author: Leech:

text:
    William T. McCaffrey, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 58743.
    Promulgated November 6, 1935.

      Edward Schoeneck, Esq., for the petitioner.

      M. B. Leming, Esq., for the respondent.
   OPINION.

Leech:

Our finding that petitioner did not exercise the seven options in question until March 13, 1928, determines! the issue submitted. That conclusion was reached after careful examination of the record and consideration of the argument of counsel. Petitioner contends that the options were exercised in January 1925, but we think the clear weight of the evidence is against that contention.

Petitioner argues that in January 1925 he exercised all seven of these options by calling upon one. Lannin and stating to him that he was willing, and would consider himself unqualifiedly bound, to take the optioned stock. It is his position that Lannin was a qualified representative of the seven banks, that such statement made to him was effective as an exercise of the option with each of those banks, and that thereafter, he was unqualifiedly bound to accept delivery of the stock.

In the first place the record does not show to our satisfaction that Lannin was empowered and authorized to represent the several banks in any change or modification of the several option agreements. These agreements provided specifically that the exercise of the option rights should be in writing by the optionee, designating the amount of the stock in respect of which he desired to exercise his option. It appears that Lannin was the president of the Rochester Clearing House Association and, no doubt, the. several banks looked to him to keep them advised and generally direct matters in connection with the newly organized bank, in which, through necessity, they had taken interests. His action for these banks so far as the record discloses, was entirely informal and premised upon the position he occupied in the association composed of the several banks. The argument of petitioner’s counsel that, even if Lannin had not been authorized by the several banks to act for-them in the exercise of the options, these banks had ratified and confirmed his representation, is without merit. We do, however, call attention to the fact that-the delivery of stock, under the orders given by petitioner on March 13,1928, is no evidence of confirmation of any action taken theretofore by Lannin. This order was within the period of the option in each case, and, irrespective of any conversation between petitioner and Lannin, was an express exercise of the option, in the manner prescribed by its terms.

Moreover, it is difficult to reconcile his- statement of a definite verbal agreement with Lannin, with other facts appearing here. We are without Lannin’s testimony, due to his death prior to the hearing, but the testimony of most of the witnesses produced by petitioner in an endeavor to prove statements by Lannin to them, substantiating an understanding between petitioner and the latter, constituting a definite exercise of the options, not only fails to substantiate petitioner’s position, but strongly indicates that no such agreement was reached.

Arthur B. Clark, later vice president of petitioner’s bank, but in 1925 a New York state bank examiner, when introduced as petitioner’s witness at the hearing, testified that in making an examination of the Merchant’s Bank of Bochester, one of the optionor banks, some two months after Haight’s death, he noted in its schedule of assets its holdings in National Bank of Bochester stock and, as the law prohibited investments of this character by that bank, he questioned this item and was referred to Lannin for advice as to the exact status of the investment. He further testified that on questioning Lannin the latter advised him that he “ expected Mr. McCaffrey would exercise an option he held on this stock.” This advice' was given Clark by Lannin subsequent to the conversation of petitioner with Lannin which petitioner here asserts was definite exercise of the option. Foulkes, another witness for petitioner and a director in the National Bank of Bochester in 1925, testified that following petitioner’s conference with Lannin he called on the latter and was advised that he understood from, his talk with McCaffrey that the option was going to be exercised.”' The testimony of - both of these witnesses indicates strongly that Lannin’s-understanding of his talk with the petitioner was merély that the latter had assured him of his intention to exercise the options. It is shown that following petitioner’s talk with Lannin no change was made by the seven banks on their records, evidencing the transfer of any beneficial interest in the stock to petitioner.: The stock remained in their investment accounts. No indebtedness was set up as1 due'from this petitioner. Likewise, in March 1928, upon receipt front petitioner of directions to deliver the stock to the Chemical National Bank, the several banks' computed the purchase price at $125 a share, plus interest from May 17,1924, to that date, whereas, under the option contract they would have been entitled to a sum computed at $125 per share, plus interest from May 17, 1924, to;the date in January 1925 when petitioner contends the options were exercised, and interest Upon this total sum to the date of delivery of the stock, if petitioner’s contention as to the date of exercise of the Option were correct.

The record further shows that, upon the sale of this stock through the Bochester Holding Co. at’ $275 per share; the question was raised by the executor of Haight’s estate as to its right to participate in the profit accruing to petitioner, upon the ground that Haight was the joint owner of the options and participated in a joint venture with petitioner. It is established that petitioner effected a settlement of this claim by payment of $50,000 of the amount received upon the sale of stock and that it became necessary to secure the approval by the probate court of that settlement. In this connection petitioner filed with that court his affidavit, purporting to set out in detail the facts in connection with the granting and exercise of the seven options. In this affidavit, presented to the court, and the basis for the court’s approval of the settlement made, petitioner states that, at the time of Haight’s death, and for two years following that time, the position of the National Bank of Rochester was very hazardous and the future value of the stock was very uncertain. He stated further in his affidavit that in March 1928, he “ became concerned about the option held by him for the purchase of the stock from the banks, inasmuch as deponent realized that should he die, or for any reason his position with the National Bank of Rochester should cease, the option for the stock would fall ”, and that “ the options were exercised by deponent on March 13, 1928 * *

In addition to this evidence which, obviously, has great weight against petitioner’s assertion of a definite and unqualified exercise of the seven options in January 1925, it is difficult to believe that a binding agreement would be thus executed by two careful business men, both bankers of experience, involving the acquisition of approximately $1,000,000 in property without that action being reduced to writing or evidenced in some way more definite than the mere recollection of the parties. The utmost care was taken in the drafting of the option agreements. These contracts are full and complete. They prescribe specific conditions and the particular mode of exercise to be followed. That the exercise of the options under these circumstances would be effected by a verbal statement, in the course of an informal conversation without even so much as a subsequent confirmation by letter, seems, at the least, a most unusual method, and one denoting a lack of business care and judgment utterly inconsistent with men of the character of the petitioner and Lannin, as revealed by the record.

It may well be that petitioner, now, after the lapse of many years, is convinced that his assurance to Lannin represented an unconditional and binding exercise of the options, but the evidence to the contrary indicates overwhelmingly to us that Lannin took from that conference no understanding of an absolute and unconditional exercise of the options, but only an assurance that petitioner would exercise them before their expiration. Cf. Lucas v. North Texas Co., 281 U. S. 11; Commissioner v. North Jersey Title Ins. Co., 19 Fed. (2d) 492.

Having found that the options in question were not exercised until March 13, 1928, the same year in which the stock was sold, and the profit here in controversy realized,- it follows that such profit, accruing from the sale of assets held less than two years, is not subject to the rate for capital gain but to normal tax and surtax.

Judgment will be entered for the respondent.


source: Caselaw Access Project

author: Smith:

license: Public Domain

text:
    Lomita Gasoline Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 44093, 54950, 61165.
    Promulgated November 6, 1935.

      A. Colder Mackay, Esq., and Thomas B. Dempsey, Esq., for the petitioner.

      Ralph E. Smith, Esq., and E. G. Sievers, Esq., for the respondent.
   OPINION.

Smith:

The only question presented by these proceedings is whether the petitioner is entitled to deduct from, gross income of each or any of the years in question an allowance for depletion of properties, and, if so, the amount thereof. The respondent has made no allowances for depletion and in those returns where the petitioner claimed a deduction representing an allowance for depletion the respondent has disallowed such deduction. The basis of the respondent’s action was that the petitioner had no depletable interest in the properties. On brief he contends that if the petitioner should be held to be entitled to the deduction of an allowance for depletion it has not proven the amount to which it is entitled.

The applicable provisions of the Eevenue Act of 1926 are as follows:

Sec. 234. (a) In computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed, as deductions:
*******
(8) In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner with the approval of the Secretary. In the case of leases the deductions allowed by this paragraph shall be equitably apportioned between the lessor and lessee.
Sec. 204. (c) The basis upon which depletion, exhaustion, wear and tear, and obsolescence are to be allowed in respect of any property shall be the same as is provided in subdivision (a) or (b) for the purpose of determining the gain or loss upon the sale or other disposition of such property, except that—
*******
(2) In the case of oil and gas wells the allowance for depletion shall be 27% per centum of the gross income from the property during the taxable year. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance be less than it would be if computed without reference to this paragraph.

Section 234 (a) (8) of the Eevenue Act of 1926, under deductions allowed corporations, is the same as section 214 (a) (9).

The applicable provisions of the Eevenue Act of 1928 are substantially the same as those of the Eevenue Act of 1926 quoted above.

