text:
    Southern Bell Telephone and Telegraph Company, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 70887-70892.
    May 6, 1936.

      George R. Himt, Esq., and Claude M. HoucMns, Esq., for the petitioners.

      Brooks Fullerton, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: Thomas S. Scott; Security Trust Company, a Corporation, Executor of Louis des Cognets, Deceased; Charles N. Manning; W. R. Springate, Executor, and Irene Dorner, Executrix of the Estate of Karoline E. Gund; and Estelle des Cognets.

   OPINION.

Van Fossan:

The respondent determined a deficiency in the income tax of the Fayette Home Telephone Oo. in the sum of $256,-623.89 for the year 1929 and proposed to assess the same proportionately against the petitioners as transferees of the assets of that corporation, under section 311 of the Revenue Act of 1928. In these proceedings the petitioners contest their liability as such transferees.

The questions now at issue are:

(1) Whether the petitioners are liable as transferees of the assets of the Fayette Home Telephone Co. under the provisions of section 311 of the Revenue Act of 1928.
(2) Whether the Fayette Home Telephone Co. realized a taxable profit upon the transfer of its assets in 1929.
(3) Whether the Fayette Home Telephone Co. was entitled to a deduction from its gross income for unamortized discount on its bonds retired before maturity.
(4) Whether the Fayette Home Telephone Co. was entitled to a similar deduction for premiums paid by it on its bonds retired before maturity.

The facts, in substantially the following form, were agreed to by the parties:

The petitioners are former stockholders of the Fayette Home Telephone Co. (hereinafter called the Fayette Co.), a dissolved Delaware corporation. The respondent has held them to be liable, as transferees of the assets of that corporation, for its alleged unpaid income taxes for the year 1929, in the amount of $256,623.89. The Fayette Co. was dissolved July 2, 1929, and at all times from December 15, 1928, to March 28, 1929, it had outstanding 101,240 shares of common stock, 3,000 shares of preferred stock, 7 percent bonds totaling $300,000 and 6½ percent bonds in the amount of $50,000. The bonds were secured by a mortgage upon its properties.

On December 15,1928, S. E. Stern, to and through C. N. Manning, made an offer in writing to the stockholders of the Fayette Co. to purchase from them the outstanding shares of the common stock of that corporation and also the outstanding shares of stock of the Wood-ford Telephone Co. (hereinafter called the Woodford Co.). The stock of the Woodford Co., consisting of 10,000 shares, was owned and held by the Fayette Co. stockholders, pro rata, it having been issued to them in February 1928 as a dividend. The petitioners continued to be the owners of record of the stock of the Fayette Co. until the certificates were delivered by G. W. Thompson & Co. to the transfer agent for cancellation on March 28,1929.

The offer made by Stern was to purchase not less than 67 percent of the said stock and up to 100 percent thereof at $30 per share for the Fayette Co. stock, the Woodford stock being included at no additional cost. The offer was accepted in writing by the holders of approximately 90 percent of such stock, including that held by the petitioners, prior to December 27, 1928, and by the holders of 100,920 shares, of the total 101,240 shares outstanding, prior to March 1,1929, the time for the acceptance of such offer having been extended. The written offer and acceptance between S. E. Stern and the Southern Bell Telephone & Telegraph Co. (hereinafter called the Southern Bell Co.), resulting in the contract between such parties, is typical of similar contracts entered into between Stern and the other stockholders, and is as follows:

Lexington, ICy., December 15, 1928.
Mr. Chaeees N. Manning,
President, Security Trust Company, Lexington, Ky.
Dear Mb. Manning : Confirming my conversation with, you today, I will purchase from you and the other stockholders of the Fayette Home Telephone Company who may wish to sell, not less than sixty-seven per cent (67%) of the outstanding shares of the common capital stock of said Fayette Home Telephone Company at Thirty Dollars ($30) per share, and as many more shares of said common stock as are offered to me prior to December 27th, 1928, with the understanding that these shares are to be paid for in full on or before March 31st, 1929.
In addition I agree to the following conditions, to-wit:
That on or before December 31st, 1928, upon notification that not less than sixty-seven per cent (67%) of the total outstanding shares of the common capital stock of said Company have been deposited with the Security Trust Company subject to the terms of this proposal, I will deposit with the Security Trust Company of Lexington, Kentucky, as escrow agent, the sum of One Hundred Thousand Dollars ($100,000) as evidence of good faith and as part of the purchase price of said shares, such sum to be held by it for account of the depositing shareholders, in escrow, subject to the fulfillment on my part of the terms and conditions set out in this letter. In the event of failure on my part to fulfill any and all of the obligations of the purchaser, the amount deposited is to be paid to the depositing shareholders, free of any claim on my part.
You agree that the attached balance sheet and earnings statement are correct and represent the true and actual status of the Company, its income and all its disbursements for the period covered.
That there are no undisclosed contingent contracts or liabilities that have not been given effect to in said balance sheet and that no contracts will be entered into by this Company except in the usual course of its business during the term of this agreement, and except also the purchase at par value of 175 shares of Jessamine Telephone & Telegraph Company stock now owned by Southern Bell Telephone & Telegraph Company, and that you will not declare or pay any dividends except the usual quarterly dividends on the preferred stock and the regular quarterly dividends of twenty-five cents per share on the common stock when they are regularly due, to-wit: On December 31st, 1928, and March 31st, 1929, the said dividends on the common stock being reserved by and payable to the present stockholders.
That you will furnish me with abstracts of title showing good and valid title to all real estate and counsels’ opinion satisfactory to my counsel that the Company is duly and legally organized and that its franchises are legal and regular, that there are no suits or actions pending against the Company, that the shares will be regularly issued, endorsed and stamped for transfer with signatures guaranteed by some bank or banker satisfactory to me.
That all tax liabilities for years prior to 1929, properly due and payable, including Federal taxes, have been paid or reserved to the correct amount, and you severally bind yourselves to indemnify me against further tax assessments for said period.
That you will, on five days’ notice deliver to the escrow agent, on my order, all the shares that you propose herein to sell to me and that you will permit my engineers and accountants to make such examination of the books and records of the Company as we deem advisable during your regular business hours, and that you will assist me in all reasonable ways in securing such information as I require.
You will agree to pay the escrow agent such fees as it may charge for services rendered herein.
Under the terms and conditions of this proposal you represent that the Fayette Home Telephone Company owns three (3) shares of the capital stock of the Woodford Telephone Company, and that the stockholders of the Fayette Company own all the balance of the outstanding capital stock of the Woodford Company (there being no other classes of stock in said Woodford Company except common), and that you will deposit as part of the delivery of the Fayette stock, and without additional cost to me, the same proportion of the total number of shares of Woodford Company outstanding as the number of shares of the Fayette Company purchased by me bears to the total number of shares of Common stock of the Fayette Company now outstanding.
Furthermore, you represent that the Fayette Company now owns or controls five hundred (500) shares of the capital stock of the Jessamine Telephone & Telegraph Company out of the seven hundred and forty-four (744) total shares outstanding in said Company (there being no other classes of stock in said Jessamine Company except common), and will endeavor to purchase at par from the Southern Bell Telephone & Telegraph Company one hundred and seventy-five (175) shares of said Jessamine stock now owned by it, and that these five hundred (500) shares (and the additional one hundred and seventy-five (175) shares if purchased) will be retained by the Fayette Company and be part of its assets at the time of the completion of the purchase by me of said Fayette Company’s stock as herein provided.
It is agreed that you may accept this proposal and confirm sale on terms stated by affixing your signature hereunder with the number of shares you will deliver to me, and that each of the assenting stockholders who may wish to become parties to this agreement may likewise sign and state the number of shares to be delivered. No subscriber is to be liable for any of the obligations of any other subscriber, but merely binds himself to sell and deliver the number of shares specified by him at the price and on the terms and conditions herein specified.
In the event the holders of at least 67 per cent of the outstanding Common stock of the Fayette Home Telephone Company shall not assent to or accept this proposal on or before December 27, 1928, I am to have the right to purchase at the price, on the terms, and at the time herein set forth the stock of the subscribers hereto, or to decline to purchase any of said stock, provided I shall notify you in writing on or before December 31, 1928, of my election to purchase or not to purchase.
Assent of shareholders to said proposal may be evidenced by their signatures to this or to any one or any number of copies of this proposal.
Respectfully yours,
S. E. Steen.
The undersigned holders of the number of shares of the Common stock of the Fayette Home Telephone Company set opposite their respective names hereby assent to and accept the above proposal and agree to deliver the number of shares set opposite their names respectively, on the terms and conditions above specified.
Number of Shares-
[Signed] Southern Belt, Telephone & Telegraph Co_21,620 12/17/1928 by Ben S. Read,
President.
Attest: George J. Yundt,
Secretary.
[seal]

The Fayette Co. purchased at par from the Southern Bell Co. the 175 shares of the Jessamine Telephone & Telegraph Co. (hereinafter called the Jessamine Co.). On December 31, 1928, S. E. Stern deposited or caused to be deposited with the Security Trust Co., as escrow agent, the sum of $100,000 as evidence of good faith and as part of the purchase price of the Fayette Co. and Woodford Co., to be held in escrow for the account of the depositing stockholders. Previous to making such deposit Stern had assigned one-half of his contract and had given an option on the other half, which option was exercised prior to March 23,1929.

Upon notice from Stern, the holders of 100,920 shares of the Fayette Co. stock and 9,973 shares of the Woodford Co. stock delivered such stock to the escrow agent, properly endorsed, and appropriate receipts were issued by the escrow agent to the Southern Bell Co. and the other stockholders. At all times from December 26, 1928, to March 28, 1929, more than 67 percent of the Fayette Co. stock and the requisite amount of the Woodford Co. stock were held by and in possession of the escrow agent. On February 6, 1929, the Fayette Co. stockholders furnished to Stern counsel’s opinion and abstracts of title covering the properties of the Fayette Co. and showing any pending litigation and undisclosed contingent contracts.

