author: LtttletoN

text:
    Appeal of JOHN E. LONERGAN.
    Docket No. 6441.
    Decided September 30, 1926.
    1. Loss upon sale of stock allowed.
    2. March 1, 1913, value of certain buildings determined.

      R. Kemp Slaughter, Esq., for the petitioner.

      Henry Ravenel, Esq., for the Commissioner.
    This appeal involves a deficiency in income tax for the calendar year 1918 in the amount of $6,991.37, arising in part from the disallowance by the Commissioner of an alleged loss of $22,572 upon the sale of certain stock, and of a deduction claimed for exhaustion, wear and tear of certain rental property.

      FINDINGS OF FACT.
    The petitioner is a resident of Philadelphia, Pa. During the period from October 6, 1906, to February 14-, 1914, he purchased 144 shares of the California Vineyards Co. at $100 a share, and the market value of such stock on March 1,1913, was equal to the amount paid therefor. Between July 6,1914, and November 6, 1915, he purchased 84 shares of the stock of this corporation for which he paid $100 a share, making a total of 228 shares costing $22,800. Pie had been a director of the company for several years prior to 1914. In that year he became president and has since occupied that position. Up to 1914 the company had operated at a profit, but due to crop failures in that and subsequent years the company became heavily indebted, and, in addition, suffered losses as follows:
    Year Amount
    1914_$14,772.12
    1915_ 17,036.78
    1916_ 4,478. 93
    1917_ 2,669.78
    1918_ 28, 552. 53
    In 1919 conditions improved and the company’s operations showed a profit, with the result that a considerable amount of this indebtedness was paid off. In 1922 and subsequent years the company sustained operating losses.
    Some time prior to December 2, 1918, the petitioner realizing that the stock which he owned in the company had greatly declined in value, and having in mind the taking of a loss in his individual income-tax return for that year, began looking for a purchaser. In this connection he consulted the accountant whom he had for several years regularly employed to audit his books and to prepare his returns, and was advised that it would be necessary for him to make a sale of the stock in order to take a loss. The petitioner stated to him that he would be willing to sell the stock for a nominal amount, and the accountant gave him the name of one Frank M. Speakman as a prospective purchaser. The petitioner did not know Speakman, and, although he was a partner of the accountant employed by the petitioner, the petitioner did not know this fact. The petitioner called to see Speakman and offered to sell him 228 shares of the California Vineyards Co. stock at $1 a share. Speakman accepted said offer and purchased said stock at that price, and on December 2, 1918, it was forthwith transferred to him upon the books of the company. The offer of the petitioner to sell the stock and the purchase thereof by Speakman was bona fide and without any agreement or understanding between the parties to the transaction that the stock would be repurchased by Lonergan.
    In May, 1922, petitioner became desirous of acquiring additional stock of the California Vineyards Co., and upon inquiry he found (that Speakman was still tbe owner of the stock which he had sold him in December, 1918, whereupon he made an offer to Speakman to purchase the 228 shares for $1 a share. This offer was accepted by Speakman and petitioner paid him $228, whereupon the stock was transferred to petitioner upon the books of the company.
    During the year 1918 the petitioner was the owner of certain dwelling houses in the City of Philadelphia which were acquired for rental purposes. These houses were purchased on the dates, at the cost, and had, on March 1,1913, a fair market price or value, as follows:

   OPINION.

LtttletoN

: All of the evidence in this appeal relative to the sale in 1918 of the stock of the California Vineyards Co. shows that the sale was bona fide and without any reservation or understanding between the seller and the purchaser that the stock would be repurchased, or that Speakman should not sell or dispose of it in any way he might desire. Testimony to this effect is uncontradicted. The petitioner testified fully concerning the transaction and was subjected to rigid cross examination. His entire testimony is consistent with the theory that he parted absolutely with all control over the stock and that the sale was bona fide. James C. Burns, the petitioner’s accountant, who had prepared his returns and who advised the petitioner that it would be necessary for him to make a sale of the stock in order to take a loss, and who gave to the petitioner the name of Frank M. Speakman as a prospective purchaser, was called as a witness by the Commissioner, but he was not questioned concerning this transaction. To hold that petitioner is not entitled to the loss claimed would be equivalent to saying that the sale was a pretended one and therefore a fraud upon the revenue such as would subject petitioner to the penalty for filing a false and fraudulent return. The record does not, in our opinion, justify such a conclusion and the loss claimed should be allowed.

From the evidence submitted we have determined the fair market value on March 1, 1913, of the various buildings owned by petitioner and their remaining useful life on that date, and the deduction for exhaustion, wear and tear of such buildings during the taxable year should be computed in accordance with such determination.

Order of redetermination will be entered on 15 days’ notice, under Rule 50.


source: Caselaw Access Project

author: Smith:

license: Public Domain

text:
    Appeal of HENDERSON COTTON MILLS.
    Docket No. 5504.
    Decided September 30, 1926.
    Amounts paid for ordinary repairs are deductible from gross income even though in excess of the annual average.

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

      ‘William H. Lcuwder, Esq., and T. M. Wilkins, Esq., for the Commissioner.
    This appeal is from the determination of deficiencies in income and profits tax for the years 1919 and 1920 of $542.41 and $20,439.91, respectively. The petition alleges error (1) in the computation of invested capital, and (2) in the disallowance of a part of the amounts deducted for repairs to plant and equipment.
    FINDINGS OF FACT.
    The petitioner is a North Carolina corporation with offices at Henderson.
    In the determination of invested capital for the years 1919 and 1920, the surplus at the beginning of each year was reduced by income and profits tax paid during the year.
    In its income-tax returns for the years 1919 and 1920, the petitioner deducted from gross income $13,440.32 and $58,126.96 for repairs to its plant and equipment. Of these amounts the Commissioner disallowed the deductions of $4,360.08 and $23,394.51, respectively, on the ground that they were not expended for repairs and accordingly did not constitute ordinary and necessary business expenses. The petitioner for the year 1919 paid 200 bills for small items which were classified by it as “ repair items.” The largest bills were for gears which were used in the repair of certain machines. The petitioner admits an error in charging certain items as repairs for the year 1920. . In its return for 1920 the petitioner claimed a deduction of $58,126.96 for repairs, $12,662.85 of which was erroneously claimed. The petitioner paid $45,464.11 for ordinary repairs.
   OPINION.

Smith:

In the determination of its tax liability for the years 1919 and 1920 the petitioner computed its invested capital by reducing surplus shown at the beginning of each year by an amount for income and profits tax paid during each year upon income of the preceding year. The petitioner now claims the benefit of the rule laid down in the Appeal of Guarantee Construction Co., 2 B. T. A. 1145. This point must be decided adversely to the petitioner in accordance with section 1207 of the Bevenue Act of 1926. Appeal of Russel Wheel & Foundry Co., 3 B. T. A. 1168.

The second point relates to a disallowance by the Commissioner of a portion of the amounts deducted from gross income by the petitioner for each of the tax years in question for repairs. The position of the Commissioner upon this point is that the petitioner paid very large amounts for repairs in each of these years and presumably did not use for repairs all of the supplies purchased under that heading, and that certain amounts claimed to have been paid for repairs were for replacements and not for repairs.

The evidence is to the effect that the petitioner took no inventory of supplies used for repair work at either the beginning or the close of either of the tax years. It purchased supplies for repairs only as needed. The difference between the cost of supplies on hand at the beginning of 1919 and at the close of 1920 was not in excess of $200. We are of the opinion that the position of the Commissioner relative to the .purchase of supplies for repairs is untenable. During the year 1920 the petitioner was required to expend $3,440.61 for repairs to a reservoir, which was about 75 feet long. The petitioner’s coal chute was located next to the reservoir.- The wall of the reservoir caved in. At the time of the cave-in there were about ten carloads of coal on hand which was piled along the wall of the reservoir. This coal and the wall fell into the reservoir. It was necessary to scoop out the coal, brick, and mud and to replace the wall next to the coal chute. After the reservoir was placed in a usable condition it was in no better condition than it was in prior to the accident. Upon this evidence we are of the opinion that the amount spent upon the reservoir was for repairs and was an ordinary and necessary expense.

In our opinion the petitioner has fully supported its claim with respect to the deduction from gross income of $13,440.32 for repairs in 1919, and also its claim to the deduction of $45,46411 spent for repairs in 1920. Of the amount disallowed by the Commissioner for 1920, $12,662.85 was properly disallowed.

Order of redetermination will be entered on 15 days’ notice, under Rule 50.


author: MoRRis:

text:
    Appeal of HANFF-METZGER, INC.
    Docket No. 5079.
    Decided September 30, 1926.
    1. Personal service classification denied.
    2. The action of the Commissioner in including in gross income $6,828.44, a portion of a reserve for advertising short rates, approved.

      Clarence L. Johnson, C. P. A., for the petitioner.