The petitioner, in support of its contention that it is entitled to a deduction from gross income representing an allowance for depletion, relies upon Signal Gasoline Corporation v. Commissioner, 66 Fed. (2d) 886. The facts in that case showed that the Signal Gasoline Corporation had made a cash investment in certain casinghead gasoline contracts and'had also issued shares of its stock in the acquisition of other contracts. The court held therefore that the corporation was entitled to a deduction from gross income of a reasonable amount representing an allowance for depletion. The case was remanded to this Board and on reconsideration this Board held (30 B.T.A. 568) that there was no evidence before it to prove that the royalties paid by the Signal Gasoline Corporation were less than the fair market value of the wet gas at the mouth of the well. For lack of evidence the determination of the respondent that the Signal Gasoline Corporation was not entitled to the deduction of an allowance for depletion was affirmed. On appeal to the Circuit Court of Appeals for the Ninth Circuit the decision of the Board in that case was affirmed, 77 Fed. (2d) 778. In the course of its opinion the court stated:

In view of the fact that under the existing law the depletion allowance is fixed at an arbitrary figure of 27.5% the importance of selecting the right base on which this allowance is to be made is of the utmost significance. The theory upon which a fixed percentage is allowed for depletion is that the mineral product to be mined or produced when still in the ground has a value of 27.5% of its value when mined or produced. Consequently the 27.5% represents a return of capital while the balance represents income to the taxpayer subject to the usual deductions in determining the net income. The difficulty in the case at bar arises from the fact that the wet gas produced and processed by the petitioner and by Holly Oil Company under a contract with petitioner was subject to the payment by petitioner of royalties to the owner of the wells for the product at the time it was produced and manufactured into dry gas and gasoline. It is apparent that if the petitioner’s contract was such that it was required to pay the full market value of the wet gas as it was produced by the wells it had no capital investment in the well or in the oil content of the land and had no advantage over a manufacturer who bought his wet gas on the market other than the exclusive right to the product of the particular wells from which it derived the gas. In such a case where the manufacturer pays to the owner or lessee of the oil land the full market value of the wet gas at the time it is turned over to the manufacturer at the mouth of the well, the entire capital investment in the wet gas belongs to the owner of the land, or lessee, and by reason of the production of the wet gas from the land his capital was depleted by an amount which Congress had arbitrarily fixed at 27.5% of the value of the wet gas at the surface. The person who paid the market price to the lessee or owner would suffer no diminution of capital investment in the oil or gas in place under such circumstances. If we assume, however, that the petitioner by reason of his favorable contract with the producer secures the wet gas when produced at a fraction of its market price at the time it is produced, say one-half for the purpose of illustration, it is clear that petitioner to that extent (50%) would have his interest in the wet gas in place in the land reduced by one-half of the amount produced. In such a case it is clear that the allowance for depletion should be equally divided between the owner or lessee and the petitioner. If the relationship between the owner or lessee and the petitioner involves a payment of less than 100% of the market value of the wet gas at the surface, then by as much as the petitioner owns a fractional portion of the market value of the wet gas when produced, its capital investment is depleted, by 27.5% of that amount. For illustration, if the amount agreed to be paid is two per cent less than the market price of wet gas, the petitioner would be entitled to a depletion allowance of 27.5% of two per cent, that is, .55% of the market value of the wet gas at the surface before the manufacturing process or separation has taken place. [Italics supplied.]

The court further stated:

Since the taxpayer is seeking a deduction for depletion from its otherwise taxable income, the burden of proof is upon it not only to prove that it is entitled to the deduction but also to prove the correct amount thereof. * * *

The petitioner has gone to great pains to show its profits from the manufacture and sale of casinghead gasoline as distinguished from its profits from the sales of dry gas. It contends that the excess of the amount realized' from the sale of casinghead gasoline over the royalties paid represents depletion sustained in the taxable years. It contends that the production of casinghead gasoline is not a manufacturing process. There -is no merit in this contention. See Signal Gasoline Corporation v. Commissioner, supra.

Since the petitioner has not met the burden of proof of showing a reasonable allowance for depletion, if it might be entitled to any such allowance, the determinations of the respondent are approved. Cf. Brea Canon Oil Co. v. Commissioner, 77 Fed. (2d) 67; certiorari denied, 296 U. S. 604; Hurley v. United Stales, decided by the District Court for the Northern District of Oklahoma and reported at 10 Fed. Supp. 365.

Judgment will be entered for the respondent.


text:
    George W. Williams, Executor, Estate of Francis Williams, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 54087.
    Promulgated November 8, 1935.

      Ferdimamd Tannenbwum, Esq., for the petitioner.

      L. W. Greason, Esq., for the respondent.
   SUPPLEMENTAL OPINION.

Leech:

This proceeding involves two questions: (a) The application of section 44 (d) of the Revenue Act of 1928, and (b) the fair market value on September 3, 1928, the date of decedent’s death, of his interest in two promissory notes. These notes were the property of decedent and two associates in equal amounts and had a total unpaid balance on that date of $355,399.92.

By opinion promulgated July 31, 1934, we sustained the respondent upon both issues, holding that section" 44 (d) applied, that the unrealized gain, represented in this installment obligation, was realized and taxable on his death, and that the notes had a fair market value, for the purpose of computing such gain, equal to their face value.

On August 3, 1934, our decision was entered, redetermining a deficiency of $7,906.02 for the period from January 1 to September 3, 1928. From this decision petitioner prosecuted a petition for review to the United States Circuit Court of Appeals for the Third Circuit and we are now in receipt of the mandate of that court, entered September 17, 1935, remanding the cause for further proceedings in accordance with the opinion of the court.

By its opinion the Circuit Court sustains the Board on the issue as to the application of section 44 (d) of the Revenue Act of 1928, but remands the proceeding for further consideration by us upon the issue as to the market value of the installment obligation. On this question the opinion states:

We think, however, that the case should be remanded to the Board of Tax Appeals for further consideration of the issue as to the value of the instalment obligation. It appears that the Board’s finding as to the value of the instalment obligation was in part based on the fact that the petitioner had . returned the instalment obligation at its face value for both federal and state inheritance tax purposes; that all due payments had been faithfully met by the obligor up to the time of the decedent’s death; and that there was no evidence that the obligor was in poor financial condition. It appears, however, to have been assumed by the Board that the collateral securing the payment of the instalment obligation had a market value at the time of the decedent’s death substantially in excess of the liabilities which it secured. Nowhere in the opinion of the Board does it appear that it took into consideration the fact that the 2,000 shares of bank stock, pledged as collateral and having an estimated value of $190,000, were pledged as collateral to secure the obligations due the two other parties to-the sale of the Bank & Trust Company stock, in addition to the obligation due the decedent. Inasmuch' as the Board’s determination of the value of the instalment obligation appears to have been based partly on the assumption that the value of the collateral was in excess of the obligation which it was intended to secure, we think the Board should clarify its findings upon this point. Helvering v. Taylor, 293 U. S. 507.

In our opinion of July 31, 1934, we found that the collateral securing the payment of the obligation here in question “ had a market value at the time of death substantially in excess of the liabilities, the payment of which it secured.” In compliance with the mandate of the court, we can, to clarify this finding, only set out the facts which convince us that the collateral, consisting of stock of the Broad & Market National Bank & Trust Co. of Newark, New Jersey, deposited to secure payment of the obligations of the purchaser to petitioner’s decedent and his associates, was substantially in excess of the total of these obligations.

The record shows that petitioner’s decedent, Francis Williams, together with two associates, owned in equal amounts 1,059 shares of stock of the Broad & Market National Bank & Trust Co. of Newark, New Jersey. This stock they sold to George S. Silzer, Isaac Alpern, and John J. Stamler, on February 18, 1926, for a total consideration of $635,400 or at a price of $600 per share. The sum of $80,000 was paid in cash and the balance of $555,400 was evidenced by three promissory notes of $185,133.33 each, with interest at 6 percent per annum. One of these notes was executed by each of the three purchasers of the stock and all of the notes were made payable to petitioner’s decedent and his two associates.

The total obligation evidenced by the three notes referred to, by a contract entered 'into between the parties, was provided to be paid at the rate of $100,000 per year from the date of sale. Under this agreement the notes were deposited with the Chase National Bank of New York City as trustee, together with the 1,059 shares of stock sold, endorsed in blank, to be held by the trustee as security for the payment of the notes.

On December 30, 1926, the parties executed a supplemental agreement, Silzer and Stamler having purchased the interest of Alpern in the stock. Under this agreement two notes were executed, one by Stamler and the other by Silzer, each in the sum of $277,700. These were substituted for the three notes of $185,133.33 each. It is indicated that, in the meantime, the capital stock of the Broad & Market National Bank & Trust Co. had been increased from $200,000 to $1,200,000 by the sale of 10,000 additional shares at par and, under this modified agreement, the 1,059 shares of stock deposited as collateral were released by the trustee for the issue of new stock, in the amount of 2,500 shares which were thereupon deposited as collateral. The agreement provided that upon the payment of $100,000 on the notes, 500 shares of the pledged stock should be released by the trustee to the purchasers.

On September 26, 1927, another agreement was executed between the parties to substitute for the note of George S. Silzer another note of John J. Stamler. The total obligation had been reduced by $100,000 and then stood at the sum of $455,400. After this substitution, the obligation was evidenced by two notes of John J. Stamler, each for the sum of $227,700, both made payable to petitioner’s decedent and his two associates and secured by 2,000 shares of the bank stock.

The record further shows that on December 31, 1927, following execution of this last agreement, the 2,000 shares of bank stock, deposited to secure payment of the total obligations of $455,400, had a fair market value of $345 a share and a total market value of $690,000.

