author: Seawell :

text:
    Estate of R. R. Russell, and J. L. Borroum, T. P. Russell and O. H. Judkins, Executors and Trustees, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 59226.
    Promulgated June 25, 1936.

      A. J. Lewis, Esq., for the petitioner.

      Hunter B. Lmton, Esq., and Dean P. Kimball, Esq., for the respondent.
   OPINION.

Seawell :

The petitioner claims that its 1926 net loss should be increased by the following alleged losses:

The petitioner concedes that the amount of the losses arising out of the decedent’s endorsement of notes of the corporations should be decreased by $120,000 on account of deductions taken in the estate tax return, and it is agreed that the remaining amounts of such items, together with the other losses, should be reduced one-half to reflect the widow’s community property interest in the estate.

Deductions from gross income, including net losses, are allowable only when clearly provided for by statute. New Colonial Ice Co. v. Helvering, 292 U. S. 435. The statutes allow, as deductions in the computation of a net loss, losses “attributable to the operation of a trade or business regularly carried on by the taxpayer.” Sec. 206, Revenue Act of 1926; secs. 117 and 169, Revenue Act of 1928. The amount of the several claimed losses is not in controversy.

The petitioner’s contention is that all of the losses are attributable to trades or businesses regularly carried on by the decedent during his lifetime, and, having continued such trades or businesses after his death, it is entitled to the benefits of the statute. The respondent’s position on the point is that the petitioner was regularly engaged in only the ranching business, and, as none of the losses are attributable to such business, the items form no part of the petitioner’s net loss in 1926.

The thing of impoi'tance respecting the items in group one is whether they are attributable to a trade or business regularly carried on by the decedent before his death, or his executors, the petitioner. The Rutledge note was endorsed and the note of R. H. Martin & Co. was acquired by the decedent during his lifetime. The Martin note for $19,904.08 was acquired by the petitioner in settling the affairs of R. H. Martin & Co. and the remaining claimed losses in group one resulted from the payment of debts of that partnership after the settlement with Martin, the surviving partner.

During his lifetime the decedent was regularly engaged in the ranching business, including the purchase and sale of livestock, in his individual capacity and as a member of partnerships. He endorsed the Rutledge note and received the partnership note in the ordinary course of operating his individual ranching business, and had the losses occurred prior to his death, undoubtedly the amount thereof would have been available to him in the computation of a net loss. His liability as an endorser existed at the time of his death and the losses resulting from it would have been sustained if the executors had not engaged in any line of business.

The activities of the executors consisted of administering the estate of the individual, including the liquidation of liabilities thereof, and operating the ranches formerly owned and operated by the decedent in his individual capacity. Russell’s death worked a dissolution of the partnership of R. H. Martin <& Co., and the activities of the executors as to it related only to settling its affairs as required by law. The ordinary duties of an executor, such as the executors here were performing in settling the liabilities of the estate on the notes and winding up the affairs of R. H. Martin & Co., do not constitute a trade or business regularly earned on. O. A. Refling, Executor, 17 B. T. A. 327; aff'd., 47 Fed. (2d) 859; Charles Lesley Ames, Executor, 14 B. T. A. 1067; aff'd., 49 Fed. (2d) 853; People’s Pittsburgh Trust Co. v. United States, 6 Fed. Supp. 447; Eli Strouse, 24 B. T. A. 748; aff'd., 59 Fed. (2d) 600. Thus the losses referred to were not attributable to any trade or business regularly carried on by the petitioner unless under the statute it and the decedent are one and the same taxpayer. In our opinion they are not.

A new corporation formed to acquire the assets and business of an existing corporation in exchange for its stock may not obtain the benefit of a net loss of the old corporation in the computation of its net income. New Colonial Ice Co. v. Helvering, supra. Under a ruling of the Commissioner of long standing a net loss of an individual may not be carried forward in determining net income of his estate, the theory of the principle being that the two are not a single taxpayer. I. T. 1562, C. B. II — 1, p. 33. The statutes classify the estate of a decedent as a taxpayer. Sec. 2,1926 Revenue Act; sec. 701,1928 Revenue Act. The taxable net income of an individual and an estate are not computed in the same manner. Certain specified contributions made by an estate pursuant to the terms of the will are deductible from gross income without limitation, whereas in the case of an individual the amount of the deduction is limited. Contributions to a public cemetery may be deducted by an estate, but not by an individual. In the case of an estate, the credit allowed is the same as that for a single person, with no allowance for dependents. Sections 214 (a) and 219 (b), Revenue Act of 1926, which contain other provisions peculiar to estates. Ro credit is available to an estate for earned income. Sec. 209, 1926 Revenue Act. A further distinction is that property of the decedent acquired a new basis when it was acquired by the estate. Sec. 113 (5), 1928 Revenue Act. In Hartley v. Commissioner, 295 U. S. 216, the Court, in holding that under the 1924 and 1926 Acts the basis for property in the hands of the executor acquired from the decedent was the fair market value thereof at the time of the decedent’s death, rather than the decedent’s basis, said: “The revenue acts consistently treat the estate of a decedent in the hands of an administrator or executor as a separate taxpayer.”

The fact of continuity of the business was stressed by the petitioner in New Colonial Ice Co. v. Helvering, supra, but the Court did not regard it as controlling, saying:

⅛ * » Besides, the matter of importance here, as will be shown presently, is not continuity of business alone but of ownership and tax liability as well. Had the transfer from one company to the other been effected by an unconditional sale for cash, there would have been continuity of business, but not ownership or tax liability.

The losses contained in group one were not attributable to any trade or business regularly carried on by the petitioner, but to businesses regularly carried on by the decedent prior to his death, and, the estate being a taxable entity separate from the individual, the petitioner is not entitled to include the items in the computation of its net loss for 1926.

The decedent and Martin had equal interests in the partnership of S. H. Martin & Co. In closing up the affairs of the firm it was determined that Martin owed the estate the sum of $19,904.08 on the two partnership notes it held, each in the face amount of $24,786.54. Whether the third note of a like sum. held bv the City National Bank of San Antonio, was taken into the reckoning is not shown by the record. If the decedent’s investment in the partnership resulted in taxable gain or deductible loss, the amount thereof should have been reflected in the return of the estate for 1924, the year in which the settlement was made between Martin and the estate. The loss on the note given by Martin did not result from any partnership activity of the decedent or his executors, but was due to the failure of Martin to pay the obligation. Lewis G. Carpenter, 33 B. T. A. 1.

The partnership debts of $3,625.06 were paid after the settlement was entered into between the partners but prior to 1926, and can not on any ground be allowed as a deduction in 1926.

The items in group two relate to losses resulting from endorsement of notes of two corporations, debts paid for the account of one of the corporations, and an individual note of R. H. Martin. In Burnet v. Clark, 287 U. S. 410, the taxpayer at various times endorsed notes of a corporation of which he was a majority stockholder and president, and to the affairs of which he devoted a large part of his time. He was not regularly engaged in endorsing notes or buying and selling securities. From these basic facts the Court refused to allow, in the computation of net losses, amounts the taxpayer paid out to satisfy his liability as endorser of the corporation’s notes.

Neither the decedent nor the petitioner was regularly engaged in the business of endorsing or guaranteeing notes, making advances to, or paying debts of corporations. Under the rule announced in the Ciarle case, sufra, the losses sustained on the corporate notes and debts paid for one of them would not have been deductible by the decedent in the computation of a net loss had they occurred during his lifetime. His estate, a separate taxpayer, acquired no greater rights.

The loss sustained on the individual note of E. H. Martin has no relation to any trade or business regularly carried on by the estate or by the decedent prior to his death, and, like the other losses, may not be used in the computation of a net loss of the petitioner for 1926.

Decision will he entered xmder Rule 50.

       This decision was prepared during Mr. Seawell’s term of office.


source: Caselaw Access Project

author: ARUndell:

license: Public Domain

text:
    Roberts-Solomon Trust Estate, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 80149.
    Promulgated June 26, 1936.

      Ward Loveless, Esq., George M. Wollcott, Esq., and Walter T. Johnson, Esq., for the petitioner.

      W. H. Payne, Esq., and R. N. McMillan, Esq., for the respondent.
   OPINION.

ARUndell:

The issue here is whether the Roberts-Solomon trust is taxable as an association. If it is taxable as a trust, the petitioner claims an overpayment of the entire tax as paid. $559.05, by virtue of the fact that all the net income of the trust for the year was distributed to the beneficiaries.