The quarterly dividends payable December 31, 1928, and March 31, 1929, were reserved by and payable to the stockholders who had deposited the 100,920 shares in escrow. To cover its fees and expenses the escrow agent withheld 75 cents per share. On December 29, 1928, Stern assigned a one-half interest in his contracts of purchase to G. W. Thompson and his associates and thereafter, but prior to March 23, 1929, he assigned his remaining one-half interest therein to Thompson and his associates and authorized that the stock be delivered to them. Such assignment included all of his interest in the $100,000 deposited on December 31, 1928. George R. Hunt and C. JST. Manning were informed of the said assignment during the latter part of January 1929, but were not furnished written evidence thereof until March 23, 1929.

Between the date of the acceptance of Stern’s offer by more than 67 percent of the Fayette Co. stockholders, and March 20, 1929, Thompson and his associates had an appraisal of the assets of the Fayette, the Woodford, and the Jessamine companies made by engineers. That appraisal was “as of March 20, 1929” and showed a present value of $3,719,944. The Fayette Co. stockholders knew of the appraisal but did not ascertain its amount.

Prior to February 28, 1929, Thompson and his associates organized the Lexington Telephone Co., a Delaware corporation (hereinafter called the Lexington Co.). By letter of February 22, 1929, the attorneys for Thompson and his associates informed the attorneys for the Fayette Co. that the Lexington Co. had been so organized and stated that the Fayette Co. assets were to be transferred to it. By letter of February 25,1929, the attorneys for the Fayette Co. replied, stating that they assumed from the letter of February 22, 1929, that it was the plan of Thompson and his associates to have the Lexington Co. purchase the stock of the Fayette Co. By letter of March 14, 1929, the attorneys for Thompson and his associates again informed the attorneys for the Fayette Co. that the assets of the latter company were to be transferred to the former company.

On March 18, 1929, the attorneys for Thompson and his associates in Lexington, Kentucky, personally submitted to George R. Hunt and C. N. Manning, directors of the Fayette Co., a proposed draft of minutes of meetings of the Fayette Co. directors and stockholders to be held on March 20 and 25, 1929, respectively, providing for the sale of the Fayette Co.’s assets and business to Thompson and his associates. Hunt and Manning declined to consider such a proposition or to submit the proposed minutes to the directors or stockholders of the Fayette Co. and, consequently, such minutes were not submitted or voted upon by the directors or the stockholders of that company. Manning refused to consider the proposed minutes because they provided for a sale of the Fayette Co. assets instead of the Fayette Co. stock, as provided in the contracts between Stern and the stockholders owning 100,920 shares of the Fayette Co. stock and because he had no authority to vary the terms of those contracts. He further asserted that a sale of assets as proposed would probably involve both the Fayette Co. and its stockholders in a Federal income tax liability.

By a letter dated March 19, 1929, the attorneys for Thompson and his associates informed the attorneys for the Fayette Co. that they had conferred with tax experts to avoid any possible income tax liability against the Fayette Co. and were advised by tax counsel to transfer the Fayette Co. assets to the Lexington Co. through a liquidating trustee instead of directly, stating that “the end accomplished would be the same.” The attorneys for Thompson and his associates thereupon employed the Security Trust Co. as their agent to act as liquidating trustee of the Fayette Co. in carrying out their plans. A revised draft of the proposed minutes was inclosed in the letter of March 19, 1929, and reflected the action taken by the directors of the Fayette Co. at the meeting held March 20, 1929. The minutes of the meeting held on that day record that it was called to consider and act upon:

1. A proposal to sell all of the real and personal property, assets, franchises and good will of the corporation;
2. A proposed redemption of the First Mortgage Twenty-Year Gold Bonds secured by lien upon the property of the corporation;
3. The matter of dissolution of the corporation in the event of the sale of its property and assets.

On March 25, 1929, the Fayette Co. stockholders passed the resolutions contained in the proposed minutes brought to Lexington, Kentucky, on that date by the attorneys for Thompson and his associates. Such directors’ and stockholders’ meetings were held and the resolutions recorded therein passed at the earnest request of Thompson and his associates in order to enable them to carry out their plans. The resolutions as ratified by its stockholders at the meeting of March 25, 1929, in part, read:

Whereas, the common stockholders of the Company have agreed to sell their stock at and for the price of $30 per share and the purchasers thereof have caused to be organized Lexington Telephone Company, a Delaware Corporation, for the purpose of acquiring all the assets, good will, franchises and other properties of this Company; and,
Whereas, in order to effect such acquisition it is advisable and for the best interests of the Company that Security Trust Company, of Lexington, Kentucky, be made liquidating trustee of the Company for the purpose of receiving the purchase price of said common stock for the benefit of the common stockholders of the Company at the rate of $30 per share, and to distribute the same to the common stockholders, and of receiving payment for and to retire the preferred stock of the Company at par, plus accrued dividends, and to retire the bonds of the Company, and for that purpose that the assets of the Company be conveyed to said liquidating trustee, or its nominee, and thereafter conveyed by said liquidating trustee to Lexington Telephone Company, a Delaware corporation; and,
Whereas, the Board of Directors of the Company, at a meeting duly convened and held according to law and the By-laws of the Company at the office of the Company on the 20th day of March 1929, by resolutions duly made, seconded and unanimously carried, considered it for the best interest of the Company and of its stockholders that all of its property and assets, including its good will and its corporate franchises, be conveyed to Security Trust Company, of Lexington, Kentucky, as liquidating trustee, and authorized and directed the proper officers of the Company to convey said property and assets for the foregoing purposes:
Now, Therefore, Be it Resolved that the action of the Board of Directors of the Company taken at its meeting held on the 20th day of March, 1929, be, and the same hereby is, authorized by the stockholders of the Company, and
Be it Further Resolved that the proper officers of the Company be, and they hereby are, authorized and directed to execute all such documents of assignment, transfer and conveyance and perform such other acts as may be necessary or proper to convey the property and assets of the Company to Security Trust Company, a corporation organized under the laws of the State of Kentucky, as liquidating trustee, or to its nominee, to be transferred and assigned by it to Lexington Telephone Company, a Delaware corporation, upon receipt of the following sums by said Trustee, to be applied by it for the following purposes:
(a) To retire and call $300,000 First Mortgage 7% Bonds of the Company at 110-$330, 000. 00
Interest at 7% to August 1, 1929_:_ 10, 500.00
(b) To retire and call $50,000 First Mortgage 6½% Bonds at 110_ 55, 000. 00 Interest at 6½% to August 1, 1929_ 1,625.00
(c) To pay on liquidation $100. per share on 3000 shares of the Company’s preferred stock_ 300, 000.00
Quarterly dividend to July 1, 1929_ 4, 500. 00
(d) To pay to the common shareholders the price of $30 per share for each share of stock issued and outstanding and owned by them;
and upon said Lexington Telephone Company assuming and agreeing to pay all current debts and obligations of Fayette Home Telephone Company as set forth on the books of account of the Company, and to pay all taxes upon the property of the Company or the transfer thereof as herein provided:
Be it Further Resolved that the Board of Directors and/or officers of the Company be, and they hereby are, authorized and directed to take such steps and perform such acts as may be necessary or expedient to carry out the intent of the proceedings had by the Board of Directors as aforesaid and by this meeting of the stockholders of the Company, and to perform all such acts and execute and deliver all such documents as will effectually vest good title in and to all the assets of this Company in Lexington Telephone Company, a Delaware corporation.

All the petitioners except Karoline E. Guncl were present at the stockholders’ meeting of March 25, 1929. At the board of directors’ meeting of March 20, 1929, the redemption of the first mortgage 20-year gold bonds of the company was authorized upon the consummation of the sale and transfer and also, upon such sale, the dissolution of the company was ordered.

March 26, 1929, the Fayette Co., for a nominal consideration, executed a deed to all its properties to the Security Trust Co. as liquidating trustee, and placed it in the hands of George R. Hunt, as its attorney. On March 26, 1929, the Security Trust Co., as liquidating trustee, at the request of Thompson and associates executed a deed to the properties then owned by the Fayette Co., including the 675 shares of the stock of the Jessamine Telephone & Telegraph Co., to the Lexington Telephone Co., and placed it in the hands of George R. Hunt as attorney for the said liquidating trustee. A deed releasing the mortgage on the assets of the Fayette Co. securing its bonds was executed by the trustee thereunder and placed in the hands of George R. Hunt, as attorney for said trustee. On March 26, 1929, the Lexington Telephone Co. executed a trust deed conveying all of its property to the Continental-Illinois Bank & Trust Co. to secure its 15-year 6 percent bonds in the sum of $2,500,000 and placed it in the hands of George R. Hunt as attorney for Thompson and associates.

Prior to February 28, 1929, Thompson and associates organized the Lexington Telephone Co., with a capital structure of $2,500,000 first mortgage 15-year 6 percent gold bonds, series 1929, $1,000,000 2-year 5½ percent ⅝ convertible gold notes, $1,100,000 6½ percent cumulative prior preferred stock, $500,000 6½ percent cumulative preferred stock, and 20,000 shares of no par value common stock. On February 28, 1929, the Lexington Telephone Co., at its first meeting, accepted the offer of Thompson and associates, dated February 27, 1929, to exchange the assets then owned by the Fayette Co. for said securities of the Lexington Telephone Co., except the $1,100,000 6½ percent cumulative prior preferred stock. The mortgagee, Continental-Illinois Bank & Trust Co., required, as a condition precedent to the issuance and delivery of the bonds of $2,500,000, that the Lexington Telephone Co. acquire clear title to the properties of the Fayette Co., and that the said deed of trust be filed of record.

The release of the mortgage securing the Fayette Co. bonds, the deed from the Fayette Co. to the liquidating trustee, and the deed from the liquidating trustee to the Lexington Telephone Co., held by George R. Hunt, in the capacities mentioned, were to be by him released and filed for record upon notice from Charles N. Manning so to do, and the trust deed from the Lexington Telephone Co. to the Continental-Illinois Bank & Trust Co., held by George R. Hunt as aforesaid, was to be by him released and filed for record immediately after the release and deeds had been released by him and filed for record. On March 26, 1929, the Security Trust Co. transmitted to the Harris Trust & Savings Bank, Chicago, Illinois, stock certificates for the 100,920 shares of Fayette Co. and 9,973 shares of Woodford Co., for the purpose of permitting inspection thereof by Thompson and associates, and to be held subject to its order or the order of C. N. Manning.