Petitioner’s decedent died September 3, 1928. At that time the obligations in which he had a one-third interest had been reduced, by payments made on the notes, to a balance of $355,399.92, which balance was secured by the deposit of the 2,000 shares of bank stock as above set out. It is further shown that on September 29, 1928, following decedent’s death there was a recapitalization of the Broad & Market National Bank & Trust Co., the par value of the stock was reduced from $100 per share to $25 per share and on December 31, 1928, the close of the year following this recapitalization and “ split ” of the stock, the market value of this new stock issued was $82 per share.

It is evident that the impression that the value of the collateral, deposited to secure the payment of both of these obligations, had a value not in excess of $190,000, arises through questions propounded by petitioner’s counsel to a witness, William B. Harding, a banker of Newark, New Jersey, as to what, in his opinion, was the value of a note for $355,000 signed by Stamler and secured by collateral of 2,000 shares of Broad & Market National Bank & Trust Co. stock, on September 8, 1926. To this question the witness answered that the note would, in his opinion, have a value not in excess of the market value of the stock, which his recollection placed at about $95 a share. The basis of this opinion was that he had personally sold 25 shares of this stock in December of that year at $94 per share.

It is quite evident from an examination of the record and the facts disclosed with respect to this stock, that this witness was referring to the new stock issued after the split in September. Unless the fact of the stock “ split ” is kept in mind, it appears that the stock of the Broad & Market National Bank & Trust Co. decreased in market value between December 31, 1927, and December 31, 1928, from $345 a share to $82 a share, but it is very apparent that this is a decrease due to the dilution of the capital value of individual shares, since a price of $82 a share on December 31,1928, is equivalent to a price of $328 per share for the old stock, deposited as collateral to secure the obligations here in question.

We have again given careful consideration to the evidence and, a,s stated in our opinion of July 31, 1934, we think that the 2,000 shares of old stock deposited to secure these obligations “had a market value at the time of death substantially in excess of the liabilities, the payment of which it secured.” We think this conclusion is amply supported by the evidence, and that the detailed statement of the reasons for our conclusion, herein made, will sufficiently clarify our finding upon this point.

Judgment will be entered of a deficiency in the sum of $7,906.08 for the period from January 1 to September 3,1988.


author: Matthews :

text:
    Susan T. Freshman, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 63964, 65358-65362, 68858, 69659, 69855, 72497.
    Promulgated November 8, 1935.

      Valentine B. Havens, Esq., Charles B. Molnnis, Esq., Robert B. Cwmming, Esq., and Mary H. Donlon, Esq., for tbe petitioners.

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

       Proceedings o£ the following petitioners are Consolidated and decided herewith: Dorothy L. Low; Angcline Low Porbes; Josiah O. Low; Mary T. F. Low; Nathalie F. Baker; Louise S. Corwin; waiter E. Meyer; Howard E. Perry; Frank J. Porter.

   OPINION.

Matthews :

Petitioners contend that the stock of the United Aircraft & Transport Corporation was distributed to the stockholders of Niles-Bement-Pond Co. in pursuance of a plan of reorganization and is not taxable in the hands of the stockholders of the Niles-Bement-Pond Co. If, however, the Board should decide against petitioners on that issue, then petitioners contend that the stock of the United Aircraft & Transport- Corporation is taxable to them to the extent of its fair market value on March 6, 1929, limited, however, to the amount of earned surplus of the Niles-Bement-Pond Co. accumulated subsequent to March 1, 1913, and finally that the fair market value of the United Aircraft & Transport Corporation’s common stock on March 6, 1929, was between $30 and $40 per share, but in no event in excess of $40 per share.

The petitioners argue that the benefits provided by section 112 of the Revenue Act of 1928 in the case of corporate reorganization should not stop with Pratt & Whitney Co.,- but that the nonrecognition of gain thereunder should be extended to the stockholders of the Niles-Bement-Pond Co., it being contended that the Pratt & Whitney Co. was in substance the mere instrumentality of its parent corporation, the Niles-Bement-Pond Co., and that it is the latter company which should be deemed the real party to the reorganization.

The respondent admits that the Pratt & Whitney Aircraft Co. and United Aircraft Co. were parties to a reorganization and that the exchange of all of the stock in Pratt & Whitney Aircraft Co. solely for stock in United Aircraft is a nontaxable exchange under the provisions of section 112 (b) (3). He denies, however, that either Pratt & Whitney or Niles-Bement-Pond were parties to a reorganization or that the distribution by Pratt & Whitney to Niles-Bement-Pond of United Aircraft stock and the distribution by Niles-Bement-Pond of United Aircraft stock were distributions of stock in pursuance of a plan of reorganization. He takes the position that such distributions were dividends paid in property and that the dividends received by the petitioners are income to them to the amount of the market value of United Aircraft stock on March 6, 1929, the date on which the dividend was payable and was paid to the shareholders. He determined this market value to be $8T.8125 per share.

The pertinent provisions of section 112 of the Revenue Act of 1928 are 112 (a), (b) (3), and (i) (1), and (2), which are quoted in the margin.

We agree with respondent’s contentions. It is clear that the acquisition by United Aircraft of all of the stock in Pratt & Whitney Aircraft Co. was a reorganization within the meaning of section 112 (i) and that Pratt & Whitney Aircraft Co. and United Aircraft Co. were both parties to the reorganization within the meaning of the statute. The Pratt & Whitney Co. was not a party to the reorganization ; it was merely one of the four stockholders of Pratt & Whitney Aircraft Co., which was a party to the reorganization. Although Pratt & Wbitney Co. and the other stockholders of the Pratt & Whitney Aircraft Co. realized a gain on the exchange of their Pratt & Whitney Aircraft stock for United Aircraft stock, the gain on such exchange was not recognized under the provisions of section 112 (b) (3). In such a case the basis for determining gain or loss on the sale of United Aircraft stock is the same as in the case of the stock exchanged, under the provisions of section 113 (a) (6). However, the cost or basis for determining gain or loss on the sale of property by a corporate owner is not necessarily the value at which stockholders of the corporation would have to report a dividend paid in such property.

This is the case of a corporate stockholder receiving a dividend in property and immediately distributing the identical property to its stockholders as a dividend.

The term “ dividend ” is defined in section 115 (a) as “ any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913 ”, and it is further provided in subsection (b) of section 115 that every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits. Article 627 of Regulations 74 reads in part as follows:

Abt. 627. Dividends paid in property. — Dividends paid in securities or other property (other than its own stock) in which the earnings of a corporation have been invested, are income to the recipients to the amount of the market value of such property when receivable by the shareholders. * * *

The Pratt & Whitney Co. invested $500 of its earnings in 1925 in common stock of Pratt & Whitney Aircraft Co. This stock had increased enormously in value by 1929 and was exchanged in February 1929 solely for stock of United Aircraft Co. but the gain on the exchange was not recognized under the provisions of section 112 (b) (3). The increase in value of the investment, which, after the exchange, was represented by the property received on exchange, was available for distribution as a dividend and was distributed by Pratt & Whitney to its sole stockholder, Niles-Bement-Pond. This dividend was an earning of Niles-Bement-Pond on its Pratt & Whitney stock, which earning was received on February 11, 1929, and was available for distribution by Niles-Bement-Pond to its stockholders. Niles-Bement-Pond immediately distributed practically all of the property received by it as a dividend to its stockholders. This was a distribution by a corporation to its stockholders in property out of earnings received after February 28, 1913.

The distribution meets all the requirements of section 115 and is a taxable dividend to petitioners to the amount of the market value of the stock on March 6, 1929.

The parties stipulated that the earnings for the period March 1, 1913, to March 6, 1929, inclusive, of the Niles-Bement-Pond Co. and subsidiaries other than Pratt & Whitney Co., reflected on the books and records of the companies, amounted to $1,540,744.56 before the revaluation of any part of the common stock of the United Aircraft received from Pratt & Whitney Co. The petitioners insist that this sum of $1,540,744.56 represents all the earnings of the Niles-Bement-Pond Co. subsequent to March 1,1913, which were available for distribution on March 6, 1929.

Petitioners overlook the fact that the value at which Niles-Bement-Pond Co. entered the dividend received by it in United Aircraft stock on its books is not conclusive as to the earnings from such dividend. The dividend received by Niles-Bement-Pond on February 11, 1929, was entered on its books at $494.35 (the basis of the United Aircraft stock to Pratt & Whitney) and it is included in the accumulated earnings at this amount. As a matter of fact, therefore, the earnings since March 1, 1913, available for distribution on March 6, 1929, were the earnings accumulated prior to March 6, 1929, and also the 429,100 shares of United Aircraft stock. The distribution of 409,062% shares of United Aircraft as a dividend did not affect the earnings accumulated between March 1, 1913, and March 6, 1929. They were still available for distribution. The distribution was a dividend in property, and it was paid out of earnings accumulated since March 1, 1913. It is taxable to petitioners to the amount of the market value of the property when received. Peabody v. Eisner, 247 U. S. 347; United States v. Phellis, 257 U. S. 156; Rockefeller v. United States, 257 U. S. 176; Binzel v. Commissioner, 75 Fed. (2d) 989, affirming an unreported Board decision; certiorari denied, 296 U. S. 579.

