author: Aeundell:

text:
    The Fifth Avenue Bank of New York, as Executor of the Estate of Frederic D. Bell, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 69534.
    Promulgated December 26, 1934.

      James L. Bohr, Esq., for the petitioner.

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

Aeundell:

The respondent has determined a deficiency in decedent’s income tax for the year 1930 in the amount of $6,645.22. The deficiency arises from respondent’s holding that a transaction whereby the decedent exchanged stock for stock and a small amount of cash was a transaction taxable in part under the recognition of gain provisions of the Revenue Act of 1928. The facts were stipulated and the stipulation is adopted by reference as our findings of fact. We set forth here only a summary of the facts.

More than two years prior to the transactions hereinafter related petitioner’s decedent, Frederic D. Bell, acquired 10,386 shares of stock in a New York' corporation, the Lederle Antitoxin Laboratories (hereinafter called Lederle), at a cost of $90,384.85. That stock, it is agreed, was a capital asset in the hands of Bell in 1930.

On February 13, 1930, Lederle entered into an agreement with the American Cyanamid Co., a Maine corporation (hereinafter called Cyanamid), which proidded in part as follows:

1. Lederle and Cyanamid shall as soon as reasonably may be reorganize by Lederle transferring or causing to be transferred to Cyanamid or to a new corporation to be formed and nominated by Cyanamid * * * all tlie properties of Lederle as an entirety * * * but subject to all liabilities of Lederle * * * the said properties embracing, among other things, all the assets, business and goad will of Lederle as a going concern * * * the right to use the name “ Lederle ” and/or “ Lederle Antitoxin Laboratories ” and/or “ Lederle Antitoxin Laboratories, Incorporated ” * * *.
2. In consideration of said transfer and as a part of said reorganization (a) Cyanamid will cause to be delivered to Lederle in such name or names as Lederle may direct sixty-four thousand five hundred (64,500) shares of the duly and legally issued full paid and non-assessable Class “ B ” Common stock without par value and without any voting rights of Cyanamid, and (b) Cyanamid will cause to be delivered to Lederle in such name or names as Lederle may direct all of the authorized seventy-five thousand (75,000) shares of the no par preferred stock of- the new corporation, said preferred stock to be callable at any dividend date at. Eighteen and two-thirds Dollars ($18%) per share, plus accrued and unpaid dividends thereon * * *; said preferred stock shall be entitled to cumulative dividends at the rate of but not exceeding one and twelve-one-hundredths Dollars ($1.12) per share per annum * * *. (c) Cyanamid will cause the transferee of the aforesaid assets to assume the payment of all obligations and indebtedness of Lederle * * *.

It was further agreed that Lederle “ as soon as reasonably may be ” would change its name, dissolve and liquidate, and distribute to its shareholders the Cyanamid B stock and the stock of the new corporation.

On the same date, February 13, 1930, the Amalgamated Phosphate Co., a wholly owned subsidiary of Cyanamid, entered into an agreement with Lederle in which it agreed that, upon the consummation of the reorganization of Lederle and Cyanamid, it would purchase from Lederle stockholders at $31 per share the Cyanamid B stock “ which said stockholders may respectively receive in said reorganization.” This purchase was to be made “ at the option of such of the stockholders of Lederle as may elect to exercise their rights within ten (10) days after such consummation of the Plan.”

The new corporation above referred to was organized under the Laws of Delaware as “ Lederle Laboratories, Inc.” (hereinafter called Laboratories, Inc.), with an authorized capital stock of 1,000 shares common and 75,000 shares preferred stock.

Upon organization of Laboratories, Inc., Cyanamid made formal offer to convey or cause to be conveyed all the assets of Lederle which were the subject of the agreement of February 13, 1930, and also all the outstanding stock of Davis & Geek, Inc., which was then owned by Cyanamid. The offer was made in consideration of Laboratories, Inc., issuing all of its 75,000 shares of preferred stock to Lederle or its nominees, and all of its 1,000 shares of common stock to Cyanamid.

The offers and agreements above mentioned were duly submitted to and approved by the directors and stockholders of the several corporations.

By unanimous agreement of the stockholders of Lederle, four of their number, one of whom was Bell, were each to receive 1,897.34 shares of Cyanamid B stock and 2,206.21 shares of Laboratories, Inc., preferred stock, as “ special compensation for their services in negotiating and concluding ” the exchange agreements. The remaining shares of Cyanamid B stock and Laboratories, Inc., preferred stock were to be distributed to all the stockholders pro rata in accordance with their holdings of Lederle stock.

The several agreements were consummated, and on February 13, 1930, Laboratories, Inc., issued 1,000 shares of its common stock to Cyanamid and 75,000 shares of its preferred stock to the stockholders of Lederle. At the same time Cyanamid issued 64,500 shares of its B common stock to the stockholders of Lederle. At the same time Lederle formally changed its name to Lynbell Corporation and on June 5,1930, was dissolved.

Bell surrendered his 10,386 shares of Lederle stock and received 9,778 shares of Cyanamid B stock and 11,370 shares of Laboratories, Inc., preferred stock, together with $12.84 to cover fractional shares. The shares so received included those that by agreement among the stockholders he was to receive as compensation for services. He exercised the option under the contract between Lederle and the Amalgamated Phosphate Co. and sold to the latter company his 9,778 shares of Cyanamid B stock at $31 per share, or a total of $303,118. The option given in the contract with the Amalgamated Phosphate Co. was exercised by the holders of 99 plus percent of Lederle stock.

In his income tax return for 1930 Bell reported no gain from the exchange of stock, but reported a gain on the sale of his Cyanamid B stock. In making the computation of the gain on the sale he valued the Cyanamid B stock at $31 per share, or a total of $303,-118, and tbe Laboratories, Inc., stock at $18% per share, or a total of $212,240.10. Using these figures, he allocated 303,118/515,358 of the basis of $90,384.85 (cost of Ledorle stock), or $53,161.63, to the 9,778 shares of Cyanamid B stock. The gain thus computed amounted to $249,956.37 ($303,118 less $53,161.63), which he reported as a capital gain.

The respondent determined that the exchange was not a tax-free transaction and computed gain upon the exchange as follows:

Cyanamid B stock (market value $31. por sliaro)-$303,118.00
Laboratories, Inc., stock (market value $18.00% per share)- 212,340.10
Cash_ 12.84
Total_ 515, 370. 94
Loss cost_ 90, 384. 85
Gain_ 424,980. 09

After arriving at the above amount of gain, the respondent applied the limitation set forth in article 575 of Regulations 74, which construes section 112 (c) (1) of the statute, and held that the gain was taxable only to the extent of the $12.84 cash and the fair market value of the Cyanamid stock, $303,118, a total of $303,130.84.

The position of the respondent now is that there was a sale of the Lederlo company assets, rather than an exchange in reorganization, and that as a result of such sale Bell realized taxable income to the extent of the difference between the cost of his Lederle stock and the value of both the Cyanamid B stock and the Laboratories, Inc., stock plus the cash. By amended answer counsel for the respondent asks that the deficiency be increased accordingly.

Counsel for the petitioner urges two points — first, that the transaction between the several corporations was an exchange upon which neither gain nor loss is recognized; second, that the fair market value of the Laboratories, Inc., stock was $13.50 .per share when received by Bell and that figure should be used in apportioning the basis between the two stocks received, rather than the figure of $18.66% which he used in computing gain on the sale of the Cyana-mid B stock. Using the lower figure, it is claimed that-Boll overpaid his tax on the income realized from the sale.

The several sections of the Revenue Act of 1928 upon which the parties base their arguments are set out in the margin. We may summarize them here. Under section 112 (b) (3) no gain or loss is recognized upon the exchange of stock or securities for other stock or securities of the same corporation or of another corporation if they are parties to a reorganization. Under subsection (c) (1) of the same section, if property or money is received in addition to the securities upon which no gain is recognized, then gain is recognized in an amount not in excess of the amount of money and the fair market value of the other property. The statutory definition of “ reorganization ”, in so far as petitioner claims it to be applicable, is found in section 112 (i) (1) (A), which provides that the term “ means (A) a merger or consolidation (including the acquisition by one corporation of * * * substantially all the properties of another corporation) * * Under section 112 (i) (2) the term “ a party to a reorganization ” includes a corporation resulting from a reorganization.

