source: Caselaw Access Project

author:
Black: TURNER,
      Leech,

license: Public Domain

text:
    William E. Mitchell, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 85612.
    Promulgated August 15, 1939.

      W. A. Sutherland, Esq., Edward B. Kane, Esq., and Elbert P. Tuttle, Esq., for the petitioner.

      Jonas M. Smith, Esq., for the respondent.
   OPINION.

Black:

The first issue in this proceeding is whether petitioner’s income tax returns for the years in question were false or fraudulent with intent to evade tax. The deficiencies determined by the respondent and the 50 percent additions thereto which were added under the provisions of section 275 (b) of the Revenue Acts of 1924 and 1926 and section 293 (b) of the Revenue Act of 1928 are barred by section 277 of the Revenue Acts of 1924 and 1926 and section 275 of the Revenue Act of 1928, respectively, unless under section 278 (a) of the 1924 and 1926 Acts and section 276 (a) of the 1928 Act the returns filed by petitioner were, respectively, false or fraudulent with intent to evade tax. “Fraud is a fact to be proven by clear and convincing evidence.” Charles E. Mitchell, 32 B. T. A. 1093, 1128. Congress in section 601 of the Revenue Act of 1928 has placed the burden of proof in respect of this issue upon the respondent.

The respondent in support of his contention that he has met the burden relies primarily upon the alleged establishment of three fraudulent acts, namely, (1) the omission from income in 1925 of a profit of $14,075.50 from two sales of 300 shares of Southeastern utility stock, and the omission from income in 1926 of a profit of $1,702.50 from the sale of Southeastern option warrants, (2) the erroneous deduction taken by petitioner in his 1929 return of a loss of $69,120 from the sale of 2,000 shares of Atlantic stock, and (3) the overstatement by petitioner in his returns of the cost of Southeastern and Commonwealth utility stocks in the amounts of $72,-018.53 for 1926, $42,214.38 for 1928, $57,894.66 for 1929, and $209,-039.84 for 1930. Petitioner admits that the above errors were made, but denies that they were knowingly made or were made with any intention of evading tax. We shall consider the three alleged acts of fraud in the order given.

(1) Regarding the first act, the respondent argues that petitioner’s failure to report the items of $14,075.50 for 1925 and $1,702.50 for 1926 when he had all the information available in his personal files, with no explanation as to how the amounts were omitted, is prima facie evidence of fraud. The facts with reference to the preparation of petitioner’s 1925 and 1926 returns have been fully stated in our findings of fact and will not be repeated in any great detail here.

A summary of petitioner’s testimony relative to the $14,075.50 item is that he could not now explain why this item was omitted from his 1925 return; that certain statements relative to the item were received by petitioner from Steiner, Rouse & Strock (stock brokers); that these statements were available when his return for 1925 was made up.; that he did not personally make up the return; that “we honestly intended to report everything and to make honest returns”; and that if the return had not been honest, he would not have signed it.

The only evidence offered by the respondent as to the $1,702.50 item was a supplemental protest sworn to by petitioner and filed with the respondent in 1985, in which petitioner says that the amount “was inadvertently omitted by Taxpayer’s attorneys in computing the tax for the year 1926 as shown in Taxpayer’s original protest dated September 9,1935.”

During the years 1925 through 1930 petitioner, in addition to the three above sales, made 87 sales of 38,450 shares of Southeastern and Commonwealth utility stocks at a total correct selling price of $723,389. On these sales petitioner reported the selling price or amount received as $732,455.49, or $9,066.49 in excess of the correct amount. The fact that these 87 sales were included in petitioner’s returns is persuasive evidence that petitioner was not intentionally omitting any sales from his returns. The- profit from the three sales that were omitted in 1925 and 1926 amounted to approximately 2.48 percent of the total profit as determined by the respondent and agi’eed to by petitioner on the 90 sales that were made during the years now before us.

The respondent determined the profit on the two sales of 300 shares of Southeastern utility stock omitted from the 1925 return as follows:

The sale of the 200 shares on July 28, 1925, was identified with lots Nos. 19 and 21, which were purchased on July 18 and July 28, 1925, respectively. The sale of the 100 shares on July 13,1925, could not be identified and as to those shares the respondent applied the first in, first out rule and arrived at the cost of $400 for lot No. 2, which was purchased in the year 1922. Counsel for petitioner points out in his brief that on July 18,1925, petitioner purchased 100 shares of Southeastern utility stock (lot No. 18) for $10,575, and on the same day sold 100 shares for $11,471, so that from a realistic standpoint he made only $896 on that day from dealings in this stock, whereas, under the respondent’s application of the first in, first out rule, since the shares sold were not identified with any particular lot, his profit on these shares has been determined to be $11,071. Petitioner never heard of the first in, first out rule until about 1933 or 1934, and he kept no regular set of books.