The market value of the stock on March 6, 1929, is a question of fact. In finding that the value of the stock on March 6 was $87.8125, which is the same value as that determined by the respondent, we have carefully considered all the evidence and the arguments of petitioners in support of a lower value. While the evidence tends to show that the intrinsic value of United Aircraft stock, based on the assets of the constituent companies and their past earnings, was less than the market price of the stock, and that the stock was not recommended by Poor and other analysts as an investment, it had been selling for a period of over two months prior to the distribution at prices as high and higher than that determined by the respondent, and for a period of over six months after distribution, except for a period of about three weeks just prior to its listing on the New York Stock Exchange, the stock had sold for much more than the value determined.

On the first day of trading on the New York Curb Exchange, November 3, 1928, the common stock opened at 57. The high for tbe common stock on that date was 63 and the low 55. The number of shares traded on the first day was 1,200. The highest number of shares traded in any one day prior to .February 11 (the date the dividend was declared) was 11,000 shares on January 31, with a high of 98% and a low of 94. On March 1 the number of shares traded was 13,800, with a high of 91 and a low of 90. On March 6 (the date the stock was distributed) the number of shares traded was 4,500, at a high of 88% and a low-of 86%. From December 14, when the stock reached a high of 90, until March 6, the stock never went below 85 and was over 90 most of the time.

On the third day of trading on the . New York Stock Exchange, the stock reached 90, when 28,100 shares were traded, and six days later it reached a high of 109, a low of 98, with 61,900 shares traded. Thereafter the stock never went below 100 until the last week of September. On May 1 it reached a high of 162, with 127,900 shares traded.

It is interesting to note that the closing quotation of Niles-Bement-Pond Co. common stock on the New York Curb on March 6 was 226, and that on March 8 (there was no- quotation on this stock on March 7), the closing was 38%; a difference of 187%, which-is slightly more than the market value as determined, of 2% shares of United Aircraft stock at time of distribution.

Eeliance is placed by the petitioners on the testimony of two witnesses who qualified as experts in the valuation of securities and who testified that they both had knowledge of the common stock of the United Aircraft. One witness expressed the opinion that the stock was worth $37.50 per share on March 6, 1929, and the other fixed a fair market value on this date of $40 per share. In the opinion of one of these witnesses, the quotations on the New York Curb Exchange reflected a hysterical state of mind on the part of the speculative public in the early part of the year 1929; with the result that the stock quotations reached points unsupported by the assets back of the stocks and their earning power’. But we have evidence of actual unrestricted sales of the stock of the United Aircraft over a long period of time at greater prices than the- petitioners seek to establish as the fair market value on March 6, 1929. These reported sales, in our opinion, more nearly reflect the fair market value of this stock than does the opinion evidence. We hold, therefore, that the respondent did not err in his determination that the fair market value of the common stock of the United Aircraft was $87.8125 on March 6,1929.

The question as to whether the market value of certain rights to subscribe to bonds of the American Telephone & Telegraph Co. is taxable income arises in the case of petitioner Howard E. Perry only, and requires little discussion. Petitioner exercised these rights and did not dispose of tliem. The respondent concedes that this issue falls within the principle of T. I. Hare Powel, 27 B. T. A. 55, which case was dismissed by the Circuit Court of Appeals for the First Circuit on July 6, 1933; and Robert G. Cooley, 27 B. T. A. 986; affd., on another issue, 75 Fed. (2d) 188. See also Thomas W. White, 29 B. T. A. 1272; James A. Connelly, 30 B. T. A. 331; Bradley W. Palmer, 32 B. T. A. 550; Margaret P. Daly, 32 B. T. A. 965. On authority of these decisions, we hold that the value of these rights did not represent taxable income to the petitioner.

Reviewed by the Board.

Judgment will be entered wider Rule BO.

       SEC. 112. RECOGNITION Off GAIN OR LOSS.
      (a) General rule. — upon the sale or exchange of property the entire amount of the gain or loss, determines under section 111, shall be recognized, except as hereinafter provided in this section.
      (b) Exchanges solely in hind.—
      *******
      (3) Stock tor stock on reorganization. — No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
      (i) Definition of reorganization. — As used in this section and sections 113 and 115 — ■
      (1) The term “ reorganization ” means (A) a merger or consolidation (including the acquisition by 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), * * *
      (2) The term “a party to a reorganization” includes a corporation resulting from a reorganization and includes both corporations in the case of an acquisition by 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.


author: Trammell:

text:
    Jefferson Standard Life Insurance Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 43199.
    Promulgated November 8, 1935.

      Julius 0. Smith, Esq., and D. E. Buchner, Esq., for the petitioner.

      Charles P. Reilly, Esq., and Dean P. Kimball, Esq., for the respondent.
   OPINION.

Trammell:

When this proceeding formerly was before us we found it unnecessary, in view of our decision as to the invalidity of the requirements of section 245 (b) of the Revenue Act of 1926, to determine what the book value of the petitioner’s home office building was at the end of the taxable year or what amount was to be included in the petitioner’s gross income with respect to the rental value thereon, and we so stated in our report.

The respondent appealed our holding with respect to the invalidity of the section.

Section 245 (b) of the Revenue Act of 1926 provides as follows:

No deduction shall be made under paragraphs (6) and (7) of subdivision (a) on account of any real estate owned and occupied in whole or in part by a life insurance company unless there is included in the return of gross income the rental value of the space so occupied. Such rental value shall be not less than a sum which in addition to any rents received from other tenants shall provide a net income (after deducting taxes, depreciation, and all other expenses) at the rate of 4 per centum per annum of the book value at the end of the taxable year of the real estate so owned or occupied.

The opinion of the Circuit Court of Appeals reversing our holding reads in part as follows:

The book value of this building (the petitioner’s home office building) was $3,069,498.47. The company received as rents from tenants during the year the sum of $226,262.73. It incurred expense in connection with the building amounting to $80,645.77 and the depreciation thereon was $34,434.00. The question involved is whether the company can deduct this expense and depreciation from its gross income without accounting for the rental value of the building as income as provided by the section of the statute to which we have just referred. The Board of Tax Appeals answered this question in the affirmative, on the ground that this section of the statute was unconstitutional; but in view of Ibe recent decision of the Supreme Court in Helvering v. Independent Life Ins. Co., - U. S. -, 54 S. Ct. 758, the decision of the Board must be reversed.
Reversed.

The mandate of the court remanding the causé to us reads in part as follows:

On Consideration whereof, It is now here ordered and adjudged by this court that the decision of the said Board of Tax Appeals in this cause, be, and the same is hereby reversed; and that this cause be, and the same is hereby remanded to the United States Board of Tax Appeals for further proceedings in accordance with the opinion of the Court filed herein.
* * Hi * * * *
You, therefore, are hereby commanded that such further proceedings be had in said cause, in accordance with the opinion and the judgment of this Court, as according to right and justice, and the laws of the United States, ought to be had, the said petition to review notwithstanding.

Subsequent to the receipt of the mandate the parties filed recompu-tations of the petitioner’s tax liability in accordance with their respective interpretations of the opinion and mandate of the court. The recomputations were not in agreement and oral argument was had thereon. The difference in the recomputations arose from the petitioner basing its computation upon the value of its home office building as originally entered upon its books less the amount of depreciation accrued thereon down to the end of the taxable year, and the respondent basing his computation upon the value of the petitioner’s home office building as originally entered upon its books but without taking accrued depreciation into consideration. Counsel for the parties agreed that this was the only matter as to which they were in disagreement. Counsel for the respondent admitted that the point as to which the parties were then in disagreement was not a question on appeal before the Circuit Court of Appeals, the question there being the correctness of our holding on the constitutionality of section 245 (b) of the Revenue Act of 1926, and that the decision of the court did not touch upon the point in disagreement.

Subsequent to the oral argument we, of our own motion and for our information, ordered that the parties submit supplemental briefs discussing and explaining the term book value ” as used in section 245 of the Revenue Act of 1926; that the question of a uniform accounting system, if any, adopted and used by life insurance companies be set forth and explained; and that any further evidence deemed necessary for the purpose of explaining and setting forth any facts relating to an accounting system in general use by life insurance companies at the time of the passage of the Act of 1926 or the accounting system used and adopted by the petitioner might be introduced if motion to that effect were duly filed.

The petitioner did not file any brief pursuant to the order. The respondent, however, filed a brief in which he contends that we have no authority under the mandate to consider the question of book value. In support of his position the respondent urges that since the court stated in its mandate that “ this cause be, and the same is hereby, remanded to the United States Board of Tax Appeals for further proceedings in accordance with the opinion of the court filed herein ” and stated in the opinion that “ The book value of this building was $3,069,498.47 ” we have no authority to consider the question of book'value and that the only question remaining for our determination is whether his recomputation is or is not in accord with the opinion of the court.