In our opinion, the trust possesses every feature enumerated in the Morrissey case, 296 U. S. 344, as essential characteristics of a corporate organization. There was centralized management, continuity of existence, transferable beneficial interests, and limited liability. Thus, the trust is distinguishable from the Guitar Trust Estate, 25 B. T. A. 1213; aff'd., 72 Fed. (2d) 544, involving a similar family settlement where the court held: “Except that the trustees were authorized to continue the going business, the trust had no feature in common with a corporation.”

There was no question but that the Roberts-Solomon trust was “doing business”, Morrissey v. Commissioner, supra; Helvering v. Coleman-Gilbert Associates, 296 U. S. 369; Swanson v. Commissioner, 296 U. S. 362; Commissioner v. Vandergrift Realty & Investment Co., 82 Fed. (2d) 387, and was not created merely for liquidation purposes, Wilson Syndicate Trust, 14 B. T. A. 508; aff'd., 39 Fed. (2d) 43; Morriss Realty Co. Trust No. 1, 23 B. T. A. 1076; aff'd., 68 Fed. (2d) 648, or merely to collect and distribute rents, Lansdowne Realty Trust v. Commissioner, 50 Fed. (2d) 56; and cf. Franklin Title & Trust Co., 32 B. T. A. 266; Smathers Power Typewriter Co., 28 B. T. A. 327; and Vandergrift Really & Investment Co., supra.

The petitioner claims that a feature distinguishing this trust from those in the Morrissey and related cases is that the parties here did not of their own volition pool their separate sources to undertake this business enterprise. It relies on statements by Chief Justice Hughes in the Morrissey case, as follows:

“Association” implies associates. It implies the entering into a joint enterprise, and ⅝ * ⅜ an enterprise for the transaction of business. This is not the characteristic of an ordinary trust — whether created by will, deed, or declaration — by which particular property is conveyed to a trustee or is to be held by the settlor, on specified trusts, for the benefit of named or described persons.
Such beneficiaries do not ordinarily, and as mere eestuis que trust, plan a common effort or enter into a combination for the conduct of a business enterprise * * *

We think that this statement, taken in its context and with reference to the circumstances of the case to which it is directed, means no more than that an “ordinary trust — whether created by will, deed, or declaration” is not created “for the conduct of a business enterprise”, but rather for the passive purpose of separating the legal and equitable title, or of liquidation. In this case we have a trust definitely created for the transaction of a business. We see no reason for distinguishing it from the ordinary business trust taxable as a corporation merely on the ground that the participants did not furnish the capital with which the business is carried on. The mere iact that they were given the business instead of creating it themselves seems no reason for holding that there is no association. Had they received undivided interests in the property by deed or will and then established the trust themselves, it would undoubtedly be taxable as an association. Cf. Lloyd M. Willis et al., Trustees, 22 B. T. A. 564; affd., 58 Fed. (2d) 121. The same should be true where they accept interests in a trust conducting a going enterprise. Had the grantor not sought the advantages of the corporate modes of procedure, she could simply have declared a trust, naming herself as sole trustee and continued to manage the business without being subject to taxation as a corporation. E. A. Holmes, Trustee, 27 B. T. A. 1229. But she chose to give to the trust features analogous to the corporate form and the beneficiaries accepted the gift, “burdened” with the advantages which are characteristic of a corporation. The trust is taxable as a corporation.

Judgment will be entered wider Rule 50.


author: McMahon :

text:
    Rosa Orino, Petitioner, v. Commissioner of Internal Revenue, Respondent. Sam Orino, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 76210, 76211.
    Promulgated June 26, 1936.

      Don F. Kiser, Esq., for the petitioners.

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

McMahon :

The question presented is whether the respondent erred in including in petitioners’ taxable incomes the amount of the retained percentages under the contracts. The parties apparently are agreed that whatever income is taxable to the petitioners is taxable equally to each as community income. The stipulated facts show that the petitioners reported their income from the contracts on the basis of the percentage of completion of the contracts. Sections 41 and 42 of the Revenue Act of 1928, which deal with methods and periods of accounting, are set forth in the margin.

We find it unnecessary to decide, and specifically do not decide, the question of whether these contracts were long term contracts within the meaning of the applicable regulations, article 334, Regulations 74. Such regulations do not require a taxpayer to return income from long term contracts on either of the bases provided therein, but permit him to do so. If we were to assume in the instant proceedings that the contracts in question are long term contracts within the meaning of the regulations, the petitioners having elected to return income therefrom on the basis of percentage of completion of contracts and no change therefrom having been sought so far as the record shows, the result would be in accord with the determination of the respondent, since under this basis of returning income the full percentage is to be returned in any particular year even though actual payment of a balance due is not made until a later year. Vansant v. Crooks, 43 Fed. (2d) 166; appeal dismissed in Crooks v. Vansant, 49 Fed. (2d) 1075; and J. L. Allhands, 10 B. T. A. 1089. If we were to assume that these contracts are not long term contracts within the meaning of the regulations, the result would still remain the same, as will be immediately pointed out.

The stipulation shows that petitioners’ books were kept, on the accrual basis and that in 1931, following their custom of former years, the petitioners set up on their books the amounts retained 'by the Government as well as the amounts received in cash. Thus the “method of accounting regularly employed in keeping the books” was in accord with the method which the respondent determined was the proper method of returning the income. Section 41 of the Revenue Act of 1928 provides that the net income shall be computed in accordance with the method of accounting regularly employed in keeping the books of the taxpayer, unless, among other things, the method employed does not clearly reflect the income. Here the respondent has held that this method does clearly reflect income. His determination has the support of a presumption of correctness and the petitioners have the burden of proving it to be wrong. Welch v. Helvering, 290 U. S. 111. The petitioners have not shown that this method does not substantially and clearly reflect their income.

The petitioners contend that it does not and point to the fact that it ultimately developed, in 1934, that they received $1,000 less than the contract price under contract No. 28-B, due to a set-off of 'claims of the Government against them for a loss from a fire alleged to have been due to negligence of Sam Orino. However, this does not show that petitioners’ system of returning income does not clearly reflect income for 1931, the only year before us. The- set-off in 1934 of $1,000 against the amount due the petitioners for 1931 does not, for income tax purposes, affect the question of the amount of income accruable by the petitioners for 1931. That is a separate transaction for tax purposes. The petitioners, by relinquishing in 1934 their right to receive $1,000 of the contract price accrued by them for 1931, secured a release from liability on account of the fire alleged! to have been due to the negligence of petitioner Sam Orino. The transaction was in effect the same as if petitioners had received the $1,000 in 1934 and then paid it out for the release, which was the consideration for the $1,000. Whether such amount might be deductible from gross income for the year 1934 when paid, or even for some other year, it is unnecessary for us to here decide. No-claim-is made-that it is deductible in the:year. before us.

Nor does the fact that work has to be re-done sometimes on contracts generally affect the question here presented. There is no evidence to show that any oí the work under any oí the contracts in question herein had to be re-done. Furthermore, we may not indulge in a presumption that the petitioners did not do the work under the contracts according to specifications or that any of it had to be re-done.

We hold that the petitioner has not shown that the respondent erred in his determination of the tax liability of the petitioners for the year 1931.

In the view we have taken it becomes unnecessary to consider the alternative affirmative allegations of the respondent.

Decision will be entered for the respondent.

       SEC. 41. GENERAL RULE.
      The net income shall be computed upon the basis of the taxpayer’s annual accounting period (fiscal year or calendar year, as the case may be) in accordance -with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. * * *
      SEC. 42. PERIOD IN WHICH ITEMS OF GROSS INCOME INCLUDED.
      The amount of all items of gross income shall be included in the gross income for the taxable year, in which received by the taxpayer, unless, under methods of accounting permitted under section 41, any such amounts are to be properly accounted for as of a different period.