We think the circumstances described above make it reasonable to believe that petitioner was telling the truth when he said he honestly intended to report everything in these two returns for 1925 and 1926. We think the Commissioner has not established that the two omissions in question were fraudulently made with intent to evade tax.

(2) The second alleged act of fraud is the erroneous deduction of $69,120 taken by petitioner in his 1929 return upon the sale of the 2,000 shares of Atlantic Ice & Coal Co. stock. The respondent contends, very much as he did in Charles Weyl et al., Executors, 38 B. T. A. 850, that there was no bona fide sale to Courts & Co. and that therefore in claiming a loss petitioner was committing fraud on the Government. We think the evidence establishes that there was a bona fide sale of the stock on November 25,1929. The reason why the loss claimed is not deductible is on account of the agreement to repurchase on January 3, 1930, entered into between petitioner and Courts & Co. on December 12,1929, or 17 days after the sale. Section 118 of the Revenue Act of 1928 provides that if anyone “has entered into a contract * * * to acquire substantially identical property” no deduction for the loss shall be allowed. Petitioner’s explanation is that he did not know of this provision of the law and that he thought that if he sold the stock and waited more than 30 days to repurchase it, he would be entitled to the deduction.

S. H. Rogers was the revenue agent who on March 31, 1931, made the first examination of petitioner’s return for 1929. Rogers was an experienced revenue agent, having been in the service since about the year 1921. He testified that his was a very brief examination; that he talked with petitioner; that he did not remember having talked with bim about the Atlantic stock loss, except to explain to him that he was entitled to a greater loss than he had taken; that he remembered having seen the invoice slip showing the sale of the Atlantic stock to Courts & Co., that he did not see the repurchase agreement or the invoice slip showing the repurchase or either of the letters under date of November 25, 1929, and January 3, 1930, set out in our findings; that he was the agent who had recommended the refund of $47.92; and that he was given everything that he had asked to see while there.

Petitioner testified that he went to Courts & Co. and probably told them that he wanted to sell the stock for a tax loss; that he would want to reestablish his position in it by rebuying into the company; that he had completely forgotten about the repurchase agreement until the matter was brought up by his attorney, who found it in his files; that he thought he had consummated a regular sale of stock; that he thought the transaction he had entered into gave him a legal right to take a tax loss; and that he would not have taken it if he had not thought so. Regarding Revenue Agent Rogers’ visit, petitioner’s testimony is in part as follows:

A. I remember be came in and questioned about the sale, yes.
Q. Did you tell bim you bad repurchased that stock?
A. I can’t say whether I did today; if be bad asked me that question, I would have told bim, and if be did ask me, I did tell bim.
Q. Did you tell bim you bad entered into an agreement * * * to repurchase the stock * * *?
A. I don’t presumo I did because it would have no effect on my mind at that time, it would have no bearing on the question be was asking me about. I didn’t know at that .time what I know today since this matter has been brought up; the signing of the agreement does not [sic] prevent me from using it for a loss, and it didn’t enter in my mind at that time that it was not a proper deductible item, nor bad I the slightest idea that I bad not a perfect right to buy the stock back, whether it was that or other stock, and the fact, if I may say—
Q. Go ahead.
A. I had thought everything was lawful, and if the Agent had any thought of it at the time, if he had thought there was anything wrong, he had the liberty to ask because I made it a practice that whenever they came in, and I think you will find they will say that my files and whatever I had were perfectly available to them; in fact, I frequently called Mr. Nabors, and I said, “If there is anything you don’t understand, or any facts or figures that you need,
Mr. Nabors is available and. everything I have got is at your disposal,” I had only a desire to be sure I had my affairs in order.
A. I certainly thought it was proper and, therefore, I never did any more about it; there was certainly no effort at concealment.

We think this feature of the case narrows down to whether petitioner at the time he filed his 1929 return was aware of that provision of section 118 of the Revenue Act of 1928 denying a stock loss to one who within thirty days of the sale “has entered into a contract or option to acquire substantially identical property.” If petitioner knew of this provision at the time he filed his return, we think he would be guilty of filing a false or fraudulent return with intent to evade tax, for certainly at that time (March 15, 1930) he was well aware of the agreement to repurchase. There is no evidence to show that petitioner knew of this particular provision of the law. Therefore, his claiming the deduction appears to have been due to a mistake of law, with no apparent intent to evade tax. Under such circumstances fraud can not be found. On this issue the Commissioner has not sustained his burden of proof.