      J. Arthur Adams, Esq., for the Commissioner.
    This is an appeal from the determination of a deficiency in income and profits taxes in the amount of $20,764.74 for the calendar year 1919. The taxpayer claims that the Commissioner erred (1) in refusing to allow it classification as a personal service corporation, and (2) in adding to gross income $6,828.44, a portion of a reserve for advertising short rates.
    FINDINGS OF FACT.
    The taxpayer is a New York corporation having its principal office in New York City. It was organized in 1913 and is engaged in conducting the business of an advertising agency.
    The original issue of capital stock was $25,000; which was paid in in cash. On January 1, 1919, the outstanding stock amounted to $50,000. On December 21, 1919, the outstanding stock amounted to $300,000, consisting of 3,000 shares of a par value of $100, the percentage held' by the several stockholders being as follows:
    Per cent.
    Joseph A. Hanff-approximately_34
    Joseph P.' Metzger-do_34
    A. O. Dillenbeck_do_16
    D. M. Jones_do_ &y2

    Arthur De Cossoy-do- 6Y2

    L. J. Seeger- 3
    O. J. Atkinson_'_1_ 2
    The increase of $275,000 in capital stock was issued to represent good will. The stock issued to Jones, De Cossey, Seeger and Atkinson was given them by the taxpayer for their cooperation.
    All of the stockholders devoted their entire time to the business of the taxpayer. Hanff, Metzger, and Dillenbeck were the directors and executives of the company. They directed the work of the taxpayer and principally made the contracts with advertisers. Seeger was the treasurer, Atkinson had charge of sending out orders, and De Cossey was in charge of executing the art ideas.
    The business of the taxpayer originated for the most part from contact between one of its executives and a prospective client and to some extent through the employment of solicitors. After a contact was made, it was customary for the taxpayer to make a thorough survey and analysis of the advertiser’s business, its products, the cost thereof, and the possible market. These factors, and the items taken into consideration in determining them, were reflected in chart form. At times the taxpayer suggested new products which it believed the advertiser could profitably manufacture and market, and prepared and submitted containers and trade-names designed to aid in marketing the advertiser’s products.
    An example of the taxpayer’s method of operation is shown in the case of a firm which, prior to 1919, had made a product for brewers. With the approach of National prohibition this firm found it necessary to put its plant to other uses. It consulted the taxpayer, which, after making a survey of the business possibilities, recommended the manufacture of corn products, such as corn flour, corn meal, hominy grits, and similar foods to which they found the mill could be adapted. The taxpayer then recommended that in this line of goods a leader be adopted which would be advertised extensively and carry most of the line. In order to carry out this idea the taxpayer gave the entire line a distinctive name and designed a series of packages which would make an attractive appearance on grocery’ shelves, the package for each product having a different color combination, but all the packages having sufficient similarity to be recognized as belonging to this special group of corn products. The taxpayer wrote all the advertising copy for this firm and assisted its sales manager in the direction of the sales force.
    In another case, that of an oil company, the advertiser had two kinds of oil, one a light or golden color and the other a dark oil. About 85 per cent of its sales had been the dark oil, as the public was familiar with oil of that color. The taxpayer, after considering the matter carefully, recommended that the golden colored oil be advertised. This was done, the advertisements of a golden colored stream of oil becoming the means of introducing a distinctive product, with the result that within three years the sales of the company’s oils had not only increased greatly, but 85 per cent of the company’s business was the sale of the golden colored oil.
    After an advertising campaign had been prepared and the mediums of advertising selected by the taxpayer, the advertisers wo’uld either indorse a schedule of advertising or give the taxpayer a written order. The taxpayer would then contract for space, in the name of the advertiser, with the advertising mediums which had been decided upon, such as magazines, newspapers, trade papers and billboards. The taxpayer neither owned any advertising mediums nor contracted for space in its own name.
    The publishers of the advertising mediums billed the taxpayer for the amounts due on the space used, showing on the bills the space used by each advertiser and the amount due therefor. The publishers us'ually gave a discount of 2 or 3 per cent for payment within the month in which the bill was rendered, and this discount was allowed by the taxpayer to the advertisers. The publisher usually billed the taxpayer from 12 to 15 days before the discount date, whereas the taxpayer customarily billed the advertisers from 15 to 40 days before that date. The taxpayer was able to do this for the reason that it knew in each case the amount of space contracted for, the publisher’s rate per line-, and the rate of discount allowed by each publisher. In most cases the advertiser was allowed the discount on the gross amount of the bill, whereas the discount allowed the taxpayer was computed on net amount, that is, the gross amo'unt less the taxpayer’s commission of 15 per cent. The commissions allowed the taxpayer by publishers constituted the greater part of its income.
    The taxpayer’s income and expenses for 1919 were as follows:
    Income. Expenses.
    Publication commissions. $152, 371. 05 Art department expenses- $2,137.41
    Billboard commissions_ 10, 324. 22 Commissions to solicitors- 11,002. 04
    Trade commissions_ 1,196. 87 Traveling-■ 3, 655. 45
    Service department_ 5,166.22 Carfares_ 624.77
    Discounts earned_ 20, 221. 69 Entertaining_ 1, 290. 80
    Messenger service_ 514. 65
    Telephone_ 1, 069.02
    Postage_ 1, 515. 41
    Expressage_ 39. 03
    Business getting_ 3, 354.77
    Rent_ 6, 0ÓO. 00
    Payroll_ 75,117.93
    Repairs_ 342. 89
    Cleaning_ 737. 00
    Stationery_ 2, 221. 32
    Legal_ 746. 90
    Light_ 136. 22
    Depreciation on furniture and fixtures_ 776.46
    Depreciation on library_ 25.65
    Customers account written off_ 5,037.38
    Miscellaneous_ 2, 646. 73
    Discounts allowed_ 21, 594.63
    Taxes_ 4, 902. 74
    Profit for year_ 43, 790. 85
    189,280.05 189, 280.05

      The item of $152,371.05 listed as publication commissions represents the 15 per cent commissions allowed the taxpayer by publishers, which the taxpayer, in remitting to the publishers, deducted from the payments received from advertisers. The item of billboard commissions represents the taxpayer’s commission on advertising placed on billboards. The item of $1,196.87 listed as trade commissions represents the amount received for placing advertising for two hotels. In exchange for the advertising the hotels gave the publishers due bills which were good for trade at the hotels and the publishers paid the taxpayer a 15 per cent commission on the amount of advertising placed with them. The amount of $5,166.22 shown as income from service department is made up of 15 per cent commissions on engraving, electrotyping and other mechanical work handled for advertisers. The taxpayer sent out work of this kind to be done by others and charged the advertisers a commission on the bills rendered. The item of discounts earned represents discounts allowed the taxpayer by publishers for payment of bills within a specified time. The taxpayer always took advantage of these discounts which were figured on the charge for space after deducting the taxpayer’s commission.
    The item of $11,002.04 shown as commissions to solicitors is the amount paid to persons employed to solicit advertising. They were paid one-third of the commissions on the business they obtained. The item listed as expense for “ business getting ” represents expenditures for experiments made by the taxpayer which it felt could not properly he charged to advertisers. The payroll expense of $75,117.93 included salaries of officers and stockholders. The amount paid employees who were not stockholders, exclusive of officers and solicitors, was $34,432.93. The taxpayer had about 35 or 40 employees who were not stockholders. Included in this number were the following:

    The item of discounts allowed represents the amounts allowed advertisers for payment of bills before a specified date. This item is larger than the amount shown in the income column as discounts earned due to the fact that the discounts allowed advertisers were figured on the amount of the bill before deduction of the taxpayer’s commission.
    The balance sheets for 1919 were as follows:

    The accounts receivable in both balance sheets represent amounts billed to advertisers. Notes receivable covers amounts loaned to employees. Commissions receivable of $579.52 is the amount due the taxpayer at that time in a case where the publisher billed the advertiser direct and the taxpayer received its commission from the advertiser. The item of advances to solicitors represents the amounts drawn, but not at that time earned, by persons employed as solicitors. The furniture and fixtures account covers the desks and similar furniture. The account listed as unbilled art and service is the amount due from advertisers on work done, such as drawing, in the preparation of advertising. In most of these cases the taxpayer received payment from the advertisers before paying the artist or mechanic who did the work. The good will shown was entered to increase the capital so as to be in keeping with the dividends. The stock subscription items represent the taxpayer’s subscriptions for stock in the Outdoor Bureau and the Advertising Agency Association. The Outdoor Bureau is an organization through which advertising agencies place their billboard advertising and the taxpayer subscribed for stock in order to become a member. The Advertising Agency Association was organized by advertising agents during the World War to assist the Government in its advertising work. The item of Liberty bonds represents bonds purchased by the taxpayer for its employees and for which the employees were permitted to pay on the installment plan.
    The “ accounts payable advertising ” are the amounts payable to publishers for advertising placed by the taxpayer for its clients. The reserves for short rates represent reserves accumulated for the purpose of adjusting the amounts finally, determined to be due upon the completion or termination of contracts. This situation arises from the fact that publishers have a sliding scale of rates for advertising space, granting to advertisers who use a large amount of space a lower rate than those who use a small amount. The publishers billed the advertisers through the taxpayer for space at the rate contracted for, but it sometimes happened that during the contract period the advertisers would use either more or less space than originally contemplated and in such cases an adjustment of rates would be in order. For example, an advertiser might estimate that it would run 6,000 lines of advertising in a certain publication during the year. This amount of space perhaps could not be obtained for as low a rate as could 10,000 lines, so in this situation the taxpayer, in handling the account, would contract with the publisher for 10,000 lines in the name of the advertiser. The publisher would render bills at the 10,000 line rate. The taxpayer would render its bills to the advertiser at the higher, or 6,000 line, rate and remit to the publisher at the 10,000 line rate, placing the difference in the “ reserve for short rate account.” If at the end of the year the advertiser had used only 6,000 lines, the publisher would render a bill for the difference between the 10,000 line rate contracted for arid the higher rate applicable to the 6,000 lines used. This bill would be paid by the taxpayer out of the reserve created. If, on the other hand, the advertiser used the full 10,000 lines, it would be entitled to the lower rate applicable to such space and the taxpayer would refund to it the excess it had paid on the basis of the 6,000 line rate.
    In 1919 the taxpayer was a member of the American Association of Advertising Agencies, the Associated Ad Clubs of the World, and the Outdoor Bureau.
    The Commissioner denied personal service classification, and added to the taxpayer’s gross income $6,828.44, a portion of a reserve for advertising short rates.
   OPINION.

MoRRis:

We are of the opinion that the taxpayer is not entitled to classification as a personal service corporation. Appeals of McLain, Hadden, Simpers Co., 2 B. T. A. 531, and Matos Advertising Agency, 3 B. T. A. 62.

With respect to the item of reserve for short rates, the taxpayer contends that this is not income but an increase in its liabilities. This contention, on its face, is unsound. The funds for which this reserve was created were collected by the taxpayer from its clients as a regular part of its business. There does not seem to have been any distinction made, at the time of collection, in billing clients or otherwise, between the amounts which were admittedly income and the amounts placed in the reserve. As far as the record shows, this segregation of receipts was a voluntary act on the part of the taxpayer, for the purpose of providing funds from which payment could be made upon completion of the contract either to the publisher, if the lower rate had not been earned, or to the advertiser, if all the space contracted for by the taxpayer had been used. The question of the deduction of reserves has been before the Board in a number of cases. In the Appeal of William J. Ostheimer, 1 B. T. A. 18, 21, we said:

The revenue laws prior to the 1921 Act have never recognized reserves as being deductible from gross income in determining net income except in the case of insurance companies. * * * The statute specifies what deductions are allowable and, except in the case of insurance companies, no provision is made in the 1918 Act for the deduction of a reserve as such. Items of expense must actually have been paid or liability therefor incurred in order to be deductible under that Act.