       AitT. 334. Long-term contracts. — Income from long-term contracts is taxable for the period in which the income is determined, such determination depending upon the nature and terms of the particular contract. As used herein the term “long-term contracts” means building, installation, or construction contracts covering a period in excess of one year. Persons whose income is derived in whole or in part from such contracts may, as to such income, prepare their returns upon the following bases:

        (a) Gross income derived from such contracts may be reported upon the basis of percentage of completion. * * * If, upon completion of a contract, it is found that the taxable net income arising thereunder has not been clearly reflected for any year or years,, the Commissioner may permit or require an amended return.
      (⅞) Gross income may be reported in'the taxable year in which the contract is finally completed and accepted if the taxpayer elects as a consistent practice so to treat such, income, provided such method clearly reflects the net income. * ⅜ *
      Where a taxpayer has filed his return in accordance with the method of accounting regularly employed by him in keeping his books and such method clearly reflects the income, he will not be required to change to either of the methods above set forth. * * *

      [See Uvalde Co., 1 B. T. A. 932; R. G. Bent Co., 26 B. T. A. 1369; but see also Fort Pitt Bridge Works, 24 B. T. A. 626.]

       To similar effect is Allhands v. Crooks, an unreported decision rendered December 27, 1930, by tbe United States District Court for tbe Western District of Missouri.


author: McMahon:

text:
    Sauk Investment Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 74642.
    Promulgated July 1, 1936.

      Joseph NievinsJei, Esq., and A. G. Elder, Esq., for the petitioner.

      Elden McFarland, Esq., for the respondent.
   OPINION.

McMahon:

The question to be considered herein is whether the petitioner was formed in 1927 or availed of in 1930 for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed within the meaning of section 104 (a) and (b) of the Revenue Act of 1928. Subsection (b) of that section provides that the fact that any corporation is a mere holding or investment company shall be prima facie evidence of a purpose of evading the surtax. However, this presumption is not sufficient to fix liability under such statute; “the test remains the state of mind itself, and the presumption does no more than make the taxpayer show his hand.” United Business Corporation of America v. Commissioner, 62 Fed. (2d) 754.

Here the petitioner was organized in 1927 for the purpose of acquiring the Butler-Cobb contract, and, except for the acquisition of such contract and the performance of the obligations arising thereunder, the petitioner transacted no other business. Butler testified, in substance, that the purchase of the stock was a very large purchase, payments for which extended over a period of five years during which something might happen to any one of the four interested therein; that it was necessary for his protection as guarantor of the contract to keep the stock together; that the petitioner was organized so that he could keep the stock together by his control of the petitioner; that, further, it would have been very disrupting in the event one of the parties to whom he has made a partial assignment died or the interest of any one of them became subjected to an attachment by creditors. Jamison testified, in substance, that the reason for incorporating the petitioner was to hold the block of stock purchased intact, to control the vote and to protect Butler if anything happened to the minor participants in the contract, as he understood that the whole contract, being a joint contract, under the laws of the State of Washington would be subject to probate upon the death of any one of the assignees. The testimony of Crosby was to similar effect. Butler testified further that, although in 1927 the prospect of a dividend from the Timber Co. was excellent, there was then no immediate prospect of a dividend; that the payment of a dividend by the Timber Co. was dependent upon future trade conditions and operations; and that the question of paying for the stock in the next five years absorbed them.

The respondent argues that if the corporation had not been formed by Butler, his wife, Jamison, and Crosby, they would have received the bond dividends in 1930 and would have had to pay taxes computed upon the par value! of the bonds, in the additional amounts of at least $14,072.89, $4,762.40, $850.06, and $476.24, respectively. However, in Cecil B. deMille, 31 B. T. A. 1161, 1174, the Board stated, “But the taxes under these statutory provisions are not imposed because of effects; avoidance per se is not prohibited. It is the purpose, the intention motivating a course of conduct which is made controlling by the very words of the statute. Unless the purpose was to prevent the imposition of surtaxes, the tax may not be imposed.”

In our opinion, and we have so found, the petitioner was not formed in 1927 for the purpose of preventing the imposition of the surtax upon its stockholders in 1930 through the medium of permitting its gains and profits to accumulate instead of being divided or distributed.

Was the corporation availed of in 1930 for such purpose? It is apparent that, although the petitioner had a book surplus of $144,-115.11 at the end of 1930, the petitioner had no funds or property which it could distribute to its shareholders; it had no cash on hand and the participation certificates representing the first and second mortgage bonds issued by the Timber Co. as a dividend were held by the National Bank in escrow under the terms of the Butler-Cobb contract. Its only remaining asset was the Butler-Cobb contract, which had not been completed and upon which there was still owing an unpaid balance of $49,373.41. The instant proceeding is distinguishable from cases wherein it was held that the corporations therein involved were formed or availed of for the purpose of preventing the imposition of surtaxes upon its shareholders, it appearing therein that the shareholders withdrew or borrowed substantial available sums from such corporations for their own purposes. In the instant proceeding the stockholders did not withdraw funds from the petitioner, but the petitioner was indebted to its stockholders at the end of 1930 for advances made to it from 1927 to 1930, inclusive, in the aggregate amount of $119,447.48. Except for the profit for the year 1930 in the amount of $4,522.52, representing the difference between interest received in 1930 in the amount of $9,626.59 and interest paid in 1930 in the amount of $5,104.07, the surplus account discloses no other profits, except the cash dividends received in 1927 and 1928 in the amounts of $11,200 and $22,400, respectively, and the amount of $138,936, representing the portion of the par value of the first and second mortgage bonds received as a dividend in 1930 allocated to income or earned surplus, which latter amount was adjusted by the respondent to $133,345.05. Prior to 1930 the petitioner had no interest income. The total amount of interest paid in each year prior to 1930 was carried into surplus as a loss for each year. There was no accumulation of surplus beyond the reasonable needs of petitioner’s business in 1930. Except that portion represented by the second mortgage bonds, all of it had been applied and paid on the Butler-Cobb contract. As heretofore stated, the participation certificates representing the second mortgage bonds were held in escrow by the National Bank.

Under all the facts and circumstances we are of the opinion, and have so found, that the petitioner was not availed of in 1930 for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed; and its gains and profits were not permitted to accumulate in 1930 beyond the reasonable needs of its business.

The respondent points on brief to his Exhibit F as strong evidence that the petitioner was availed of for the purpose of evading surtaxes, and in particular to the statement therein as follows:

* * ⅜ It is understood that when such assignment shall have been made such dividends as may be declared upon the International Timber Company shares will, in effect be payable to the Delaware Corporation, although the said shares of the International Timber Company still stand in the name of the seller, assigned by him in blank and deposited in escrow in a bank with, the contract of purchase, and said dividends being in effect payable from one-corporation to another corporation, will not he subject to the Federal Income Tax until they are paid out by the Delaware Corporation [petitioner] by way of dividends.

The accountant testified, among other things, that he was secretary of the petitioner merely for the purpose of keeping its books since-its incorporation; that he had two other men who assisted him in-keeping the records and in preparing the tax returns for 27 corporations ; that .he usually prepared a memorandum similar to Exhibit F so that if anything happened to him the men would know what he had done; that he knew, as appears in the memorandum,, that the petitioner was to be formed; that the information contained in the first part of the above quoted statement was obtained from the Butler-Cobb contract itself and not from his discussion with Butler; that he did not talk about the transaction with any stockholder other than Butler; that, when he added the portion of such statement to the effect that dividends payable by one corporation to another corporation will not be subject to Federal income tax until paid out. to shareholders, he probably had in mind the effect that this would have upon the petitioner’s Federal income tax return because that was the law and he knew that he would be called upon to make its returns and take care of matters of that sort; that he prepared the memorandum for his own use and attached it to the journal of petitioner; that he did not at any time exhibit such memorandum to Butler or the other shareholders; and that he voluntarily turned over such memorandum to the revenue agent who examined the books pf petitioner and permitted him to take it out of the office for the purpose of making a copy thereof. Butler testified that such accountant was the “head of the office”, that such accountant was entrusted with the bookkeeping and the preparation of the tax return of petitioner; that he never looked over the books and records of the corporation; that the accountant and the books were on the floor above; that he never went up to the accountant but that the accountant came down to him; and that he had never seen such memorandum. Section 23 (p) (1) of the 1928 Act provides that dividends received by a corporation from a domestic corporation shall be allowed as a deduction from gross income; and the Butler-Cobb contract provided that any dividends which might be received from the Timber Co. were to be applied on the contract. Hence, the accountant’s explanation of the preparation of such memorandum, and in particular the quoted portion thereof, is plausible and reasonable, especially in view of the fact that he was expected to prepare the petitioner’s tax returns. Under all the facts and circumstances, in any event, such statement in the memorandum is not sufficient to sustain a finding or holding of a purpose or intention on the part of Butler and his associates to form the petitioner in 1927 or avail of it in 1930 for the purpose of evading surtaxes as contemplated by the applicable statute. There is no evidence that such purpose or intention was disclosed to the accountant, or that such memorandum actually reflected such purpose or intention on the part of Butler and his associates, or that such purpose or intention on their part existed, sufficient to justify such findings or holdings.