(3) The third alleged act of fraud is the one which caused the largest understatement of income. Petitioner’s erroneous determination, through his agents Maguire and Nabors, of his cost basis of the utility stocks caused petitioner’s income for the taxable years involved in this proceeding to be understated in the total amount of $381,167.41. This was a very serious and substantial understatement of income and merits the closest scrutiny.

We have in our findings of fact set out in considerable detail the exact manner in which Maguire for 1926 and Nabors for 1928, 1929, and 1930, acting for petitioner, arrived at the cost basis of the stock sold in those years. Briefly, Maguire attempted to identify each of the 25 sales in 1926 with certain purchases previously made. In the final determination by the Commissioner only 2 sales could be identified and it was necessary to apply the first in, first out rule to 23 sales. Maguire testified at the hearing as a witness for the respondent and the substance of his testimony was that at the time he prepared the schedule for petitioner’s income tax return for 1926, showing the 25 sales of stock in question, he had never heard of the first in, first out rule, that he did his best to prepare the schedule correctly, and that he thought he had done so when he turned it over to Nabors to be used in the preparation of petitioner’s income tax return for the year 1926.

We have no reason to doubt the truth of Maguire’s testimony. The testimony shows that both Nabors and petitioner relied upon the schedule which had been prepared by Maguire and believed that it was correct.

Respondent's allegation that petitioner’s income tax return for 1926 was false and fraudulent with intent to evade tax is therefore not sustained. We make the same holding as to petitioner’s income tax returns for the years 1928 and 1929. However, the facts as to these two latter years are not the same as for 1926. Maguire had nothing to do with the preparation of the 1928 and 1929 returns. These returns were prepared by Nabors and signed and sworn to by petitioner. In their preparation Nabors took as the basis of cost of most of the utility stock sold in these years the highest cost utility stock owned by petitioner. It was l'epresented by a 5,000-share block of Southeastern voting trust certificates then up as collateral security with the Southeastern Securities Co. of New York City to secure the payment of two notes which petitioner owed the Securities Co. Nabors made no attempt to fix the cost basis of shares sold by the identification of the particular certificates sold or by the application of the first in, first out rule. He testified that he never heard of the first in, first out rule until long after the returns in question were filed and that at the time he filed the 1928 and 1929 returns he thought petitioner had the right to deduct from the selling price of the stock sold the highest cost of an equivalent number of shares then owned by petitioner. To the same effect is the testimony of petitioner. It is plain that he and Nabors talked over this question of the cost basis to be used and came to the conclusion that petitioner had the right to use his highest cost stock. In 1928 the cost of 1,400 of these 5,000 shares was used in determining the gain on the sale of 1,400 shares of Southeastern stock. In 1929, 1,500 more of the shares were thus used. Then came on June 10, 1929, the reorganization when shares of Southeastern were exchanged for shares of Commonwealth on the basis of 414 shares of Commonwealth and certain option warrants for 1 share of Southeastern.

At the time the reorganization came in 1929, according to the method which was being used by Nabors and concurred in by petitioner, the cost basis of 2,900 shares of the 5,000 share block had been used up, leaving 2,100 shares. These 2,100 shares converted into Comm on - wealth shares represented 9,450 shares of the latter. Of these 9,450 Commonwealth shares Nabors used up 5,500 in 1929 in figuring petitioner’s cost basis of Commonwealth stock sold1 after the reorganization. Of course, it can be readily seen that this method of using as a basis of cost of petitioner’s stock sold in 1928 and 1929 the highest cost stock owned by petitioner without reference to the identification of any particular certificates of shares sold was an erroneous method of figuring cost and resulted in large understatements of income.

We are not convinced, however, by the evidence that either Nabors or petitioner had any intention to deceive by the use of this method in the years 1928 and 1929. We therefore hold that the Commissioner’s determination of fraud for 1928 and 1929 is not sustained.