Several of the matters dealt with in the statutory provisions above mentioned can be disposed of without much discussion. First, there was unquestionably an exchange of stock for stock. Bell surrendered his Lederle stock and received in exchange therefor stock of Cyanamid and Laboratories, Inc. Likewise it is beyond dispute that the exchange was pursuant to a plan, cf. J. M. Harrison, Inc., 30 B.T.A. 455, and we hold that there was a plan of reorganization, but reserve the question of the extent to which Cyanamid was a participant. We are further of the opinion that, in so far as it concerns Lederle and Laboratories, Inc., there was a statutory reorganization to which both were parties. Laboratories, Inc., acquired all the assets of Lederle, and the stock of Lederle was turned in and it liquidated and dissolved. This acquisition was for stock, a part of wdiicli went to Lederle’s stockholders. There was thus a continuity of stock ownership by the same interests, which serves to distinguish the transaction from a sale as urged by the respondent. Cf. Pinellas Ice & Gold Storage Co. v. Commissioner, 287 U.S. 462. Under circumstances very similar to those present here we held, in First National Bank of Champlain, N. Y., 21 B.T.A. 415, that the term “ party to the reorganization ” includes the corporation which was reorganized and whose securities were surrendered as well as the corporation resulting from the reorganization. We said in part (p. 423) :

* * * Any other interpretation would stultify the statute. * * *
* * * It will be observed that paragraph (2) of subdivision (h) of section 203 [Revenue Act of 1926], does not, like paragraph (1), which defines the term “ reorganization,” employ the word “ means,” but says that the term “ a party to a reorganization includes,” thereby merely extending the definition to certain other corporations than the one reorganized.

To the same effect is Rockford Dairy, Inc., 26 B.T.A. 501. See also H. E. Muchnic, Administrator, 29 B.T.A. 163, where but one corporation was involved and common stock of that corporation was exchanged for its preferred stock, and we said, “ If there was a reorganization, this company was a party to it, for it was the only corporation involved.”

In line with the above cases we hold that both Lederle and Laboratories, Inc., were parties to the reorganization.

It follows from what we have said thus far that, under subsections (b) (3) and (c) (1) of section 112, no gain or loss is to be recognized upon Bell’s exchange of Lederle stock for Laboratories, Inc., stock.

The res£>ondent’s contention that the transaction was in effect a sale appears to be based at least in part on the fact that the Lederle stockholders had an option to sell their Cyanamid B stock within 10 days at $31 per share. We think this is not decisive of the question of whether there was a statutory reorganization. The option did not bind the stockholders to sell to Amalgamated Phosphate Co. Any stockholder who wanted to keep his stock could have done so, or he might have sold elsewhere. The fact that there is a market for the stock, whether created by contract or existing through the medium of a stock exchange, does not convert an exchange into a sale. See Daisy M. Ward, 29 B.T.A. 1251.

The next question is whether the receipt by Bell of Cyanamid B stock was a transaction within the nonrecognition of gain or loss provisions. Was there a statutory “ reorganization ” affecting Cy-anamid and was Cyanamid “ a party to the reorganization ” ? There was no merger or consolidation of Cyanamid with either of the other corporations, nor did they merge or consolidate with it. Nor did it either transfer or acquire the requisite amount of property or stock to come within the parenthetical clause of subdivision (A) of section 112 (i) (1). Petitioner makes no claim that the transaction comes within any other subdivision of section 112 (i) (1), and on brief expressly disclaims any attempt to come within subdivision (B). It is obvious that the exchange could not qualify under (B), as Cyana-mid acquired only common stock of Laboratories, Inc., and did not acquire preferred stock, hence it did not have “ control ” under section 112 (j). See Thomas W. White, 29 B.T.A. 1212. In this respect the present case differs from First National Bank of Champlaim,, N. Y., supra, in which the corporation holding a position analogous to that of Cyanamid acquired all the stock of the newly organized corporation. Consequently it appears that there was no statutory reorganization in so far as Cyanamid is concerned. It does not follow, however, that Cyanamid stock was not received without recognition of gain or loss. It is sufficient to meet the requirements of section 112 (b) (3) if the stock received is stock in a corporation which is “ a party to a reorganization.” We have held above that there was a reorganization embracing both Lederle and Laborato-ríes, Inc., and the question now is whether Cyanamid was a party to that reorganization. We have heretofore pointed out that the statutory definition of “ party to a reorganization ” is not all-inclusive; it appears rather that the definition is designed merely to bring in some corporations in addition to those which are so intimately connected with the reorganization as to require no specific mention in order to come within the term. See article 577 of Regulations 74, stating in part that the definition “ simply enumerates certain cases with respect to which doubt might arise.”

Examining some of the steps taken in connection with the transfer of property and exchange of securities, it is to be noted that the principal underlying agreement is that of February 13, 1930, between Lederle and Cyanamid. Therein Lederle agreed to transfer its properties “ to Cyanamid or to a new corporation to be formed and nominated by Cyanamid.” As part of the consideration under this agreement Cyanamid agreed to issue 64,500 shares Class B common stock to Lederle or its nominees. The directors of Cyanamid formally approved the agreement, approved the organization of Laboratories, Inc., and authorized the transfer to it of all the stock of Davis & Geek, Inc., then owned by Cyanamid. The transfer of Lederle properties to Laboratories, Inc., was accomplished, not as a consequence of direct negotiations between those two, but as the result of an offer by Cyanamid to “ convey or cause to be conveyed ” to Laboratories, Inc., all of the properties of Lederle. Cyanamid obtained actual control of the new corporation by the acquisition of all of its common stock. This outline of Cyanamid’s participation in the reorganization indicates that it was in a very substantial way “ a party to the reorganization.” It was so intimately connected with the several transactions which resulted in the statutory reorganization that in our opinion it must be held to be a party to the reorganization within the statutory sense of the term. The situation here is very similar to that of Tulsa Oxygen Co., 18 B. T. A. 1283. In that case the Tulsa Oxygen Co. agreed to sell its properties to the Union Carbide & Carbon Corporation for stock of the latter. A contract was subsequently drawn designating a subsidiary of Union Carbide & Carbon as the transferee, but upon the actual transfer the Tulsa Oxygen Co. parceled out its assets to several of Union Carbide So Carbon’s subsidiaries by direct assignments without regard to the contract. We held that the transaction was a statutory reorganization and that gain was not to be recognized upon the Tulsa Oxygen Co.’s receipt of the stock for its assets. We said in part:

It is apparent that the transaction here involved almost literally satisfies the statutory definition of a nontaxable corporate reorganization. It is clear that the transaction was between the petitioner and the Union Carbide & Carbon Corporation. All details ol tlie sale were worked out in advance between them and payment made, in accordance with such agreement, out o£ the stock of this holding corporation. The substitution, therefore, of the name of a subsidiary corporation, in the contract at the suggestion of the attorney was a mere expediency that in no practical way changed the status of the parties responsible for the deal. * * *

While in the Tulsa Oxygen Co. case we did not directly discuss the matter of whether Union Carbide & Carbon was “ a party to the reorganization,” it must necessarily have been; otherwise, the receipt of its stock would have been subject to the gain or loss provisions. Wo are of the opinion that in this case Cyanamid was a party to the reorganization, and accordingly its stock was received by Bell without recognition of gain.

Summarizing what we have said thus far, we hold that both Laboratories, Inc., and Cyanamid stock were received by Bell without recognition of gain. Consequentty respondent’s motion for an increased deficiency, on the ground of the exchange of stock for stock being a taxable transaction, is denied.

Petitioner concedes the realization of a taxable profit on the sale of the Cyanamid B stock in 1930 at $31 per share. In making his income tax return for 1930 Bell reported a profit. In computing the amount of the profit he allocated the basis — $90,384.85, this being the cost of the old stock — between the Cyanamid B stock and the Laboratories, Inc., stock in the proportions of $31 and $18% per share, respectively, those figures being what he then regarded as the market values of the stocks. Petitioner now claims that the market value of the Laboratories, Inc., stock was but $13.50 per share, and, using that figure in the allocation of cost, the profit was less than that reported and the tax was overpaid.

Wo may say at this point that there appears to be no question as to the method of allocation of the basis between the two kinds of stock. See I. T. 2335, C. B. VI-1, p. 18; Glenn H. Curtiss, 21 B. T. A. 629; affd., 57 Fed. (2d) 847. Nor is there any issue as to treating the amount of the taxable gain as a capital gain. See section 101(c) (8) (A), Revenue Act of 1928.

The question here is as to the value to be assigned to the Laboratories, Inc., stock for the purpose of apportioning the basis between the two kinds of stock. The Laboratories, Inc., stock was callable on any dividend date at $18% plus accrued dividends. It had, counsel for petitioner concedes, a book value of $18% and the annual dividend was earned three or four times. The stock was not listed on any exchange. There is evidence of but two sales, one in 1930 and another in 1932, which sales are conceded to be insufficient to establish a real market. The only witness called was the auditor and assistant secretary of Laboratories, Inc., who expressed the opinion that due to the fact that the stock was not listed its value was 30 percent less than the callable price. It is obvious, we think, that an opinion based upon that one factor alone will not support a finding of fact. It omits too many other factors which go into any determination of value. Consequently we are unable to find the value was any less than $18% per share, which is the figure assigned to the stock in the exchange and was used by Bell in reporting his gain and also by the respondent in determining the deficiency.

