statute is section 25 (b) (1) of the Revenue Act'of 1936.

Petitioners contend that, since- incompetent .supported her dependent children, and her right to provide for the children was based upon legal and moral obligations, she is entitled to the exemption. They maintain that, although incompetent did not support them within one household, force of circumstances required her to be separated from her family. Respondent argues that incompetent was not in any sense a head of the family, since she spent most of the time after 1929 in' various sanitaria and was physically and mentally incapable of looking after herself.

The statute does not define “a head of the family.” Eespondent’s Regulations 94, article 25-4, however, gives a definition of an individual who may be entitled to a personal exemption as a head of the family. We have considered this regulation and similar regulations under prior revenue acts and have held them to be a fair interpretation of the respective statutes. Charlotte Hoskins, 42 B. T. A. 117; Alfred E. Fuhlage, 32 B. T. A. 222.

In our opinion incompetent was not a head of the family within the meaning of the statute. She maintained no home in the taxable year. This is perhaps sufficient to deny the exemption. Florence W. Hunt, 35 B. T. A. 1042. Further, it seems clear that an individual claiming the exemption must have a right to exercise family control. The legal proceedings in which Mrs. Ratkowsky’s incompetence was declared deprived her of any right to exercise family control. Moreover, the incompetent was mentally incapable of exercising such control. Respondent is sustained on this issue.

The final issue is whether or not incompetent was entitled to a deduction from gross income of expenditures relating to the incompetency proceedings and other payments made pursuant to court order.

The incompetent was not engaged in a trade or business. The claimed deduction for expenditures, therefore, is not allowable on that ground. Commissioner v. Linderman, 84 Fed. (2d) 727; certiorari denied, 299 U. S. 589; Van Wart v. Commissioner, 295 U. S. 112. The fact that an early office decision of the Bureau of Internal Revenue (I. T. 2238, C. B. IV-2, p. 49) was favorable to petitioners is not determinative. Higgins v. Commissioner, 312 U. S. 212. Moreover, petitioners have made no argument that there was a detrimental reliance on respondent’s early ruling. We know of no ground on which the claimed deductions are allowable. Commissioner v. Linderman, supra.

Decision mill be entered for the respondent.

       A»t. 25-4. Personal exemption of head, of family.—A head of a family is an individual who actually supports and. maintains in one household one or more individuals who are closely connected with him by blood relationship, relationship by marriage, or by adoption, and whose right to exercise family control and provide for these dependent individuals is based upon some moral or legal obligation. In the absence of continuous actual residence together, whether or not a person with dependent relatives is a head of a family within the meaning of the Act must depend on the character of the separation.