See also Appeals of Consolidated Asphalt Co., 1 B. T. A. 79; Uvalde Co., 1 B. T. A. 932; Morrison-Ricker Mfg. Co., 2 B. T. A. 1008.

In Appeal of Kleeman Dry Goods Co., 2 B. T. A. 369, a deduction for a so-called reserve was allowed upon the finding that the amount claimed represented liabilities actually incurred. In the present appeal, the liability on the part of the taxpayer to refund to the advertiser or to make additional payments to the publisher was not incurred until the completion of its contract with each client. No evidence was offered to show what part, if any, of the reserve was attributable to contracts completed or terminated during the taxable year.

Judgment for the Commissioner.

Phillips and Sternhagen dissent.


author: Smith

text:
    Appeals of ARTHUR H. LEONARD, CHARLES M. LEONARD, and FLETCHER L. BARROWS.
    Docket Nos. 3156, 3157, 3158.
    Decided September 30, 1926.
    A partnership sold a part of its assets and divided the balance among the partners upon the basis of values placed upon them by accountants, which values were less than book values. Held, that the evidence does not show that the partners sustained a loss as a result of the division of the assets among them.

      Charles P. Choate, Esq., for the petitioners.

      Thomas P. Dudley, Jr., Esq., for the Commissioner.
    These appeals are from determinations of deficiencies in income tax for the years 1918 and 1919 as follows:

    Only a portion of these amounts is in controversy. The taxpayers allege error on the part of the Commissioner (1) in the computation of allowable depreciation on patterns, lasts, and dies for the years 1918 and 1919, and (2) in the disallowance of the deduction from gross income of certain dissolution losses.
    The taxpayers were members of a partnership, under the firm name of Leonard & Barrows, engaged in the manufacture and sale of men’s and boy’s boots and shoes, with plants at Micldleboro, Mass., and Belfast, Me. The partnership had been in existence for many years prior to 1913. By written agreement dated December 31, 1919, the partnership was dissolved as of that date. This agreement provided “ for the liquidation of their business [the partners’] by a division of its assets between them.”
    The dissolution was precipitated by a demand made by letter from Arthur H. Leonard to his partners, dated January 14, 1919, exercising his right, in accordance with the articles of the copartnership, to terminate the partnership at the end of the year. He insisted on acquiring the Belfast plant so that he 'might thereafter conduct it as his own individual business. He had consulted his lawyer about this and his partners employed their lawyers to oppose dissolution on that basis. Arthur H. Leonard also employed his accountant and the other two partners employed their accountant to make the determinations of values at which the assets were to be transferred to the several partners. After numerous conferences between counsel, it was finally agreed that the Belfast plant should be transferred to Arthur H. Leonard and that the two accountants should work out the capital interest of each partner, credit him therewith, debit him with assets taken over by him, and adjust the balances in cash.
    To work out the capital interest of the partners it was necessary to value the assets. The values were determined by the two accountants after considerable negotiation and trading back and forth between Arthur H. Leonard and his partners. Some of the assets were sold to outsiders and other assets, including the two plants., were transferred to the partners at agreed values. The accountants wrote down or set up reserves against various assets to reduce them to liquidating values. They set up a reserve for purchase discount, a reserve for sales discount, an item of accrued expenses for fees of auditors and lawyers in connection with the dissolution, a reduction in the value of certain securities, a reserve for bad debts, and an adjustment for prepaid taxes.
    In computing the firm’s net income for 1919, the partners deducted as losses the amounts by which the accountants reduced the book values of the items referred to above to liquidating values. Among the amounts thus deducted were certain amounts disallowed as deductions by the Commissioner as follows:
    1. Reserve for purchase discount-$11, 308. 41
    2. Reserve for sales discount_ 38, 853. 83
    3. Accrued expenses_ 4, 000.00
    4. Write-down on securities_ 2, 816. 00
    5. Addition to reserve for bad debts_ 700. 00
    6. Adjustment for prepaid taxes_ 3, 512. 51
    61,190.75
    Less:
    Reserve for bad debts transferred to selling expense_ 967. 99
    Amount in dispute_ 60, 222.76
    The reserve for purchase discount included the discounts on purchases allowable for cash payments within the period of credit and was used to reduce inventory accordingly. The reserve for sales discount included similar discounts allowable to customers of the partnership. The item of accrued expenses represented an estimate of legal and accounting expenses in connection with the dissolution, the exact amount of which had not been determined at the close of 1919. The write-down on securities represented the difference between the cost of certain securities and their market value at December 31, 1919. The addition to reserve for bad debts represented an estimate of the accounts receivable which would prove worthless. The adjustment for prepaid taxes represented an amount which appeared as such on the partnership’s books of account in 1919.
    The liquidation of the affairs of the partnership proceeded in 1920. In that year payments in cash, aggregating $18,942.16, were made to Arthur H. Leonard by the other two partners who had taken charge of the liquidation of the partnership.
    In the computation of allowable depreciation upon patterns, lasts, and dies for the years 1918 and 1919, the Commissioner did not allow any deduction for depreciation in respect of patterns, lasts, and dies purchased during the years 1911, 1918, and 1919. Depreciation was sustained upon these assets at the rate of 33% per cent annually.
    The partnership of which the taxpayers were members kept its books of account upon the accrual basis.
   OPINION.

Smith

: The taxpayers allege two errors on the part of the Commissioner in the determination of tax liability for the years 1918 and 1919:

First, that he made an error in his mathematical calculation of the depreciation deductible from the gross income of the partnership for the years 1918 and 1919 upon patterns, lasts, and dies purchased during the years 1917, 1918, and 1919;

Secondly, that he disallowed as deductions from gross income certain losses alleged to have been suffered by the taxpayers as a result of the dissolution of the partnership.

Upon the first point the taxpayers allege that the Commissioner allowed depreciation upon patterns, lasts, and dies on hand on January 1, 1917, at proper rates for 1918 and 1919, but that he failed to allow any deduction for depreciation on patterns, lasts, and dies acquired during the years 1917, 1918, and 1919 for the two taxable years under review, and that depreciation was sustained upon such assets at the rate of 33% per cent per annum. The Board finds from the evidence that depreciation was sustained upon these patterns as claimed by the taxpayers.

The second point in issue is stated by counsel for the taxpayers as follows:

* * * It arises out of tlie Unit’s refusal to allow tlie partners to deduct the losses they sustained when the accountants at the time of dissolution on Decern-ber 31, 1919, wrote clown the book values to liquidating values by setting up the various reserves, charging Up the dissolution expenses and writing down securities. Ii the taxpayers prevail on this issue the not income for 1919 will be * * * reduced by $60,222.76.

He then states that the Commissioner claimed that, because upon dissolution the Belfast plant was transferred to Arthur H. Leonard and the Micldleboro plant was transferred to his partners, it was a distribution in kind within the meaning of article 1510 of Regulations 45. and that no profit or loss can be predicated upon such a distribution. He contends, however, that article 1510 is inconsistent with and not authorized by section 202 of the Revenue Act of 1918, and also that the transfer of the assets to the partners was not a distribution in kind but amounted to a sale of the two plants, by the firm to the respective partners.

The agreement of dissolution dated December 31,1919, provided in part:

The business of the copartnership shall be liquidated by Charles M. Leonard and Fletcher L. Barrows in accordance with the methods hereinafter set forth. For the purpose of such liquidation, the books of the copartnership as now made up shall be deemed to be accurate, except as modified or corrected by the schedule hereto annexed, marked ‘A’, and shall govern the amounts payable to the several partners. The books shall be made up at the conclusion of the present run in the usual manner, with the exception that all new run merchandise, new run payrolls, and new run expenses shall be entered on the books up to and including December 31, 1919, and the liabilities for the same shown in the books, but said new run property shall not include any new run lasts, dies, patterns or blocks which were not used in completing the old run, and the profits thus determined shall be divided between the partners at the time and in the manner which follow.
***#*$#
V. FINAL DIVISION OF PROPERTY IN LIQUIDATION.
The present old run shall be finished in each factory, and the goods shipped therefrom to fulfill the present old run orders. The bills for the same shall be sent out in the name.of Leonard & Barrows, and payments therefore made to Leonard & Barrows in Liquidation. The expenses of finishing the said old run shall be provided for out of the partnership assets, and any advances necessary for such purpose shall be made to said Arthur H. Leonard, Charles M. Leonard, and Fletcher L. Barrows respectively. The Liberty bonds standing to the account of the Belfast plant shall be taken over by Arthur H. Leonard at the amount thereof, and the Liberty bonds standing to the account of the Middle-boro plant shall be taken over by said Charles M. Leonard and Fletcher L. Barrows at the amount thereof. The shares of the stock in the United Shoe Machinery Company shall be sold to the best advantage, and the proceeds of such sales applied in payment of the liabilities of the copartnership. * * *

Granted that the conveyance of the Belfast plant to Arthur H. Leonard and the conveyance of the Middleboro plant to Charles M. Leonard and Fletcher L. Barrows were sales of property from which the partners might individually derive a profit or a loss, we are not in possession of any information which enables us to determine whether any of the taxpayers sustained any gain or loss in respect of such conveyances; neither are we in possession of any information which enables us to determine whether any loss was sustained by the partnership upon the liquidation of the several assets in the manner in which that liquidation was carried out. It was contemplated by all parties that the two liquidators, Charles M. Leonard and Fletcher L. Barrows, should wind up the affairs of the partnership and distribute any proceeds which might be received upon the accounts of the partnership in the year 1920. The evidence all goes to show that the accounts receivable of the partnership were collected and the accounts payable were liquidated and that distribution was made among the several partners in accordance with the dissolution agreement. Whether the liquidators collected in 1920 the full amount of the accounts receivable on December 31, 1919, is not in evidence. Upon the evidence of record, we must determine whether the reserves and accrued expenses claimed as deductions from gross income of the year 1919, amounting to $60,222.76, are legal deductions from gross income in the determination of the profits of the partnership for the calendar year 1919.

The reserve for purchase discount represents an estimate by the accountants of the amount of discounts which might be taken by the partnership at the time that it liquidated its accounts payable. The reserve for sales discount likewise represents an amount which the accountants estimated might be taken by creditors when they paid the amounts owed to the partnership on December 31, 1919. Whether the discounts provided for by these reserves were cash discounts or trade discounts is not apparent from the record. Apparently the partnership had never before set up reserves for discounts. Accounts payable and accounts receivable standing upon the books of the partnership at January 1,1919, were not offset by any reserves for discount.