The petitioner also adduced evidence as to the value of the bonds of the Timber Co. issued as dividends and in particular pertaining to the value of the second mortgage bonds in support of its claim that the book surplus was overstated in that the value of the bonds was considerably below par. It is also contended by petitioner that the bonds were payable out of a sinking fund to be created by contributions on the basis of $3.75 per thousand feet of lumber logged and hence were not a taxable distribution. In view of our holding that the petitioner was not formed in 1927 or availed of in 1930 for the purpose of preventing the imposition of surtaxes upon its shareholders through the medium of permitting its gains and profits to accumulate beyond the reasonable needs of its business instead of being divided or distributed, as heretofore fully set forth, it is not necessary for us to pass upon these or other contentions of the petitioner not heretofore disposed of herein or other questions suggested by the record; but see A. D. Saenger, Inc., 33 B. T. A. 135, to the effect that a corporation owning less than a majority of the stock of another corporation may be a “holding” company within the meaning of the applicable statute.

Reviewed by the Board.

Decision will be entered for the yetitioner.

       SEC. 104. ACCUMULATION OF SURPLUS TO EVADE SURTAXES.
      (a) If any corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there shall be levied, collected, and paid for each taxable year upon the net income of such corporation a tax equal to 50 per centum of the amount thereof, which shall be in addition to the tax imposed by section 13 and shall be computed, collected, and paid upon the same basis and in the same manner and subject to the same provisions of law, including penalties, as that tax.
      (b) The fact that any corporation is a mere holding or investment company, or that the gains or profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax.

        United Business Corporation of America, 19 B. T. A. 809; affirmed in United Business Corporation of America v. Commissioner, 62 Fed. (2d) 754; certiorari denied, 290 U. S. 635 ; William C. de Mille Productions, Inc., 30 B. T. A. 826; A. D. Saenyer, Inc., 33 B. T. A. 135; Edward G. Swartz, Inc., 33 B. T. A. 355. See Gardiner v. Welch,-Fed. Supp. - (Dist. Ct., S. Dist. Cal., Feb. 13, 1936).


author: Akundell:

text:
    Central Hanover Bank & Trust Company and Chauncey Ford Warner, Co-executors, Estate of Horace H. Work, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81027.
    Promulgated July 1, 1936.

      Wm. Cogger, Esq., for the petitioners.

      Wilford E. Payne, Esq., and P. A. Sebastian, Esq., for the respondent.
   OPINION.

Akundell:

The aim of the statute dealing with the income of estates and trusts is to tax such income either in the hands of the fiduciary or the beneficiary. Secs. 161 and 162, Revenue Act of 1932. Under section 162 (b) the fiduciary takes a deduction for the amomit of the trust income “which is to be distributed currently by the fiduciary to the beneficiaries”, and such income is taxable to the beneficiaries. As to income of this sort “the scheme of the act is to treat the amount so distributable, not as the trust’s income, but as the beneficiary’s.” Freuler v. Helvering, 291 U. S. 35. There seems to us no room for doubt that the income of the trusts here under consideration was of this kind. But this does not necessarily mean that all of the income collected by the trustee at any particular moment was currently distributable. In fact the trust instruments specifically provide for the discharge by the trustees of certain expenses.

The phrase “to be distributed currently” as used in the statute “presupposes a periodic duty of the trustee” to distribute as directed by the trust instrument. Commissioner v. Stearns, 65 Fed. (2d) 371. Where the trust instrument provides for payment of expenses, taxes, and other charges, it is not until after provision therefor is made by the trustee that he can determine the amount of income currently distributable. Not until then can it be known what amount the beneficiary has a right to receive. The test of taxability to the beneficiary is his “present right to receive” income. Freuler v. Helvering, supra. The question here thus narrows down to whether or not the beneficiary had, prior to his death, the present right to receive the trust income as and when collected by the trustees. As we read the trust instruments the trustees were required to make provision for the designated charges before distributing to the beneficiary. In the trust established by Alice C. Work the direction to the trustees is: “ * * * after paying * * * all the necessary and proper charges and expenses * * * to apply the said net rents, issues and profits to the use of the said Horace Hutchins Work * * In the Hutchins trust the trustees are directed “to apply the net income” of the trust to the use of the beneficiary, and are further authorized and empowered “to use so much of the income of the said trust as may be necessary to pay and discharge one-half of the expense of maintenance of my residence and estate at Madison, New Jersey, including all the cost, care, upkeep and taxes incidental thereto * * In McCrory v. Commissioner, 69 Fed. (2d) 688, where the trustee was directed to pay certain taxes and distribute the remainder annually, he set aside a sum to meet estimated taxes and then claimed that such amount was currently distributable and taxable to the beneficiaries. The Board and the Circuit Court held otherwise, the court saying:

The right of the beneficiaries to a distribution does not depend on the will or discretion of the trustee, but on there being enough income to enable him to make a distribution. The right, however, is conditioned on his first setting aside a sufficient amount to discharge the burdens of the trust. But it is not necessary that they should have been discharged nor even precisely ascertained. The trustee cannot escape a distribution by refusing or neglecting to ascertain them. If they cannot be exactly estimated, his duty is plain to set aside what is reasonably sufficient to cover them and to distribute the balance.

The rule of the McOrory case applied here sanctions the act of the trustees in withholding from distribution, as they did, an amount sufficient to meet estimated charges against the trust. There is no showing that the amounts so withheld were unreasonable. Indeed, the evidence shows that taxes coming due shortly after the death of the decedent would absorb nearly all of the income received up to that date. Counsel for the respondent proposes that we look ahead from the date of death and see what additional income might be anticipated between that date and the tax-due dates. However, he does not couple this with any showing of certainty that any future income would be realized, and it is more in keeping with a trustee’s duties to rely on income in hand than to speculate on the future. Having regard for the provisions of the trust instruments which directed and controlled the actions of the trustees, we think that, under the rule of the Freuler and McOrory cases, the beneficiary had no present right at or prior to his death to the income then in the hands of the trustees; hence, it was not currently distributable and was not income to him. Whether it was taxable as income to the trustees or subject to estate tax as corpus of decedent’fi estate is not before us for decision.

Decision will he entered for petitioners.


author: ARNOLD:

text:
    Houston Lighting & Power Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 74922.
    Promulgated July 3, 1936.

      Claude M. Houchins, Esq., for the petititoner.

      Harold Allen, Esq., and B. H. Transue, Esq., for the respondent.

      George W. Billings, Esq., for the city of Houston, Texas, as amicus curiae.

   OPINION.

ARNOLD:

The question presented in this case is whether certain amounts of petitioner’s net earnings in the taxable years which were subsequently paid over to the city of Houston, under the circumstances set out in our findings of fact above, are taxable to petitioner.

During the taxable years petitioner operated its public utility properties under a contract evidenced by an ordinance adopted by the city of Houston in 1915 and duly accepted by petitioner, which provided that all net earnings of petitioner in excess of operating-expenses, Federal and state taxes, depreciation, and other items, and an agreed reasonable return on its investment, should be divided equally between the city and petitioner. Pursuant to such contract petitioner paid to the city of Houston for the respective taxable years certain amounts representing one-half of its excess net earnings, computed by deducting the Federal income tax on its one-half of such excess earnings. In its income tax returns petitioner deducted from gross income, in computing taxable net income, the amount paid to the city for each year. Upon audit of the returns, respondent determined that the sums paid by the petitioner to the city of Houston constituted taxable income to petitioner, and are not allowable deductions from gross income.

In support of his action respondent argues on brief that the alleged contract was ultra vires on the part of the city of Houston, and, not being a legally enforceable agreement, the amounts paid by petitioner to the city were merely gratuities, which are taxable to petitioner in the same manner and to the same extent as any other ordinary income, and for the same reasons do not constitute allowable deductions from gross income.