As heretofore indicated the pleadings in the proceeding presented for determination the question of .the book value of the home office building and property occupied by the .petitioner. ' While our findings of fact contained in our report in the proceeding set out in accordance with the evidence in the case certain facts respecting the petitioner’s accounting system and the amount at which such property was shown on its books, we made.' no finding as to book value and expressly stated in the report that a determination of the question of book value was not being made since under our decision on another point the question was moot. An examination of the petition for the review of pur decision filed by the respondent shows that it contained no assignment of error with respect to the question of book value. The.opinion of the Circuit Court of Appeals in stating the question involved shows that the court considered only the question of the correctness of our holding as to the constitutionality of section 245 (b).

Notwithstanding the fact that the court previously in its opinion had made the statement that “ the book value of this building was $3,069,498.47” (the amount at which the building was originally entered on petitioner’s books), it seems clear from the court’s later statement of the question before it and its disposition thereof that the court, considered it was deciding only the one question, namely, the correctness of our decision as to the constitutionality of the statute, and none other. Considering the language of the mandate relied on by the respondent in connection with the foregoing, it is clear that the mandate never attempted to make a decision on any issue not considered in the court’s opinion.'

. The position taken by the respondent in his brief as to the effect of the court’s opinion is contradictory to thát taken by him at the time of the oral argument on the recomputations when he conceded that the point in which the parties are in disagreement was not a question before the Circuit Court of Appeals and- was not touched upon by it in its decision. Whatever his reason for this change of position, we think it is clear from the record that the Circuit Court of Appeals never attempted to find the book value of the home office building or otherwise to dispose of the issue as to book value. Since we had never made any finding as to book value tbe court would have been without authority to make such finding even if it had attempted to, and as the respondent contends that it did. Eespecting the authority of Circuit Courts of Appeal to make findings of fact in cases arising in the Board, the Supreme Court in Helvering v. Rankin, 295 U. S. 123, said:

Fourth. The Court of Appeals is without power, on review of proceedings of the Board of Tax Appeals, to make any findings of fact. “ The Board of Tax Appeals is not a court, it is an executive or administrative hoard, upon the decision of which the parties are given an opportunity to base a petition for review to the courts after the administrative inquiry of the board has been had and decided.” Old Colony Trust Co. v. Commissioner of Internal Revenue, 279 U. S. 716, 725, 49 S. Ct. 499, 502, 73 L. Ed. 918. The function of the court is to decide whether the correct rule of law was applied to the facts found; and whether there was substantial evidence before the Board to support the findings made. See Phillips v. Commissioner of Internal Revenue, 283 U. S. 589, 599, 600, 51 S. Ct. 608, 75 E. Ed. 1289; Burnet v. Leininger, 285 U. S. 136, 138, 52 S. Ct. 345, 76 L. Ed. 665; Old Mission Portland Cement Co. v. Helvering, 293 U. S. 289, 294, 55 S. Ct. 158, 79 L. Ed. —. Unless the finding of the Board involves a mixed question of law and fact, the court may not properly substitute its own judgment for that of the Board. If the Board has failed to make an essential finding and the record on review is insufficient to provide the basis for a final determination, the further procedure is to remand the case for further proceedings before the Board. Compare Helvering v. Taylor, 293 U. S. 507, 55 S. Ct. 287, 79 L. Ed. —; Murphy Oil Co. v. Burnet, 287 U. S, 299, 308, 53 S. Ct. 161, 77 L. Ed. 318. And the same procedure is appropriate even when the findings omitted by the Board might be supplied from examination of the record.

Since the question of book value of property owned and occupied in part by the petitioner was properly presented by the pleadings and has never been decided by us, .and as its determination is essential to a correct determination of the petitioner’s tax liability, we think it is properly before us and that we have authority to determine it. The contention of the respondent on this point,, therefore, is denied.

In his brief filed pursuant to our order the respondent states that if we should hold that we have authority to determine the question of book value of the property in question and the rental value of the space occupied by the petitioner then, .as an alternative argument, he contends that the rental value of the space occupied by the petitioner was not less than the amount shown in the deficiency notice, $11,-596.98. In his amended answer he alleges that rental value of. such space was $32,200. In this connection he concedes that the .term “book value” as used in section 245 of the act means the.cost less accrued depreciation and that the hook value of the petitioner’s home office building at the end of 1927 was $2,940,018.47 which, was the amount used by the petitioner in its return.

This concession of the respondent amounts to no more than a mere statement of his opinion as to the legal significance of the term “ book value ” and would not be binding on us in event we were disposed to disagree with it. However we are not disposed to disagree, but think this interpretation of the term is correct. While the legislative history of the term throws no light on the question, there is, however, nothing in it to indicate that the term was used in any unusual or extraordinary sense. The petitioner’s books are kept on the cash basis and when a property is acquired it is entered thereon at cost and remains thereon at that amount unless because of improvements or some other similar change of conditions adjustment is made necessary. In common with the practice of insurance companies generally, depreciation is carried in a memorandum account and in the reports to the insurance commissioners of the various states in which business is conducted the amount of such depreciation is shown among the liabilities. So far as a determination of the financial condition of the company is concerned, this method produces the same result as if the asset account were actually written down by the amount of yearly depreciation. While heretofore we have not had occasion, nor have the courts so far as we can ascertain, to consider the meaning of the term as used in paragraph (b) of section 245 of the applicable act, we have considered a similar question under an earlier act.

In Standard Life Insurance Co. of America, 13 B. T. A. 13; affd., 47 Fed. (2d) 218, we were called upon to determine the book value of the taxpayer’s home office building for the purpose of determining the taxpayer’s deduction for investment expenses under section 245 (a) (5) of the Revenue Act of 1921, which reads in part as follows:

* * * Provides,, That ii any general expenses are in part assigned to or included in the investment expenses, the total deduction under this paragraph shall not exceed one-fourth of 1 per centum of the book value of the mean of the invested assets held at the beginning and end of the taxable year.

In that case the taxpayer in 1917 purchased its home office building and assumed a mortgage thereon of $400,000. Between the date of purchase and, 1921 the taxpayer paid off $50,000 of the mortgage. From the time of purchase to the end of 1921 the taxpayer made certain permanent improvements to the property, bringing its depreciated cost inclusive of the mortgage up to $537,761.97 at December 31, 1921. At the end of 1921 the property was carried on the books of the taxpayer at its net investment figure, namely, $187,761.97, or its depreciated cost of $537,761.97 less the unpaid amount of the mortgage, $350,000. The amount of $187,761.97 was the book value at which the taxpayer included the property in its report to the Insurance Department of Pennsylvania, the state in which the taxpayer was incorporated. In determining the taxpayer’s invested assets under section 245 (a) (5) of the Revenue Act of 1921 the respondent allowed a value for the property of only $187,761.91. The taxpayer sought to include the property in its invested assets at the depreciated cost thereof inclusive of the unpaid amount of the mortgage. In sustaining the respondent’s determination of a book value for the property of $187,761.91 and in denying the taxpayer’s contention that this amount should be increased by the unpaid portion of the mortgage, we said:

* * * We are oí the opinion that it can not consistently be said that the book value of the invested assets is inclusive of an unpaid encumbrance. The interest on the unpaid encumbrance is deductible under section 245 (a) (8) of the Revenue Act of 1921. Why, therefore, should the amount of the encumbrance be included as an invested asset for the purpose of determining the investment expenses under subdivision (5) ? We are of the opinion that the conclusion reached by the respondent upon this point is correct.

In that case no question was raised as to the term “ book value ” meaning anything else except cost less depreciation, and we reached the conclusion that such was its meaning without a discussion of the matter.

We find nothing in the act here involved to indicate that the term book value ” as used in section 245 (b) is employed in any different sense to that in which it is used in section 245 (a) (5) of the Act of 1921. If as in that case the amount of the unpaid portion of a mortgage on a home office building is not to be included as a part of the book value of such building for the reason that the interest on such mortgage is deductible in determining taxable net income, we know of no; reason why book value is to include an amount representing depreciation sustained on a home office building and deductible in determining net income.

We therefore conclude that the term “book value” as used in section 245 (b) of the applicable act means cost less accrued depreciation. In conformity with this conclusion we have found as a fact that the book value of the petitioner’s home office building at the end of the taxable year was $2,940,018.47.

Having reached the foregoing conclusion, there remains for determination the question of the amount to be included in income by the petitioner on account of that portion of its home office building which it occupied.

The respondent’s determination of the rental value to be included in the petitioner’s income on account of the portion of the building occupied by it, as set out in our findings, shows that it was based on a rental which, together with the amount received from tenants after the allowance of certain specified deductions, would provide a net income of not less than 4 percent of the book value of the property at the end of the taxable year. The measure used by the respondent in determining the amount of rental to¡ be included, therefore, was the minimum required by the act on the book value as determined by him.

While conceding that the book value determined by him was excessive to the extent that it represented accrued depreciation, the respondent’s principal position is that the rental value of the space occupied by the petitioner was $32,200; that since in the determination of the deficiency he determined the value of such space to be only $11,596.98, the value so determined should be increased by $20,608.02 and the petitioner’s taxable income and tax liability increased accordingly. In support of his contention the respondent urges that the provisions of section 245 (b) relating to the rental value that shall be reported in order that certain deductions be allowed are provisions as to the minimum, rental to be reported and not the maximum rental.