In order to dispose of the main points with as little digression as possible we have proceeded thus far in accordance with the theory of both parties in their presentation of the case, namely, that all of the Cyanamid B stock and Laboratories, Inc., stock received by Bell was in exchange for his Lederle stock. It appears, however, from the stipulation that Bell and three others were each to receive, and did receive, 1,891.34 shares of Cyanamid B stock and 2,206.21 shares of Laboratories, Inc., stock as “ special compensation for their services ” in negotiating the exchange agreements. It is also stipulated that the total 9,118 shares of Cyanamid B and 11,310 shares of Laboratories, Inc., stock received by Bell represented both his share of the allotment of stock for services and “ his pro rata share of the remaining shares of said stocks.” This, as we understand it, means that Bell received 7,880.66 shares of Cyanamid B and 9,163.79 shares of Laboratories, Inc., stock in exchange for his Lederle stock, the remaining shares being compensation for services. This matter was called to the attention of counsel for the parties who appeared at an informal hearing. Counsel for petitioner indicated that he had no desire to present further evidence or argument concerning it. Consequently our decision must rest on the stipulated facts, which make it appear obvious that both parties erred in treating all of the stock received by Bell as being in exchange for his Lederle stock. The shares received as compensation were not received in a nontaxable reorganization, but represent income to the extent of their fair market value, taxable at ordinary rates as distinguished from the capital gain rates applicable to the income realized upon the sale of the shares received upon the exchange. The amount of tax computed at ordinary rates will of course be greater than the tax at capital gain rates, but, in so far as the resultant tax may be greater than the amount of the deficiency determined by the respondent, it will not be redetermined as a deficiency, in view of the respondent’s failure to move for an increase. While the respondent has asked for an increase in the deficiency on the ground that the transaction between the corporations was a sale, he has not asked for any increase growing out of the matter we are considering here. Treating a part of the stock as compensation and the balance as received on the exchange will change the fractions to be used in making an allocation of the basis in determining the amount of the gain on the sale of the Cyanamid B stock. These matters will be. given effect in the recomputation.

Decision will T)e entered under Rule 50.

       Sec. 112 (b) (3). Stock for stock on reorganization. — No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization. * * *
      Sec. 112 (e) (1). If an exchange would be within the provisions of subsection (b) (1), (2), (3), or (0) of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such oilier property.


source: Caselaw Access Project

author: Smith :

license: Public Domain

text:
    Houbigant, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 74225.
    Promulgated December 28, 1934.

      Allen G. Gartner, Esq., for the petitioner.

      R. W. Wilson, Esq., for the respondent.
   OPINION.

Smith :

This is a proceeding for the redetermination of a deficiency in income tax for the fiscal year ended June 30, 1931, in the amount of $8,981.71. The amended petition alleges:

(a) The determination of tax set forth in the said notice of deficiency [mailed to the petitioner September 14, 1933] is based upon the following errors: Refunds of customs duties paid during the years 1924 to 1929, inclusive, were received during the taxable year ended June 30, 1931 and the net amount received after lawyers’ fees were deducted should not be included as taxable income for the year ended June 30, 1931. Also, the lawyers’ fees paid for securing these refunds of customs duties are a proper deduction for the fiscal year ended June 30, 1931.
(b) The petitioner claims a deduction from gross income amounting to approximately 8087.29 for the fiscal year here involved representing that part of the uninsured loss attributable to this year resulting from acts of embezzlement committed by one of its employees.

The respondent admits the correctness of the petitioner’s con-tension contained in (b) above, but it is agreed by counsel that the correct amount deductible is $678.29 and not $687.29.

The respondent also admits that the petitioner is entitled to deduct -from gross income attorneys’ fees paid in the amount of $37,428.12.

During the years 1924 to 1929, inclusive, the petitioner paid certain customs duties under protest, claiming an incorrect classification, and brought suit for refund. In 1929 the Court of Customs Appeals (now United States Court of Customs and Patent Appeals) decided the case of United States v. Hudnut et al. (including petitioner), 17 C. C. P. A. (Customs) 207, and held that certain merchandise imported by the petitioner during the years 1924 to 1929, inclusive, was legally dutiable at 50 cents per gross instead of at 55 percent ad valorem. During the fiscal year ended June 30, 1931, the customs duties erroneously collected by the United States in excess of the amount legally due were refunded to the petitioner in the amount of $74,856.24. Under its contract with its attorneys the petitioner was obligated to pay a fee of 50 percent of the amount refunded and during the fiscal year paid to its attorneys $37,428.12 representing such fee.

The petitioner kept its books of account and filed its income tax returns upon the accrual basis.

In its tax return filed September 15, 1931, for the fiscal year ended June 30,1931, the petitioner included in gross income $37,419.46 representing the net amount of the refund of customs duties received by it. The amount representing attorneys’ fees paid in the amount of $37,428.12 was not deducted.

After the aforesaid return was filed petitioner filed a claim with the respondent for a refund of income tax paid for the fiscal year ended June 30, 1931, and the respondent’s action thereon resulted in a refund of tax amounting to $8,269.22, based upon the exclusion from gross income of the refund of import duties returned in the amount of $37,419.46 and the inclusion in deductions of the attorneys’ fees paid of $37,428.12.

Later, the respondent issued the notice of deficiency from which this appeal is taken, wherein he reversed his previous action on the claim for refund by adding back to net income both of the above amounts representing the refund of import duties and attorneys’ fees paid, producing the deficiency herein involved:

Of the total import duties refunded, amounting to $74,856.24, $17,588.91 was applicable to the previous year ended June 30, 1930, and the balance of $57,267.33 was applicable to the years 1924 to 1929, inclusive. All of the duties so refunded were included in the cost of goods sold appearing in the petitioner’s tax returns for the proper prior applicable years and the statute of limitations against respondent asserting additional- taxes for the years 1924 to 1929, inclusive, had run when the claim for refund of 1931 tax was filed.

It is the petitioner’s contention in this proceeding that in its income tax returns for prior fiscal years it erroneously claimed the deduction from gross income of $74,856.24 representing excess customs duties paid for those years; that in adjusting its income tax returns for those years the respondent should have disallowed the deductions of the customs duties illegally collected from it; that the petitioner did not derive any taxable income from the refunds of the excess customs duties made to it in the fiscal year ended June 30,1931, in the amount of $74,856.24; and that the fact that the respondent is barred by the statute of limitations from adjusting its income tax returns for the years 1924 to 1929, inclusive, is no ground for holding that the refunds applicable to those years constitute a part of the petitioner’s gross income for the fiscal year now under review.

Section 22 (a) of the Revenue Act of 1928 requires the inclusion in gross income of “ gains, profits, and income derived * * * from any source whatever.” Section 41 of the same act provides that “ the net income shall be computed upon the basis of the taxpayer’s annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer.”

The facts in this case show that in the income tax returns filed by the petitioner for the years 1924 to 1930, inclusive, the petitioner claimed and was allowed the deduction of the full amounts of the customs duties paid. They were not allowed under the name of customs duties, but in increased cost of goods purchased by the peti- ■ tioner. Having been deducted in prior year returns, if they are not taken up in the gross income when recovered, the petitioner clearly, over a series of years, escapes tax upon gains and profits equaling the amount of the customs duties recovered. It can not be presumed that such a result was contemplated by Congress. Furthermore, from any standpoint, the petitioner was enriched by the recoveries of the import duties in the fiscal year ended June 30,1931. The argument that the income received from this source is exempt from tax has no support in the law.

In Burnet v. Sanford & Brooks Co., 282 U. S. 359, it was held that under the income tax laws each tax year stands by itself and that a taxpayer is required to return in each year the full amount of its gross income even though that amount might represent a recovery of amounts paid out by it and deducted as expenses in prior years. It has also been held in a long line of cases that where a debt is ascertained to be worthless and deducted from gross income in one year and is collected in part in a later year the amount collected in the later year must be returned as income. Hartford Hat & Cap Co., 7 B. T. A. 714; Excelsior Printing Co., 16 B. T. A. 886; Iberville Wholesale Grocery Co., Ltd., 17 B. T. A. 235; Carr v. Commissioner, 28 Fed. (2d) 551, affirming 6 B. T. A. 541; Davidson Grocery Co. v. Lucas, 37 Fed. (2d) 806; Putnam National Bank v. Commissioner, 50 Fed. (2d) 158, affirming 20 B. T. A. 45; Commissioner v. Liberty Bank & Trust Co., 59 Fed. (2d) 320, reversing 14 B. T. A. 1428. It has also been held that checks given for valid claims allowed as deductions in the year issued but uncashed at the end of two years and credited to profit and loss were taxable income when credited back. Chicago, Rock Island & Pacific Railway Co. v. Commissioner, 47 Fed. (2d) 990, affirming 13 B. T. A. 988; Charleston & Western Carolina Railway Co. v. Burnet, 50 Fed. (2d) 342, affirming 17 B. T. A. 569; Chicago & North Western Railway Co., 22 B. T. A. 1407; Atlantic Coast Line Railroad Co., 23 B. T. A. 888. It has also been held that where losses resulting from fire were deducted by a corporation, insurance subsequently received represented taxable income, Cooper v. United States, 9 Fed. (2d) 216; and that back railway mail pay for transporting United States mail in 1916 and 1917 received by a railroad company in 1920 and taken up on its books of account as income in that year constituted taxable income of 1920, thereby overruling earlier opinions to the contrary. International-Great Northern Railroad Co., 24 B. T. A. 726. In accordance with the plain terms of the sfatute and the legal principles established by the above cited cases, it must be held that the customs duties refunded to the petitioner in the fiscal year ended June 30, 1931, in the amount of $74,856.24 constituted a part of petitioner’s gross income for that year.