It is suggested by the amicus curiae that the validity of the contract between petitioner and the city can not be attacked by respondent in this proceeding. As a general rule, a private party, a stranger to a transaction, can not question the want of power in, or its abuse by, a corporate party thereto. 14A Corpus Juris, 337. A contract unenforceable for want of mutuality can not be attacked by a stranger. Underwood v. Texas & Pacific Railway Co., 178 S. W. 38. In any event, to entitle a party to raise the question of ultra vir.es it must appear that some right of his has been invaded by the act of which he complains. 14A Corpus Juris 337, and cases there cited.

It is to be observed that the contract under consideration, in so far as concerns the taxable years before us, has been fully performed without complaint by the parties, and it is the settled rule of law that the validity of an executed contract, not malum in se, can not thereafter be questioned. Storm v. United States, 94 U. S. 76; Chicago, etc. R. Co. v. United States, 218 Fed. 288; aff'd., 244 U. S. 351.

Not only has the contract here been performed by the parties, neither of which has questioned its legal sufficiency, but it does not appear that any right of the respondent has been invaded by the asserted lack of power on the part of the city of Houston. If the bona fides of the transaction were assailed and it was shown that respondent’s rights depended upon the question of validity of the contract, as in the case of a fictitious contract of purchase and sale designed to establish a loss for income tax purposes not in fact sustained, a different situation would be presented. But respondent makes no such contention here, and, as we view the matter, for the reasons hereinbelow indicated, the right of respondent to assess and collect the deficiencies in controversy is not dependent upon whether the contract was or was not legally enforcable as between petitioner and the city of Houston.

It does not follow, however, that respondent’s action in determining the deficiencies must be disapproved merely because it is predicated upon erroneous grounds, if it otherwise appears to be correct. We must then examine thé entire record before us to determine whether the deficiencies asserted are legally due from the petitioner. Cf. American Bond & Mortgage Co., 15 B. T. A. 264; John I. Chipley, 25 B. T. A. 1103, 1106, and authorities cited.

In its brief petitioner urges that the portion of its excess net earnings paid over to the city of Houston under the terms of the contract was never at any time income to it; that the amounts so paid accrued to the city and, therefore, are not taxable to petitioner. In the alternative petitioner says that, if such amounts constituted income to it, then the amounts should be allowed as deductions from its gross income. Petitioner assigns no reason and cites no authority in support of its alternative contention.

The statutes which govern this proceeding are the Revenue Acts of 1926 and 1928. Section 213 (b) (7) of the 1926 Act, which is identical with section 116 (d) of the 1928 Act, provides as follows:

(b) Tbe term “gross income” does not include .tbe following items, which shall be exempt from tax under this title:
if: ⅜ * ⅜ * * *
(7) ⅜ * *.
Whenever any State * ⅜ * or any political subdivision of a State * * * prior to September 8, 1916, entered in good faith into a contract with any person, the object and purpose of which is to acquire, construct, operate, or maintain a public utility—
(A) If by the terms of s,uch contract the tax imposed by this title is to be paid out of the proceeds from the operation of such public utility, prior to any division of such proceeds between the person and the State * * * [or political subdivision] and if, but for the imposition of the tax imposed by this title, a part of such proceeds for the taxable year would accrue directly to or for the use of such State * * * [or political subdivision] then a tax
upon the net income from the operation of such public utility shall be levied, assessed, collected, and paid in the manner and at the rate prescribed in this title, but there shall be refunded to such State * ⅜ * [or political subdivision] an amount which bears the same relation to the amount of the tax as the amount which (but for the imposition of the tax imposed by this title) would have accrued directly to or for the use of such State ⅝ * ⅜ [or political subdivision] bears to the amount of the net income from the operation of such public utility for such taxable year.

Petitioner’s contention, tRat the quoted statute is not applicable here on the theory that the contract between petitioner and the city pertained only to regulation and hence not to one of the objects stated in the statute, we think, is not sound. The object and purpose of the contract was not only to regulate rates or fix the amount of the net income which petitioner would be entitled to earn, but it also looked to the continued operation and maintenance of the public utility as well. This is further borne out by the fact that the ordinance of May 17, 1915, provided for representation of the city by two members on petitioner’s board of directors.

It will be noted that for this case to come within the purview of the statute, the following facts must appear: (1) That the city of Houston, which is a political subdivision of the State of Texas, entered in good faith into a contract prior to September 8,1916, with petitioner, the object of which was to acquire, construct, operate or maintain a public utility, and (2) that the Federal income tax, under the terms of the contract, was to be paid out of the proceeds from the operation of the public utility prior to any division of such proceeds between petitioner and the city. These factual elements are all present in the instant case.

It is also important to note that the statute does not treat that part of the proceeds which accrued to the city under the contract as income of the petitioner. On the contrary, it manifestly treats the city’s portion of the proceeds from operation as income of the city, but, since by the terms of the contract the tax was to be paid out of the proceeds from operation prior to any division of the proceeds between petitioner and the city, the statute imposes upon petitioner, as custodian of the fund prior to division, the obligation to pay the full amount of tax thereon, and then provides for the refund of a proportionate part to the city. If this had been done, as required by the statute, one-half of the total tax would have come out of that part of the operating revenue which accrued to petitioner and one-half out of the city’s portion, since the entire amount would have been deducted from the excess revenue before division. Thus, in substance and effect, the burden ultimately borne by petitioner would have been only the tax computed upon the net income which accrued to and was actually received by it.

However, petitioner did not follow the plain requirements of the statute. It paid the tax only upon its portion of the operating net income, and deducted the amount of such tax from the total net proceeds of operation prior to paying over to the city its share. The effect of this was to increase petitioner’s income by one-half of the tax not paid on the city’s share, or to give it the benefit of a deduction to the extent of one-half the tax not paid on the city’s share, and correspondingly to diminish the city’s share of the net operating income; a result which the statute was particularly designed to prevent.

The conclusions reached above are supported by the legislative history of this statute. The provisions quoted hereinabove first appeared in their present form in section 218 (b) (7) of the Revenue Act of 1924. The corresponding provision of the 1921 Act reads as follows:

Seo. 213. Tliat for the purpose of this title ⅝ ⅜ ⅜ the term “gross income”—
# ⅝: ⅜ ⅜ sji ⅜ ⅜
(b) Does not include the following items, which shall be exempt from taxation under this title;
⅜ ⅜ ⅜ ⅜ ⅜ ⅜ ⅜
(7) ⅝ ⅜ ⅜ Whenever any State * * * or political subdivision of a State or Territory, prior to September 8, 1916, entered in good faith into a contract with any person, the object and purpose of which is to acquire, construct, operate, or maintain a public utility, no tax shall be levied under the provisions of this title upon the income derived from the operation of such public utility, so far as the payment thereof will impose a loss or burden upon such State * ⅝ ⅜ or political subdivision; but this provision is not intended and shall not be construed to confer upon such person any financial gain or exemption or to relieve sucli person from the payment of a tax as provided for in this title upon the part or portion of such income to which such person is entitled under such contract.

Provisions similar to those just quoted from the Revenue Act of 1921 appeared also in the Acts of 1913, 1916, and 1918. Under those acts, where the operator of a public utility paid the tax upon its portion of the net income by deducting the amount of such tax in computing the portion payable to the city, as was done by petitioner in the case at bar, a portion of the burden of taxation fell upon the city and to that extent the operator derived a financial gain to the defeat of the plainly expressed intention of the statute. This situation led to the changing of the provisions of the statute as embodied in the 1924 Act, sivpra, so' that thereafter instead of no tax being levied upon the city’s portion of the income, as under the earlier acts, a tax was levied which the operator was required to pay not only upon the net income which accrued to the operator, but also upon the city’s portion. This is made clear, we think, by the report of the Senate Finance Committee on the Revenue Bill of 1924, which reads as follows:

Tlie existing law provides in section 213 (b) (7) that whenever a State [or political subdivision] prior to September 8, 1916, has entered into a contract with any person to acquire, construct, operate, or maintain a public utility, the portion of the income to which such person is entitled shall be taxed but no tax shall be imposed upon the income derived by the State [or political subdivision] in such a manner as to impose a loss or burden upon the State, Territory, or political subdivision. In order that this exemption may more readily be administered, the paragraph has been reworded to provide that the tax upon the income from the operation of the utility shall be levied as provided in this title, but there shall be refunded to the State, Territory, or political subdivision thereof * * * a part of the tax equal to the amount by which the share of the income accruing to the State, Territory, or political subdivision thereof * * ⅜ was reduced in the imposition of the tax.