The reason why inventories and accounts receivable and accounts payable are taken into account in determining the profits of a business for a given year is that only in that way can the profits be accurately determined. But for such purpose it is of the utmost importance that the inventories and accounts receivable and accounts payable be placed upon the same basis both at the beginning and at the close of each taxable period. Relative to the reserve for purchase discount ($11,308.41), a certified public accountant who appeared as a witness for the taxpayers was asked the question:

Q. From the standpoint of computing the gain, profit and loss or income of the partnership was it correct to charge these against the inventory?
A. Absolutely not; it was not done as a trading charge, although the individuals reported that in their tax originally. In my opinion, absolutely not allowed as a trade receipt against partnership income. This was simply a part of the dissolution procedure. I think, if I interpret Mr. Dudley’s [Commissioner's counsel] explanation that we could not consider this as a loss, that that could not be taken under the circumstances, that [but] that is not exactly the point; the taxpayer has never tried to handle it in that way. The taxpayer, as I understand, did show that on the return; but this could have been handled in another way, and I think that these accountants simply got together and said “ we will agree on this ” and show the account in this way and that is why there was a write down. * * *
Q. What would you consider it?
A. I would believe it was a loss in the disposition of the assets; that merchandise was inventoried in order to dispose of it after they reached the correct amount, and they wrote it down to find a basic price to the partners.
Q. Now, with respect to the question of items of sales discount of $38,853.83. Do you know how that was arrived at?
A. Exactly the same way, agreed by the two conferring accountants. They worked this out in their conferences until they got the account to where it was acceptable by them at this reduced value.

This Board has held in Appeal of Thatcher Medicine Co., 3 B. T. A. 154, that reserves for cash discounts which may be taken in the future are contingent reserves and are not allowable deductions from gross income. From the standpoint of determining the correct profits of the partnership for the year 1919, we are of the opinion that the reserves for discounts were not proper deductions.

The item of “ accrued expenses ” of $4,000 represents the estimate made by the accountants of the portion of the charges which might be made by lawyers and accountants for work performed during the year 1919 in connection with the dissolution of the partnership. In our opinion such amounts were not “ ordinary and necessary expenses ” and are not deductible from gross income.

The “ write-down on securities ” in the amount of $2,816 simply represented the shrinkage in the value of certain securities owned by the partnership. The statute provides for the deduction of losses sustained. These' securities had not been sold or disposed of at December 31, 1919, and the partnership had sustained no deductible loss in respect of them.

The “ addition to reserve for bad debts ” appears to have been only an estimate by the accountants of the percentage of the accounts receivable which would prove to be worthless. The statute (Revenue Act of 1918) permits the deduction of debts ascertained to be worthless and charged off within the year but not of any addition to reserve for bad debts.

The “ adjustment for prepaid taxes ” appears to have been a deduction made in 1919 for taxes of some character paid in a prior year. These were presumably real estate taxes, since these are the only taxes that the partnership was required to pay in advance. We think that this item was a proper deduction from the gross income of. the partnership.

From the foregoing, we are of the opinion that of the items in dispute only that for “ adjustment for prepaid taxes,” in the amount of $3,512.51, was a proper deduction from gross income in computing the income of the partnership for the year 1919. This, in our opinion, is the only item which could have been deducted if the partnership had not been dissolved at the close of 1919.

On behalf of the taxpayers, it is contended that the assets of the partnership distributed to the several partners were taken up upon the books of the partners at the values determined by the accountants representing the several partners. We are of the opinion, however, that this is not determinative of a gain or loss in respect of such assets. If the individual partner received from the liquidators in 1920, from the collection by them of accounts receivable, a less amount than his proportionate share of the accounts receivable as they stood on the partnership books at December 31, 1919, before there was any write-down of such accounts by the two accountants, that partner undoubtedly realized a loss from such collection. But such loss was not sustained in 1919.

Order of redetermination %oill be entered on 15 days' notice, under Bule 50.


author: Love

text:
    Appeal of ILLINOIS PAPER BOX CO.
    Docket No. 770.
    Decided September 30, 1926.
    1. Additional compensation for the year 1921, authorized in 1922, is not a deductible item for 1921.
    2. A motion made by the Commissioner to decrease invested capital for each year to the extent of the full tax paid for the prior year, instead of prorating such tax from the time it became due and payable, denied under authority of section 1207 of the Revenue Act of 1926.
    ' Samuel J. Moran, Esq., for the petitioner.

      B. H. Saunders, Esq., for the Commissioner.
    This is an appeal from the determination of a deficiency in income and profits tax for the years 1919, 1920 and 1921, in the amount of $2,942.28. The deficiency arose from the action of the Commissioner (1) in refusing to allow certain depreciation claimed by the taxpayer for 1919 and 1920, (2) in increasing income by the amount of certain donations, and (3) in refusing to allow additional compensation to officers for the year 1921. At the close of the hearing the Commissioner also moved that the invested capital of the taxpayer for each year be reduced by the entire amount paid subsequently as income and profits tax for the said years.
    FINDINGS OF FACT.
    The taxpayer is an Illinois corporation with its principal office at Chicago, and was incorporated in the year 1903. Prior to that time it was operated as a partnership.
    Prior to January 1, 1908, the taxpayer kept a single-entry system of books, but it kept no separate machinery or expense accounts. On or about January 1, 1908, the taxpayer opened a double-entry system of books. At that time the officers of the taxpayer made an appraisal of the machinery and other assets, based on the information contained in the old books and the condition of the assets as they existed at that time. For machinery they arrived at a value of $10,919.70, which was entered upon the books as the value of the machinery and equipment as of January 1, 1908. In the fall of 1908, upon solicitation of one Davis, who represented himself to be an experienced factory appraiser for insurance purposes, the taxpayer employed him to appraise its assets. This appraiser appraised the machinery and equipment at $15,341.05, or $4,361.35 in excess of the amount carried upon the books of the taxpayer at that time. On January 1, 19(09, the taxpayer wrote up the amount of $4,361.35 as an additional investment in equipment and has carried it upon its books ever since.
    As a basis of depreciation, the Commissioner accepted the taxpayer’s original valuation as carried upon its books January 1, 1908, namely, $10,979.70. The taxpayer used as a basis this same amount plus the $4,361.35 above referred to. There is no controversy over a 10 per cent rate of depreciation. The taxpayer and the Commissioner are also in accord as to the additions to the machinery account in arriving at the March 1, 1913, value, the only difference being the said $4,361.35. The depreciation disallowed by the Commissioner for 1919 and 1920 is only that resulting from the said additional amount written upon the taxpayer’s books January 1, 1909, based upon the said insurance appraisal and carried upon the books of the taxpayer through the ta,xable years in question.
    The Commissioner increased the gross income of the taxpayer for 1920 in the amount of $243, representing the amount of donations the taxpayer is alleged to have taken as deductions. The income-tax return of the taxpayer shows that it reported $227.85 as “ unallowable deductions,” and did not deduct the same from income before computing the tax.

      The principal stockholders and dominating directors in the management of the affairs of the taxpayer were H. A. Crofts and M. L. Twomley. Crofts had been president and treasurer of the corporation since its incorporation. Twomley acquired an interest in 1919 and acted as vice president and manager. These two stockholders, together with H. C. Crofts, a son of H. A. Crofts, and some employees who held qualifying shares, composed the board of directors. The board of directors held formal meetings but once a year, usually the latter part of January or the first part of February, at which time they adopted the recommendations of the said president and vice president.
    In prior years the president and vice president had drawn $230 per week as salary, but in 1921, owing to poor business conditions, this was reduced. On January 31,1921, the board of directors passed a resolution fixing the salaries of the Crofts and Twomley at $200 per week for the year 1921. On or about April 1, 1921, Twomley, while acting as president during the absence of Crofts, further reduced the drawing account of the two said officers to $150 per week. Upon the return of Crofts several months later, he protested and the salaries were restored to $200 per week. There was also some understanding that there would be a further increase to $230 per week, but the salaries were not credited on the books in excess of $200 per week until after the directors’ meeting of February T, 1922, as hereinafter referred to. On February 7, 1922, before the closing of the books of the taxpayer for 1921, the following resolution was adopted by the board of directors:
    On motion duly made and seconded and carried, the compensation of the president and treasurer, H. A. Crofts, for the year 1921, and the compensation of vice-president and general manager, M. L. Twomley for the year 1921 was increased $30 a week, and the same was ordered to be paid them as of December 31, 1921, on account of the inadequacy of the compensation fixed at the beginning of 1921.
    The increase of $30 per week was entered upon the books as of December 31, 1921, but the actual entry and payment of the increase were subsequent to the said meeting of February 7, 1922. It is this increase of salary, amounting to $3,120, which the Commissioner has disallowed and which is in controversy.
   OPINION.

Love

: In respect to the controversy over depreciation, there is no dispute between the Commissioner and the taxpayer as to the rate of depreciation or additions to the machinery account since January 1, 1909. The sole issue relates to the value to be used as the basis of depreciation. On January 1, 1909, the taxpayer increased its machinery account by $4,361.35, based on additional values attributed to the machinery by an insurance appraiser employed by the taxpayer. The Commissioner refused to recognize and accept this increase, and used as a basis the former valuation as carried upon the taxpayer’s books January 1, 1908. This amount is the only difference entering into the Commissioner’s and the taxpayer’s March 1, 1913, values and the amounts of depreciation in 1919 and 1920.

It appears that the taxpayer, on January 1, 1908, for the first time opened a double-entry system of books in which it kept a separate machinery account and expense account. The machinery valuations were based upon appraisals by the officers of the taxpayer derived from a personal knowledge of the condition of the equipment and the information contained in its old single-entry system of books. This valuation was carried upon the books until January 1, 1909.

In the fall of 1908 an insurance appraiser persuaded the taxpayer that it was entitled to more insurance and that he was qualified to reappraise the property. He was employed and as a result of his appraisal the taxpayer, on January 1, 1909, carried the increased appraised value upon its books. The appraiser was not present at the hearing for examination nor were any of the factors used by him in arriving at his valuations presented in evidence. The officers of the taxpayer knew nothing of his qualifications as an appraiser, either before or after his appraisal, except that he had letters of recommendation when he applied for employment. Under the circumstances, we are of the opinion that the Commissioner was justified in refusing to accept the increased valuations and correctly used the taxpayer’s valuations of January 1, 1908.