The petitioner disagrees with the position taken by the respondent. It contends that the respondent’s request for an increased deficiency was not timely made; that since it reported in its return a rental value for the space occupied by it of $45,599.25 and as its deduction of $39,181.46 taken for real estate taxes on the building for 1927 was disallowed, its gross income' should be increased only by the difference between these two amounts, or $6,417.79, as representing the rental value of the space occupied by it and that at most its taxable income should not be increased by more than $11,596.98 representing the rental value of the space determined by the respondent when determining the deficiency. It further contends that the inclusion of any amount in excess of $11,596.98 would result in the imposition of a direct tax, prohibited by the decision in Helvering v. Independent Life Ins. Co., 292 U. S. 371.

The parties have stipulated that the value for rental purposes of the space occupied by the petitioner in its home office property in the taxable year was $32,200. In conformity with this stipulation we have found as a fact that such value was of that amount.

At this point we will consider the petitioner’s objection as to the timeliness of the respondent’s action in seeking to have the stipulated rental value of the space occupied by the petitioner included in petitioner’s gross income. The petitioner urges that, since the proceeding has been to the Circuit Court of Appeals and has come back and since at all times subsequent to the determination of the deficiency down to the time of the hearing at which the parties submitted their stipulation showing a rental value of $32,200 for the space occupied the respondent has contended that the rental value of the space was $11,596.98 as determined by him in the deficiency notice, he is precluded from asking that we find such value to be $32,200, and that the deficiency should be increased accordingly. The respondent contends that, since the statute permits the Board to redetermine a deficiency in excess of that determined by him if claim therefor is made at or before a hearing or a rehearing and since he made claim for the increased deficiency at the hearing for the taking of evidence as to the rental value of the space occupied by the petitioner, his claim was timely made and should be allowed.

In the course of his argument the petitioner refers to the proceeding as now being before us under Bule 50. That, however, is not the situation. Although upon receipt of the mandate from the Circuit Court of Appeals after its reversal on the one issue that we had decided the parties were inadvertently directed, to submit recomputations of the petitioner’s tax liability pursuant to the mandate, there remained at that time undecided two issues presented by the pleadings. A determination of these issues was essential before the proceeding properly could. be placed under Bule 50. Until these issues are determined the proceeding in so far as such issues are involved is in the same status as it was prior to the entry of our former report at 25 B. T. A. 1335. The fact that a decision determining a deficiency in tax was entered subsequent to argument on the computations of petitioner’s tax liability submitted by the respective parties would not alter the situation, since the entry of such decision was just as inadvertent as the direction to the parties to submit recomputations. Further, when the respondent promptly after the entry of the decision pointed out by motion that the two issues remained undecided, such decision was duly vacated.

In Helvering v. Edison Securities Corporation, 78 Fed. (2d) 85, the Board had promulgated its report wherein it had made a determination of the issues presented. Under its determination of one of the issues the profits from a certain transaction not theretofore considered taxable by the respondent or the petitioner became taxable. Subsequent to the promulgation of the report the respondent moved for a rehearing at which to make claim for an increased deficiency. This was denied and the petitioner filed its recomputation of its tax liability under Buie 50. The. respondent then filed written claim for an increased deficiency which was denied. Entry then was made of the final decision determining a deficiency. In reversing our action the court said:

The Board refused to entertain the claim for increased deficiency seemingly on the ground that the power given it by Section 274 (e) is to be exercised only if the claim is asserted by the Commissioner at or before the hearing or a rehearing of the case, and because in the opinion of the Board, this stage had been passed when the Commissioner set up the claim in this case. We think that the power still persisted, for there seems to be no reason why the word “hearing” should not be given a significance broad enough to include the whole proceeding down to the final decision. Ordinarily a hearing in equity embraces the decision also. Joseph Dry Goods Co. v. Hecht, 120 F. 760, 763; American Grain Separator Co. v. Twin City Separator Co., 202 F. 202, 205; Chicago Ry. Equip. Co. v. Blair, 20 F. (2d) 10; International Banding Machine Co. v. Commissioner, 37 F. (2d) 660. Blit here the purpose is manifest to give the taxpayer an opportunity to answer and resist the claim before it is made effective by the action of the Board. If this is done, a claim of increase may be made and considered with propriety, whether it is presented during the taking of the evidence or in the period allowed for oral arguments, or written briefs, or even subsequently during the hearing under Rule 50; in short, at any time before or after the filing of the Board’s findings of fact until the decision and judgment of the Board has been entered; or even later, in the event of a rehearing.
This statement, however, must be taken with the qualifications that the power to receive the claim should not be exercised unless a reasonable opportunity to oppose it is given to the taxpayer, and unless it is presented in accordance with reasonable rules laid down by the Board. If the question involved in the increase has been actually raised during the trial, and the taxpayer has presented his evidence and his views on the point, or has been given a chance to do so, the claim may be received at any time before the decision and allowed therein, if found to be correct; but the taxpayer ought not to be taken by surprise. Nor should the Board be required to receive a claim unless it is presented seasonably, in accordance with its rules, as for instance, Rule 50, which forbids the parties to use the hearing on the computation of deficiency, in accordance with the Board’s announced findings, for the consideration of matters disposed of therein, or of new issues. Compare Davison v. Commissioner, 60 F. (2d) 50; Weiller v. Commissioner, 64 F. (2d) 480.

In view of the foregoing holding of the Circuit Court to which an appeal in this proceeding would lie, we think the respondent’s claim for an increased deficiency was timely filed. It was filed at a hearing held for the purpose of permitting the parties to submit whatever evidence they wished to submit as to the actual rental value of the space occupied by the petitioner and at which they submitted a stipulation showing a value in excess of that determined by the respondent in the deficiency notice. Both parties were represented by counsel at this hearing and the petitioner was given full opportunity to oppose the respondent’s claim which is grounded on the rental value stipulated by the parties.

In Helvering v. Independent Life Insurance Co., supra, the Supreme Court had before it the question as to whether the provisions of section 245 (b) of the Revenue Acts of 1921 and 1924, the identical provisions being contained in section 245 (b) of the Act of 1926 here involved, violate the rule that no direct tax shall be laid except by apportionment. In holding that they did not the Court pointed out that, if the statute levied a tax on the part of the building occupied by the owner or upon the rental value of that space, such tax would be a direct tax which could not be sustained. After further pointing out that the rental value of a building used by the owner thereof does not constitute income within the meaning of the Sixteenth Amendment, the Court said:

Earlier acts taxed life insurance companies’ incomes substantially the same as those of other corporations. Because of the character of the business, that method proved unsatisfactory to the Government and to the companies. The provisions under consideration were enacted upon the recommendation of representatives of the latter. As rents received for buildings were required to be included in gross and expenses chargeable to them were allowed to be deducted, it is to be inferred that Congress found — as concededly the fact was — that the annual net yields from investments in such buildings ordinarily amounted to at least 4 per cent, of book value. Where an insurance company owns and occupies the whole of a building it receives no rents therefor and is not allowed to deduct the expenses chargeable to the building. Where part is used by the company and part let, the rents aré required to be included in the gross, but expenses may not be deducted unless, if it be necessary, there is added to the rents received an amount to make the total sufficient, after deduction of expenses, to leave 4 per cent, of book value. All calculations contemplated by section 245 (b) are made subject to that limitation. Congress intended that the rule should apply only where rents exceed such 4 per cent. Where they are less than that, addition of the prescribed rental value and deduction of expenses operate to increase taxable income. The classification is not without foundation.
The company is not required to include in gross any amount to cover rental value of space used by it, but in order that, subject to the specified limitation, it may have the advantage of deducting a part of the expenses chargeable to the building, it is permitted to make calculations by means of such an addition. The statute does not prescribe any basis for the apportionment of expenses between space used by the company and that for which it receives rents. The calculation indicated operates as such an apportionment where the rents received are more than 4 per cent, of book value, but less than that amount plus expenses. In such cases the addition, called rental value of space occupied by the company, is employed to permit a deduction on account of expenses. That, as is clearly shown in the dissenting opinion, supra, page 473 of 67 F. (2d) is the arithmetical equivalent of lessening the deduction by the amount of the so-called rental value.
* * * As shown above, the prescribed calculation, section 245 (b), is in substance a diminution or apportionment of expenses to be deducted from gross income under the circumstances specified. See Anderson v. Forty-Two Broadway Co., 293 U. S. 69, 36 S. Ct. 17, 60 L. Ed. 152.
Unquestionably Congress has power to condition, limit, or deny deductions from gross income in order to arrive at the net that it chooses to tax. Burnet v. Thompson Oil & Gas Co., 283 U. S. 301, 304, 51 S. Ct. 418, 75 L. Ed. 1049; Stanton v. Baltic Mining Co., 240 U. S. 103, 36 S. Ct. 278, 60 L. Ed. 546; Brushaber v. Union Pac. R. Co., supra, 23, 24 of 240 U. S., 36 S. Ct. 236.

As indicated by the foregoing, the calculation prescribed in section 245 (b) has for its purpose the lessening or apportioning of the amounts for taxes, expenses and depreciation that a life insurance company occupying a part of its building may deduct from gross income by the amount of the rental value that is to be included on account of the space occupied by the company. The amount included in gross income on account of the space occupied by the company serves as a reduction of or as an offset to the total of the amounts deductible for taxes, expenses and depreciation. As pointed out by tbe Supreme Court, a life insurance company occupying a part of the property owned by it is not required to include in its gross income any amount to cover the rental value of space used by it, but, in order for it to obtain deductions for taxes, expenses and depreciation, rental value of the space occupied must be included in gross income.