Reviewed by the Board.

Judgment will be entered under Rule SO.


author: Seawell :

text:
    Frederic C. Pitcher, Petitioner, v. Commissioner of Internal Revenue, Respondent. George H. Englehard, Petitioner, v. Commissioner of Internal Revenue, Respondent. Carl S. Stern, Petitioner, v. Commissioner of Internal Revenue, Respondent. Walter H. Pollak, Petitioner, v. Commissioner of Internal Revenue, Respondent. Ruth I. Wilson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 56701-56703, 56737, 59844-59848, 70931, 70932.
    Promulgated December 28, 1934.

      George H. Englehard, Esg., for the petitioners.

      Frank M. Thompson, Jr., Esg., for the respondent.
   OPINION.

Seawell :

These proceedings were consolidated for hearing and report and involve the redetermination of deficiencies in income tax as follows:

The common issue is whether the sum of $7,500 received each taxable year by the partnership of Englehard, Poliak, Pitcher & Stern, of which the petitioners were members, as compensation for services rendered as counsel for the Board of Housing of the State of New York, is exempt from tax. The petitioners contend that the compensation is exempt from taxation because received as employees of an essential instrumentality of the government of the State of New York. The position of the respondent is that the functions of the Board of Housing were not strictly governmental, and that the petitioners were independent contractors. The facts were stipulated.

The New York Board of Housing was created in 1926 for the purpose of aiding in the correction of certain congested and unsanitary housing conditions which the legislature of the State of New York found to exist in certain areas of the State of New York, in low priced dwellings, and which, in the opinion of the legislature, constituted a menace to the health, safety, morals, welfare and reasonable comfort of the citizens of the state.” Section 2 of the act reads as follows:

Legislative finding. It is hereby declared that congested and unsanitary housing conditions which exist in certain areas of the state- in low priced dwellings are a menace to the health, safety, morals, welfare and reasonable comfort of the citizens of the state. The correction of these conditions in such areas being now otherwise impossible, it is essential that provision be made for the investment of private funds at low interest rates, the acquisition at fair prices of adequate parcels of land, the gradual demolition of existing unsanitary and unsafe housing and the construction of new housing facilities under public supervision in accord with proper standards of sanitation and safety and at a cost which will permit monthly rentals which wage earners can afford to pay and not in excess of the rates hereinafter provided. Therefore, there are created and authorised the agencies and instrurnentulities hereinafter prescribed, which are declared to be the agencies and instrumentalities of the state for the purpose of attaining the ends herein recited, and their necessity in the public interest is hereby declared as a matter of legislative determination.

The act provides the manner by which public limited dividend housing corporations may be formed and for the supervision of any corporations organized under the act, the amount of capital to be paid in, the rate of interest or dividends to be paid on the stock, bonds, or mortgages issued by the corporations, and the amount to be received by the stockholders on dissolution. It provides further that any surplus in excess of the par value of the stock, plus unpaid accumulated dividends, be paid into the general fund of the state, and grants to the corporations power of eminent domain on projects for the construction of housing accommodations approved by the Board of Housing.

Article 3 of the act exempts corporations formed under its provisions from the payment of franchise, organization, income, mortgage recording, and other taxes to the state, and all fees to the state and its officers. It also declares bonds, mortgages, and income debenture certificates of the corporations to be instrumentalities of the state issued for public purposes, and exempts such securities and interest thereon from taxation.

The Board of Housing consists of five members appointed by the ■governor with the advice and consent of the senate. They serve without pay, but are allowed all necessary expenses incurred in the exercise of their duties. The state architect is an ex officio member of the board. One member of the board is required to serve on the board of directors of every corporation formed under the provisions of the act. Other duties of the board, as prescribed by the act, are:

* * * to study bousing needs and conditions throughout the state; to determine in what areas there exist congested and unsanitary conditions, and to prepare plans for correcting such conditions; to collect and distribute information relating to housing, and study means of lowering rents on dwellings by securing economy in the construction and arrangement of buildings; to assist in the preparation of legislation and regulations in relation to housing throughout the state; to cooperate with local housing boards or similar bodies in cities and other localities; to investigate monopolies of building materials and cooperate with federal and state prosecuting officers to end such monopolies; to encourage cooperative housing and tenant-ownership of dwellings; to report from time to time to the Superintendent of Public Works with respect to matters within its jurisdiction; and to investigate into the affairs of limited dividend housing companies, incorporated under said acts, and into the dealings, transactions, or relationship of such companies with third persons.

The respondent questions the governmental character of the Board of Housing only on the ground that a member of the board is required to be on the board of directors of every corporation formed under the provisions of the act and that the state is entitled to receive certain surplus of the corporations. Under the view we take upon another phase of the case, it is not necessary for us to decide whether the Board of Housing is engaged in an essential governmental function; and this question is remitted to some future case which may require its decision.

The act empowers the Board of Housing to appoint such “ * * * officers and employees as the board may require for the performance of its duties and shall fix and determine their qualifications, duties and salaries.”

On August 24, 1926, the Board of Housing confirmed the engagement of the partnership of Englehard, Poliak, Pitcher & Stern as its counsel, subject to the terms of the partnership’s letter of acceptance, reading as follows:

Wo accept witli great pleasure tlie retainer as counsel tor tlie State Board oi Housing, the compensation to be $7500. a year. It is understood, however, that this compensation will not include services in conducting litigations, and further that if the work required oC counsel is disproportionately greater or less than now contemplated, the amount will be subject to readjustment within the year.

We deem it unnecessary to set forth or discuss the numerous Board and court cases cited by counsel relating to the question of whether or not the petitioners were employees of the State of New York and, as such, exempt from tax on the compensation the partnership received for its services. No general rule has ever been laid down as a guide for determining such questions. The decision must turn on the peculiar facts present. Register v. Commissioner, 69 Fed. (2d) 607; Kreipke v. Commissioner, 32 Fed. (2d) 694, affirming 7 B. T. A. 777; Burnet v. Livezey, 48 Fed. (2d) 159; Harry D. Kremer, 31 B. T. A. 566.

The partnership rendered such sendees as were assigned to it by the Board of Plousing. The services performed consisted of “ attendance at board hearings, drafting legislation, rendering opinions upon questions referred to them by the board; examining projects of limited dividend housing companies incorporated under the State Blousing Laws that are submitted to them by the board and investigating questions arising out of the operation of such projects.” The compensation of $7,500 received each year for these services was paid directly to the partnership by the superintendent of public works.

The partnership was not employed for a particular case, as in Lucas v. Reed, 281 U. S. 699, but for the performance of general law woi'k, other than litigation, for an indefinite period. Such facts were present in Burnet v. Livezey, supra, and United States v. Butler, 49 Fed. (2d) 52, cases in which the compensation was Held to be exempt from tax. The firm was at the beck and call of the board in connection with any legal matters which might arise in the exercise by the board of any of its functions. To the extent that the work of the partnership was advisory only and it could not affirmatively act on conclusions reached by it without approval of the board, the board exercised control over the work of the partnership. Such facts have frequently been referred to as indicating the relationship of employer and employee. Other considerations, however, lead us to the conclusion that the partnership was an independent contractor. The firm did not agree to do all of the law work of the Board of Housing, exclusive of litigation, for the stipulated retainer of $7,500 per year. If the volume ivas more or less than the amount contemplated at the time the firm’s services were engaged, the fee was to be adjusted proportionately. In Burnet v. Livezey, supra, and United States v. Butler, supra, it was shown that the employer had first call on the services of the taxpayers. As to that'point, the stipulation here is silent. If we were to hazard a guess, it would be that the firm would not have agreed to give all of the time of all of its members without a definite understanding on the question of compensation therefor. All of the work performed for the Board of Housing was done by petitioner Stern with the aid of employees of the partnership. Of course, the partnership had absolute control over its employees and was free to direct their activities in detail. Cf. Underwood v. Commissioner, 56 Fed. (2d) 67. Nothing here is contrary to the fact that petitioner Stern chose his own time to do the work. Certainly, he relied on his own judgment and skill in determining how the work should be performed. The parties agree that the laws of New York do not require its employees to take oaths of office. It does not appear that the degree of control exercised by the Board of Housing over the services of the partnership was different from that which ordinarily exists between attorney and client. E. A. Simpson, 28 B. T. A. 556.