In relation to the disallowance of additional salaries to officers, the taxpayer contends that, since it was a close corporation, the informal discussions and agreements of the two dominant stockholders and directors during the year 1921, in relation to salary increases, should be given the effect of corporate acts under the principles adopted by the Board in Appeal of Reub Isaacs & Co., 1 B. T. A. 45. From the evidence in the instant appeal it appears that, whatever discretion the directors gave the two officers as to corporate management, it was the practice and custom to fix the salaries by formal resolution of its directors. Thus, on January 31, 1921, the directors by resolution fixed the 1921 salaries of the two officers at $200 per week each. Formerly it had been $230 per week. For a short time the drawing account was reduced to $150 per week in 1921, but it was restored to $200 so that at the end of the year each had drawn at the rate of $200 per week in accordance with the resolution of January 31, 1921. But the two officers evidently considered it necessary to get authority from the board of directors for' a retroactive raise of $30 per week for 1921 and this was accordingly done February 7, 1922, by resolution of the directors. A close reading of the resolution does not indicate or suggest a mere ratification of former acts of the officers, but clearly indicates an original attempt to refix the 1921 salaries, which, under the decisions of this Board, were deductible only in the year in which the authority was given. Appeal of Van De Kamps Holland Dutch Bakers, 2 B. T. A. 1247.

As to the donations, the taxpayer’s returns admitted in evidence indicate that the taxpayer reported donations as follows: 1919, $226.41; 1920, $227.85; 1921, $155.21; but it did not deduct them as expenses before the computation of the tax. The Commissioner added the amounts to income on the theory that they had been deducted by the taxpayer, but the evidence shows that the Commissioner was in error and the deficiency should be computed accordingly.

After the hearing and argument, the Commissioner for the first time made a motion that' the invested capital of the taxpayer for each year be reduced to the extent of the full amount of the tax paid for the prior year, instead of prorating such tax from the time it became due and payable.

Since the submission of this appeal the .Revenue Act of 1926 has been passed. Section 1207 of that Act precludes any action on the part of the Board other than to deny the motion of the Commissioner, and his motion is, therefore, denied.

The action of the Commissioner in disallowing certain depreciation claimed by taxpayer and in disallowing additional compensation to officers is approved.

The action of the Commissioner in adding certain donations to gross income is disapproved.

The motion of the Commissioner to decrease the amount of invested capital for each taxable year by the amount of income tax paid for the prior year is denied.

Order of redeterrmnation will be entered on 15 days’ notice, under Rule 50.


text:
    Appeal of FRANK A. DOUGHERTY, Administrator, Estate of ANN L. KEENAN, Deceased.
    Docket No. 680.
    Decided September 30, 1926.

      Ben Jenkins, Esq., for the petitioner.

      L. G. Mitchell, Esq., for the Commissioner.
   Love

: This is a proceeding for the redetermination of a deficiency in estate tax in the amount of $1,158.06.

At the hearing the Commissioner, on request, was granted leave to file an amended answer, alleging a valuation of the interest of the estate of Ann L. Keenan in C. W. Keenan, Inc., at date of her death, of $87,000, in lieu of the valuation of $67,540 used by the Commissioner in his original determination of deficiency.

In his petition the petitioner complained of action on the part of the Commissioner, as follows:

(1) The raising of the valuation of the interest of the estate in C. W. Keenan, Inc., from $43,375 to $67,540, which last amount was raised by amendment to $87,000.

(2) The reduction of allowance for funeral expenses from $7,462 to $1,212.

At the hearing the Commissioner conceded error with reference to item (2) ; hence the same is eliminated from consideration.

FINDINGS OF FACT.

The petitioner is the administrator of the estate of Ann L. Keenan, who, prior to her death, resided in Kings County, New York, and who died November 29, 1922. Her estate consisted in part of the ownership of 125 shares out of a total of 250 shares of stock in the corporation “ C. W. Keenan, Inc.”

The business conducted by C. W. Keenan, Inc., is a retail paint store, dealing in various makes and brands of paint and painters’ supplies. The business was founded by C. W. Keenan many years ago. In 1907 C. W. Keenan died, and his estate then passed to his two sisters, Mrs. Dougherty and Miss Ann L. Keenan, in equal shares. Mrs. Dougherty had two sons, Frank A. Dougherty and Joseph B. Dougherty. These two sons of Mrs. Dougherty took charge of the business and ran it for about two years as a partnership, and then in 1909 they formed a corporation of $25,000 capital stock, in 250 shares, 125 shares being issued to each of the two sisters.

When the Dougherty boys took charge of the business they found it in a very badly run-down condition, the building being antiquated, with no modern devices for display purposes, and no modern conveniences to meet demands of employees or patrons. They assumed the task of building up the business, accepted very meager salaries for several years ($40 per week), carried all net profits to the surplus account, and from year to year improved the appearance as well as conveniences of the store, and, by close attention to business, by 1918 had succeeded in building up a prosperous business.

No dividends were paid by the corporation during the five years 1918 to 1922, inclusive.

The following tabulations reflect the scope and trend of the business of C. W. Keenan, Inc., for the five years 1918 to 1922, inclusive:

Balance sheet as of December SI, 1922.

Liabilities and capital:

Assets:

Capital stock_$25, 000. 00 Cash_$39,807.54

Surplus_ 113, 845. 17 Accounts receivable_ 28, G51. 07

A. L. Keenan_ 3,125. 00 Delivery equipment_ 8, 604. 30

J. B. Dougherty_ 400. 2B Furniture and fixtures_ 7, 310. 33

IT. A. Dougherty_ 5, 325. 00 Inventory_ 76, 288. 81

Accounts payable_ 13, 017. 64

ICO, 722. 07 160, 722. 07

In 1920, the corporation expended $7,623.05 in installing a new elevator and heating plant, and charged the same to expense.

The value of the estate’s interest in C. W. Keenan, Inc., in 1922 was $87,000.

The deficiency will be redetermined on 15 days’ notice, under Bule 50.

Trammell dissents.


text:
    Appeal of WHEELER B. GAMBEE.
    Docket No. 3972.
    Decided September 30, 1926.
    Cost of building certain bouses ascertained for purpose of determining tbe gain resulting from tbe sale thereof.

      Arthur I. Strang, Esq., for the petitioner.

      L. G. Mitchell, Esq., for the Commissioner.
    This is an appeal from the determination of a deficiency for the year 1920 in the amount of $15,852.16, of which $14,929.57 is in controversy. The controversy arises over the cost of certain houses used as the basis for determining gain resulting from the sale thereof.
    FINDINGS OF FACT.
    The petitioner is an individual residing at White Plains, N. Y., and was, during the time mentioned herein, an attorney for an abstract company. As a side line he constructed several residences for profit. In the year 1920 he sold five of such residences, the cost of which, as the basis for determining the gain from the sales, is-in controversy.
    The houses were built at various times since March 1, 1913, in a fashionable residential district in and about White Plains, N. Y. They were well constructed and included all modern conveniences and refinements, such as hardwood floors throughout, steam heat, fire places, extra baths, laundries, garages, cement walks, etc.
    From the evidence the Board finds that the cost of the land and houses (designated by the Commissioner and the petitioner as “ Parcel No. 1,” “ Parcel No. 2,” “ Parcel No. 3,” “ Parcel No. 4,” and “ Parcel No. 5 ”) was as follows:

      The petitioner sold the houses in 1920 and paid certain brokers’ fees as commissions, as follows:

    The total cost of the land and the buildings, less depreciation, was $89,721.11, and the net selling price in 1920 was $110,750, the total gain resulting from the transactions being $21,028.89. The Commissioner determined that the cost, less depreciation, was $45,,-070.95, that the selling price was $114,500, and that the total gain resulting from the transaction was $69,429.05.
   OPINION.

Love

: The question in this appeal is solely one of fact. We must find the cost of the buildings in question for the purpose of determining the gain resulting from their sale.

The petitioner at the hearing was unable to produce his original checks and other original memoranda to show the precise cost of the buildings. At the time he made his return he did have that data but the same has been lost or destroyed. He did present, however, data prepared from his best recollection of the cost of the buildings. He was also able to produce the original plans as well as actual photographs of the houses built. Standing alone, this evidence would not have controlling weight, but it was corroborated by an expert builder and estimator whose testimony we are disposed to accept. The petitioner’s witness, Albert H. Smith, had been engaged in the business of contracting and building houses in and about White Plains for over 25 years. His reputation as a building cost expert was such that he was frequently used in the courts as a cost expert. He was also employed by fire insurance companies to estimate and adjust fire losses to buildings. His qualifications were conceded by the Commissioner. He personally inspected and appraised the buildings in question and appraised the eosts in excess of those claimed by the petitioner. The figures of the petitioner and the appraiser seem fair and certainly within the bounds of reason, when we take into consideration the style of house built, the sale price and the resulting gain. The petitioner’s own figures show a profit of approximately 20 per cent on the amount invested. The Commissioner has determined a gain of $69,429.05 on an investment of $46,606.29, which on its face seems extremely abnormal in the absence of evidence of abnormal building profits in this district at the time in question. The method by which the Commissioner ascertained the cost is not disclosed, but we are convinced that the petitioner’s figures, which we have accepted in our findings of fact, are much more within the bounds of reason and, under the circumstances, should be used for the purpose of determining the gain.

Order of redetermination will he entered on 15 days’ notice, under Bule 50.


author: Phillips

text:
    Appeal of DEERLAND TURPENTINE CO.

      Docket No. 6182.
    Decided September 30, 1926.
    1. A South Dakota corporation may legally accept promissory notes worth par in payment for the issuance of its corporate stock.
    2. Evidence examined and held, insufficient to show that a note received in payment for capital stock was worth par. Such note excluded in the computation of invested capital.
    3. Where a loss was sustained under a contract in 1920, and all the factors necessary to determine the amount were known in that year, although the amount was not computed until 1921, held, that such loss is deductible in 1920, the books being kept upon an accrual basis.

      Camden R. McAtee, Esq., for the petitioner.