The year 1930, we think, is different and a different result must be reached for that year. Although petitioner had used up most of the cost basis of the 5,000-share block of Southeastern stock, including the shares of Commonwealth into which the remainder- had been converted, in figuring his gains on sales of stock in 1928 and 1929, he set about in 1930 to use up this same cost basis of this block of stock, now converted into Commonwealth, all over again. Our findings of fact show in full detail how this was done. Both petitioner and Nabors, who prepared the 1930 return for petitioner, admitted in their testimony at the hearing that they knew they had no right to use the cost basis of the same block of stock twice; they admitted that by the use of any reasonable degree of diligence they could have ascertained that most of the cost basis of the 5,000-share block had been used up in 1928 and 1929. They gave no reasonable explanation as to why they used the cost basis of the same 5,000-share block of stock twice. Nabors testified that he was unable to tell why or how he could have become so confused as to use the basis of this 5,000-share lot the second time. He testified: “I, of course, knew that stock could only be sold once and yet even now, after three years or more that this investigation has been under way, I am unable to explain how I made that sort of a mistake.” He also testified: “I can offer no explanation except that it was an error, unintentional, of course, not deliberately made.” The substance of petitioner’s explanation is that he relied upon the correctness of the computations made by Nabors and that it did not occur to him to question their accuracy. In the light of all the facts in the record, we find ourselves unable to accept this explanation.

By the end of the year 1930 petitioner had deducted $524,588.40 as cost of utility stock sold from 1925 through 1930. The entire amount of utility stock — Alabama, Southeastern, and Commonwealth— which petitioner had purchased from 1920 through 1930 had cost him only $493,289.74. Of this stock at the end of the year 1930 he still had on hand 81,257.5 shares of Commonwealth stock and 53,536.5 option warrants with a total cost basis of $302,831.25, figured on the basis of the first in, first out rule and by identification of shares wherever that is possible. Yet notwithstanding that petitioner had already deducted in prior years and the year 1930 the entire cost basis of all his stock, he went right on using as his cost basis the cost of the 5,000-share block. This was largely responsible for an understatement of his income for the year 1930 of $209,040.34. Furthermore, this very pronounced overstatement of costs went right on through 1931. While 1931 is not before us for redetermination of the deficiency, the evidence as to that year is a part of the record of the instant case. A summary of the cost of the utility stocks and option warrants deducted by petitioner on his returns for the years 1925 through 1981 shows that he deducted a total cost of $938,965.15. The total cost which should have been deducted as now agreed upon by the parties-is $392,368.56.

We do not think petitioner can be guilty of such careless indifference to the basis of cost of shares of stock which he was selling and to a correct return and the oath to which he subscribed and now expect to be be absolved from the consequences of his acts. It does not tax our credulity to believe that in the years 1928 and 1929 petitioner knew nothing about the first in, first out rule and believed that he had the right to use, as the cost basis of the stock which he sold, the cost basis of an equivalent number of the highest cost shares which he owned, but certainly petitioner knew that he could not use the same block of stock twice in figuring his cost basis of stock sold. This he has done, and he gives no satisfactory explanation as to why he did it.

The Commissioner does not have to establish his determination of fraud “beyond a reasonable doubt.” All that he is required to do is to make proof of his fraud charges by a preponderance of the evidence which is clear and convincing. In re Locust Building Co., 299 Fed. 156. In the instant case he has proved clearly that in filing his income tax return for 1930 petitioner used in large part all over again as his basis of cost for Commonwealth shares sold in that year the cost basis of shares which had been largely used up in the prior years of 1928 and 1929, he has proved that petitioner knew that he had no right to do this, and that the use of such unauthorized basis of cost was largely responsible for an understatement of income for 1930 of $209,040.34. This, in the absence of any satisfactory explanation by petitioner, is convincing proof to us that petitioner’s income tax return for 1930 was false and fraudulent with intent to evade tax. Cf. White v. United States, 20 Fed. Supp. 623; M. Rea Gano, 19 B. T. A. 518; Frank A. Weinstein, 33 B. T. A. 105; Charles E. Mitchell, supra.

Petitioner strongly relies upon the finding in his favor upon the issue of fraud for the taxable year 1931 by the District Court of the United States for the Middle District of Georgia in the case of William E. Mitchell v. W. E. Page, Jr., et al., decided March 30, 1938. All of the evidence in that proceeding has been introduced by petitioner in this proceeding and we have carefully considered it.

It is sufficient to say that we regard the proof which respondent has submitted on the issue of fraud for the year 1930 as considerably stronger than that which he submitted before the court in the 1931 case. Particularly is this true of petitioner’s use in 1930 for the second time in determining the basis of cost of certain shares of Commonwealth sold in that year of the 5,000-share block of stock which we have already mentioned. Respondent at the hearing in the instant case traced in great detail the use of this 5,000-share block of stock by petitioner in making his income tax returns for 1928, 1929, and 1930. This respondent did by offering in evidence the work sheets used by Nabors in making up petitioner’s income tax returns for the years 1928, 1929, and 1930. No such evidence appears to have been before the court in the 1931 case. Petitioner does not contend that the decision of the United States District Court for the Middle District of Georgia in the 1931 case is res judicata on the fraud issue involved in this proceeding. He concedes that it is not.