The transactions were consummated March 28, 1929, at a meeting held in Chicago, Illinois, by representatives of the Harris Trust & Savings Bank, Chicago, Illinois, as agent of the Security Trust Co., Charles N. Manning, president of the Security Trust Co., representatives of the Continental-Illinois Bank & Trust Co., and G. W. Thompson, president of G. W. Thompson & Co., in the following sequence:

(1) Continental-Illinois Bank and Trust Company made a temporary loan of $3,622,200 to G. W. Thompson and Company, Inc., on their collateral form note.
(2) G. W. Thompson and Company, Inc., drew a cneck, payable to the Security Trust Company, against the above sum for $3,622,200, which was certified by the Continental-Illinois Bank and Trust Company and held by its said representatives.
(3) The president of Security Trust Company, Charles N. Manning, delivered to G. W. Thompson, certificates properly endorsed in blank, with revenue stamps affixed, for the 100,020 shares of Fayette Company common stock and 9,973 shares of Woodford Company stock. G. W. Thompson received the said certified check for the $3,622,200 from the representative of the Continental-Illinois Bank and Trust Company, and delivered it to said Charles N. Manning, and the stock certificates were held by the representative of the Continental-Illinois Bank and Trust Company as collateral security for the said temporary loan of $3,622,200.
(4) C. N. Manning deposited the check, immediately upon the receipt to the credit of the Security Trust Company, in the Harris Trust and Savings Bank, Chicago, Illinois, and also immediately made call loans of the greater portion thereof at the rate of approximately 15 per cent, which prior to disbursement of said funds by the said Security Trust Company, earned interest in excess of $5,000.
(5) C. N. Manning, after receipt of the check for $3,622,200, telegraphed and telephoned George B. Hunt at Lexington, Kentucky, to release and file for record the title instruments, which George R. Hunt did immediately upon his being so notified, and in the following sequence:
First: The release of mortgage securing Fayette Company bonds.
Second: Deed from Fayette Company to Security Trust Company, as liquidating trustee.
Third: Deed from Security Trust Company, as liquidating trustee, to Lexington Telephone Company.
Fourth: Trust deed from Lexington Telephone Company to the Continental-Illinois Bank and Trust Company.
(6) Immediately after releasing and filing for record the aforesaid title instruments, George R. Hunt advised the Continental-Illinois Bank and Trust Company thereof by telegraph.
(7) Upon receipt of the telegram from George R. Hunt, the Continental-Illinois Bank and Trust Company delivered the bonds, notes, and preferred and common stocks of Lexington Telephone Company to G. W. Thompson and Company, Inc. who apportioned them to itself and its associates, and simultaneously Thompson and associates paid the tempoz-ary loan of $3,622,200, with money borrowed from the Continental-Illinois Bank and Trust Company on their collateral form notes, secured by trust receipts on bonds and notes of Lexington Telephone Company, and other securities.

The rates for call money were high, and the Continental-Illinois Bank & Trust Co. required, as a condition to making the temporary loan of the $3,622,200 to G. W. Thompson & Co., that the transactions should take place as nearly simultaneously as possible and in the designated sequence, and the said transactions from the delivery by C. 1ST. Manning to! G. W. Thompson of the certificates for the 100,920 shares of Fayette Co. stock, and the 9,973 shares of Woodford Co. stock up to and including the delivery of the trust receipts to the Continental-Illinois Bank & Trust Co. by Thompson and associates, were consummated in less than three hours.

Thompson and associates paid their notes secured by the trust receipts with the proceeds from the sale of the securities of the Lexington Telephone Co., contracts for the sale thereof having been made by them prior to March 28, 1929. On March 28, 1929, G. W. Thompson & Co. stamped its name, as assignee, on the certificates for the 100,920 shares of Fayette Co. common stock and delivered them to the Harris Trust & Savings Bank, which forwarded them to the Security Trust Co., transfer agent, and the said transfer agent on April 6, 1929, issued a new certificate to G. W. Thompson & Co. for 100,920 shares of Fayette common stock. The letter, dated March 28,1929, transmitting such stock certificates of the Fayette Co. from G. W. Thompson & Co. to the Security Trust Co., in part, reads:

We herewith surrender and deliver to you for cancellation upon liquidation of Fayette Home Telephone Company, certificates for 101,240 shares of the common stock of the Fayette Home Telephone Company stock purchased from the former owners thereof by S. E. Stern under a written proposal dated December 15, 1928, addressed to Mr. Charles N. Manning, President of the Security Trust Company, Lexington, Kentucky, which stock and the certificates evidencing ownership thereof, together with all the rights, benefits and privileges accruing to said Stern by reason of the acceptance of said proposal, the said S. E. Stem by written assignment dated March 23, 1929, sold and assigned to us.

Upon the receipt of the $100,000 paid by S. E. Stern on December 31,1928, the Security Trust Co. opened an account in its trust ledger designated “Escrow Agreement between S. E. Stern, C. N. Manning, et al.”, and entered therein the said $100,000 as a receipt. Upon the receipt of the $3,622,200, paid by G. W. Thompson & Co. on March 28, 1929, the Security Trust Co. entered $2,927,600 thereof in the account, and $694,600 thereof in an account in its trust ledger designated “Liquidating Trustee for Fayette Home Telephone Company.”

The $3,722,200 was disbursed as follows:

From account designated “Escrow Agreement between S. E. Stern, O. N. Manning, et al.” — ■
Paid to common stockholders of Eayette Home Telephone Company — 100,920 shares deposited with escrow agent at $29.25_$2,951, 910. 00
Thomas A. Coombs, commission_ 62, 880.14
Hunt and Bush, attorney’s fees__ 500. 00
Security Trust Company, commission_ 10,089. 39
Miscellaneous expenses_ 2, 220. 47
- $3, 027, 600.00
From account designated “Liquidating Trustee for Fayette Home Telephone Company” — ■
Paid to holders of Fayette Home Telephone Company common stock not deposited with escrow agent 220 shares common at $29.25_ $6, 435.00
Retained by Security Trust Company — 220 shares common at $0.75_ 165. 00
Retained by Security Trust Company — 100 shares common never surrendered to liquidating trustee at $30.00_ 3, OOO. 00
Paid bondholders—
For redemption of $300,000 first mortgage 7% bonds at 110_ 330, 000. 00
For redemption of $50,000 first mortgage 6½% bonds at 110_ 55, 000. 00
Paid preferred stockholders — Redemption of 2,974 shares of 6% preferred stock_ 297,400.00
Retained by Security Trust Company — 26 shares at $100.00_ 2, 600.00
- 694, 600.00
3, 722,200.00

The petitioners herein were paid by the Security Trust Co. out of the account designated “Escrow Agreement between S. E. Stern, C. ÜT. Manning, et al.” sums equal to $29.25 per share for each share deliv-erecL by them to the escrow agent under their said contracts with S. E. Stern, as follows:

Southern Bell Telephone & Telegraph Oo:
Por stock held by it direct_$626, 535. 00
Por stock held for it by Read and AVebb- 5, 850. 00
O. N. Manning_ 132, 356.25
Estelle des Cognets- 100, 035. 00
Karoline E. Gund_ 118,170. OO1
Thomas S. Scott- 120,422. 25
Louis des Oognets (now deceased)_ 99, 450. 00

In their Federal income tax returns for the year 1929, each petitioner reported therein and paid a tax on the difference between the above stated amounts received and the cost to them of their Fayette Co. stock. The check covering the payment by the Security Trust Co. to the Southern Bell Telephone & Telegraph Co. of the above sum of $026,535 is typical of the checks issued to the other depositors of Fayette Co. common stock with the escrow agent, except the name of the payee and the amount thereof. On July 2, 1929, and at all times thereafter the Fayette Co. had no assets except cash in the amount of $188,372.21, and securities in the amount of $125,000 in the hands of the liquidating trustee.

The directors of the Fayette Co. met April 8,1929, and reduced the board to five directors, who thereupon passed a resolution to dissolve the Fayette Co., subject to the ratification of the stockholders. The Fayette Co. stockholders met May 6,1929, and ratified the resolution of the directors to dissolve the Fayette Co. At said stockholders’ meeting 101,196 shares of stock were represented, of which the 100,920 shares issued to G. W. Thompson & Co. were voted for it by proxy. On July 2,1929, the State of Delaware issued a certificate dissolving the Fayette Co., and its 20-year bonds, par $350,000 dated February 1,1921, which had been called for redemption, were retired, as aforesaid, as of August 1, 1929, with funds from the account designated “Liquidating Trustee of Fayette Home Telephone Company.” The unamortized discount on the aforesaid bonds at the time of retirement was $16,153.41, and they were retired at a premium of $35,000.

March 15, 1930, a Federal income tax return was filed for the Fayette Co. with the collector of internal revenue for the district of Kentucky, at Lexington, Kentucky, and did not include any income from the transactions. The Commissioner of Internal Revenue disallowed as a deduction from gross income the bond discount and premium, and on the basis thereof made a jeopardy assessment of $5,557.41, and thereafter on November 17, 1930, by registered mail, he sent the Fayette Co. notice of the said deficiency and the jeopardy assessment. The jeopardy assessment of the said $5,557.41 was made on a list approved November 1, 1930. Thereafter the Commissioner determined that the Fayette Co. sold its assets at a profit to it, in the period January 1 to March 31,1929, of $2,282,422.56, and on the basis thereof made a jeopardy assessment against the Fayette Co. of $251,066.48, and thereafter on December 28, 1930, by registered mail, he sent the Fayette Co. notice of the said deficiency and the jeopardy assessment thereof. The jeopardy assessment of the $251,066.48 was made on a list approved December 12, 1930. No petition was filed with the Board by the Fayette Co. from the above determinations. The said assessment lists were duly received by the collector for the district of Kentucky. The deficiencies assessed in jeopardy are still outstanding and unpaid. By notices of deficiency dated February 7, 1933, the Commissioner determined the petitioners herein were transferees of the assets of the Fayette Co., and liable for the deficiency for the year 1929, aggregating the amounts assessed in jeopardy.