The clear intendment of Congress as expressed both in the 1921 and prior acts and in 1924 and subsequent acts, was to tax to the operator of a public utility, under the conditions specified, only the income accruing to and derived by such person, and it was merely the method of levying, assessing and collecting the tax which was changed by the 1924 enactment. That change was made for the purpose of insuring relief to the state or political subdivision from any burden of taxation, and likewise to insure that the person operating the public utility would not receive any benefit of exemption from tax in that connection.

Petitioner can not successfully argue, and as we understand does not in fact contend, that it should not bear the burden of the tax upon the income accruing to and actually received by it. This it has not yet done in respect of the years before us. On the other hand, if petitioner be now required to pay the deficiencies asserted by respondent, it is plain, of course, that it will then have paid more than the amount of tax due on its own income, but this result flows from the failure of petitioner to pay the tax, as required of it by the statute, at the time of filing its returns, and it has no legal cause of complaint against the Government. Its remedy lies in making proper adjustment of its accounts with the city. If and when the requirements of the statute have been fully complied with, and when proper adjustments have been made between the petitioner and the city in accordance with the terms of their contract, the net result will be that petitioner will have borne only the tax due upon its own income, and the city will have had refunded to it the tax assessed against and paid out of its funds by petitioner. We must, therefore, approve the deficiencies determined by respondent.

Reviewed by the Board.

Judgment will be entered for the respondent.


text:
    Clara O. Beers, Petitioner, v. Commissioner of Internal Revenue, Respondent. Frank T. Beers, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 67873, 67874.
    Promulgated July 3, 1936.

      Reuben O. Carlson, Esq., and George J. Buseh, C. P. A., for the petitioners.

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

McMahon:

The respondent contends that the petitioner and his wife as a marital community derived taxable income from the sale in 1930 of the 1,000 shares of Dupont common and the 1,100 shares of Shares, Inc. Apparently the amount of the gain determined by the respondent resulting in the deficiencies herein involved is not in dispute. However, both of the petitioners claim that the transactions involved herein did not constitute a sale resulting in taxable income, but constituted a capital contribution to Townsend & Co. Whether the transaction involved was a sale is among other things dependent upon the intention of the parties, a governing factor, to be gathered from all the attending facts and circumstances. United National Corporation, 33 B. T. A. 790, 794; Commissioner v. Neighbors Realty Co., 81 Fed. (2d) 173. Frank T. Beers testified that, at the time a number of stockholders started an investigation of Shares, Inc., informal meetings of some of the directors of both corporations were held; that he felt considerable responsibility as the stock of Shares, Inc., had been more widely distributed than was anticipated when he invested therein and that unless something was done to clean up the situation Townsend <& Co. would suffer very severely; that he inquired as to how much money it would take to call in the stock of Shares, Inc., at $50 per share; that it was decided that it would take $200,000; that Townsend & Co. was in no position to put up $200,000; that it was in a pretty shaky condition; that Frank Townsend stated he would raise $100,000, but later was not able to raise $100,000 and turned in $85,000; that he, petitioner, stated that he did not have $100,000 in money, but that he would contribute 1,000 shares of Dupont common and 1,100 shares of Shares, Inc.; that he turned the shares' over to Townsend & Co. about April 20, 1930; that he received no evidence of indebtedness in the form of a note or otherwise from the company; that his interest in cleaning the situation up was such that he was willing to contribute that much; that he turned over his stock as an outright contribution to the company; and that subsequent thereto there never was any money made available to him by the company as a result of turning over the stock. This testimony of the petitioner was corroborated by Wells J. Huntley, secretary-treasurer of Townsend & Co., who attended some of the informal meetings above referred to and in particular the meeting at which the agreement as to the contributions was made, and by Frank C. Heal, who also attended such meetings as the attorney for the corporations. The respondent’s determination is presumed to be correct, but that presumption is rebuttable, Motter v. Patterson, 68 Fed. (2d) 252, and in our opinion it has been successfully overcome.

The respondent contends that the Board may discredit the testimony of witnesses where the balance of the record justifies such action, citing Uncasville Manufacturing Co. v. Commissioner, 55 Fed. (2d) 893. That case does not support such a contention. It holds that the Board may reject the uncontradicted testimony of a witness, who was the taxpayer’s president and sole stockholder, respecting the value of taxpayer’s property, the court stating that “of all things value is most uncertain. Opinions about it are prophecies, whose truth can not ordinarily be verified save where the property is fungi - bles, and there is a concourse of buyers and sellers.” Cf. Dempster Mills Manufacturing Co. v. Burnet, 46 Fed. (2d) 604. However, we are not concerned herein with mere opinion evidence, but with the testimony of an unimpeached witness as to facts, whose testimony was substantially and essentially corroborated by other unimpeached witnesses. “And the Board may not arbitrarily discredit the testimony of an unimpeached taxpayer so far as he testifies to facts.” Blackmer v. Commissioner, 70 Fed. (2d) 255. In Nichols v. Commissioner, 44 Fed. (2d) 157, cited by the respondent, although the court stated that the Board is not bound by the opinions of witnesses as to the fact of value, it also stated that the testimony of several witnesses to the effect that the bonds in question had no value overcame the presumption arising from the determination of the Commissioner that the bonds had a value of $11,000; that “The burden then shifted to the Commissioner to support his determination by evidence, and this he did not do nor attempt to do, and accordingly his determination can not stand. United States v. Rindskopf, 105 U. S. 418”; and that the disregard of such positive and affirmative evidence by the Board is ground for the reversal of its determinations approving the determination of the Commissioner. To similar effect is Whitney v. Commissioner, 73 Fed. (2d) 589. The only evidence presented by the respondent consisted of copies of the two proposed agreements which were attached to the amended petition of petitioners. He contends that such writings prepared at about the time of the transaction are entitled to greater weight than the oral testimony of witnesses submitted years after the transaction occurred. The evidence shows that these proposed agreements were not prepared until the end of June 1930, while the agreement pertaining to the contributions was reached during April 1930; that the petitioner, although he signed the proposed agreements, took no part in bringing about the drafting of such agreements; that they were prepared at the suggestion of Frank Townsend; that the purpose of the agreements was disclosed to the attorney by the secretary-treasurer of the company; and that the purpose of the agreements as stated therein was that the contributions were “not to be a liability of Townsend & Company” but merely a liability in the sense that the contributions be paid, upon the consent of the preferred and common stockholders, only out of future dividends if and when declared, and were not to be preferred above the general creditors of the company. This plan was suggested by Frank Townsend because he felt that the contributors ought to be reimbursed in the event the company was able, as a result of such contributions, to work out of its difficulties. Under that plan the stockholders were to deliver their stock to the Tacoma Branch of the Bank of California as trustee. However, the agreements never became effective, they were never signed by all the parties or performed, and the trustee named therein refused to accept the trust. The purpose of the proposed agreements was not to reflect the transactions in April 1930, but rather a new and different arrangement. Such agreements tend rather to corroborate the testimony of the petitioner and to sustain his contention that the stock involved was a contribution, and they tend to negative a sale. The agreements indicate an attempt on the part of the contributors at most to have the other stockholders recognize the contributions only to the extent of a preference over stockholdings if and when dividends were available. But the stockholders refused to do so even to that extent.