For the reasons which we have stated above, we hold that petitioner’s income tax return for 1930 was false and fraudulent with intent to evade tax, that the deficiency for that year is not barred by the statute of limitations, and that part of the deficiency is due to fraud with intent to evade tax and the 50 percent penalty added to the tax by the Commissioner is sustained.

The parties have stipulated that petitioner made 35 sales of Commonwealth stock in 1930, totaling in all 25,400 shares; that the correct amount realized from the sales of these shares was $296,925; that the correct cost was $11,740.97; and that the correct net gain was $285,188.03.

Ordinarily we would accept these figures as correct, without question, but there is in evidence petitioner’s Exhibit No. 6, which is entitled “Complete Chronological Statement through 1930 of all transactions in stock of Alabama Traction Light and Power Company, Southeastern Power and Light Company, and Commonwealth and Southern Corporation.”

The Commissioner determined the deficiencies for the years in question upon the basis of this chronological statement. The figures for 1930 and other years given in this chronological statement show that the Commissioner completely disregarded the rule of averaging costs which takes place when there is a statutory reorganization and shares in an old corporation are exchanged for shares in the new corporation. See Christian W. Von Gunten, 28 B. T. A. 702; affd., 76 Fed. (2d) 670; followed by the Board as recently as Henry Hudson, 39 B. T. A. 1075.

The facts show that on June 10, 1929, petitioner exchanged 23,794 shares of Southeastern stock which he owned for 107,073 shares of stock and 53,536.5 option warrants in Commonwealth in a statutory reorganization. Instead of allocating the entire cost basis of petitioner’s shares in Southeastern between the common stock and option warrants which he received in Commonwealth and then averaging the cost basis of each share of Commonwealth in accordance with the rule laid down by the Board in the Von Gunten case, the Commissioner continued to use the first in, first out rule against the old shares owned in Southeastern. He appears to have used exactly the same method in computing petitioner’s gain on the sales of Commonwealth in 1930 as he used in the Von Gwnten case, which method we disapproved in that case. For example, as we figure it, the 23,794 shares in Southeastern which petitioner owned at the time of the reorganization on June 10, 1929, had a cost basis to him of ¡$291,-391.96. We are not making a finding of fact to this effect because this computation is made by us after giving effect to the other reorganization which took place in 1924, when shares in Alabama were exchanged for shares in Southeastern, and would, of course, be subject to mathematical error, but the figures are all in the record, from which a correct computation can be made. Whatever the correct figure is, it should be used in a recomputation under Rule 50. Assuming that our figures of $291,391.96 as the cost basis of the 23,794 shares of Southeastern stock are correct, then, when these were exchanged for 107,073 shares of Commonwealth stock and 53,536.5 option warrants, petitioner thereafter had a cost basis of $2.2964 per share for his Commonwealth stock after allocating a part of the $291,391.96 cost basis to the option warrants.

As already stated, the Commissioner in determining the deficiency for 1930 used the first in, first out rule, applying it to the old shares in Southeastern without using the averaging rule laid down in the Von Gunten case. This apparently, as applied to the year 1930, has resulted in a considerable overstatement of net income. It should be corrected in a recomputation under Rule 50.

Apparently similar errors were made for the other taxable years in question, which, however, did not result in nearly so pronounced an overstatement in net income. In fact petitioner’s income for 1929 will be considerably more than the Commissioner has determined. In view of the fact, however, that we have held that the statute of limitations bars any deficiencies for these other years, their correction becomes unimportant.

As we view it, this failure of the Commissioner to apply the rule laid down by the Board in the Von Gunten case does not in the slightest degree affect the issue of fraud. Petitioner has not contended that he was endeavoring to apply the first in, first out rule or the rule of averaging prescribed by the Von Gunten case. What he did do was to use as a basis of cost his highest cost stock, whether those particular shares were sold or not, and in 1930 he used again a cost basis of shares already used up in prior years. The facts as to this Rave already been fully discussed and will not be repeated, since they have nothing to do with the first in, first out rule or the rule of averaging in the Von Gunten case.

We direct the recomputation of the deficiency for 1930 to be made in accordance with the Von Gunten case, however, because we are convinced that it will result in a considerably lower tax and penalty for 1930 and petitioner should not be required to pay any greater tax and penalty for 1930 than he owes.

Eeviewed by the Board.

Decision will be entered under Rule 60.

TURNER,

concurring: While I concur in the conclusion reached and the thoughts expressed in the majority opinion, the picture presented by the record in this case prompts me to express some additional views.