The basic issue in the case before us is whether the petitioners sold their stock.

The petitioners contend that the original contract related solely to the sale of the Fayette Co. stock, was consummated exactly as agreed, and was not modified or superseded by any subsequent acts or agreements.

The respondent contends there was a sale of the assets of the Fayette Co. and that petitioners are liable for income taxes on such sale, as transferees.

These are transferee proceedings and, therefore, the burden of proof is on the respondent to establish the liability of the petitioners.

The essential facts may be restated very briefly. The petitioners agreed to dispose of their stock in the Fayette Co. (and proportionate shares in the Woodford Co.) pursuant to a proposal made by S. E. Stern on December 15, 1928, and accepted by the petitioners at various times later, but before March 1, 1929. The stock was to be placed in escrow. Stern agreed to buy the petitioners’ stock for $30 per share, less certain escrow charges, and pay for it on or before March 31, 1929. He deposited $100,000 in escrow as evidence of good faith and as a part of the purchase price. Certain assurances of the correctness of balance sheets and the validity of titles were to be furnished by the sellers and other minor details were set forth. In order to make the contract effective, a time limit for securing the assent of 67 percent of the stockholders to the proposal was set at December 31, 1928, but was extended to a later date. With the exception of such time extension, the terms of the original contract were strictly complied with. Over 90 percent of the stockholders became signators thereto and the stock was deposited in escrow. It amounted to all but 320 of the 101,240 outstanding shares. Stern deposited the $100,000 in escrow. He, in the person of his assignees, paid for the stock on March 28,1929, by means of a temporary loan made to G. W. Thompson & Co. on their collateral form note. At the same time the escrow agent delivered the stock certificates, properly endorsed in blank, to G. W. Thompson & Co., representing Stern’s assignee. Thus, the consummation of the contract was accomplished with no change whatever in its terms or the status of the parties thereto. See Samuel Keller, 21 B. T. A. 84; aff'd., 59 Fed. (2d) 499; Fred Messerschmidt, Docket No. 47848, memorandum opinion entered October 4, 1933; appealed by the Government to the Circuit Court of Appeals for the Seventh Circuit and there dismissed on motion of the Government, 69 Fed. (2d) 998. Cf. Motter v. Patterson, 68 Fed. (2d) 252.

The respondent seeks to inject into the case the methods and means adopted by the assignees of Stern in carrying out their further plans and attempts to impute to the petitioners a complete knowledge of, acquiescence in, and agreement with those measures. He would charge them with the consequent tax burden created by such a situation. We believe his action in so doing is erroneous.

The petitioners proceeded in exact compliance with their agreement with Stern. Thompson and his associates attempted to compel the petitioners to transform the contract into one transferring the assets of the Fayette Co., but Manning and the other petitioners persistently refused to do so.

On March 1, 1929, over 90 percent of the Fayette Co. stockholders, owning almost all of its stock, had become parties to the contract and had divested themselves of the ownership of the stock. The petitioners were among these stockholders. At this time only delivery of the stock and payment therefor by the escrow agent remained to be done. At that time they were the nominal owners of stock and as such acted as directors and officers of the company. Their actions on March 20 and 25, 1929, in passing the resolutions and orders set forth in the record, were directed, controlled and dictated by the purchasers. The petitioners then had no personal interest in such corporate actions. To carry out the plan of securing the money with which to pay the petitioners for the stock, the formal approval of the Fayette Co. officials, then technically and nominally in control of the corporation, was required, but we are not justified in concluding that the official acts of the petitioners secured under such circumstances were their personal acts.

The acts of the petitioners individually and as the officers of the Fayette Co. are comprehended in separate, distinct and unrelated sequences of events. The money which Stern and his assignees needed to complete the contract and pay their obligations under it may have been secured through the organization of the Lexington Co. and the pledging of its assets as collateral security with a bank, but that procedure was no affair of the petitioners. It was conceived, arranged and carried out by Thompson and his associates. The only point of contact between them and the petitioners was the procurement of the petitioners’ official actions as directors of the Fayette Co., as we have heretofore noted. Likewise, what Thompson and his associates did with the Fayette Co. after they had bought its stock from the petitioners and thus secured control of it, was of no concern to the petitioners. The record does not convince us that the assets of the Fayette Co. were transferred to the petitioners and by them sold to Stern and his assignees.

The various book entries made by the Security Trust Co. were cited as being persuasive that the Fayette Co.’s assets, rather than its stock, were sold, but we must bear in mind that the Trust Co. acted in several capacities. Its functions and duties were tripartite; it was trustee under the deed of trust securing the Fayette Co.’s bond issue; it was escrow agent under the stock sale agreement; and it was the liquidating trustee under the Thompson plan. Its actions may have overlapped and been somewhat confusing, but do not disturb the fundamental facts.

Respondent relies heavily on George M. Brady, 22 B. T. A. 596. The facts in that case are basically different. There the stockholders clearly departed from their plan to sell the stock and made a sale of the assets. Here they adhered rigorously to their original plan.

Since petitioners are not liable as transferees, it is unnecessary to consider the other issues.

Decisions of no transferee liability will be entered.


source: Caselaw Access Project

author: Smith: Murdock, ARundell,

license: Public Domain

text:
    James E. Davidson, Petitioner, v. Commissioner of Internal Revenue, Respondent. Edith L. Davidson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 61741, 72904, 72905.
    Promulgated May 8, 1936.

      Edward J. Svoboda, Esq., and J. A. G. Kennedy, Esq., for the petitioners.

      E. G. Algire, Esq., for the respondent.
   OPINION.

Smith:

The petitioners contend that the respondent has erroneously applied the first in, first out rule in computing their gains upon the above described sales of stock and that in each of the transactions involved the shares of stock sold were identified by their instructions to the broker to sell certain specified shares.

By amendments to his answers duly filed in each of the proceedings the respondent admits error in applying the first in, first out rule to the 400 shares of the American Gas & Electric Co. stock sold by Edith L. Davidson in 1929 and avers that such shares were identified by the certificates which the petitioner delivered to the broker in completion of the sale as those acquired by stock dividend, with a stipulated cost of $27.50 per share.

The respondent further avers that if the rule of first in, first out is held not applicable to the gains on the sale of certain of the shares of stock sold in 1928 and 1929 such gains are not taxable as capital net gains, as they were treated in the computation of the deficiencies herein, but are taxable as ordinary gains at the normal rate.

The respondent .further avers in the amendment to his answer filed in Docket No. 72905 that, due to error in the computation of the deficiency therein asserted against Edith L. Davidson, capital net gains were understated in the amount of $22,660.79.

For reasons hereinafter discussed we have found that the first in, first out rule is not applicable to any of the transactions involved in these proceedings, since in each transaction the shares sold were sufficiently identified. This ruling, however, does not dispose of the proceedings. We must still determine what shares were sold in each transaction and the amount of the profit or loss thereon.

The several transactions will be discussed in the order indicated in the above findings of fact.

National Power & Light Co. transactions of James E. Davictson in 1928.

As to the sale of the several lots of National Power & Light Co. shares in 1928, we think that there was an identification by the petitioner of all the shares sold and that the first in, first out rule is therefore inapplicable. The Commissioner’s regulations, article 58 of Regulations 74, provide that this rule is to be applied only when the identity of the lots sold can not be determined. See Helvering v. Rankin, 295 U. S. 123. In each of these sales the shares which the petitioner instructed the broker to sell had been bought and paid for by the petitioner and, with the exception of the 100 shares sold on September 24, 1928, the certificates for the shares had been issued to him. In each instance the petitioner instructed his broker to sell certain shares which he clearly identified by certificate numbers, and afterwards he delivered the shares so identified to the broker where they were not already in the broker’s possession.

The respondent makes the argument that the evidence does not show that the broker actually sold the shares which the petitioner instructed him to sell or delivered to him for sale and that in fact the shares sold by the broker were all kept in “street” names and were not susceptible of identification. That is immaterial, we think. It is not identification by the broker, but the owner and seller of the shares, that is required. In Helvering v. Rankin, supra, the Court said:

* * ⅜ It is true that certificates provide tlie ordinary means of identification. But it is not true tliat they are the only possible means. Compare Richardson v. Shaw, 209 U. S. 365; 28 S. Ct. 512, 52 L. Ed. 835, 14 Ann. Cas. 981; Gorman v. Littlefield, 229 U. S. 19; 33 S. Ct. 690, 57 L. Ed. 1047; Duel v. Hollins, 241 U. S. 523, 36 S. Ct. 615, 60 L. Ed. 1143. Particularly is this so when, as here, the thing to be established is the allocation of lots sold to lots purchased at different dates and different prices. The required identification is satisfied, if the margin trader has, through his broker, designated the securities to be sold as those purchased on a particular date and at a particular price. It is only when such a designation was not made at the time of the sale, or is not shown, that the “Eirst-in, first-out” r.ule is to be applied.

The petitioner’s instructions to the broker to sell certain specified shares and the subsequent delivery to the broker of certificates for the shares specified sufficiently identifies the shares sold.

National Power & Light Co. transactions of James B. Davidson in 1929.

As to the petitioner’s 1929 transactions in the National Power & Light Co. stock a different situation is found. The first four sales in that year, 500 shares sold January 8, 200 shares sold January 22, 1,000 shares sold January 28, and 600 shares sold February 16, were all made through the petitioner’s trading account with the broker, which was “long” at the time of the sales for the number of shares sold. No certificates for the shares sold had ever been issued to the petitioner. The shares were carried by the broker in “street” names and were not earmarked. In each instance the petitioner instructed the broker to sell certain shares purchased on a specified date. Under the decision of the Supreme Court in Helvering v. Rankin, supra, that was a sufficient identification of the shares sold. Apparently, the transactions in Helvering v. Rankin, supra, were conducted in substantially the same manner as the transactions here, since in both instances the shares sold had not been issued in the name of the customer or earmarked by the broker, but were held in “street” names.