      John W. Fisher, Esq., for the Commissioner.
    This is an appeal from the determination of a deficiency in income and profits taxes in the amount of $14,028.11 for the calendar year 1920. The issues presented are whether a demand promissory note given for stock may be included in invested capital, and whether the petitioner is entitled to deduct a claimed loss.
    FINDINGS OF FACT.
    The petitioner is a South Dakota corporation with its principal office at New Orleans, La., and is engaged in the production of turpentine and resin.
    At a special meeting of the stockholders of the petitioner on June 2, 1919, it was voted to increase the capital stock from $5,000 to $80.000 by the' issuance of 750 additional shares at $100 each, par value. Of this additional stock, W. B. Gillican, president of the petitioner, subscribed for 890 shares, and L. L. Shaw, who then owned 24 shares, subscribed for 360 shares. In payment for the 360 additional shares, Shaw gave his promissory note for $36,000, dated June 2,1919, payable on demand to the New Orleans Naval Stores Co., Inc., and indorsed by that company to the petitioner, bearing interest at 8 per cent, and pledged the stock as collateral security. At the time Shaw executed the note he owned, and still owns, a considerable amount of real property.
    On December 31, 1923, the petitioner declared a dividend of $90,000, of which $43,200 was credited to Shaw:
    December, 1923. - 31 -
    Divided Account-$90, 000.00
    JO. 30. Shaw, Special Account_$43, 200. 00
    New Orleans Naval Stores Oo- 46, 800. 00
    Distribution of above dividend on basis of 48 per cent and 62 per cent ownership.
    Of such amount, $11,540.22 was applied in full settlement of interest on his note for $36,000 at 7 per cent from the date of the note to December 31, 1923, and $17,504 was applied against the principal of the note. The balance of Shaw’s share of the dividend was applied to reduce his indebtedness to the taxpayer on other notes and drafts. No payments on the $36,000 note, other than the above credits, have been made.
    The Commissioner refused to permit such $36,000 to be included in invested capital.
    The products of the petitioner were sold by the New Orleans Naval Stores' Co. On January 7, 1920, the Gillican-Chipley Co., Inc., the Western Naval Stores Co., the New Orleans Naval Stores Co., and the Lake Charles Naval Stores Co., entered into an agreement with the sales department, Gillican-Chipley Co., Inc., a Louisiana corporation, appointing the latter corporation exclusive sales agent of their products and agreeing to pay it a commission of iy2 per cent on the net amount of its sales of their products. The agreement further provided that each of the four corporations would absorb one-fourth of all losses sustained by the appointed selling corporation and that any profits made by the selling corporation should be paid over to the four corporations in the proportion of one-fourth thereof to each.
    The sales department, Gillican-Chipley Co., Inc., sustained a loss during the year 1920. The amount of the loss was not determined until January, 1921. A portion of the loss, $128,983.07, was charged to the New Orleans Naval Stores Co., which in turn distributed its portion among its subsidiaries by the following journal entry under date of January 31, 1921:
    Deerland Turpentine Oo-$21,382.99
    Escambia Turpentine Co- 10, 826.49
    Hood Naval Stores Co- 42, 667.39
    Quitman Naval Stores Co- 32, 429. 31
    Wilco Turpentine Co_ 21, 676. 89
    Loss and Gain, 1920-$128, 983.07
    Our loss on stock in Sales Dept, carried for , above and now prorated on basis of $24,493 per barrel of turpentine produced.
    A journal entry to reflect the loss charged to it was made on the books of the petitioner under date of January 31, 1921, as follows:
    Loss and Gain, 1920-$21, 382.99
    New Orleans Naval Stores Co_ $21,382. 99
    Loss on stock of Sales Dept. Inc. prorated on basis of $24,493 per Bbl. of turpentine produced.
    The amount of $21,382.99 was claimed by the petitioner as a loss in its income-tax return for 1921, but was disallowed by the Commissioner.
    W. B. Gillican was president of both the petitioner and the New Orleans Naval Stores Co. L. L. Shaw was vice president and a director of the petitioner, but had no interest in the New Orleans Naval Stores Co.
   OPINION.

Phillips

: The first question for decision is whether the petitioner may include in invested capital the note given by Shaw in payment for 360 additional shares of capital stock of the petitioner. The Commissioner contends that, under the Constitution of South Dakota, a corporation organized in that State may not legally accept notes in payment of capital stock. Article 17, section 8, of the South Dakota Constitution provides:

No corporation shall issue stocks or bonds except for money, labor done, or money or property actually received; and all fictitious increase of stock or indebtedness shall be void.

This provision was considered in Schiller Piano Co. v. Hyde, 39 S. D. 74; 162 N. W. 937, in which case it was held that:

A promissory note is property within the meaning of the above constitutional provision. * * * The acceptance of promissory notes that are worth par for the issuance of corporate stock is not a violation of said constitutional provision..

The petitioner relies upon the decision of this Board in the Appeal of Hewitt Rubber Co., 1 B. T. A. 424, and Appeal of American Steel Co., 1 B. T. A. 839. In those appeals, in which notes given for stock were permitted to be included in invested capital, and in the Appeal of Ready Auto Supply Co., 2 B. T. A. 730, the decisions turned upon the bona fides of the transactions. In the latter case the taxpayer was denied the right to include the notes in invested capital, and it was stated, at p. 731:

The Board is not disposed to extend what it believes to be tbe sound rule indicated in tbe Appeal of Hewitt Rubber Co., supra, to cases generally involving indebtedness of stockholders to- corporations on account of their stock. Only transactions clearly evidencing good faith may be so recognized.

A consideration of the bona fides of such transactions is necessary in view of the wording of section 326(a) (2) of the Revenue Act of 1918, providing that “ invested capital ” means the “ actual cash value of tangible property * * * bona fide paid in for stock or shares * * * .”

In the present appeal we find the petitioner receiving for the stock issued to Shaw his note payable to the New Orleans Naval Stores Co., Inc., and indorsed by that company to the order of the taxpayer. Shaw has never made any payments on the note. His liability on it has been reduced, not by payments, but by dividends on the stock issued for the note. The only evidence offered as to Shaw’s solvency was the testimony of one witness, who testified that he considered Shaw “worth a good deal more than the amount due on the note,” and that “ he owns a large quantity of land, and especially the land at the present prices. I think his assets have increased.”

These facts fall far short of being convincing either of the bona fides of the transaction or of Shaw’s ability to meet his liability on the note. Nor is there any showing of the financial condition of the indorser. We shall not disturb the action of the Commissioner in excluding from invested capital for the year 1920 the note for $36,000.

The petitioner sold its products through the New Orleans Naval Stores Co. That company entered into an agreement with three others, whereby a joint sales department was created, the companies agreeing to share equally any profits or losses of this sales organization. There is evidence in the record to the effect that the petitioner was to share in any sales loss which might be sustained by the New Orleans Naval Stores Co. The petitioner did in fact share such loss. The two companies -were not affiliated and no reason is shown why a loss should have been paid by the petitioner if there was no liability. The fact of payment, corroborating the oral testimony, is very convincing that the liability existed, and while the amount was not determined until 1921, all of the factors necessary to determine the amount were ascertainable at the close of 1920, The accounts of the taxpayer are kept on tbe accrual basis and in such circumstances the loss is deductible in the year 1920. United States v. Anderson, 269 U. S. 422; 46 Sup. Ct. 131; 5 Am. Fed. Tax Rep. 5674.

Order of redetermination will be entered on 10 days’’ notice, under Rule 50.


text:
    Appeal of F. D. KEIM.
    Docket No. 2488.
    Decided September 30, 1926.
    1. When a corporation liquidates and its assets are taken oyer by its stockholders, who conduct the business as a partnership, the transaction is controlled by section 201 (c) of the Revenue Act of 1918.
    2. When it is shown that no market overt existed at the time and place of transfer of property, its fair market value may otherwise be shown.

      Harry 0. Weeks, Esq., for the petitioner.

      Willis D. Nanee, Esq., for the Commissioner.
    This appeal is from the determination of a deficiency in income tax for the year 1919 of $705.70, with the petitioner claiming an overassessment of $1,065.34.
    The petitioner alleges that the Commissioner erred in treating as taxable income an alleged profit realized by the petitioner on the liquidation of a corporation in which he owned stock, and the transfer of the assets of the corporation to the stockholders, as a partnership. The petitioner offered no evidence of the cost to him of his stock in the corporation. Neither was there evidence of the amount of capital stock of the corporation nor of the cost to the corporation of the capital assets other than the book values shown in the findings of fact.
    FINDINGS OF FACT.
    The Dixon-Keim Motor Co. was a corporation operating an auto sales agency and a garage business in Wichita Falls, Tex.
    The entire stock of the corporation was owned by three persons. F. D. Keim owned ll/24ths; L. L. Dixon owned ll/24ths; and Lloyd Weaver 2/24-ths.
    On July 1, 1919, in pursuance of a prearranged plan, the corporation surrendered its charter and its assets were taken over by its three stockholders, as a partnership, each partner having the same proportionate interest in the partnership held by him in the corporation, and the business was thereafter conducted as a partnership. On July 1, 1919, the assets and liabilities of the corporation were as follows:

    One of the valuable assets of the corporation was a sales agency contract with the Buick Automobile Co., which was not listed as an asset and was not assignable. The partnership retained the Buick agency and operated under it.
    There was no open market, in the common acceptation of that term, for the business conducted by the corporation as a going concern at the time and place of dissolution. As a going concern its capital assets did have a substantial value, that is, a fair market value of 75 per cent of their book value. The petitioner in his return did not include any gain in the transfer of assets from the corporation to the partnership. The Commissioner alleged and included a gain in that transfer of. $11,229.54, and determined a deficiency.
   OPINION.

Love

: The- petitioner’s only assignment of error is: “ There was included as income to the petitioner the sum of $11,229.54, claimed to be a profit upon the liquidation of the Dixon-Keim Motor Company, a corporation, whereas petitioner alleges upon information and belief that no sum whatsoever should have been included upon this account.”

The petitioner’s propositions of law, under his assignment of error, in substance, are:

(1) Under the Bevenue Act of 1918 no taxable gain or income is received by one who receives in lieu of his stock in a private corporation a proportionate interest in a partnership formed by the stockholders to take over the assets of the corporation upon dissolution. •

(2) A tax levied upon or measured by the difference between the cost of the stock in a corporation and the proportionate share of the net book value or net actual value of the assets is not a tax on income, but a direct tax, and conflicts with clause 3, of section 2, and clause 4 of section 9 of Article I of the Constitution of the United States.