This brings us to a consideration of the question as to whether the provision in section 245 (b) that’“ Such, rental value shall be not less than a sum which in addition to any rents received from other tenants shall provide a net income (after deducting taxes, depreciation, and all other expenses) at the rate of 4 per centum per annum of the book value at the end of the taxable year of the real estate so owned or occupied ’’.(italics supplied) was intended as the basis for computing a.minimum rental value or a maximum rental value. The respondent takes the position that it was intended as a basis for computing the minimum rental value that a life insurance company could include in order to get the benefit of the deductions specified and that where the actual or true rental value, as in the instant case, exceeds such minimum the actual or .true rental value is to be included subject to the limitation that it shall not exceed the deductions for taxes, expenses and depreciation. The petitioner takes the position, that the proper rental value to be reported under the statute is that which in addition to rents from tenants provides an amount, after deducting taxes, expenses and depreciation, equal to 4 percent of book value of the property at the end of the taxable year.

The first sentence of section 245 (b) is: “ No deduction shall be made under paragraphs (6) and (7) [relating to taxes, expenses and depreciation] of subdivision (a) on account .of any real estate owned and occupied in whole or in part by a life insurance company unless there is included in the return of gross income the rental value of the space so occupied.” (Italics supplied.) The next sentence provides that “ Such rental value shall be not less than a sum ”, etc. Considering the two sentences together it is .our opinion that the second sentence provides the minimum rental value that is to be reported if any deduction is to be allowed with respect to taxes, expenses and depreciation. The first sentence provides that no deduction shall be allowed unless “ the rental value ” of the space occupied is included in gross income, while the second provides that such rental value shall.be “ not less than ” a sum computed on a prescribed basis. It seems to us ■ that if Congress had intended the second sentence to have the meaning contended for by the petitioner it would have omitted the words “ not less than ” and enacted the sentence to read “ Such rental value shall be a sum which ” etc. As stated by the Supreme Court in Helvering v. Independent Life Ins. Co., supra, the provisions of the acts there involved, which are identical with those here involved, were enacted upon the recommendation of representatives of the life insurance companies and that Congress found that investments of-the companies in buildings “.ordinarily amounted to at least 4 per cent, of book value.” This we think is a further reason supporting the view that the rental value provided for in the second sentence of - section 245 (b) was intended as a minimum. .

.In reaching the foregoing conclusion we are not unmindful of the example set forth by the Supreme Court in the final paragraph of footnote 3 in Helvering v. Independent Life Ins. Co., supra. This example 'seems, to lay down the proposition that, where the rents received (after deducting taxes, expenses and depreciation) equal 4 percent' of the book, value of the property, the rental value, of the space occupied by the company need not be reported.; The example finds support in the statement in the body of the-decision which reads: “ Where part is used by the company and part let, the rents are required to be included in the gross, but expenses may not be deducted unless-, if it Toe necessary, there is added to the rents received an amount to make the total sufficient,- after . deduction of expenses, to leave 4 percent of book value.” (Italics supplied.) The inference contained in the words “ if it be necessary ” seems to be that no rental value need be added if the rents received from tenants are alone sufficient (after deducting taxes, expenses and depreciation) to leave 4 percent of book value. We think it is clear, however, that this example in the. footnote and the inference contained in the language of the Court are not in harmony with the express wording of the statute involved that “ no deduction shall be'made * * * unless there is included in the return of gross income the rental value of the space so occupied ” by the company and that “such rental value shall be not less than a sum which” etc. The Court did not there have before it the question presented here. It is our view that the rule of construction announced by the Court is to be confined to cases where the computation provided by section 245 (b) serves to increase the rentals entering into taxable net income beyond the amount actually received as rents from tenants. Until such a result follows from the application of the language of the statute no taxes are imposed on the owner’s building or upon the rental value of the space occupied therein by the owner or upon any part of either.

In view of the conclusions reached by us . above we are unable to sustain the petitioner’s contention- that the proper amount to be included in its gross income as representing the rental value of the space occupied is $6,417.79, or the difference between the rental value reported by it in its return and the amount of real estate taxes on the building for 1927 which were deducted in the return but were disallowed, such disallowance being conceded proper by petitioner. Nor are we able to sustain the contention that the amount determined by the respondent as the rental value in the deficiency notice is the proper amount.

Inasmuch as $32,200 was the rental value of the space occupied by petitioner in its home office building and the inclusion of that amount in its gross income will not, after the deduction of expenses and depreciation result in the amount of rentals entering into its taxable net income being increased beyond the amount actually received from tenants as rent or even by as much as either of the amounts deductible as expenses and depreciation we hold that the proper amount to be included in the petitioner’s gross income on account of the space occupied by it in its home office building is $32,200. In determining the deficiency the respondent determined the amount to be included in gross income as the rental value of such space to be $11,596.98, and, as we hold that the amount to be included is $32,200, the respondent’s claim that the amount determined by him should be increased by $20,603.02 and the deficiency increased accordingly is granted.

Reviewed by the Board.

Decision will be entered under Rule 50.


author: McMahon:

text:
    Boyle Ice Company of Delaware, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 51777, 62092, 69294, 73851.
    Promulgated November 8, 1935.

      John G. Gregory, Esq., for the petitioner.

      E. A. Tonjes, Esq., for the respondent.
   OPINION.

McMahon:

These are proceedings, duly consolidated for hearing and opinion, for the redetermination of deficiencies in income tax for the years 1928, 1929, 1930, and 1931, in the respective amounts of $628.91, $595.92, $598.54, $598.54. Each petition contains an allegation that the respondent erred in determining the deficiency and each contains the allegation, in substance, that respondent erred in holding that the basis, for purposes of exhaustion, of a certain contract is the same as in the hands of the transferor, such basis as determined by the respondent being nothing, since it cost the transferor nothing, and in failing to hold that the basis of such contract is $100,000, alleged to be its cost to the petitioner. These allegations were denied by respondent.

The parties entered into the following stipulation of facts:

1. Tlie petitioner is a corporation duly organized and incorporated under the laws of the State of Delaware on August 17, 1928.
2. Exhibit “A”, attached hereto and made a part hereof, is a true and correct copy of a certain contract, involved in this proceeding, dated June 25, 1923, between the Pennsylvania Railroad Company, first party; Boyle Ice Company, a corporation organized and existing under the laws of the State of Illinois, second party; and Fruit Growers Express Company, a corporation organized and existing under the laws of the State of Delaware, third party, together with guarantee letter dated June 28,1923, addressed jointly to the Pennsylvania Railroad Company and Fruit Growers Express Company and signed by John P. Beyle in his lifetime, which guarantee letter was duly accepted by the Pennsylvania Railroad Company and Fruit Growers Express Company.
3. Exhibit “ B ”, attached hereto and made a part hereof, is a true and correct copy of a certain resolution duly adopted by the Boyle Ice Company, of Delaware, the Delaware Corporation, at the first meeting of its board of directors held the 22nd day of August, 1923.
4. Exhibit “ C ”, attached hereto and made a part hereof, is a true and correct copy of a certain resolution duly adopted by the Boyle Ice Company, the Illinois corporation, at a special meeting of its board of directors held the 22nd day of August, 1933. [1923]
5. Exhibit “ D ”, attached hereto and made a part hereof, is a true and correct copy of a certain resolution duly adopted by Boyle Ice Company, the Illinois corporation, at a special meeting of its board of directors held the 20th day of September, 1923.
6. On or about September 20, 1923, pursuant to the resolutions set forth in Exhibits “ B ” and “ D ”, the Boyle Ice Co. of Delaware, the Delaware corporation, acquired from the Boyle Ice Company, the Illinois corporation, the contract referred to in paragraph 2 hereof as Exhibit “A”; and in exchange therefor, the Boyle lee Company of Delaware, the Delaware corporation issued 7,000 shares of its common capital stock to the Boyle Ice Company, the Illinois corporation, the certificate for said shares being issued in the name of John P. Boyle, who held the stock as nominee of the Boyle Ice Company, the Illinois corporation.
7. The aforesaid 7,000 shares of stock issued to John P. Boyle as nominee of the Boyle Ice Company, the Illinois corporation, was held in this manner until January 1, 1924.
8. That of the 7,000 shares of stock issued to John P. Boyle, as aforesaid, certificates for 3,000 shares thereof were reissued on or about January 2, 1924 to Boyle Ice Company, the Illinois corporation, and certificates for the balance, to-wit, 4,000 shares, were thereafter reissued to various and sundry purchasers of 2,000 shares of preferred stock of Boyle Ice Co. of Delaware, the Delaware corporation, as a bonus in connection with their purchases of said preferred stock.
9. That of the 7,000 shares of stock issued to John.P. Boyle, as aforesaid, 4,766 shares were a.cquired by stockholders of the Boyle Ice Company, the Illinois corporation. Boyle Ice Company of Delaware, the Delaware corporation, had an iss ue of 3,000 shares of preferred stock; and of this stock 1,883 shares thereof were purchased by stockholders of the Boyle Ice Company, the íllinois corporatism, subsequent to January 2, 1924.