In each of the two remaining sales in 1929, 500 shares sold June 19 and 500 sold July 1, the petitioner instructed the broker to sell certain shares represented by certificates which had been issued to him and were then being held by the bank as collateral on a loan. The petitioner expected to get these identical certificates from the bank and deliver them to the broker in completion of the sales, just as he had done in the 1928 sales, but through a mistake on the part of the bank other certificates, representing shares acquired at an earlier date, were delivered to the broker. In those circumstances, we think that the shares delivered to the broker were the shares actually sold by the petitioner.

In Miller v. Commissioner, 80 Fed. (2d) 219, the rule pronounced in Helvering v. Rankin, supra, was held to apply to transactions other than those conducted by a “margin trader.” The facts there were that the broker, who had in his possession a number of shares of stock which the taxpayer had purchased at different times and for different prices, was instructed to sell a certain number of shares from a specified lot, but instead sold and delivered to the purchaser shares from a different lot. The court held that the taxpayer’s instructions to the broker to sell certain of the shares identified those shares as the ones sold, notwithstanding that the broker delivered other shares to the customer. In concluding its opinion, the court stated the three following rules:

* * * (i) that where there is no designation by the taxpayer at the time of making the sale, the certificate should be treated as the proper means for identification; (2) that a designation by instructions to the broker of the shares to be sold is controlling though the certificate delivered does not correspond with the instructions; (3) that the “First-in, first-out” rule applies only where there is neither identification by a certificate, nor by designation of the taxpayer.

In Estate of Uzal H. McCarter, 34 B. T. A. 535, the Board followed Miller v. Commissioner, supra, with the qualification, however, that clause (2) of the above quotation from the court’s opinion in that case should be construed to mean that a designation by instructions to the broker is controlling though the certificate delivered by the broker does not correspond with the instructions. Where the shares are already in the broker’s possession there is nothing more for the seller to do after he instructs the broker to sell certain of those shares. Ordinarily, too, it is of no consequence to the broker or to the customer which shares are delivered by the broker. But as long as the petitioner has possession of the shares he is free to exercise his own choice and deliver whatever shares he may choose to in conclusion of the sale. In the instant case, for instance, the petitioner after instructing the broker to sell certain shares was free to change his mind about what shares he would dispose of and to deliver certificates for other shares. See also Horner v. Commissioner, 72 Fed. (2d) 407, affirming 28 B. T. A. 360; Helen V. Kelchner, 31 B. T. A. 262; George Vamber, 31 B. T. A. 884; aff'd., 83 Fed. (2d) 11. There is no suggestion in the Court’s opinion in Helvering v. Rankin, supra, that the seller’s instructions to the broker to sell certain shares would have prevailed as a means of identification over the fact of the delivery to the broker of certificates for other shares, nor was this question presented by the facts in Miller v. Commissioner, supra. In this case the delivery of the certificates by the petitioner or by the bank as his agent, we think, definitely identified the shares sold. The brokers sold the shares of stock represented by the certificates of indebtedness delivered — not those represented by some other certificates.

General Electric Co. stock transactions of James E. Davidson in 1929.

The petitioner had only one completed transaction in General Electric Co. stock in 1929, involving the purchase of 100 shares on February 19 and the sale of those shares on March 26. The material facts with respect to the transaction are identical with those relating to the purchase and sale of the several lots of National Power & Light Co. stock in 1928. The petitioner received delivery of certificates for the shares purchased, deposited them with the bank as collateral on a loan, instructed the broker to sell those specific shares, and when the sale was made delivered the identical certificates to the broker in completion of the sale. The purchase price of the 100 shares was $22,705, the sale price $22,791, and the profit $86.

American Gas & Electric Co. stock transactions of Edith L. Davidson m 1929.

The questions raised with respect to the transactions of Edith L. Davidson in American Gas <& Electric Co. stock in 1929 have also been answered in our foregoing discussion of the sales of National Power & Light Co. shares by the petitioner, James E. Davidson, in 1929. There, other shares than those _ which the broker had been instructed to sell were delivered to him through a mistake on the part of the bank acting as agent for the petitioner. Here, other shares than those which the broker had been instructed to sell were delivered to him by the seller intentionally because she was unable to get possession of the shares which she had instructed the broker to sell. As to the identification of the shares sold there is no basis for a distinction in these transactions and, for the reasons already stated, we hold that the shares sold were the shares actually delivered to the broker and not in part other shares which the seller instructed the broker to sell but did not deliver. We can not sustain the petitioner’s contention “that the delivery of a certificate other than the share representing that particular lot [which the broker was instructed to sell] because of inability to obtain the identical certificate from the bank did not alter the transaction and that it still remained the sale of that specific lot.”

With respect to the net capital gain question raised by the respondent in the amendments to his answers, it can be readily ascertained from the above stated facts whether the different lots of shares of stock sold by the petitioners in 1928 and 1929 had been held by them for a period of two years or more and therefore constituted capital assets within the meaning of section 101 of the Revenue Act of 1928. Where the shares sold had been held for less than two years the gains derived from such sales were not capital net gains, but were ordinary income taxable as such. Pursuant to the amended answers filed by the respondent the necessary adjustments in petitioners’ tax liabilities will be reflected in the Rule 50 computations.

The further averment contained in respondent’s amendment to his answer filed in Docket No. 72905 that Edith L. Davidson’s net capital gains have been understated by the amount of $22,660.79 due to an error in the computation of the deficiency is supported by the evidence. The error appears on the face of respondent’s Exhibit C. Adjustment in respect of this error likewise will be made in the Rule 50 computation.

Reviewed by the Board.

Judgment will he entered under Bule 50.

Murdock,

concurring: The author of the prevailing opinion attempts to distinguish the present case from the Miller and McCarter cases on the ground that in the latter cases the delivery of the wrong certificate was made-by the taxpayer’s broker, while in the present case the wrong delivery was made either by the taxpayer himself to the broker or by a bank to the broker. I do not agree that the difference in the facts is a sound basis for distinguishing the cases. A broker, just like a bank, is merely the agent of the seller, and where it appears, as it did in the Miller and McCarter cases, that the certificate actually delivered was identifiable as that pertaining to a different lot of stock from the one which the taxpayer designated for sale, there is just as good reason for holding the seller to the basis applicable to the shares represented by the certificate actually delivered as there is in the present case. I agree with the result reached in the present case because I think that identification by certificates is a better method of identification than identification by designation to the broker. See William W. Miller, 31 B. T. A. 192, and my dissent in Estate of Uzal H. McCarter, 34 B. T. A. 535.

McMahon and Turner agree with the above.

ARundell,

dissenting: In the case of Estate of Uzal H. McCarter, 34 B. T. A. 535, we definitely held that we would follow the rule laid down by the Second Circuit in Miller v. Commissioner, 80 Fed. (2d) 219, to the effect that a designation to the broker of the shares to be sold is controlling although the certificate delivered does not correspond with the instructions given. I think we depart from that ruling in the instant case when we hold that the mistaken delivery by the banker of certain certificates shall prevail as an identification of what was intended to be sold over the very definite instructions of the owner to the contrary. The two rulings can not be reconciled. We should adhere to the rule announced in Miller, supra.

Van Fossan, Mellott, and Arnold agree with this dissent.


author: Mellott :

text:
    The Acorn Refining Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 74959.
    Promulgated May 12, 1936.

      Carmi A. Thompson, Esq., Orville Smith, Esq., and A. W. Jappe, Esq., for the petitioner.

      P. A. Bayer, Esq., for the respondent.
   OPINION.

Mellott :

The petitioner contests a deficiency in income tax determined by the respondent for the fiscal year ended January 31, 1931, in the amount of $7,809.93. The petitioner alleges that respondent erred (1) in disallowing as a deduction in computing the consolidated net income of an affiliated group the statutory net losses reported by its subsidiary, the Madison Paint Co., for the fiscal years ended January 31, 1929, and January 31, 1930, aggregating $69,760.97; and (2) in determining that the total cost or aggregate basis of the stock, of the Madison Paint Co., owned by members of the affiliated group was not in excess of $8,308.30.

The petitioner is an Ohio corporation, engaged in the manufacture of paints. Its principal office is located in Cleveland, Ohio, and it is affiliated with the following subsidiary companies:

The Electric Paint & Varnish Co.
The Progress Paint Co.
The American Asbestos Products Co.
The Madison Paint Co.
The Surety Products Co.
The Franklin Paint Co.
The Fulton Paint Co.
The Adams Paint Oo.

For the fiscal year ended January 31, 1931, the affiliated group filed a consolidated return.

The Madison Paint Co. was organized in the year 1921 by Samuel S. Sanders and E. 1ST. Katz. These two individuals also organized the other seven companies listed in the preceding paragraph. Prior to October 1929, the capital stock of the eight companies was owned by Sanders and Katz. They then organized a new corporation known as the Essenkay Corporation to which they transferred all of the stock of the eight corporations in exchange for all of the stock of the Essenkay Corporation.

On October 30,1929, petitioner acquired all of the capital stock of the eight corporations from the Essenkay Corporation in exchange for the stock of a certain real estate holding company. Sanders and Katz each owned one-half of the capital stock of petitioner.

The Madison Paint Co. was one of petitioner’s sales agencies and handled nothing but its products. Its place of business is located at the plant of petitioner, and the advertising of its products was handled by petitioner. One of the methods used was to acquire lists of people looking for positions as sales agents and to mail letters to them. Those employed were furnished with sample outfits by petitioner. Petitioner paid all of the expenses of this advertising, but would then charge a portion of the amount expended to the Madison Paint Co., and such charges would be entered on the books of petitioner as an account receivable from the Madison Paint Co. The latter company would set up these charges as an account payable to petitioner, and on October 31, 1929, it was indebted to petitioner in the amount of $78,817.46. In 1934 the deficit of the Madison Paint Co. amounted to over $73,000.

In August 1934, petitioner canceled the account receivable due it by the Madison Paint Co. in the amount of approximately $80,000 and this amount was treated as a contribution to the capital of the Madison Paint Co. by petitioner.

The Madison Paint Co. filed a separate income tax return for the fiscal year ended January 31, 1929, on which it reported a net loss of $21,452.19. In arriving at the amount of this loss there had been deducted as an expense approximately $25,000, representing the amount of advertising charged to this company by petitioner.