The respondent further contends that Townsend & Co. sold the 1,000 shares of Dupont common for the petitioner as his agent and that receipt by an agent is equivalent to receipt by the principal. The evidence however does not permit such a construction of what occurred. The testimony shows that the sale was not made through the petitioner’s account or upon his order; that the company treated the stock as its own; that the company sold the stock as its own and received about a thousand dollars more for it than the value entered on its books, of which the petitioner was not informed. As stated in William Parris, 20 B. T. A. 320, “The test as to constructive receipt is whether the debtor has funds standing to the credit of the taxpayer which the debtor is able to pay and which are available and subject to the taxpayer’s demand.” The testimony discloses that the transaction was not entered on the books of the company as an ordinary sale by the company for a client or as a loan; that at no time was there a credit for the amount of $143,000 or the proceeds of the stock in the petitioner’s account on the books of the company, subject to his demand; that no entries were made until at the end of June 1930 to reflect the entire transaction; that when the entry was made of the transaction the result was that the surplus account was credited with the amounts of $110,000 and $33,000 reflecting the contribution of the 1,000 shares of Dupont common and the 1,100 shares of Shares, Inc., respectively. It appears that no funds received for this stock were available to petitioner in any event, since the company could not have paid the petitioner for the stock, as prior to the sale it used the stock as collateral and drew against it for the purchase of shares of Shares, Inc. The petitioner agreed to contribute the Dupont stock in question. This stock was then in the possession of Townsend & Co; the company used the stock as its own and as it saw fit and exercised control and dominion thereover. There is no evidence showing that the petitioner received any consideration, either in the form of cash, a credit on the books of Townsend & Co., or a promise to pay. That the petitioner entertained a hope at the time he made the contribution that the company would, if it ever again became prosperous, make some provision to return the contribution or its equivalent to him, did not create an obligation or liability on the part of the company. He testified that at that time no arrangement to that effect was made.

The respondent on brief cites the case of Frank E. Best, 21 B. T. A. 1264. It appears in that case in the report of the Board on a rehearing thereof, 26 B. T. A. 1070, that the taxpayer “was unwilling to make an outright donation of any more stock to the company”; that such taxpayer authorized the company in writing to sell certain of his stock, and to retain 20 percent as commission on such sales and 80 percent thereof as a loan to the company. Furthermore, no claim was made by the taxpayer therein that he had made a contribution to the company of the stock sold by the company. That case is distinguishable on the facts and is not controlling herein.

The evidence shows that the petitioner filed a claim against Townsend & Co. in the bankruptcy proceedings covering his open account, in which there was a considerable credit. There is no evidence showing what items were included in such claim and whether such claim was allowed in whole or in part.

The respondent argues further that the failure of the petitioner to produce the records of Townsend & Co. and his monthly statements received from that company raises a presumption that, if produced, they would not be favorable to the petitioner’s contention. In Graves v. United States, 150 U. S. 120, the United States Supreme Court stated as follows:

* * * The rule even in criminal cases is that if a party has it peculiarly within his power to produce witnesses who testimony would elucidate the transaction, the fact that he does not do it creates the presumption that the testimony, if produced, would be unfavorable. * * *
But this presumption does not apply to every fact in the case which it may be in the power of the defendant to prove. He is not bound to anticipate every fact which the government may wish to shew [show] in the course of the trial, and produce evidence of that fact. * * ⅜ [Emphasis supplied.]

While these records were not produced by petitioner, there is considerable testimony as to the contents of these records pertaining to the transaction here involved, which was received without objection and was, to a large extent, elicited by the respondent upon cross-examination. This testimony shows in substance that the transaction was not treated in such records as a sale through the petitioner’s account ; that after the entries covering the entire transaction had been made no credit for the stock remained on the books in petitioner’s account; and that surplus was increased by the contribution made by the petitioner. It also appears that the records of the company were in the possession of the trustee in bankruptcy, and hence equally available to the respondent. As heretofore stated the petitioner met his burden of proof, the burden then shifted, and the respondent “was required to come forward with evidence to refute the evidence of the petitioner. * * * The Board cannot draw inferences and conclusions from facts or suppositions outside the record.” Whitney v. Commissioner, supra. To similar effect is C. F. Martin, 34 B. T. A. 111, 116-117.

We conclude that the petitioners herein contributed the 1,000 shares of Dupont common and 1,100 shares of Shares, Inc., as capital surplus to Townsend & Co., and the determination of the respondent that the transaction constituted a sale is therefore disapproved.

Decision will be entered for the petitioners.


author: Aknold :

text:
    Spalding Trust (Entity) by the Spalding Company, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 57127.
    Promulgated July 8, 1936.

      Arthur McGregor, Esq., for the petitioner.

      Arthur L. Mvnrray, Esq., for the respondent.
   OPINION.

Aknold :

In this proceeding petitioner appeals from the determination by respondent of a deficiency in income tax for the calendar year 1928 in the amount of $3,502.17, and assigns as error the action of the respondent (1) in failing to allow as a deduction from income for 1928 depreciation sustained in the amount of $17,056.50, and (2) in refusing to allow as a deduction from income for 1928 a net loss alleged to have been sustained by petitioner during the calendar year 1927.

The facts were stipulated by the parties substantially as follows:

Petitioner is a trust estate created and existing under and by virtue of a Declaration of Trust dated October 5, 1909, * * * The Spalding Company has acted as trustee ever since the date of Declaration of Trust and is now the duly appointed, qualified and acting Trustee of said trust estate.
During the calendar year 1929 The Spalding Company acting as trustee for the Spalding Trust made two returns of income for the calendar year 1928, one a fiduciary return on form 1041, * ⅜ * wherein it disclosed a net income of $75,259.79 distributable under the provisions of said Declaration of Trust, and the other return on form 1040, ⅜ * ⅜ wherein there was reported profit from the sale of stocks, bonds, etc. in the sum of $75,808.02. On this return there was deducted an item purporting to be an operating loss carried forward from the calendar year 1927 in the sum of $15,253.63. Respondent in his notice of determination has disallowed this item of $15,253.63 as a deduction from 1928 income.
During the year 1928 Petitioner owned the following depreciable assets which it held in said trust during the entire calendar year. A reasonable allowance for exhaustion, wear and tear on these assets is shown in the following tabulation:
In determining tile taxable income to this trust estate taxable to this Petitioner as trustee, Respondent has not allowed any of this depreciation.
During the year 1928 Petitioner made two returns of income for the calendar year 1927, one a fiduciary return on form 1041, * * * wherein it disclosed an income of $156,679.74 as distributable under the provisions of the Declaration of Trust, * * * and the other return on form 1040, * ⅜ * wherein it reported the income from the sale of a portion of the trust assets in the sum of $1,802.87 and took as a deduction depreciation on the above referred to trust assets in the sum of $17,056.50, which showed a loss for the calendar year 1927 to the trust estate of $15,253.63. As indicated above this loss was carried forward and taken as a deduction on Petitioner’s 1928 return form 1040, on line 16 thereof, all of which the Respondent has disallowed as a deduction from income for said year.

The trust instrument provided in part as follows:

First: Said trustee shall receive the rents and profits of said property, both real and personal, and pay them to the persona hereinafter named as hereinafter provided; and in order that good rents and profits may be derived from said property at all times during the continuance of this trust, and in order to facilitate the handling of this trust by said trustee, it shall have full and absolute power; to contract in respect thereto, to sell, convert, lease, let, improve, exchange, invest or re-invest in any kind of property; ⅜ * * in other words, said trustee shall have full power subject only to the obligations to pay the rents and profits as hereinafter provided, to manage and control said property, both real and personal to all intents and purposes as it could do if said property belonged to it in fee simple absolute. * * * Said trustee shall always keep and maintain said property hereby conveyed to it, both real and personal, together with the rents and profits therefrom as a separate and distinct fund, and upon any sale or exchange the new property so acquired of whatever kind it may be, shall become and constitute a part of such fund.
Second: During the lifetime of said trustor, said trustee shall pay to said trustor and upon his demand, not exceeding fifty per cent (50%) of the entire annual rents and profits of said property, both real and personal, after deducting all expenses incident to the management and niaintenance of said property, and all sums paid or required for taxes, assessments or other charges imposed upon such property and the expense of administering the trust created hereby as hereinafter provided.
During the lifetime of said trustor, said trustee shall pay to each of the five children of said trustor, to-wit: Rufus P. Spalding, James M. Spalding, Julia M. Senni, Catherine L. Bodrero and Alice M. Bonzi, or their lawful issue by representation, if issue there be, five per cent (5%)' of the said entire annual rents and profits of all of said property, both real and personal; but should the directors of said trustee deem it necessary, or to the best interests of any of one or more of said five children that he or she, or his or her issue, should receive a sum greater than five per cent (5%) of said rents and profits, then the directors of said trustee may authorize the payment by said trustee to such child, or children, or issue, of any additional sums of money out of said rents and profits which said directors may deem advisable. But the total payments to said children, or their issue as hereinabove provided, shall in no event, during the lifetime of said trustor exceed the sum of fifty per cent (50%) of said entire rents and profits.
Should the said trustor not demand, during any year, from January first to December 31st, from said trustee the said entire fifty per cent (50%) of said rents and profits or should any of the remaining fifty per cent of the rents and profits not be paid to the children of said trustor, or their issue, as hereinabove provided, either on account of the death of any one of said children without issue, or because the directors of said trustee shall not have deemed it advisable to pay all of said remaining fifty per cent to said children, or their issue during any such year, then any such rents and profits so remaining unpaid shall accumulate and become a part of the principal of the trust estate hereby conveyed.
Third: After the death of said trustor, said trustee shall pay to the said five children of said trustor, or their issue, as hereinafter provided, in equal shares, and in lieu of the sums hereinbefore provided to be paid, the entire rents and profits of all the said property, both real and personal. * ⅜ ⅜

The trust instrument further provides that upon the death of the last of the children of the trustor, the trust estate shall go to and be vested in their issue and upon failure of such issue to the legal heirs of the trustor. It also provides that the trustor shall have no right to revoke the trust.