The argument of counsel for the petitioners is, in effect, that employment of the partnership as it existed in 1926 made each member thereof, at that time and during subsequent years, employees of the Board of Housing. The stipulation does not disclose the membership of the firm in 1926 or 1927. In 1928 it consisted of the petitioners and Lewis A. Pinkussohn and Howard A. Spellman; in 1929 it consisted of the petitioners and Pinkussohn; and in 1930 the partners were such persons and G. Frank Dougherty. Each year there was a change of interests in the partnership. The record fails to disclose whether the Board of Housing was aware of the membership of the firm as it existed in 1926 and subsequent years. Under the circumstances, we can not say that the Board of Housing actually employed the services of each member of the partnership in the taxable years. Cf. Victor G. Marquissee, 11 B. T. A. 334; Russell v. Heiner, 45 Fed. (2d) 872; affd., 53 Fed. (2d) 1009.

We find no error in the action of the respondent in holding that the compensation in question was received by the petitioners as independent contractors and was not exempt from income tax.

Reviewed by the Board.

Decision will he entered in each proceeding under Rule 50.

MuRDOCK concurs in the result.


author: Leech:

text:
    Douglas L. Edmonds, Administrator, Estate of John W. Mitchell, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent. Douglas L. Edmonds, Administrator, Estate of Adina Mitchell, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 47516, 66584, 70861.
    Promulgated December 28, 1934.

      Ralph W. Smith, Esq., Glaude I. Parker, Esq., and L. A. Luce, Esq., for the petitioner.

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

Leech:

These proceedings were duly consolidated for hearing. Under Docket No. 47516 the. petitioner seeks redetermination of deficiencies of $5,742.99 for the calendar year 1924 and $11,270.77- for the period from January 1 to July 2, 1925, the date of death of decedent, John W. Mitchell. At the hearing it was formally stipulated by the parties that the deficiency for the calendar year 1924 is the sum of $4,048.04. This leaves for consideration in this docket the deficiency for the year 1925.

Under Docket No. 66584 petitioner, as administrator of the estate of Adina Mitchell, seeks redetermination of deficiencies and penalties asserted against his decedent for years and in amounts as follows:

Under Docket No. 70861 petitioner, as administrator of the estate of Adina Mitchell, seeks redétermination of a deficiency of $17,600.17 and penalty of $4,400.04 asserted against his decedent for the calendar j'ear 1925. This latter deficiency includes the deficiency for a portion of the year 1925 included in the appeal under Docket No. 66584.

The deficiencies in question arise from respondent’s treatment of the profit accruing in the several years on certain properties held in trust. It is contended by him that the two decedents, John W. Mitchell and Adina Mitchell, held a joint tenancy in such property with right of survivorship and that Adina Mitchell having survived her husband, John W. Mitchell, one half of the income during the period January 1 to July 2, 1925, the date of John W. Mitchell’s death, was taxable to each of the petitioners and that the entire income from the property for the balance of the year 1925 and for the years 1926, 1927, and 1928 was taxable to Adina Mitchell.

The facts are formally stipulated and we include the stipulation by reference as our findings of fact. Briefly stated the facts are that John W. Mitchell died July 2, 1925, and his wife, Adina Mitchell, died April 20, 1931. At the time of their marriage Mrs. Mitchell had separate property of $10,000 and subsequently inherited additional funds. These funds of Mrs. Mitchell were used many years ago in the purchase of land at Vermont Avenue and Beverly Boulevard in Los Angeles, California, on which a home was built and occupied for many years by the couple. The title to this property was in Mrs. Mitchell.

Sometime between 1888 and March 1, 1913, John W. Mitchell acquired two parcels of real estate. Subsequent to the year 1913 Mr. Mitchell, in the course of certain business transactions in which he was engaged and for the purpose of furnishing necessary security for loans made him and to effect the subdivision and sale of some of the properties, had conveyed in trust the two properties which he individually owned, and secured the conveyance in trust by Mrs. Mitchell of the home property. The beneficiary under each trust was John W. Mitchell.

On April 1, 1924, John W. Mitchell, under power vested in him under the trusts, caused the trustee in all three of the trusts mentioned above to issue one declaration of trust in respect of the properties held under these three trusts. This declaration of trust provides in part as follows:

Whereas it was the intention of John W. Mitchell and Adina Mitchell, his wife, that all of said properties should be held by them as joint tenants, with right of survivorship.
Now THEREFORE THIS Is To WITNESS that TITLE GUARANTEE AND TRUST Company, at the request of John W. Mitchell and Adina Mitchell, his wife, declares that it holds the said Trusts and all assets thereof in Trust for John W. Mitchell and Adina Mitchell, his wife, as joint tenants, with right of survivorship * * *.

Certain of the property held under the above trust consisted of notes representing deferred payments of the purchase price of certain portions of the real property deeded in trust and which had been sold by the trustee. These deferred payments included unrealized profits on the sales. Upon the death of John W. Mitchell on July 2,1925, Adina Mitchell was appointed as executrix of his estate, and in reporting such estate for Federal tax included the notes held by the trustee as part of the corpus of that estate. She filed no personal income tax return for herself for the year 1925 or the three following years. In 1930 delinquent returns were prepared for Mrs. Mitchell by a deputy collector for the period July 2 to December 31,1925, and for the years 1926 and 1927. These returns were filed with the collector of internal revenue for the sixth district of California on February 7,1930. For the year 1928 a return was prepared for Mrs. Mitchell by a deputy collector and filed with the same collector on November 4, 1930.

In determining the deficiencies here in question the respondent has included in income of the decedent, John W. Mitchell, one half of the profit derived from the trust property for the period January 1 to July 2, 1925. In determining the deficiencies against the decedent, Adina Mitchell, he has included in her income for the year 1925 one half of the income from the trust property for the period January 1 to July 2,1925, and all of the income from such properties for the balance of that calendar year and for the three succeeding years. For each of these years respondent has asserted a delinquency penalty against this taxpayer upon her failure to file returns.

The answer to the question here involved is determined by the character of the estate possessed by John W. Mitchell and Adina Mitchell in the trust property at the time of his death on July 2, 1925. The property in question was held under an indenture of trust providing specifically that the interests of these two parties were as K joint tenants with right of survivorship.” It necessarily follows that if their titles were those of joint tenants, Adina Mitchell did not take the property as an heir or devisee of her husband but as survivor. She succeeded to no new title or right but from that time forward was entitled to the absolute estate. Carter v. English, 15 Fed. (2d) 6.

It is contended by counsel for petitioner that under the last declaration of trust no joint tenancy was created as one of the parties to that conveyance was the husband, in whom there was an interest prior to such conveyance. He admits an inability to find a decision by the California courts on this question, but contends that the weight of authority is that a joint tenancy cannot thus be created.

We have considered this question carefully and cannot agree that the weight of authority is as contended by petitioner’s counsel. We conclude that a joint tenancy was created, by the last declaration of trust, above mentioned. Lawton v. Lawton, 48 R. I. 134; 136 Atl. 241; Ames v. Chandler, 265 Mass. 428; 164 N. E. 616; Colson v. Baker, 87 N. Y. S. 238; Saxon v. Saxon, 93 N. Y. S. 191.

Section 683 of the Civil Code of California provides “ a joint interest is one owned by several persons in equal shares, by a title created by a single will or transfer, when expressly declared in the will or transfer to be a joint tenancy, or when granted or devised to executors or trustees as joint tenants.” We think that the provision of the trust instrument in this case brings it within the definition of the statute. The purpose of the quoted section of the code is stated by the Code Commission of California to be the recognition of a joint tenancy if expressly declared.

We hold that under the declaration of trust, #822 B ”, made a part of the stipulation filed, the two decedents, John W. Mitchell and Adina Mitchell, took interests as joint tenants in the trust property and that the decedent, John W. Mitchell, was entitled to one half of the profits from this property from January 1 to July 2, the date of his death, and that the balance of the profit from the trust property for the calendar year 1925 and all of the profit from such property for the calendar years 1926, 1927, and 1928 was taxable to the decedent, Adina Mitchell.

As to the several 25 percent penalties determined, despite the fact that there may have been reasonable cause for failure to file timely returns for the years in question, no returns were filed by the taxpayer. The filing of them by the deputy collector is not a filing by the taxpayer. Seasonable cause was, therefore, no defense, and the imposition of the penalties was mandatory. Section 3176 of Revised Statutes, as amended; Scranton, Lackawanna Trust Co., Trustee, Katherine W. Murray Trust, 29 B. T. A. 698; John B. Nordholt, 4 B. T. A. 509.