(3) That, unless there was a market for the business, stock or assets of the corporation, there was no market value within the meaning of the taxing statute, and hence no measure by which gain or loss may be computed.

The petitioner by his first proposition seeks to bring himself within the provisions of section 202 (b) of the Revenue Act of 1918, which deals with the reorganization of a corporation. It is evident that the rights and powers of a partnership are essentially different from the rights and powers of a corporation. Appeal of E. C. Huffman, 1 B. T. A. 52.

Moreover, in the instant appeal, the assets of the corporation were not taken over by the partnership as an entity, but were taken over by the individuals who constituted the partnership, and although the partnership agreement was consummated prior to the dissolution of the corporation, the legal result was not different from what it would have been had the partnership been formed after the dissolution.

This case is governed by the following provision of section 201 (c) of the Revenue Act of 1918:

Amounts distributed in tbe liquidation of a corporation shall be treated as payments in exchange for stock or shares, and any gain or profit realized thereby shall be taxed to the distributee as other gains or profits.

The measure of gain or loss is the difference between the cost or March 1,1913, value of the shares of stock and the money or money’s worth of what is received in liquidation. If property other than money is received, the taxpayer has received income to the extent of its fair market value.

In his second proposition the petitioner challenges the constitutionality of a statute which levies a tax measured by the difference between cost of shares of stock in a corporation and the value of its assets distributed to its stockholders in liquidation of the corporation. We do not feel called upon to discuss in detail the question of the constitutionality of the statute involved in this appeal. Suffice it to say that the language of the statute as to the taxability of such profits is plain, and the courts have in a number of cases enforced its provisions.

We come now to the petitioner’s third proposition, wherein he contends that, by reason of the fact that no market existed for the business as a going concern, or for the stock, or the assets in bulk, no measure of gain or loss has been provided by statute. Hence there was no taxable gain or loss in the transaction. It was clearly shown by the evidence that the business conducted by the corporation had been a prosperous one. The two principal stockholders in the corporation and largest shareholders in the partnership, F. D. Keim and L. L. Dixon, testified by deposition. A part of Keim’s deposition is as follows:

Q. Upon wliat basis do you think it [the business] would have had to have .been placed in order to have sold either the entire business or your interest in it?
A. You mean the accounts and everything?
Q. Yes, the whole thing. I am not asking for an exact figure, but whether it would have had to have been sold at a sacrifice, or a profit.
A. I think it would have had to have been sold at a sacrifice.
Q. A considex-able sacrifice?
A. I would say from 15 to 25 per cent.
Q. Off of what?
A. Off of the inventory value of the assets.
Q. Now in your opinion would that have been adequate from your standpoint for a business which was paying you like that was paying you?
A. No sir.
Q. Would you have sold at such a price?
A. No sir.

L. L. Dixon testified as follows:

Q. Now let us assume, Mr. Dixon, that at the time this dissolution took place it was the desire of all the partners to sell this business for the best price they could get and to sacrifice it if necessary to move it, what would be your opinion as to how much you would have to discount these assets from their book value in order to sell them?
A. That would be a matter of speculation. It would be more or less contingent on the Buick Motor Company’s attitude towards the person to whom we were selling, as the price we could get would depend on whether it was satisfactory with the Buick Motor Company to make a new contract with the purchaser, or else the other assets would have to be greatly discounted.
Q. How much?
A. 50 per cent.
Q. Even if the purchaser could make a new contract with the Buick people could you in your opinion have received book value for your assets?
A. No sir.
Q. Under such circumstances, about how much would you have to discount them?
A. I would say- some items more than others, on an average of 25 per cent.

In the case of Walter v. Duffy, 287 Fed. 41, the question was the “ fair market value ” of stock on March 1,1913. Proof had been made of sales of shares of the stock involved near the date in question, but it was further shown that the stock was not on the market, and, in the common acceptation of the term, had no market value; that the feiv sales made were made under abnormal conditions, either forced by a creditor who held stock as collateral or under other circumstances equally impelling. The trial court refused to admit evidence tending to show real value and based its decision on values shown by the few sales.

After discussing at length the purport of the term “fair market value,” the court said:

We are of tlie opinion that the court fell into error in holding, as it did; that because sales of this stock had been made, the fact of sales, in itself and without any regard to the circumstances under which they were made, conclusively established the statutory'"fair market price” of this stock. Clearly not. * * * And it was error not to admit proof of the circumstances under which the sales were made, and evidence tending to establish the intrinsic value of the stock on March 1, 1913.

If evidence is admissible to controvert or vary prices obtained in actual sales, then surely, where it is shown that no sales were made, evidence of value is pertinent and probative. The petitioner and his witnesses furnished such evidence, which is the only evidence submitted, and we have accepted the valuation placed on the assets by the petitioner. Petitioner himself testified that in his judgment the assets were worth something like 85 per cent of the book value. Another member of the firm testified that they were worth 50 to 75 per cent of their book value.

We believe that, under the evidence, a fair market value of 75 per cent of book value has been established.

Redetermination of the amount of deficiency, using cost as originally used by the Commissioner■, will be made on 15 days' notice, under Rule 50.


author: Morris:

text:
    Appeal of J. E. ASBURY.
    Docket No. 6723.
    Decided September 30, 1926.

      Geo. M. Stanton, Esq., for the petitioner.

      M. N. Fisher, Esq., for the Commissioner.
    This appeal is from the determination of a deficiency of $1,165.87 in income tax for the year 1919. The only question involved is the correctness of the Commissioner’s action in including in the petitioner’s gross income for the calendar year 1919 his distributive share of a partnership’s income for its entire fiscal year end^d August 31, 1919.
    FINDINGS OF FACT.
    Petitioner is a resident of Elberton, Ga. During 1920 his tax liability was investigated by an internal revenue agent, who included in his income for the calendar year 1918 a proportionate part of the earnings for the period September 1, 1918, to December 31, 1918, of Elberton Cotton & Compress Co., a partnership of which the petitioner was a member, and which was on a fiscal year basis ended August-31. Based on such investigation, he paid an additional tax of $461.40 for the year 1918. The Commissioner has now included the petitioner’s distributive share of the earnings of the Elberton Cotton & Compress Co. for the entire fiscal year beginning September 1, 1918, and ending August 31, 1919, in his income for 1919.
    The petitioner renders his return on a calendar year basis.
   OPINION.

Morris:

The adjustment, upon which the.petitioner alleges error, of his income for the calendar year 1919 from the partnership of which he was a member, having a fiscal year ended August 31, is in accordance with section 218 (a) of the Revenue Act of 1918. Appeal of J. H. Goadby Mills, 3 B. T. A. 1245.

Judgment for the Commissioner.


author: Love:

text:
    Appeal of LINDLAHR SANITARIUM, INC.
    Docket No. 1619.
    Decided September 30, 1926.
    Value of real estate determined for invested capital purposes.

      Edward Wm. Krueger, C. P. A., and John A. Stolp, C. P. A., for the petitioner.

      B. K. Saunders, Esq., for the Commissioner.
    This is an appeal from the determination of a deficiency in income and profits tax for the fiscal years ended June 30, 1917, and 1918,'in the aggregate amount of $1,159.91. The deficiency arose from the action of the Commissioner in reducing certain real estate values, resulting in a decrease of invested capital and depreciation.

      BINDINGS OB PACTS.
    The petitioner is an Illinois corporation, organized June 20, 1914, and operates a sanitarium.
    Prior to June 20, 1914, Dr. Henry Lindlahr owned and operated a sanitarium, one branch of which was located at 525 South Ashland Boulevard, Chicago, and another branch at Elmhurst, Ill.
    Lindlahr had owned these properties for a number of years. He had purchased them in depleted condition and remodeled and repaired them at great expense.
    After the corporation was organized, Lindlahr addressed a communication to it in which he proposed to sell and convey to the corporation all the property and equipment used in said sanitarium, together with its good will, and specifically including the South Ashland Boulevard property and the Elmhurst property, for a consideration of $125,000, to be paid in stock of the corporation at par.
    In that proposition it was specifically mentioned that said properties were encumbered by indebtednesses in the aggregate amount of $38,500, interest thereon, and unpaid taxes, which the corporation should assume and pay, together with all taxes due on said properties. That offer was formally accepted by the corporation.
    On July 10, 1914, Lindlahr addressed a communication to the board of directors in which he proposed to transfer and surrender to the treasury of the corporation 400 shares ($100 par value) of the stock held by him in consideration of $1. It was explained that this action was taken on demand of C. J. Miller, who had agreed to purchase and pay cash for 100 shares ($100 par value) of preferred stock on condition that such action be taken. This proposition of Lindlahr was duly accepted and said stock was transferred to the treasury.
    Instead of putting the entry in the journal for the $125,000 par value of stock as being Lindlahr’s subscription, the bookkeeper did not enter the donation of $40,000 in stock but put in his subscription at a net figure of $15,000. The entry as shown on the journal is as follows:
    1915.
    March. 1 Unsubscribed stock_$125, 000
    To capital stock_$125, 000
    To place upon the books of the Lindlahr Nature Cure Institutes the capital stock as follows:
    1,150 shares of common at $100_$115, 000
    100 sháres of 6% preferred at $100_ 10,000
    125, 000
    As per minutes of stockholders meeting of June 22, 1914.