Issue 1 — 1928 Deduction for Depreciation.

The returns filed by the petitioner, attached to the stipulation of facts and referred to above, disclose that for the year 1927 petitioner distributed the ordinary net income to the beneficiaries computed without deducting depreciation, as shown by form 1041, but deducted the agreed depreciation in the amount of $17,056.50 on form 1040, which directly gave rise to the item of $15,253.63 carried forward and claimed as a net loss deduction on the 1040 return for the year 1928. Thus, for the year 1927 petitioner did not reserve out of the ordinary income distributed to the beneficiaries an amount sufficient to make good the loss suffered by way of depreciation of the trust assets.

This method was not followed in the subsequent year. In the return on form 1041 for 1928 petitioner deducted the depreciation from ordinary income and distributed the balance to the beneficiaries, thus maintaining the trust capital intact out of ordinary income, and claiming as a deduction from capital gain reported on form 1040 only the alleged 1927 net loss, which represented the depreciation sustained in 1927 in excess of the capital net gain for that year.

The Revenue Act of 1928, in section 23 (k), provides that in computing net income there shall be allowed as deductions, among other things, a reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence, and in the case of property held in trust, the allowable deduction shall be apportioned between the income beneficiaries and the trustee in accordance with the pertinent provisions of the instrument creating the trust, or in the absence of such provisions, on the basis of the trust income allocable to each.

In article 201 of Regulations 74, respondent construes these provisions of the statute as follows:

* ⅜ ⅛ jji0r example if the trust instrument provides that the income of the trust computed without regard to depreciation shall be distributed to a named beneficiary, such beneficiary will be entitled to the depreciation allowance to the exclusion of the trustee, while if the distributable income shall first make due allowance for keeping the trust corpus intact by retaining a reasonable amount of the current income for that purpose, the allowable deduction will be granted in full to the trustee.

That the quoted regulation embodies a correct construction of the statute is not questioned by either party to this proceeding. The controversy concerns the proper interpretation of the trust instrument, that is to say, whether the trust instrument requires the trustee to distribute the ordinary income computed without regard to depreciation, or whether it contemplates that the trustee shall first make due allowance for keeping the trust corpus intact by retaining a reasonable amount of the current income for that purpose.

The contemporaneous construction placed upon the trust instrument by the interested parties, so far as disclosed, does not afford aid in answering this question, since, as above pointed out, the ordinary income for 1927 computed without regard to depreciation was distributed to the beneficiaries, while the distributable income for 1928 was computed by first deducting an amount sufficient to make good the depreciation sustained. We must, then, examine the terms of the trust instrument itself to determine the intention of the trustor on this point.

The trust instrument, the pertinent provisions of which are set out abov.e, makes no provision as to depreciation of trust assets and does not authorize the trustee to set aside a sum as a charge for depreciation on the property.

It contains complete provisions for the management of the trust estate and the distribution of the “entire annual rents and profits” from the property to the beneficiaries “after deducting all expenses incident to the management and maintenance of said property, and all sums paid or required for taxes, assessments or other charges imposed upon such property and the expense of administering the trust.” It further provides that all inconie not paid to the beneficiaries under the terms of the trust, be added to the corpus. The setting aside of a sum as a charge for depreciation would amount to the creation of a sinking fund for replacement. The trust instrument makes no provision for such a fund nor does it direct that the corpus should be preserved intact. Undoubtedly the trustor might have provided that depreciation should be deducted from the net income accruing to the beneficiaries had he so desired, but no such provision was made. Moreover it is specifically provided that it is the purpose of the trust to provide income for the beneficiaries, and that the life beneficiaries shall have no interest in the corpus of the trust. In our opinion the trust goes no further than to require (or authorize) the trustees to maintain the property in such good condition as results from the making of ordinary and necessary repairs. In the absence of a provision in the trust instrument authorizing the trustee, in determining the distributable income, to first keep the trust corpus intact we think the entire net income is distributable to the beneficiaries. Cf. F. E. Hubbell, 14 B. T. A. 1040; aff'd., Hubbell v. Burnet, 46 Fed. (2d) 446; In re Chapman, 66 N. Y. S. 235; Baltzell v. Mitchell, 3 Fed. (2d) 428, 430; Whitcomb v. Blair, 58 D. C. App. 104; 25 Fed. (2d) 528, and that th,e loss, if any, from depreciation must be borne by the remaindermen. Cf. Kaufman v. Commissioner, 44 Fed. (2d) 144; Merle-Smith v. Commissioner, 42 Fed. (2d) 337; Codman v. Miles, 28 Fed. (2d) 823; Codman v. Commissioner, 50 Fed. (2d) 763. It follows that'under section 23 (k) of the Revenue Act of 1928 and article 201 of Regulations 74, the petitioner is not entitled to deduct the depreciation claimed.

Issue 2 — 19¶7—Alleged Loss.

Petitioner contends that it suffered a statutory net loss of $15,253.63 from the operation of its business in 1927, which it is entitled to carry forward and deduct from gross income in computing its taxable net income for 1928. For 1927, petitioner filed two returns, one on form 1041 (fiduciary return) showing the net ordinary income distributable to the beneficiaries, computed without deducting depreciation, in the amount of $156,679.74. The other return on form 1040 reported capital gain of $1,802.87, less deduction for depreciation of $17,056.50, resulting in the purported net loss of $15,253.63.

Respondent asserts that petitioner in fact suffered no loss in 1927, and hence there is no net loss to carry forward and deduct from 1928 income. Respondent’s position on this point, we think, is well taken.

Section 206 (a) of the Revenue Act of 1926 defines the term “net loss” as meaning the excess of the deductions allowed by section 214 or 234 over the gross income, with certain exceptions and limitations not presently material. Section 234 deals with deductions allowed corporations, while section 214 specifies the deductions allowed individuals. Section 219 provides that the net income of a trust shall be computed in the same manner and on the same basis as provided in section 214, which relates to the computation of net income of individuals, and further provides that there shall be allowed as an additional deduction in computing the net income of a trust the amount of the income for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries.

It is plain that under the above provisions of the statute the net loss of a trust estate must be computed in the same manner as in the case of an individual taxpayer. A net loss in the case of an estate, therefore, is the excess of the deductions allowed by section 214 over the gross income, without taking into consideration the additional deduction of the amount of income currently distributable to the beneficiaries allowed by section 219. The alleged net loss claimed by petitioner here results from the deduction allowed under section 219, when both of the 1927 returns are considered, or as it might otherwise be stated in referring only to the 1040 return, the amount claimed represents the excess of a portion of the deductions allowed under section 214 over a portion of the gross income. Viewed from either perspective, it is not a statutory net loss.

Petitioner’s gross income for 1927, as shown by the returns, consisted of $192,909.12 of ordinary income and $1,802.87 of capital gain, or a total gross income of $194,711.99. It claimed deductions from ordinary income of $36,229.38 on form 1041, allowable under section 214, and from capital gain on form 1040 a deduction for depreciation of $17,056.50, or total deductions allowable under section 214 of $53,285.88, leaving an aggregate net income, comprising both ordinary distributable income and nondistributable capital gain, in the amount of $141,426.11. The deductions allowed by section 214, as claimed in both returns, not only do not exceed the gross income, but the gross income exceeds such deductions by the amount above stated. Petitioner, therefore, sustained no statutory net loss, nor in fact a loss of any kind, for the year 1927.

Respondent’s action on the second issue is approved.

Judgment will be entered vmder Rule 60.