The petitioner is an engineer and since May 1927 has been vice president and general manager of the Georgia Power Co., with offices located in Atlanta, Georgia. He graduated in 1903 from the Massachusetts Institute of Technology, with a degree of Bachelor of Science in electrical engineering. After serving two years with the General Electric Co. in Schenectady, New York, he was employed for six years in Brazil, returning to the United States in 1911, at which time he procured a position as construction foreman with the General Electric Co. on the west coast. Early in 1912 he was employed by the Alabama Power Co. as electrical engineer in connection with the development of the first major hydroelectric project in that state. This project combined the development of navigation and water power. By 1919 or 1920 he had advanced to the position of vice president in charge of operations, which position was held by him, except for a brief interlude of a few months during which time he returned to Brazil, until he was appointed to his present position. By 1920 he was drawing a salary of approximately $18,000 a year and at or about that time he began the purchase of stock in the Alabama Traction Light & Power Co., which in turn held the stock of the Alabama Power Co. and a number of other subsidiaries. In or about 1924 the Alabama Traction Light & Power Co. became a subsidiary of the Southeastern Power & Light Co. and the petitioner continued the policy of making his principal investments in the stock of that company. He had in mind the building up of a substantial estate, principally for the purpose of providing adequate income for his wife and daughter in the event anything should happen to him. During the period from 1920 through 1931, and possibly some subsequent years, the petitioner carried out a program which included the purchase and sale of securities in substantial quantities. The bulk of these securities were the stock of public utilities, as previously indicated. Some of the shares sold were acquired not by purchase, but by way of stock dividends and split-ups. During the years 1925, 1926, 1928, 1929, and 1930 the petitioner made 89 different sales covering 38,750 shares of public utility stocks.

From his testimony, and to some extent the testimony of other witnesses, it would appear that the petitioner is the type of man who maintains and exercises meticulous regard for proper personal conduct in all of his activities, civic as well as business, and who has a high sense of responsibility to his family, to his community, and to his government. The distinct impression is made that he has consistently given particular care and attention to things done and to be done, and yet in the preparation and filing of his Federal income tax returns we find him completely out of character. Tear after year he filed erroneous returns, admittedly understating income in substantial amounts. For the year 1925 he failed to report a profit of $14,075.50 from two sales of public utility stocks, and for 1926 he failed to report a profit of $1,702.50 from the sale of certain option warrants. With respect to the sale of Southeastern and Commonwealth stocks, he understated his profit for the year 1926 in the amount of $70,182.53, for the year 1928 in the amount of $41,970.64, and for the year 1929 in the amount of $50,907.41, and for 1930 it is stipulated that the amount of the understatement was $209,040.34. It appears also that for the year 1929 his net income was further understated in the amount of $69,120 by reason of his claiming a deduction to which he was not entitled.

The understatement of the profit from the sale of Southeastern and Commonwealth shares for the years 1926, 1928, and 1929 resulted from petitioner’s failure to apply the so-called first in, first out rule in determining the basis of the shares sold. He used as his basis the highest price which had been paid for such stock, regardless of the fact that the certificates delivered upon the said sales did not evidence shares purchased at the highest price but evidenced shares purchased at prices not then determinable. The erroneous deduction of $69,120 claimed in 1929 resulted from the fact that petitioner ignored the so-called “wash sales” provision of the statute and claimed a deductible loss on the sale of 2,000 shares of Atlantic Ice & Coal Co. common stock sold on November 25, 1929, even though on December 12 of the same year he entered into an agreement with the purchaser to repurchase the said shares at the same price at which they had been sold. As to the failure to report the profit from the sales of the utilities stocks and option warrants in 1925 and 1926, the only explanation is that it must have been an oversight. The understatement of profit from sales of Southeastern and Commonwealth shares in 1930, like the understatement of profit on similar sales in 1926, 1928, and 1929, resulted from the use of an erroneous basis, but unlike the errors in those years the understatement of such profit for 1930 resulted from the use of an amount as basis which petitioner now admits he knew he had no right to use. His explanation is that he was negligent and careless, but that he had no intent to evade tax.

It is the claim of the petitioner that he never heard of the first in, first out rule until the investigation was made which resulted in the determination of the deficiencies and penalties herein. He claims that he was under the impression that he could use as the basis for determining the gain from the sale of any shares of stock the highest prices paid for such shares, regardless of the fact that the certificates used in making the transfer of the shares sold were not the certificates received at the time the highest-priced purchases were made. With respect to the loss deduction claimed in respect of the Atlantic Ice & Coal Co. stock, his explanation is that it was his belief that once he had sold the stock his right to deduct any loss sustained was established, regardless of the time of any repurchase agreement on his part.