The Madison Paint Co. filed a separate income tax return for the fiscal year ended January 31,1930, on which it reported a net loss of $48,212.35. In arriving at the amount of this loss there had been deducted as an expense approximately $90,000, representing the amount of advertising charged to this company by petitioner.

The Madison Paint Co. sustained a net loss in the amount of $31,943 for the fiscal year ended January 31,1931.

On the date the stock of the eight companies listed above was acquired by petitioner, the net worth of these companies as shown by their books was as follows:

In the consolidated return filed by the affiliated group for the fiscal year ended January 31, 1931, petitioner claimed as a deduction in computing the consolidated net income the net losses of $21,452.19 and $48,212.35 reported by the Madison Paint Oo. in its returns for the fiscal years ended January 31,1929, and 1930, respectively.

Respondent disallowed the claimed deduction and determined that the net loss that could be deducted in computing the consolidated net income for the taxable year was not in excess of $8,308.30, which he determined to be the total cost or aggregate basis of the stock of the Madison Paint Co. owned by members of the affiliated group.

The pertinent provisions of the Revenue Act of 1928 are the following:

Sec. 141. (a) Privilege to file consolidated returns. — An affiliated group of corporations shall, subject to the provisions of this section, have the privilege of making a consolidated return for the taxable year 1929 or any subsequent taxable year, in lieu of separate returns. The making of a consolidated return shall be upon the condition that all the corporations which have been members of the affiliated group at any time during the taxable year for which the return is made consent to all the regulations under subsection (b) prescribed prior to the making of such return; and the making of a consolidated return shall be considered as such consent. In the case of a corporation which is a member of the affiliated group for a fractional part of the year the consolidated return shall include the income of such corporation for such part of the year as it is a member of the affiliated group.
(b) Regulations. — The Commissioner, with the approval of the Secretary, shall prescribe such regulations as he may deem necessary in order that the tax liability of an affiliated group of corporations making a consolidated return and of each corporation in the group, both during and after the period of affiliation, may be determined, computed, assessed, collected, and adjusted in such manner as clearly to reflect the income and to prevent avoidance of tax liability.

In accordance with the authorization conferred upon him by section 141 (b), supra, the respondent, with the consent of the Secretary of the Treasury, promulgated Regulations 75, article 41 (<?) of which reads as follows:

(,e) Ret Loss Sustained 6y Separate Corporation Prior to Consolidated Return Period.
A net loss sustained by a corporation prior to the date upon which its income is included in the consolidated return of an affiliated group (including any net loss sustained prior to the taxable year 1929) shall be allowed as a deduction in computing the consolidated net income of such group in the same manner, to the same extent, and upon the same conditions as if the consolidated income were the income of such corporation; but in no case in which the affiliated status is created after January 1,1929, will any such net loss be allowed as a deduction in excess of the cost or the aggregate basis of the stock of such corporation owned by the members of the group.

Petitioner and its subsidiaries filed a consolidated return for the fiscal year ended January 81, 1981. The filing of this consolidated return constituted an acceptance by them of the regulations prescribed by the respondent. Ilfeld Co. v. Hernandez, 292 U. S. 62. Although petitioner in its brief questions the authority of the Commissioner to promulgate article 41 (e), Regulations 75, supra, it does not attempt to show in what particular the Commissioner exceeded the authority conferred upon him. That Congress intended to authorize the Commissioner to place a limitation upon the deduction in computing consolidated net income of net losses sustained by a corporation prior to affiliation is apparent from the following statement contained in the report of the Committee on Finance (Senate Report No. 960, 70th. Cong., 1st sess., p. 15) accompanying the Revenue Act of 1928:

Among the Regulations of which it is expected that the Commissioner will prescribe was:
* ⅜ * * * * *
(3) The extent to which and the manner in which net losses sustained by the corporation before it became a member of the group shall be deducted in the consolidated return; * * *

The obvious purpose of limiting the amount of the net loss which may be carried forward to an amount not in excess of the cost or basis of the stock of the corporation sustaining it is to “make it profitless * * ⅜ to purchase stock for the purpose of the benefit of deductions in excess of what is paid.” Woolford Realty Co. v. Rose, 286 U. S. 319. Petitioner refers to this limitation as being “drastic”, but we are not of that opinion. Under the provisions of the revenue acts applicable to the years prior to 1929, the net loss sustained by a corporation in one year could not be carried forward to a subsequent year and deducted in computing the consolidated net income of an affiliated group, this privilege being restricted to the corporation which sustained the loss. Woolford Realty Co. v. Rose, supra. Plowever, under the regulation before us, the affiliated group of corporations is permitted to deduct, in computing consolidated net income for 1929 and subsequent years, part of the net loss sustained in a prior year by a corporation which was not then a member of the group. *

It is our conclusion from the foregoing that article 41 (o), supra, is a valid exercise of the authorization conferred upon the Commissioner by the provisions of section 141 (b), supra, and that the amount of any net loss of the Madison Paint Co. deductible in computing the consolidated net income of petitioner and its subsidiaries for the taxable year is limited to the cost or aggregate basis of the stock of the Madison Paint Co. owned by petitioner.

The capital stock of the Madison Paint Co. and of the seven other subsidiary companies was acquired by petitioner for a consideration consisting of the stock of a real estate holding company. The Commissioner determined that the value of the stock of this holding company was $533,027.03. The net worth of the subsidiary corporations at the time petitioner acquired their stock was $641,544.26. Although the Madison Paint Co. had a deficit of $52,081.61 at that time the respondent attributed some cost to its stock and arrived at this cost by taking the capital stock of the Madison Paint Co., namely, $10,000, and taking $533,027.23, which produced a figure of $8,308.30, the amount respondent determined to be the cost of the Madison Paint Co. stock to petitioner.

Petitioner contends that the basis of the stock of the Madison Paint Co. to petitioner included the advances made to petitioner by it and that these advances exceeded the amount of the claimed losses. With this contention we do not agree. By advances petitioner undoubtedly means the amounts charged to the Madison Paint Co. for advertising. Petitioner treated these amounts on its books as accounts receivable and the Madison Paint Co. treated them as accounts payable. There is no indication in the record that at the time petitioner acquired the stock of the Madison Paint Co. on October 30, 1929, it intended to treat advances as part of the cost of the stock of the Madison Paint Co., and the evidence clearly shows that these advances or loans were not canceled until October 30, 1934. They were not, in our opinion, a part of the cost or aggregate basis of the stock of the Madison Paint Co., at the time it was acquired by petitioner.

The Commissioner determined that the cost of the stock of the Madison Paint Co. to petitioner at the time it was acquired in 1929 was not in excess of $8,308.30. In view of the fact that this subsidiary had a deficit of $52,081.61 at that time, we believe that the cost determined by the Commissioner was fair and reasonable. The burden was on the petitioner to overcome the prima facie correctness of the respondent’s determination by competent evidence. It has not sustained this burden. We hold that the net loss of the Madison Paint Co. which may be allowed as a deduction in computing the consolidated net income of the affiliated group for the year ended January 31, 1931, is $8,308.30.

Judgement will be entered for the respondent.


author: Aeundell:

text:
    Pillar Rock Packing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 70485.
    Promulgated May 15, 1936.

      Robert T. Jacob, Esq. for the petitioner.

      R. P. Uertzog, Esq. for the respondent.
   OPINION.

Aeundell:

The issue here is whether the transaction between petitioner and the New England Fish Co. comes within the statutory definition of a reorganization (Revenue Act of 1928, sec. 112 (i) (1)) and is therefore taxable only to the extent of the cash and notes received (secs. 112 (b) (4) and (d) (1)). Petitioner argues that either (1) the transaction is a merger within the ordinary and accepted definition of that term, or (2) it comes within the parenthetical enlargement of the term which deals with cases where substantially all the assets of one corporation are acquired by another corporation.

It is not suggested that petitioner and the New England Fish Co. complied with any requirements for consummating a “merger” provided by the statutes of the states of their creation, but petitioner apparently assumes that transactions other than statutory mergers are included in the term “merger”, apart from the parenthetical enlargement which follows it in the reorganization definition. We have not heretofore passed upon this point, although we have held that, where a consolidation or merger is undertaken pursuant to statute, the statute must be strictly complied with. Alice V. St. Onge, 31 B. T. A. 295 (pending before C. C. A., 1st Cir.). However, passing the question of whether a merger within the meaning of the revenue act can exist in the absence of proceedings under a state statute in terms authorizing “merger”, we must hold the transaction here is not a merger even within the general definitions of that term. Merger has been defined as follows:

As applied to corporations, the terras “merger” and “consolidation” have well known legal meanings. "While the result is practically the same in either event, there is this difference. In a merger one corporation absorbs the other and remains in existence while the other is dissolved. In a consolidation a new corporation is created and the consolidating corporations are extinguished. In either event, the resulting corporation acquires all the property, rights and franchises of the dissolved corporations, and their stockholders become its stockholders. Royal Palm Soap Co. v. Seaboard Air Line Ry. Co. (C. C. A.) 296 F. 448; Bouvier’s Law Dictionary (3d Ed.) p. 2202, verbo “merger.” [Pinellas Ice & Cold Storage Co. v. Commissioner of Internal Revenue, 57 Fed. (2) 188.]
Numerous definitions of the words “merger” and “consolidation” may be found in the reports, state and federal, but though the definitions differ, there is practical agreement that, when employed to define forms of union between two corporations, a merger is said to take place when one of the corporations retains its existence and succeeds to the franchises and acquires the property and assets of the other; whereas a consolidation under similar circumstances occurs where all the corporations involved become extinct and go out of existence as separate organizations and a new and different corporation is created to take over the assets of the dissolved corporations.
Judge Hand recently, in a case involving the statute we are here concerned with, defined the term “merger” as an “absorption” by one corporation of the properties and franchises of another whose stock it has acquired. In that case he said: “The merged corporation ceases to exist, and the merging corporation alone survives,” and at the same time he defined the term “consolidation” as involving a dissolution of the companies consolidating and a transfer of corporate assets and franeises to a new company. Cortland Specialty Co. v. Commissioner (C. C. A.) 60 F. (2) 937, 939. [Fordyce v. Helvering, 76 Fed. (2) 431.]