In reference to the contention by petitioner that the statute of limitations has barred recovery of any deficiency, it need only be stated that no returns were filed by the taxpayer, Adina Mitchell, and consequently the statute did not begin to run until the filing for her of returns by a deputy collector, and that the deficiency letter in each case was mailed within the period of three years from that date. It is stipulated that a return was filed for the taxpayer, John W. Mitchell, by Adina Mitchell as executrix, for the period January 1 to July 2,1925. The date this return was filed is not disclosed and it follows that petitioner has failed to show that the statutory period for assessment and collection of the deficiency for that year has elapsed. Assessment and collection of the deficiencies are not barred.

Judgment will he entered under Bule 50.


author: MoRRis:

text:
    Estate of John D. Beals, John D. Beals, Jr., and Douglas Nicholson, Executors, Petitioners, v. Commissioner of Internal Bevenue, Respondent. Estate of Walter R. Comfort, Petitioner, v. Commissioner of Internal Revenue, Respondent. William J. Weller, Petitioner v. Commissioner of Internal Revenue, Respondent. Harold W. Comfort, Petitioner, v. Commissioner of Internal Revenue, Respondent. Robcliff V. Jones, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 56389-50393.
    Promulgated December 31, 1934.

      Lawrence P. Mattingly, Esq., Andrew T. Smith, Esq., and Virgil Y. Moore, Esq., for the petitioners.

      Richard W. Wilson, Esq., for the respondent.
   OPINION.

MoRRis:

Respondent determined deficiencies in 1928 income tax against tlie petitioners as follows:

Estate of John D. Beals_$16, 408. 67
Estate of Walter R. Comfort_ 54, 955.14
William J. Weller_._1_ 76, 791.15
Harold W. Comfort_ 40,479. 91
Kobcliff V. Jones__ 42,019.12

Petitioners allege, in the first instance, that respondent erred in determining that the receipt by them of certain shares of capital stock constituted taxable gains; and, alternatively, that he erred in determining that said gains were ordinary income subject to tax at the ordinary rates, instead of capital net gains subject to tax at 12% percent. The proceedings were submitted upon a written stipulation of facts, and, upon motion duly granted, were consolidated for hearing.

The stipulation of facts, of which a brief summary is given below, is incorporated herein by reference.

By an agreement entered into on November 1, 1927, Reid Ice Cream Corporation, hereinafter called the Reid Co., sold all of its assets and business, including trade name and good will, as of December 31, 1927, to the Borden Co., hereinafter called Borden, for (a) 89,000 shares, of an aggregate par value of $4,450,000, of Borden’s capital stock, (b) cash sufficient in amount (1) to redeem on March 1, 1928, all of the Reid Co.’s preferred stock, of which there was $2,127,500 par value outstanding on November 1, 1927, together with the accrued dividend thereon, and (2) to redeem on January 1, 1928, all of the Reid Co.’s 5-year 6-percent gold notes, of which there was $1,766,000 face amount outstanding on November 1, 1927, together with accrued interest thereon, and (c) the assumption by Borden of all of the other outstanding indebtedness and liabilities of the Reid Co., as of December 31, 1927, the aggregate amount of which is not disclosed by the stipulation. The agreement set forth that the Reid Co.’s preferred stock was redeemable at $110 per share, and its gold notes “ at the price of 101.”

The undertaking of Borden, in the aforesaid agreement, was subject to certain conditions precedent and to the Reid Co.’s obligations, among which were the following:

(a) The Reid Co. was required to procure and deliver to Borden the several agreements of Walter R.. Comfort, William J. Weller and John D. Beals with Borden, in which those three individuals would guarantee unconditionally to make up any deficiency in the net worth of the Reid Co. occurring between June 30, 1927, and December 31, 1927, other than that permitted by the agreement between the Eeid Co. and Borden, and would agree to forthwith enter and, during a period of not exceeding ten years from January 1, 1928, continue in the employ of Borden or one of its subsidiaries in an advisory capacity as Borden’s directors from time to time might request, and would further agree that, except in the employ of Borden or its subsidiaries, they Avould not on or before January 1, 1933, either directly or indirectly engage in the ice cream business or without the consent of Borden be interested, or hold stock in or extend financial aid or assistance to any firm or corporation engaged in the ice cream business, within certain described territory. In consideration for their making and entering into such agreements, Borden agreed to issue to the said three individuals, to be divided among them in such proportions as they might mutually agree upon, 4,667 shares of its capital stock.

(b) The Eeid Co. was required to procure and deliver to Borden, the several agreements of EobclifE V. Jones, Harold W. Comfort, and Walter E. Comfort, Jr., with Borden, in which they would agree to enter and continue in the service of Borden and/or its subsidiaries, as officers and/or employees, the initial period of employment and the amount of cash salary to be specified in each of said agreements to be such as will be satisfactory to the said three individuals.

(c) The Eeid Co. was required to procure and deliver to Borden, the several agreements of Eobcliff V. Jones, Harold W. Comfort, and Walter E. Comfort, Jr., with Borden, that they would not, except in the employ of Borden or its subsidiaries, on or before January 1, 1933, engage in the ice cream business or be interested or hold stock in or extend financial aid or assistance to any firm or corporation engaged in the ice cream business, in certain designated territory. In consideration for their making and entering into such agreements, Borden agreed to issue to the said three individuals, to be divided among them in such proportions as they might indicate, 2,500 shares of its capital stock.

(d) The Eeid Co. agreed to take the necessary steps to change its corporate name to some other corporate name in which neither the name “ Eeid ” nor the words “ Ice Cream ” should appear, so that such new corporate title should be entirely dissimilar from either the name “ Eeid' Ice Cream Corporation ” or “ Eeid’s Union Dairy.”

(e) The Eeid Co. agreed that it would, with all reasonable dispatch, take the necessary steps for its dissolution and the distribution to its common stockholders, of the shares of Borden’s capital stock then held in its treasury.

The Eeid Co. changed its corporate name to Milk Products Corporation of Delaware, and, after compliance with the terms and conditions of its agreement with Borden, in January 1928, distributed to its common stockholders 89,000 shares of Borden’s capital stock and dissolved.

Of the 7,167 shares of its capital stock which Borden agreed to issue, as set forth in (a) and (e) above, the petitioners herein received the number of shares set opposite their respective names:

Walter R Comfort, Sr_2, 000
William J. Weller_1_1,960
John D. Beals_ 647
Itobcliff Y. Jones_1, 000
Harold W. Comfort_1, 000

(Seventy-five percent of the shares so issued to and received by Walter B. Comfort, Sr., William J. Weller and John D. Beals was consideration for their agreements to refrain from competition with Borden.

The fair market value of shares of capital stock of Borden, as of January 3, 1928, was $170 per share.

The petitioners herein and their associate, Walter B. Comfort, Jr., owned a majority of the common stock of the Beid Co. and its predecessor corporations continuously from their organization. The Beid Co. began business on January 1, 1925.

The late Walter B. Comfort and William J. Weller were continuously directors, and president and treasurer, respectively, of the Beid Co. and its predecessors for a period of more than forty years next preceding January 1,1928; the late John D. Beals was a director and the secretary of the Bekl Co. and its predecessors for a period of more than thirty years next preceding January 1, 1928; and Harold W. Comfort and Bobcliíi V. Jones were during 1927 and on January 1, 1928, directors of the Beid Co. and for eight years next preceding January 1, 1928, general sales and advertising manager and general manager, respectively, of the Beid Co. and its predecessors.

The acquisition of the Beid Co.’s assets and business was authorized by Borden’s board of directors by resolution of November 1,1927, the preamble of which states in part as follows:

Whereas, under the terms of the said i>roposed contract the consideration which this Company is to pay for the acquisition of said property will consist of 96,167 shares of tlio par value of $50. each of this Company’s capital stock and the furnishing of cash to the amount of $4,214,121.25 for the redemption of the outstanding Preferred Stock and Five-Year 6% Gold Notes of said Keid Ice Cream Corporation. In addition to the assets so to be received by it this Company will also, in consideration of the above stock issues, secure certain guarantees and agreements to perform services. * * *

On its books of account, Borden recorded the issue of 96,167 shares of its capital stock, being the total number of shares mentioned in its agreement with the Beid Co., by one journal entry charging and crediting, respectively, “ Milk Products Corporation of Delaware ” and “ Capital Stock ”, in the amount of $4,808,350, with the explanation “ To record the issuance of 96,167 shares of Borden’s Common Stock as consideration in part payment of the assets and business acquired from the Milk Products Corporation of Delaware (formerly Reid Ice Cream Corporation).