To say the least, it is difficult to understand how a man of the type portrayed by this record could or would have failed to make some serious effort to have informed himself, or at least have required the person to whom he delegated the task of preparing his income tax schedules to familiarize himself with the proper and established method of determining the basis and computing the gain or loss from the sales of securities, particularly where the purchases and sales in question and the gain realized therefrom were so substantial in amount both as to the number of transactions and the sums of money involved and occupied such an important place in petitioner’s personal and financial program. It is not so startling or surprising, however, that any person should have difficulty in understanding and applying the first in, first out rule. Considered in the most charitable light, it is arbitrary and artificial. It rests on the assumption that one share of stock in a particular corporation is identifiable or different from other shares of stock of the same class and ignores the fact that a share of stock is merely indicative of the undivided interest of the holder in the welfare of the corporation, and that the certificate is not a share in itself but merely evidences ownership of such undivided or pro rata interest, not in some particular asset or activity of the corporation, but in the corporation as a whole. The application of the rule has resulted in a mad scramble on the part of taxpayers to earmark particular stock certificates and in case of sale to use certificates received at the time the highest-priced shares were acquired so as to report the minimum amount of gain or to obtain the maximum deduction in the case of loss. The Government, on the other hand, if the early purchases were made at a lower figure, undertakes to show that the cei’tificates used with respect to a particular sale were certificates evidencing unidentifiable shares and that the first in, first out rule should apply. The natural consequence is that income is distorted year after year, in some instances at the expense of the Government and in other instances at the expense of the taxpayers, and the Bureau, the Board, and the courts are flooded with cases the majority of which would undoubtedly be eliminated to the eventual advantage of both the Government and the taxpayers if it were permissible to determine the basis of the shares sold by the apparent and logical method of averaging the unrecovered cost of all shares owned by the taxpayer immediately prior to a sale. The regulation establishing the first in, first out rule is a regulation of long standing, however, and, since its promulgation has been held to be reasonable under the statute, it has the force and effect of law and it is likely that action by Congress would be necessary to change it. Furthermore, it is our duty to undertake the application of the law as it exists and not as it might or in our opinion should be.

While the petitioner’s use of the highest-priced shares in his portfolio as the basis for computing gain is no more reasonable or logical than the application of the first in, first out rule, it is certainly no less so. It does not appear of record that the instructions accompanying the income tax forms contained any information concerning the said rule, and, in the face of petitioner’s insistence that he had no knowledge of it whatever, the record seems to fall short of a satisfactory showing of an intent to evade tax in reporting the gain on the transactions in question.

It is with greater difficulty that I am able to give full credence to the testimony with respect to the loss deduction claimed by reason of the sale of the Atlantic Ice & Coal Co. stock. The petitioner certainly was tax conscious, and the record clearly indicates that he would not have parted with the stock except for the purpose of procuring a deduction against income and then only on the belief that he could reacquire such stock at no advance in price. He had no intention or desire to finally and definitely part with his interest in the company. He proposed a sale to Courts & Co., but was able to close the transaction only upon the condition that he would save them from loss. This was followed some 17 days later by the admitted agreement to repurchase the shares at the selling price. These facts are strongly persuasive that the agreement to repurchase was existent from the beginning but was not expressed until December 12. The witnesses have testified, however, that the sale was an outright sale, and Courts & Co. apparently made some effort to resell the stock to outside interests between November 25 and December 12, and, as to the agreement to indemnify Courts & Co. against loss, there might have been some serious question as to its enforceability, the said agreement not being in writing. These factors, supplemented by the claim of lack of knowledge of the statutory prohibition against the deduction of such losses where a repurchase agreement has been entered into within 30 days after the sale, may be sufficient to justify the conclusion that the record does not sustain the charge of fraud, although it is very difficult to believe that the petitioner could or would have informed himself, as he obviously did, of that part of the statutory provision prohibiting the deduction of such losses if the property sold is actually repurchased within the period of 30 days after the sale and not have informed himself of the prohibition of the loss deduction where an agreement to repurchase is entered into within that period.

Petitioner’s failure to make any report of the gain from certain sales of securities in 1925 and 1926 is equally difficult to understand. He had no explanation except that it must have been an oversight, reiterating his claim that he had no intent to evade tax. Compared with other items involved in this proceeding, the amounts were comparatively small and it may be, as counsel suggests, that the omission of the larger amount in 1925 was due to a mistake as to basis and confusion as to sales and purchases made at or about the same time.