See also Von Weise v. Commissioner, 69 Fed. (2d) 439.

The transaction here meets none of these definitions. The petitioner corporation was not absorbed in or swallowed up by the New England Fish Co. — this for two reasons: First, petitioner retained a substantial part of its assets. It is argued that the retained assets should be disregarded as they were accounts receivable due from the partnership and the same persons owned substantially identical interests in both enterprises. Even if this be important, the facts as found do not disclose a substantial identity of interest by the same persons in both the partnership and petitioner. We may not therefore disregard the retained accounts as assets unless, for example, they had been transferred in liquidation prior to the transfer to the New England Fish Co. Cf. Helvering v. Minnesota Tea Co., 296 U. S. 378. Secondly, the instant transaction falls short of a merger because the petitioner corporation remained in existence. The parties assumed that its existence continued for only two' years after the transaction in question, at which time it was struck from the files of the Department of State of the State of Washington for failure to pay annual license fees. The law of Washington would indicate, rather, that such striking does not amount to a dissolution (sec. 3843, Wash. Rev. Stats.; State ex rel Preston Mill Co. v. Howell, 67 Wash. 377; 121 Pac. 861; Moore v. Los Lugos Gold Mines, 172 Wash. 570; 21 Pac. (2d) 253. Cf. Lang Body Co., 16 B. T. A. 728). In either event, we think that a merger requires early dissolution of the corporation which is absorbed in another. This is not required under the parenthetical enlargement of the term “merger” which follows it in the statute Helvering v. Minnesota Tea Co., supra) but is, we think, required to make the transaction a “strict”, “true”, or “technical” merger.

As to petitioner’s further contention that the transaction here falls within the parenthetical enlargement of the term “merger” in that substantially all of its assets were transferred to the New England Fish Co., we find that under the most favorable method of computation (see Western Industries Co., 30 B. T. A. 809, and Cortland Specialty Co. v. Commissioner, 60 Fed. (2d) 937) only approximately two-thirds of its assets can be said to have been conveyed. There were $45,294.52 of accounts receivable which were retained as against a cost of assets transferred of $60,536.06 and a selling price of $94,591.50. There is no showing that the retained accounts receivable were canceled out or written off the books as a result of the transaction with the New England Fish Co. Under this state of facts, we do not think that “substantially all” of the assets were transferred. Arctic Ice Machine Co., 23 B. T. A. 1223.

Judgment will he entered for respondent.

       Sec. 112 (i) (1). The term “reorganization” means (A) a merger or consolidation (including the acquisition hy one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation).


author: Mellott:

text:
    Mary Q. Hallock and Central United National Bank of Cleveland, Trustees, Petitioners, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 76802, 76803, 76927.
    Promulgated May 19, 1936.

      Walker H. Nye, Esq., for the petitioners in Docket Nos. 76802 and 76803.

      W. H. Annat, Esq., for the petitioner in Docket No. 76927.

      Eugene G. Smith, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: Mary Q. Hallock, Executrix of the Estate of Henry Hallock, Deceased; S. H. Squire, Superintendent of Banks of the State of Ohio in Charge of the Liquidation of the Union Trust Co., Successor of the First Trust and Savings Co.. Trustee, Cleveland, Ohio.

   OPINION.

Mellott:

The respondent determined a deficiency in estate taxes against the estate of Henry Hallock, in the amount of $6,096.97 under the Revenue Acts of 1926 and 1932. (Docket No. 76803.) A deficiency in the same amount was determined against the petitioners in dockets numbered 76802 and 76927 as transferees. In these proceedings, consolidated for hearing, petitioners seek a re-determination of the deficiencies. All of the facts are stipulated.

Henry Hallock died October 10, 1932, testate. His widow, Mary Q. Hallock, was duly appointed executrix of his estate. She filed an estate tax return showing no tax to be due. Respondent determined that 884 shares of 7 percent preferred stock of the Ohio Rubber Co., valued at $70,720, should have been included in the estate and accordingly he added such amount. He also reduced the deductions on account of debts and charges against the estate from $171,378.17, reported by the executrix, to $114,822.36, on the theory, as stated by him in his notice of deficiency, that “no greater amount may be allowed than the value of the probated estate which is subject to the payment of such items.”

The facts with reference to the shares of stock of the Ohio Rubber Co. are as follows. On September 3, 1919, Henry Hallock entered into a separation agreement with his then wife, Anne Lamson Hal-lock, which provided for the payment to her of $500 per month by way of alimony and for the creation of a trust to produce such sum. On the same day Henry Hallock transferred in trust to the First Trust & Savings Co. of Cleveland, Ohio, 884 shares of 7 percent preferred stock of the Ohio Rubber Co. The dividends of such stock amounted to $6,188 per annum, sufficient to pay the necessary $6,000 per year to the beneficiary and leave $188 per year for the expenses and compensation of the trustee. The Union Trust Co. was the successor in trust of the First Trust & Savings Co., and it is now in liquidation by S. H. Squire, Superintendent of Banks of the State of Ohio.

Anne Lamson Hallock secured a divorce from Henry Hallock on October 28, 1919. She is still living and has not remarried. The trust agreement contained the following provision with reference to the disposition of the trust estate:

O. If and when Anne Lamson Hallock shall die then and in such event and thereupon the within trust shall terminate and said Trustee shall and will pay Party of the Hirst Part if he then be living any accrued income, then remaining in said trust fund and shall and will deliver forthwith to Party of the Hirst Part, the principal of the said trust fund. If and in the event said Party of the Hirst part shall not be living then and in such event payment and delivery over shall be made to Levitt Hallock and Helen Hallock, respectively son and daughter of the Party of the Hirst Part, share and share alike. If and in the event either said Levitt Hallock or Helen Hallock shall at such time be dead, the share which would have gone to him or her if living, shall go to the children of such deceased child and if there he no such children living, then said entire income and principal shall be paid to that child of Henry Hallock then living.

The respondent concluded that the trust estate amounting to $70,-720 came “within the purview of sections 302 (c) and 302 (d) of the Revenue Act of 1926” and added such amount to the gross estate.

The petitioners in Docket No. 76802 are trustees under an agreement of trust dated September 1, 1925, to whom the decedent had transferred certain policies of life insurance taken out on his own life. No issue is involved herein relative to such transfer, but it is stipulated that the proceeds, or the investment of the proceeds in the hands of the trustee, exceed in amount the deficiency determined by the respondent. Thus, if the deficiency is upheld, such petitioners are liable for the tax as transferees.

Of the several errors assigned in the various petitions the following were relied upon at the hearing and upon brief:

(1) Tbe inclusion as part of the gross estate of the decedent of a trust fund created by a trust agreement made by Henry Hallock on September 3, 1919, valued at $70,720.00 as a transfer to- take effect in possession or enjoyment at or after death under Sections 302 (c) and 302 (d) of the Revenue Act of 1926.
(2) The inclusion of the trust estate at its full value, without deducting the value of the life estate or interest in the trust of Anne Lamson Hallock, the life beneficiary of all of the income.
(3) The disallowance as deductions from the gross estate of debts and charges of $56,551.81 on the ground that no greater amount may be allowed as deductions than the value of the probated estate administered by the executrix.
(4) The assessment against the petitioner, as trustee and transferee, of the entire alleged deficiency of Six Thousand Ninety-Six Dollars and Ninety-Seven Cents ($6,096.97).

The respondent relies upon section 302 of the Revenue Act of 1926, and especially subsections (c) and (d).

Subsection (c), supra,, has been construed by the courts in many cases and it is unnecessary for us to discuss it at any considerable length. In the recent case of Helvering v. St. Louis Union Trust Co., 296 U. S. 39, the Court collates the previous decisions and again enunciates the rule that “The event which gives rise to the tax is the death of the decedent, with the resulting transfer of his estate either by will or the law relating to intestacy.” The tax is laid “upon the theory that such a transfer is in effect testamentary” but if “no interest in the property involved in a given case pass from the ‘possession, enjoyment or control of the donor at his death,’ there is no interest with respect to which the decedent has created a trust intended to take effect in possession or enjoyment at or after his death.” Helvering v. St. Louis Union Trust Co., supra; Becker v. St. Louis Union Trust Co., 296 U. S. 48, and cases cited.

In the instant case it can not be said that the decedent had transferred his property “in contemplation of or intended to take effect in possession or enjoyment at or after his death.” He divested himself of all title and ownership in the shares of stock when he conveyed them to the trustee. He retained “no power to resume ownership, possession or enjoyment except upon a contingency in the nature of a condition subsequent, the occurrence of which was entirely fortuitous so far as any control, design or volition on his part was concerned.” (Helvering v. St. Louis Union Trust Co., supra.) The trust instrument provided that “If and when Anne Lamson Hal-lock shall die * * * the trust shall terminate.” She is still alive, and the trust has not yet terminated. The only other provision of the trust instrument providing for the termination of the trust was “by the written assent of [Henry Hallock] and [his former wife] the beneficiary”; but such written assent was never given.

Here, as in the cases cited supra, the decedent had no right in the trust estate which was the subject of testamentary disposition. The trust instrument — and not the death or testament of the decedent— disposed of the corpus of the trust property. It directed that in the event of the death of the settlor — decedent—prior to the death of the beneficiary “payment and delivery over [of any accrued income and the principal of the trust fund] shall be made to Levitt Hallock and Helen Hallock, respectively son and daughter of the Party of the First Part, [settlor] share and share alike.” By the death of the settlor, who, under the trust instrument had the right to have delivery over of the trust property made to him upon the death of the beneficiary, the son and daughter became vested remain-dermen, whereas their interest, prior to the death of their father, had been contingent. But such change is not, in our opinion, the “shifting of an economic benefit of property which is the subject of a death tax.” We hold, therefore, that the trust property is not required to be included in the gross estate of the decedent under section 302 (c), supra.

Is section 302 (d) applicable? The trust instrument provides that the “trust may be terminated, modified, altered, canceled or in any way varied by the written assent of the Party of the first part [settlor-decedent] and beneficiary.”