Exhibits A, B, C and D, referred to in the above stipulation, we incorporate herein fully by reference. Exhibit C authorizes John P. Boyle to subscribe, on behalf of the Illinois corporation, for 1,000 shares of preferred stock of petitioner. By Exhibit A, the Boyle Ice Co. of Illinois agreed to construct an ice plant on or before January 2, 1924, at Huntingdon, Pennsylvania, to furnish and sell ice to the express company and the railroad company. The guarantee letter, attached to the contract, provided that the rights and obligations of the Illinois corporation might be assigned to a Delaware corporation, the Illinois corporation to guarantee full performance by the Delaware corporat ion.

After the contract in question was executed, it was determined that the consideration, to be paid for it by the new corporation, the petitioner, should be. 1,000 shares of petitioner’s common stock, and that 1,000 of these shares should constitute the compensation of the Boyle Ice Co;, the Illinois corporation, for its services in securing the contract.

The plant was. ready for operation on January 1, 1924. By January 1, 1924, Boyle had disposed of $240,000 of preferred stock. By some time in April 1924 $25,000 more preferred stock had been disposed of and the sale of the remainder of the $300,000 preferred stock was practically completed by June 1924. Of the 7,000 shares of common stock of petitioner 1,000 shares were retained by the Boyle Ice Co., the Illinois corporation, as compensation for obtaining the contract, 2,000 shares were given to such Illinois corporation in its capacity as purchaser of $100,000 of preferred stock, and 4,000 shares were distributed to a group of 56 other preferred stockholders.

On or about January 2, 1924, the petitioner sold 110 shares of common stock for $15 cash per share- to three individuals. These 7,110 shares of common stock of petitioner and $300,000 par value preferred stock were all the shares of stock issued by the petitioner up to and through 1924.

At the date the petitioner was formed no money was paid in to petitioner. .The contract was its sole asset. While the preferred stock of petitioner was being sold, the plant at Huntingdon was erected on the credit of John P. Boyle.

John P. Boyle’s undertaking to erect an adequate icing station to be ready for use on January 1, 1924, was quite a responsibility, because if there were a failure it would mean that this potential influence for future business or other divisional icing plants would be gone. Frederick A. Thulin, an attorney and accountant, advised Boyle that he would have to assume the responsibility of financing the preferred stock of petitioner, and that the remaining 6,000 shares of common stock of petitioner would have to remain available to be allocated for the purpose of securing $300,000 of financing.

On or about September 20, 1923, the date the petitioner acquired the contract from the Boyle Ice Co. of Illinois, such contract had a fair market value of at least $100,000. At that time the 7,000 shares of common stock which petitioner exchanged therefor had a fair market value of at least $100,000.

In each of the years in question the respondent disallowed the deduction of $5,000 claimed by the petitioner as amortization of the cost of the contract.

Upon the foregoing facts, which we find, we are called upon to determine the proper basis for the deduction of exhaustion allowances upon the contract in question in the .hands of the petitioner, during the years 1928 to 1931, inclusive. Petitioner contends that the basis is $100,000, which it claims was the amount of va^ue paid by petitioner for it to the Boyle Ice Co. of Illinois or, in other words, its cost to petitioner. (See MacCallum Gauge Co., 32 B. T. A. 544). Respondent now contends, in conformity with his determination, that the basis is nothing, since under the Revenue Act of 1928 the basis is the same in the petitioner’s hands as it would be in the hands of Boyle Ice Co. of Illinois and that the contract cost the . Boyle Ice Co. of Illinois nothing. There are set forth in the margin pertinent provisions of the Revenue Act of 1928

The evidence shows that the petitioner acquired the contract in question on or about September 20, 1923, from the Boyle Ice Co. of Illinois in exchange for 7,000 shares of its common capital stock and that John P. Boyle held such stock as nominee of the Illinois corporation until January 1,1924. In the stipulation of facts it is stated in part, “ On or about September 20, 1923, * * * the Boyle Ice Co. of Delaware, * * * acquired from the Boyle Ice Company, the Illinois corporation, the contract * * *; and in exchange therefor, * * * issued 7,000 shares of the common capital stock to the Boyle Ice Company, the Illinois corporation.” No other common stock was issued by the petitioner until about January 2, 1924. There is no proof that any of the preferred stock of the petitioner was outstanding immediately after the transfer of the contract to the petitioner.

Upon the evidence we are constrained to approve the respondent’s determination. So far as the evidence shows the transaction in question comes within the provisions of section 112 (b) (5). The contract was transferred to the petitioner by the Boyle Ice Co. of Illinois solely in exchange for stock of the petitioner and, so far as the evidence shows, immediately after the exchange the Illinois corporation was in control of the petitioner. Immediately after the exchange, the Illinois corporation owned all of the 7,000 outstanding shares of common stock of petitioner. As pointed out above, we do not know that there was any outstanding preferred stock of petitioner immediately after the exchange. If there was, there is no evidence to show that the Illinois corporation did not own a controlling portion of it within the definition of control in section 112 (j)

In our opinion it is not determinative that at or about the time of the exchange the Illinois corporation authorized its nominee, John P. Boyle, to deliver as a bonus to purchasers of preferred stock of the petitioner a portion of the common stock received by the Illinois corporation upon the exchange or that it was originally contemplated that this would be necessary. There is no evidence to show that petitioner had any agreement with the Illinois corporation that such Illinois corporation would return any of the common stock to petitioner, or that any of it would be issued for the benefit of the petitioner. The Illinois corporation had the right to do with the stock as it saw fit, so far as the evidence shows. About three months after the exchange the Illinois corporation did distribute some of such common stock as a bonus to purchasers of preferred stock of petitioner, but this was done, the evidence, particularly exhibit D, shows, because the Illinois corporation deemed it advisable for its own benefit. There is no escape from the conclusion that immediately after the exchange the Illinois corporation owned more than 80 percent of the outstanding common stock of the petitioner. Schmieg, Hungate & Kotzian, Inc., 27 B. T. A. 337, and Samuel Insull, Jr., 32 B. T. A. 47. In the former case we stated in part:

* * * The situation does not require that the original owners shall remain indefinitely in control after the exchange. It is only necessary that the owners of the property transferred shall be immed/iately in control of the corporation to which the transfer of property is made. Federal Grain Corp., 18 B. T. A. 242.

In the latter case we stated in part:

* * * Clearly, “ immediately after the exchange ” [early in January 1929] the transferors were in control of Insull Utility Investments, Inc., and remained in control of it until after January 18, 1929. What happened on and after that date has no bearing upon the question in issue. Our opinion in Federal Grain Corporation, 18 B. T. A. 242, is apposite. * * *

Under the provisions of section 114 (a), the basis for the exhaustion of the contract is the same as provided in section 113 (a) (8) for the purpose of determining gain or loss, which is the basis in the hands of the transferor, the Illinois corporation. Under the general provisions of the revenue acts such basis in the hands of the transferor is the cost to the transferor. Section 202 (a) of the Beve-nue Act of 1921 and section 113 (a) of the Bevenue Act of 1928, which are substantially the same in this respect. Such basis is not to be increased or decreased, since, under section 202 (c) (3) of the Bevenue Act of 1921, which is substantially the same as section 112 (b) (5) of the Bevenue Act of 1928, no gain or loss could have been recognized upon the exchange. The respondent has held that the contract cost the Illinois corporation nothing. There is no evidence lo show that the contract did cost the Illinois corporation anything. Consequently, the petitioner is entitled to no deductions for exhaustion of the contract.

The evidence shows, and we have found as a fact, that at the time of the exchange the contract and the stock exchanged therefor each had a fair market value of at least $100,000. In the view we have taken this is of no consequence, but we may say in passing that in fixing such value we have taken into consideration the terms of the contract regarding the quantity of ice to be sold and the prices therefor, the cost of manufacturing the ice, the duration of the contract, estimated and actual earnings of the stock, the fact that on or about January 2, 1924, petitioner made several small sales of some of its common stock for $15 per share, under conditions substantially the same as those of September 20, 1923, and all other facts and circumstances bearing on the question of value.

Decision will be entered for the respondent.

       SBC. 114. BASIS FOR DEPRECIATION AND DEPLETION.
      (a) Basis for depreciation. — The basis upon which exhaustion, wear and tear, and obsolescence are to be allowed in respect oí any property shall be the same as is provided in section 113 for the purpose o£ determining the gain or loss upon the sale or other disposition of such property.
      SEC. 113. BASIS EOR DETERMINING GAIN OR LOSS.
      (a) Property acquired after February ISIS. — The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that—
      * * * . * * !¡"
      (8) Same — Corporation controlled by transferor. — If the property was acquired after -December 31, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5) (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities), then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made;
      * t * * * * Jft
      Sec. 112 (b) (5). Transfer to corporation controlled by transferor. — No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange. [Emphasis supplied.]

       (j) Definition of control. — As used in this section the term “control” means the ownership of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.