The petitioners computed net income in their 1928 income tax returns on the cash receipts and'disbursements basis. They included nothing in income in respect of the shares of Borden’s stock issued to them by Borden pursuant to their separate agreements with Borden. As to each petitioner, the respondent determined that he realized income upon the receipt of Borden shares pursuant to his separate agreement with Borden, to the extent of the fair market value thereof, computed at $170 per share, which income Avas subject to tax at the ordinary income rates.

The petitioners contend that the 6,667 shares of Borden’s stock received by them in 1928, pursuant to their separate agreements with Borden, were received by them in exchange for their common stock in the Reid Co., pursuant to the plan of reorganization of the latter company, and, consequently, the resulting gains are, by the provisions of section 112 (b) (3) of the Revenue Act of 1928, not to be recognized for income tax purposes. Failing in that contention, the petitioners contend, in the alternative, that the gains are capital gains, within the meaning of section 101 (c) (1) of the aforesaid act, arising from the disposition of capital assets — the sale of rights to engage in the ice cream business within a designated territory for a definite period of time — and, therefore, are subject to tax at the rate of 12% per cent, as provided by section 101 (a) of the said act. The respondent not only opposes these contentions of the petitioners, but avers that the said 6,667 shares were paid to and received by them as compensation for services and for their agreements to refrain from engaging in the ice cream business, except in their capacities as officers and employees of Borden, and, therefore, that the resulting gains are recognizable and taxable as ordinary income.

We pass the question as to whether or not the sale of the Reid Co.’s assets and business to Borden, together Avith the distribution of the Borden shares received as part consideration therefor to the stockholders of the Reid Co. and the dissolution of the latter, constitute a reoi’ganization as defined by section 112 (i) (1) of the 1928 Act, which, of course, must be a major premise of petitioners’ first contention ; for unless it can be said that the 6,667 Borden shares in question were received by the petitioners in exchange for their shares in the Reid Co., the question is of no importance. Section 112 (b) (3), under which petitioners claim immunity from tax on the gains derived from the receipt of those shares, deals only with gains resulting from an exchange of securities, and, unless the facts of the instant case disclose an exchange of shares in the Reid Co. for the 6,667 Borden shares, the provisions of that section can have no application here, regardless of whether or not there was a statutory reorganization of the Reid Co. The agreements between the Reid Co. and Borden and between these petitioners and Borden establish beyond any doubt whatever that the 6,667 Borden shares came to the petitioners, not in exchange for their shares in the Reid Co., nor because of any rights as shareholders of the Reid Co., but solely as compensation for their undertakings in their several agreements with Borden, and these were (1) to guarantee Borden against any deficit in the net worth of the Reid Co. occurring between June 30,1927, and December 31, 1927, (2) to enter the employ of Borden as officers and employees, and (3) to refrain from engaging in competition with Borden in the ice cream business and from lending financial aid and assistance to others so engaged, until January 1,1933. The considerations of the agreements thus involved no exchange of securities in the Reid Co. for these 6,667 Borden shares, and the gains in question are not, therefore, within section 112 (b) (3).

The petitioners’ alternative contention is untenable. It may be readily conceded, upon the numerous authorities quoted in their brief, that the right of an individual to pursue his chosen profession, occupation, or business is property. But such right is personal and inalienable. One can noi more dispose of such a right than he can alienate his right to own and possess property, or his rights to “ life, liberty and the pursuit of happiness.” The petitioners here did not dispose of property or any capital asset in their agreements with Borden; they merely agreed to refrain, for a definite period, from exercising their individual rights to engage in the ice cream business in such a manner as to be brought into competition with Borden, and for their agreements in that respect they received compensation in Borden shares, and such compensation is within the realm of ordinary income.

Judgment will be entered for the respondent.


author: Van Fossan:

text:
    David Hannah, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 41390.
    Promulgated December 31, 1934.

      Irl F. Kemierly, Esq., and D. R. Bullard, Esq., for the petitioner.

      W. Frank Gibbs, Esq., and E. G. Sievers, Esq., for the respondent.
   OPINION.

Van Fossan:

The respondent determined deficiencies in tax, as follows:

Year Deficiency
1923_$6,920.42
1924_52,100.89
1925_12, 713. 33

At the hearing the parties filed a stipulation of facts in substantially the following form:

David Hannah, the petitioner, and his wife, Ethel May Hannah, are citizens of the State of Texas, and of the United States, and were married and living together during the taxable years involved herein, and had two dependent children under eighteen years of age during the year 1923 and throe dependent children during the years 1924 and 1925.

About the year 1901, said David Hannah, then unmarried, acquired fee simple title to 296.5 acres of land in the Jesse Devore League in Liberty County, Texas, for a consideration of $5 per acre, which title included the exclusive right to exploit and develop same for oil and other minerals; and the respective tracts of land covered by the written instruments referred to in the three following paragraphs are out of and a part of the aforesaid 296.5 acres of land.

On March 2, 1923, the petitioner and his wife executed and delivered, to the Texas Co. an oil and gas lease bearing that date, a true copy of which was attached to the stipulation as petitioner’s Exhibit No. 3.

On March 17, 1924, petitioner and his wife executed and delivered to Humble Oil & Helming Co. an oil and gas lease bearing that date, a true copy of which was attached to the stipulation as petitioner’s Exhibit No. 4.

On June 2, 1924, petitioner and his wife executed and delivered to said Humble Oil & Befining Co. an oil and gas lease bearing that date, a true copy of which was attached to the stipulation as petitioner’s Exhibit No. 5.

As consideration for the execution and delivery of said instruments referred to above as petitioner’s Exhibits Nos. 3, 4, and 5, cash payments were made to petitioner in the years and in the amounts set forth below:

The above amount of $37,500 was received by petitioner on March 2, 1923.

By reason of the drilling and completion, as a commercial producer, of “The Texas Company — Vacuum Oil Company, Hannah 50-acre lease, Well No. 2 ”, which is so designated on the map marked petitioner’s Exhibit No. 6, and which was begun on February 14, 1924, and completed as a producer on May 12, 1924, and which is agreed to have been the discovery well with respect to the tracts of land described in petitioner’s aforesaid Exhibits Nos. 3, 4, and 5, and which was so treated and claimed by petitioner in his income tax return filed for the calendar year 1924, the Commissioner has agreed that, against the sum of $144,411.12 received as bonus payments during the year 1924, petitioner shall be allowed a deduction of $72,205.50 as depletion allowance thereon, which allowance is a further deduction from petitioner’s adjusted income for the year 1924 as disclosed by the Commissioner’s written notice of deficiency dated September 28, 1928, and which additional deduction is agreed to by petitioner and Commissioner as being correct under the provisions of the Revenue Act of 1924. Depletion allowed by reason of the discovery on said well No. 2 was used both by the petitioner and the Commissioner for the determination of the allowance for depletion upon the royalties received under said leases, and has also been used as a basis for allowance for depletion upon the bonuses received in the year 1924.

The. sum of $849.44 has been determined by the Commissioner, and agreed to by petitioner, as the proper amount of depletion allowance applicable to the sum of $3,088.88 received by petitioner as bonus payment during the year 1925 under and by virtue of the instrument represented by petitioner’s Exhibit No. 3.

A photostatic copy of the drilling log of “ The Texas company— Vacuum Oil Company, Hannah 50-acre lease, Well No. 1 ” (Exhibit No. 7), a map of the Hull Oil Field (Exhibit No. 6), a copy of the drilling log of “ Republic Production Company-David Hannah Well No. 1 ” (Exhibit No. 8), and a statement of the geology and producing oil horizons (Exhibit No. 9) were all attached to the stipulation.

Without admitting that the $37,500 cash bonus received by petitioner in 1923 as part consideration for the execution of the instrument represented by petitioner’s Exhibit No. 3 is subject to any allowable deduction for depletion, based upon a discovery value, the Commissioner has determined that, in the event the Board finds as a matter of law that said $37,500 bonus is subject to depletion, based upon a discovery value established on said well No. 2 referred to above, then the amount of $26,267.05 is the proper allowable deduction for such depletion and the sum of $11,232.95 is the correct taxable amount applicable to said bonus payment.

In 1925 David Hannah and his wife, Ethel May Hannah, received net, as rents and royalties, the sum of $105,667.17, all of which was received by petitioner from the properties acquired by him prior to his marriage.

All income from any source whatsoever received by petitioner or his wife since their marriage has been treated and deemed by them to be community income and the fruition of their common efforts. For each of the years 1923 and 1924 petitioner filed a joint income tax return for himself and his wife; and, for the year 1925, separate income tax returns were filed by petitioner and his wife, on which each claimed as income one half of the total income received during said year.

The Commissioner has determined that, of petitioner’s taxable income for the year 1923, the sum of $8,770.33, derived from the sale of certain' real estate and stocks, is capital gain and taxable as such under the provisions of section 206 of the Revenue Act of 1921, which determination petitioner and Commissioner agree is correct and which amount ha.s heretofore been treated as ordinary income.