Petitioners concede that, under Helvering v. City Bank Farmers Trust Co., 296 U. S. 85, inasmuch as the settlor in conjunction with the beneficiary might revoke or terminate the trust, the property conveyed in trust, if such conveyance were made after the passage of the act, must needs be included in the estate of the settlor. But is a different rule applicable where, as here, the property was conveyed before the effective date of the act ? This question is answered by the Supreme Court in two recent cases — Helvering v. Helmholz, 296 U. S. 93, affirming the decision of the Court of Appeals for the District of Columbia (75 Fed. (2d) 245) which affirmed the decision of this Board in 28 B. T. A. 165, and White v. Poor, 296 U. S. 98.

In Helvering v. Helmholz, supra, the Court said:

Another and more serious objection to the application of section 302 (d) in the present instance is .its retroactive operation. The transfer was complete at the time of the creation of the trust. There remained no interest in the grantor. She reserved no power in herself alone to revoke, to alter or to amend. Under the revenue act then in force the transfer was not taxable as intended to take effect in possession or in enjoyment at her- death. Reinecke v. Northern Trust Company, 278 U. S. 339. If section 302 (d) of the Act of 1926 could fairly be considered as intended to apply in the instant case its operation would violate the Fifth Amendment. Nichols v. Coolidge, 274 U. S. 531.

The above language is clearly applicable in its entirety to the facts of the instant case. It follows that we must hold that the trust property is not includable in the gross estate of the decedent under section 302 (d), supra. Respondent erred in including said property in the trust estate and his action in doing so is disapproved. Our holding upon this question makes it unnecessary to consider the second assignment of error urged by the petitioners.

There remains for our consideration the assignment of error relating to the disallowance by the respondent of deductions on account of debts and charges against the estate in the amount that such charges exceed “the probated estate which is subject to the payment of such items.”

Section 303 of the Revenue Act of 1926, part of which is shown in the margin, authorizes the deduction “to the extent * * * incurred or contracted bona fide and for adequate and full consideration in money or money’s worth.” It is stipulated that “The debts and deductions of $111,378.17 claimed in the estate tax return filed by petitioners were incurred or contracted bona fide and for an adequate consideration in money or money’s worth.” The respondent directs our attention to no provision of the act limiting the deductions as he attempts to do in his notice of deficiency. The decisions of the courts and of this Board have uniformly permitted the deductions, on the theory that the statute governs and that the department is without power or authority to make a rule to the contrary. Union Guardian Trust Co., Administrator, 32 B. T. A. 996, and Commissioner v. Strauss, 77 Fed. (2d) 401. We hold that the respondent erred in reducing the deductions from $171,378.17 to $114,822.36.

The respondent erred in determining the deficiencies and his action in doing so is set aside.

Judgment will be entered for -petitioners.

       Sec. 302. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
      *******
      (c) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after his death, except in case of a bona fide sale for an adequate and full consideration in money or money’s worth. * * *
      (d) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power, either by the decedent alone or in conjunction with any person, to alter, amend, or revoke, or where the decedent relinquished any such power in contemplation of his death, except in case of a bona fide sale for an adequate and full consideration in money or money’s worth. * * *

       Sue. 303. For the purpose of the tax the value of the net estate shall he determined—
      (a) In the case of a resident, by deducting from the value of the gross estate—
      (1) Such amounts for funeral expenses, administration expenses, claims against the estate, unpaid mortgages upon, or any indebtedness in respect to, property (except, in the case of a resident decedent, where such property is not situated in the United States), to the extent that such claims, mortgages, or indebtedness were incurred or contracted bona fide and for an adequate and full consideration in money or money’s worth.


author: ARNOLD:

text:
    D. S. DeVan, as Executor of the Last Will and Testament of R. Fred Vogel, Deceased, Petitioner, v. Commissioner of Internal Revenue.
    Docket No. 56182.
    Promulgated May 19, 1936.

      Byron G. Hanna, Esq., for the petitioner.

      A. L. M-wray, Esq., for the respondent.
   OPINION.

ARNOLD:

The year 1927 is controlled by the Revenue Act of 1926, and the years 1928 and 1929 by the Revenue Act of 1928. However, the provisions applicable are the same in both acts. Petitioner, in claiming the deductions, insists the amounts in question fall within section 214 (a) (2) of the Revenue Act of 1926, and section 23 (b) of the Revenue Act of 1928: “All interest paid or accrued within the taxable year on indebtedness.”

Respondent, in denying the deductions, claims the payments in question fall within section 215 (a) (1) of the Revenue Act of 1926, and section 24 (a) (1) of the Revenue Act of 1928:

(a) General rule. — In computing net income no deduction shall in any case be allowed in respect of—
(1) Personal, living, or family expenses.

There was a rift in the marriage relations. Edna R. Vogel sued her husband for divorce on February 13, 1923. As an inducement to get his wife to dismiss her divorce proceeding and return to him and resume marital relations, he offered to convey to her certain real •estate and execute and deliver to her the note for $100,000 with interest at the rate of 6 percent per annum payable monthly. She accepted his offer. She dismissed her divorce action and returned to his home with her children and resumed marital relations with him on the assurance he would demean himself in a proper manner. He made the deed and delivered the note to her upon those conditions. There was no impediment in the law preventing them from contracting with each other the same as strangers. (Civil Code of California, sec. 158.) Agreements to renew conjugal relations and restore peace and harmony in family affairs are certainly not contrary to public policy.

The dismissal of her divorce action and resumption of marital relations with her husband was a valid consideration for the execution of the note; Adams v. Adams, 91 N. Y. 381; Bowden v. Bowden, 175 Cal. 711; 167 Pac. 154. See also cited cases in 11 A. L. R., p. 277.

The Civil Code of California, section 1605, defines “consideration” as:

Any benefit conferred, or agreed to be conferred, upon tbe lnomisor, by another person, to which the promisor is not lawfully entitled, or any prejudice .suffered, or agreed to be suffered, by such person, other than such as he is at the time of consent lawfully bound to suffer, as an inducement to the promisor, .is a good consideration for a promise.

The execution of the note and the return and resumption of marital .relations by the wife did not relieve the husband from his duty to maintain and support his wife. No conclusions can be reached nor •any inference be drawn from the stipulated facts that at the time ■of the giving of the note by It. Fred Vogel to Edna It. Vogel it was in any way concerned with alimony or support and maintenance for Edna E. Vogel. On the same day the note was given, the maker, in the written instrument set forth in the stipulation of facts, declared and acknowledged that the consideration for the deed and note was the promise of his wife to cause her counsel to cooperate with ’his in procuring an early dismissal of the divorce proceeding and her promise to return with their children to his home and in good faith resume the marital relations with him and that she made no other promise or inducements for the giving of either the deed or the note.

Upon her return and the resumption of marital relations, E. Fred Vogel was as much under obligation to maintain and support his wife as if the note had never been given. This conclusion is likewise justified by the court proceedings in the separate maintenance action. There the wife, in her complaint, alleged her husband offered to make the deed and execute the note and cease the use of intoxicating liquors if she would dismiss her divorce action and resume marital relations with him, and, relying upon such promises, she dismissed her suit for divorce and with her children returned to her husband’s home and resumed marital relations with him.

Her husband, in answering the separate maintenance suit, denied his wife was entitled to any maintenance or support, relying on the execution and delivery of the deed and note to her as relieving him from that obligation. The court decreed the note was executed upon considerations and under conditions set forth in the complaint; that it was the sole and separate property of Edna E. Vogel and she was the unconditional owner of it; that it represented an unconditional and legal obligation of E. Fred Vogel; and that Edna E. Vogel was entitled to the payment of principal and interest as provided in the note. The decree then awarded specific sums for support and maintenance of the wife, “Without regard to plaintiff’s property as aforesaid.”

The provisions in the note that it should not be assigned or transferred and that it should not be enforceable by any transferee did not affect its validity or enforceability in the hands of the payee, Edna E. Vogel. It represented an indebtedness due from E. Fred Vogel to his wife and was based on a good and valuable consideration.

By the terms of the note, should default be made in the payment of the monthly installments of interest when due, payee could sue and recover, and, should default in payment of interest continue for one year, the whole sum of principal and interest, at the option of the payee, became immediately due and payable and suit could then be maintained to recover both principal and interest due.

Having determined that the note was a valid subsisting obligation of E. Fred Vogel and that it was enforceable in the hands of Edna E. Vogel, and it being admitted that the sums in question were paid by E. Fred Vogel to Edna E. Vogel “as interest” on the note within the taxable years, it follows under the applicable statute that such sums are properly deductible.

In the case of John M. Longyear, Jr., 28 B. T. A. 1086, cited and relied upon by the respondent, later affirmed in 11 Fed. (2d) 116, what appears to be interest on a $150,000 note given in settlement of a claim for maintenance and support was held not deductible. However, in that case the note was part of an agreement which was founded on the legal duty of the husband to support his Avife and children, and in which the interest was part of the sum to be paid for such maintenance and support. The note and agreement were construed together. The Board there held, in speaking of the deductibility of the amounts paid as interest, that the payments were intended by the parties to be in lieu of alimony, and that, as alimony is not founded in contract but grows out of an obligation imposed by law upon the husband, the interest payments were payable as part of the agreement made in lieu of an alimony award and, therefore, were not deductible as interest on an indebtedness. Likewise, in affirming the Board, the Circuit Court of Appeals said: “The obligation did not lose the character of alimony when incorporated in the note.”

We have an entirely different situation here. The note here represents a contractual obligation that does not grow out of any legal duty of the husband to support his wife. There, the note was given in a proceeding where the family relation was severed and in settlement and release of any and all claims and demands of the wife imposed by law against the husband for alimony, maintenance and support, temporary and permanent. Here, the note was given to restore the family relation and dismiss the divorce proceedings. Here, after giving the note, the obligations of the husband to maintain and support his wife continued unaffected. There, that obligation ceased.

We, therefore, hold that petitioner is entitled to deduct $6,000 from his gross income for each of the years 1927, 1928, and 1929 as interest paid on indebtedness.

Decision will he entered wider Rule 50.