      March 1 Henry Lindlahr- $75,000
    To unsubscribed stock_ $75, 000
    To record bis subscription to 750 shares of common stock at $100 per share par value as per minutes of -.
    There is no evidence of the assets and liabilities of the business at the time of the transfer to the petitioner, but the opening entries appear to be as of March 1, 1915. The assets and liabilities of the petitioner, as shown upon the books on that date, are as follows:
    Assets:
    Real estate_ _$129,000.00
    Personal property-_ 16, 492. 24
    Supplies_ _ 786.28
    Accounts receivable_ _ 706.97
    Merchandise_ _ 441.40
    Cash_ _ 433.42
    Unexpired insurance_ _ 386.52
    Bank discount_ _ 267.33
    Good will-_ 10,000. 00
    Liabilities:
    Accounts payable_ - $1,419.07
    Notes payable-_ 6, 516. 52
    Mortgage interest accrued-_ 228.85
    Interest accrued on notes payable. 123. 90
    Taxes accrued—
    Chicago real estate_ $80.00
    Personal property_ 4. 89
    Elmhurst real estate_ 33.62
    118. 51 118. 51
    Wendell State Bank of Chicago_ _ 397.97
    First National Bank of Elmhurst_ _ 90.36
    Henry Lindlahr (accounts payable) _ 1, 702.43
    Mortgages payable—
    Chicago , real estate_ $18,600
    Elmhurst real estate_ 18, 700
    37, 300 37, 300. 00
    Henry Lindlahr (subscription)_ - 75, 000. 00
    Surplus_ _ 25, 616. 55
    Real estate purchase (Elmhurst) - 10, 000.00
    158, 514.16 158, 514.16
    Under date of June SO, 1918, a journal entry was made decreasing the real estate value by $67,181.99. The said journal entry is as follows:
    Surplus_$67,181. 99
    To real estate_ $67,181. 99

      For excess valuation on the Chicago and Elmhurst buildings and grounds, estimated as follows:
    Books show June 30, 1918_$147,181.99
    526 Ashland Boulevard, actual cost_$25, 000. 00
    515 Ashland Boulevard, actual cost_ 19, 000. 00
    Elmhurst, actual cost_ 21, 500. 00
    Improvement on Chicago property up to June 30, 1917, estimated at_ 7, 500. 00
    Improvement on Elmhurst property up to June 30, 1917, estimated at_7, 000. 00
    Actual cost is- 80, 000.00
    Excess valuation_ 67,181. 99
    In August, 1920, a journal entry was made partially restoring the real estate values. The entry in the journal of the petitioner is as follows:
    GENBRAI, JOURNAL CHICAGO MONTH OP AUGUST 1920
    Real Estate — Chicago:
    Buildings 525 Ashland Boulevard_$18, 000. 00
    Ground- 14, 500. 00 $32, 500. 00
    To Surplus:
    To partially offset Journal Entry on June 30, 1918, as Real Estate should have been as follows :
    Buildings Ground Total
    Should have been_ 40,000 25,000 65, 000
    Books show_'22, 000 10, 500 32, 500
    Difference-i_ 18,000 14,500 32,500
    Real Estate — Elmhurst:
    Buildings- 11, 000. 00
    Ground--- 9,500. 00
    20, 500. 00
    To Surplus:
    To partially offset Journal Entry on June 30, 1918, as Real Estate should have been as follows :
    Buildings Ground Total
    Should have been_ 30,000 19,000 49,000
    Books Show- 19, 000 9, 500 28, 500
    Difference- 11,000 9,500 20,500
    Above two journal entries partially restore the original valuation of buildings and grounds reduced by error on June 30, 1918.

      On June 1, 1924, the petitioner had an appraisal of its real estate made by valuation committees of the Chicago Real Estate Board and said properties were appraised, as of June 1, 1914, as follows:
    For the property at 525 Ashland Boulevard:
    Land, exclusive of improvements_$25, 000
    .Improvements- 50, 000
    For the property at Elmhurst:
    Land_ 16, 000
    Improvements--- 22,000
    which the Board finds was the value of said properties on that date, subject to incumbrances, or a net value of $65,700.
   OPINION.

Love:

The controversy in this appeal is over the proper value to attribute to real estate for the purpose of computing invested capital. The record discloses that the petitioner’s own valuations were vacillating. It appears that Dr. Lindlahr incorporated his business June 20, 1914. At this time he owned two pieces of real estate subject to certain incumbrances, as set forth in our findings of fact. At that time he put in all his real estate, good will, and business at $125,000. His total incumbrances were $47,300, including $10,000 due on the purchase price of the Elmhurst property. A short time thereafter, on July 10, 1914, desiring to interest outside capital, he turned back $40,000 par value of his stock into the treasury of the petitioner. One Miller thereupon purchased $10,000 of stock at par value, the proceeds of which were used to pay the balance due on the Elmhurst property. This transaction indicated that the parties regarded the total net value of the property to be $85,000. There does not seem to be any opening entry in the petitioner’s journal until March 1, 1915, at ivliich time there was entered in Lind-lahr’s stock account a net amount of $75,000. Journal entries of the same date place a value of $129,000 on the real estate, against which were $47,300 incumbrances, or a net value of $81,700. The value of the land and buildings was not segregated. The petitioner further complicates the situation by writing down the value of real estate on June 30, 1920, to the extent of $67,181.99, and in August, 1920, by restoring $53,000 of this decrease.

The retrospective real estate appraisal made by the Chicago Real Estate Board placed the total valuation of the real estate at $113,000 which, after subtracting the incumbrances which existed in 1914, would leave a net value of $65,700.

Under the circumstances, we are disposed to give full credence to the valuation placed upon these properties by the Chicago Neal Estate Board. While retrospective appraisals are not usually given great weight as evidence, in this appeal the appraisers are supported by at least two members of the appraisal committee who subjected themselves to examination and cross examination and demonstrated the fact that personally each was sufficiently posted and properly qualified by experience to enable him to fix with fair accuracy the market value of the property at the date in question. One particular appraiser «’testified that he was personally familiar with the values and actual sales of similar property in the same locality as of June 1, 1914, and that the property could have been sold for cash at the values fixed.

Order of redetermination will be entered on 15 days’ notice, under Bule 50.


text:
    H. L. GUEYDAN, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
    Docket No. 522.
    Decided September 30, 1926.
    Debts claimed to be worthless but not charged off the petitioner’s books of account are not legal deductions from gross income.

      H. L. Gueydan pro se.

      Ward Loveless, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in tax for the year 1919 in the amount of $10,506.93, which deficiency arises from the disallowance of a deduction of $39,579.63 for alleged bad debts.
    BINDINGS OP PACT.
    During the year 1919 the petitioner was a resident of Gueydan, La., and was engaged in the business of advancing money to rice farmers. The money was advanced to enable them to prepare ground for a crop, to purchase seed, and, in some cases, for living expenses. The petitioner also sold plows, disc fertilizers, and thrashing machines to the farmers on vendor’s lien notes. During the year 1919 he made advances to farmers, principally share-croppers, in excess of $200,000. In most cases the only security for the advances was a lien upon the crops. Owing to the very wet season the crop was largely a failure. Sixty-five or 70 of the creditors were tenant farmers, and when they lost their crops they had no property from which the petitioner could collect the amounts owing him. Of the total amount advanced in 1919, petitioner satisfied himself that there was little likelihood of ever recovering $43,659.23. He charged to profit and loss, however, only $4,079.60 advanced. On his income-tax return for 1919 he deducted from gross income the entire $43,659.23. Of this amount the Commissioner disallowed the deduction of $39,579.63, upon the grounds (1) that the amounts were not ascertained to be a loss, and (2) that the amounts were not charged off the petitioner’s books of account.
    Tenants of the character of those to whom the petitioner loaned money will sometimes lose the crop upon which they have borrowed money but in a succeeding year will have a good crop which will enable them to pay their debts. The petitioner in the conduct of his business has found this often to be the case. Although the petitioner believed that the accounts were worthless at the close of 1919, he did not wish to charge them to profit and loss for the reason that by so doing he would lose sight of them and there was always a possibility that in succeeding years he would be enabled to collect the accounts. It also occasionally happened that a judgment would be taken against such a debtor and might be collected a number of years later, when the debtor would come into possession of property. In succeeding years petitioner advanced money to other tenant farmers, and in some cases to some of the 65 or 70 tenant farmers who had not been able to pay him for advances in 1919. These advances were made in the hope that the debtors would be able to pay back previous advances. The tenant farmers, however, lost their crops for a number of years subsequent to 1919, and the petitioner not only lost the amounts which he had advanced to the 65 or 70 farmers in 1919 but additional amounts in succeeding years.
   OPINION.

Smith

: The Revenue Act of 1918 permits an individual taxpayer to deduct from gross income “ debts ascertained to be worthless and charged off within the taxable year.” Section 214(a)(7). It will be noted from the foregoing that the statute prescribes two conditions before debts claimed to be worthless may be deducted from gross income in an individual tax return — first, that they must be ascertained to be worthless, and, secondly, that they must be charged off within the taxable year. Although the petitioner may have had reason to believe that he would never collect a large part of his advances to rice farmers during the year 1919, we do not consider that there was such an ascertainment of worthlessness of the ac~ counts as is contemplated by the statute. Furthermore, there was no charging off of the debts by the petitioner.

Judgment for the Commissioner.


text:
    E. CARRE CO., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
    Docket No. 8929.
    Decided September 30, 1926.

      J. C. Willcins for the petitioner.

      W. Frank Gibbs, Esq., for the respondent.
   Smith:

This is a proceeding for the redetermination of a deficiency in income and profits tax for the years 1918 to 1924, inclusive, in the aggregate amount of $3,549.65, plus penalty of $935.35 — total $4,485. The only error alleged in the determination of the deficiency was a reduction of the president and manager’s salary from $9,000 per annum to $6,000 per annum.

BINDINGS OF FACT.

The petitioner is an Alabama corporation with its principal place of business at Mobile. Its capital stock is $10,000, approximately all of which was owned during the years 1918 to 1924, inclusive, by the president and manager. There was no adverse interest. The corporation held no stockholders’ meetings or directors’ meetings. Its business was that of bottling soft drinks. The president and manager of the company is J. C. Wilkins, who drew from the business such amounts of money as he desired during the tax years under review. Prior to 1918 the amount withdrawn each year and charged on the books as salary was $6,000 or $7,200. Beginning with 1918 there was credited upon the books of the petitioner each year as a salary to Wilkins $9,000. The amounts withdrawn by him from the business during each of the years was substantially that amount; in some years slightly in excess of $9,000. The profits of the business before the deduction of any amount for compensation for Wilkins averaged slightly more than $9,000. Wilkins gave to the business practically his entire, time and attention. The only other employees were laborers, clerical and stenographic assistants, solicitors, and salesmen. There was no managerial expense other than the amount paid to Wilkins. The books of account of the petitioner were kept upon the accrual basis. The tax returns for the years under review showed a payment of $9,000 for salary of the manager. This was reduced by the Commissioner to $6,000 and the deficiencies were determined accordingly.

Judgment for the Commissioner.