The Commissioner has determined that, of petitioner’s taxable income for the year 1923, the profit of $2,887.65 derived by petitioner from the transaction evidenced by the two instruments dated May 19, 1923 (Exhibits Nos. 1 and 2) is capital gain and taxable as such under the provisions of section 206 of the Revenue Act of 1921, which determination petitioner and Commissioner agree- is correct provided any amount is taxable as income for the year 1923 as a result of said transaction. The Commissioner and petitioner agree that the property described in petitioner’s Exhibit No. 1, as of date May 19,1923, was owned, jointly and equally, by petitioner and R. A. Welch, and that petitioner received, on May 19, 1923, the sum of $12,500 cash, same being petitioner’s one half of the cash consideration provided for in said instrument.

The parties agree that the propositions of law to be determined by the Board are as follows:

Is the petitioner entitled to an allowance for depletion based upon the discovery value established on Well No. 2 referred to above upon the bonus of $37,500 received during 1923 under and by virtue of the oil and gas lease dated March 2, 1923, to The Texas Company?
Is any amount received by petitioner during the year 1923 under and by virtue of the transaction between the petitioner and R. A. Welch on the one hand and John H. Kirby on the other hand, as sel out by petitioner’s Exhibits Nos. 1 and 2, taxable as income for said year?
Did the Commissioner of Interna] Revenue err in treating as the separate income of petitioner the amounts received under and by virtue of the three oil and gas leases executed by petitioner and his wife, on March 2, 1923, March 17, 1924, and June 2, 1924, instead of treating the sums so received as community income of the petitioner and his wife, as to the taxable years 1923, 1924, and 1925?

The depletion, if any, to which petitioner is entitled on account of the bonus of $37,500 received in 1923 is that which w the applicable statutes allow.” Murphy Oil Co. v. Burnet, 287 U. S. 299. The Revenue Act of 1921 did not contain the provision for percentage depletion found in the 1926 and later acts. Section 214 (a) (10) of the 1921 Act provides, in part, as follows:

(a) That in computing net income there shall be allowed as deductions:
Hi * * Si! * * *
(10) In the case of mines, oil and gas wells * * * a reasonable allowance for depletion * * * according to the peculiar conditions in each case, based upon cost * * * Provided, That in the case of such properties acquired prior to March 1, 1913, the fair market value of the property (or the taxpayer’s interest therein) on that date shall be taken in lieu of cost up to that date: Provided further, That in the case of mines, oil and gas wells, discovered by the taxpayer, on or after March 1, 1913, * * * the depletion allowance shall be based upon the fair market value of the property at the date of the discovery, or within thirty days thereafter * * * such reasonable allowance in all the above cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. * * *

Pursuant to the above authority the Commissioner duly promulgated article 215 (a) of Regulations 62, which reads as follows:

Where a lessor receives a bonus or other sum in addition to royalties, such bonus or other sum shall be regarded as a return of capital to the lessor, but only to the extent of the amount remaining to be recovered through depletion by the lessor at the date of lease. If the bonus exceeds the amount remaining to be recovered, the excess and all the royalties thereafter received will be income and not depletable. If the bonus is less than the amount remaining to be recovered by the lessor through depletion, the difference may be recovered through depletion deductions based on the royalties thereafter received to the extent that such deductions are legally allowable. The bonus or other sum paid by the lessee for a lease made on or after March I, 1913, will be his value for depletion as of date of acquisition.

The quoted regulation was substantially the same as that contained in Regulations 45 and Regulations 65.

On November 13,1926, all three regulations were amended by T. D. 3938, so as to read identically, as follows:

Where a lessor receives a bonus in addition to royalties, there shall be allowed as a depletion deduction in respect of the bonus an amount equal to that proportion of the cost or value of the property on the basic date which the amount of the bonus bears to the sum of the bonus and the royalties expected to be received. Such allowance shall be deducted from the amount remaining to be recovered by the lessor through depletion, and the remainder is recoverable through depletion deductions on the basis of royalties thereafter received.

In approving the amended regulations, the Supreme Court, in Murphy Oil Co. v. Burnet, supra, said, in part:

AVe think the Commissioner’s method “reasonable” within the meaning of the statute. The deduction for depletion from the bonus payments, which the statute requires, must either be made after the process of extracting the oil is complete, to the extent that royalties received have been insufficient to replace invested capital, with the attendant inconvenience of indefinite postponement of the allocation of the bonus to income and return of capital, or a formula must be adopted by which the appropriate allocation may be made as the two classes of gross income, bonus and royalties, are received.
That formula the regulation purports to furnish. Whore the estimates are reasonable, the formula affords a fair and convenient method of avoiding the present taxation of the bonus, when received, as income, in the face of the probability that it will ultimately prove not to be such. * * *
The method of computation provided by the amended regulation must be taken to have received the approval of Congress, for, as already noted, the provisions of article 215 (a), as amended, have been continued in the Treasury Regulations since 1920, and those of section 234 (a) (9) of the Revenue Act of 1918 (49 Stat. 1078) have been reenacted without substantial change in the Revenue Acts of 1928 (26 USCA §§ 2023, 3023) and 1932.
The problem here is different from that involved in Burnet v. Thompson Oil & Gas Co., supra. * * * 1-Iero an anticipated depletion of capital is to be returned from bonus and future royalties, to the extent that the applicable statutes allow, and the problem is to allocate such anticipated depletion to a payment made in advance of its occurrence. This allocation is permitted by the statute.

The above cited case, though arising under the 1918 Act, is peculiarly applicable to the case at bar.

Under the above quoted provision of the applicable law, the basis of depletion would be either the discovery value, if any, or the March 1, 1913, value. Since there was no discovery until 1924 we must eliminate this factor, leaving only the March 1, 1913, value as a basis. Here we are met by a failure of proof. The record contains nothing as to the value of the property on that date. Likewise, Ave have no evidence of the “ royalties expected to be received ”, another requisite factor in computing depletion under the provisions of T. D. 3938, supra. Accordingly, we must hold that the petitioner, on whom rested the burden of proof, has failed to furnish evidence necessary to establish his case as to depletion.

As to the second issue, it is stipulated that the only question is as to the taxability in 1923 of a profit of $2,887.65 realized on a certain sale of real estate. Petitioner contends it was taxable in 1928 because of certain conditions surrounding the sale. There is no dispute over the fact or amount of gain.

On May 19, 1923, the taxpayer and one K. A. Welch, coowners, sold certain property to John TI. Kirby for $222,169.50, payable $25,000 in cash and the balance in two promissory notes, each for $98,584.75, payable one to each of the vendors five years after date. A warranty deed with usual covenants was signed and delivered, in which a vendors’ lien was expressly reserved, conditioned for discharge upon the payment of the notes. The notes contained the following paragraph:

This note is given in part payment for the land therein described and it has been agreed that a suit or suits will be brought to perfect the title to the said land and any purchaser of this note shall take the same charged with notice of said agreement and of any and all suits brought to perfect the title and shall be bound by the result thereof. This note shall not be negotiated until two (2) years and one day after the rendition of such judgment,, or of the last of such judgments if more than one suit be filed, in the suit or suits above referred to to clear the title to said land.

The taxpayer contends that the agreement to bring suit to perfect title made title to the land doubtful and the transaction conditional. He points also to the fact that under the general warranty of the deed he might, should good title not be made, be obliged to return all of the money received and cancel the notes. He relies on Baird v. United States, 65 Fed. (2d) 911. The facts in the Baird case aré so wholly -dissimilar that it is no authority in the present situation. It dealt with a contract to sell, deed to be given after payment. Here we have a completed sale, a warranty deed delivered, cash and notes all paid over in 1923. The remote contingency of invalid title came from some alleged squatter rights, the evidence of which is meager. No suit was pending. The precaution of bringing suit to perfect title did not postpone the passing of title- nor the completion of the sale. The transaction was closed in 1923 and income then accrued. See Blaine L. Stoner, 29 B. T. A. 953, and cases there cited. -

The remaining question involves the concept of community property, it being petitioner’s contention that all of the income from the bonus and royalties should be divided between himself and wife and taxed accordingly. The facts show that the income all accrued from property constituting the separate property of the taxpayer, the same having been acquired by him prior to marriage. The facts further are that for the years 1923 and 1924 petitioner and his wife filed joint returns while for 1925 separate returns were filed. This question has been fully considered by the Board and decided adversely to taxpayer’s contention. See E. Michna, 24 B. T. A. 715, and cases cited. The petitioner may not divide with his wife for taxation the income received from his separate property as bonuses and oil royalties.

Various other matters originally in dispute are settled by the stipulation of the parties, and effect will be given to such stipulation in the recomputation of taxes due.

Decision will he entered under Rule 50.