With respect to the understatement of income for 1930, however, I am fully convinced from the testimony of both petitioner and Nabors that petitioner’s conduct goes far beyond carelessness or negligence and indicates an intent to evade tax within the meaning of the statute. The amount of the understatement was substantially greater than the combined understatements for the preceding years. Both Nabors and petitioner admit they knew they had no right to use as the basis for determining gain on the 1930 sales the cost of stock which had already been exhausted in reporting gain on prior sales, and yet they did just that. I am unable to give credence to the claim or testimony that it resulted from an innocent mistake and agree fully with views expressed in the majority opinion.

Leech,

dissenting: Fraud must be established by clear and convincing evidence. Charles E. Mitchell, 32 B. T. A. 1093. I agree with, the majority that no such evidence exists here in petitioner’s returns for 1925,1926,1928, and 1929. I also find none in the return for 1930.

There may have been negligence in the filing of the returns for each of the years in question. Certainly that was so in the return for 1930. But negligence, alone, does not sustain a finding of fraud. Griffiths v. Commissioner, 50 Fed. (2d) 782; L. A. Meraux, 38 B. T. A. 200; Harold B. Franklin, 34 B. T. A. 927; Oscar G. Joseph, 32 B. T. A. 1192.

Petitioner was a church leader, prominent in the Boy Scout movement, relief work, and similar community activities. He was a very busy executive and engineer. His returns for 1930 and several prior years were prepared by a trusted employee, Nabors, in whose honesty and ability petitioner had absolute confidence, which clearly was not unjustified, though Nabors was not an accountant. Petitioner did not examine the computations on any of the returns. Respondent’s agents investigated those for 1930 and for other years, and constructively approved them. Nothing was concealed from these agents then or in their later investigation. All of petitioner’s data, supporting the returns, was made available to them. See Harold B. Franklin, supra; John Thomas Smith, 40 B. T. A. 387. Though there were omissions of three sales of securities for 1925 and 1926, every sale petitioner made in 1930 — and there were 35 — was reported in his return for that year. His receipts therefrom were all correctly reported except for a small overstatement. The error which resulted in the understatement of income upon which the deficiency for that year mainly arose and upon which the finding of, fraud in this proceeding was made, was the use of the wrong basis for computing the gain petitioner realized on these sales.

It is now conceded that the proper basis was not used in that computation. After seven months’ investigation by respondent, the computation of gain on these sales and those for the earlier years involved, was completed. But this computation exceeded the amount later stipulated as correct, by the amount of approximately $70,000. A tax specialist in the employ of petitioner then spent several months on another computation of petitioner’s income, for the several years here in review!, which computation respondent accepted as correct, with only minor changes, after investigation, and determined the present deficiencies thereon. The income thus computed is here stipulated as correct. Those facts indicate the complexity of the necessary computation. But that extreme complexity is even more graphically and startlingly evidenced.

Petitioner’s income for each of the years here, as thus stipulated, is shown, upon the face of the record, to be incorrect and overstated in a large amount because of the use of an erroneous basis for the stock then sold. The majority opinion admits the existence of this error and directs that it be corrected. In the face of this condition, can it be doubted that the computation of the correct basis of the stock sold in each of these years, is a matter so technical and involved that an error, resulting in a large understatement or overstatement of income could be made honestly and without fraudulent intent? Certainly the respondent had no intent to overstate petitioner’s income for 1930, and yet, the basis used by his accountants after months of detailed work, with all the records before them, resulted in a computation of income in an amount of $70,000 in excess of the income finally stipulated. And that figure, thus agreed upon, as I calculate it, is about $44,000 in excess of the correct income.

But the majority says that even this error by respondent “does not in the slightest degree affect the issue of fraud.” This may be theoretically true when the finding of fraud is limited to the narrow one of petitioner’s use, for the second time, of a cost basis for the so-called 5,000-share lot. But is it true, in fact — in view of the peculiar complexity of the calculation of basis for this stock? I think not.

This record convinces me that when the return for 1930 was filed, neither petitioner nor Nabors knew they were using a cost basis that had already been exhausted. The basis thus used was, indeed, wrong. But, error in such a complicated computation — not even yet correctly made — is surely no basis here for a finding of fraud. And the fact that this error actually resulted in the use of a cost basis already exhausted — in the picture presented — is, at least, far removed from “clear and convincing evidence” of fraud.

Petitioner and Nabors now admit that the use of such basis was a mistake, but they both categorically deny they knew they were making this mistake when the return was prepared and filed. Nevertheless, the majority regards petitioner’s explanation that this error was an unintentional mistake, as unsatisfactory. They dismiss it with that brief comment.

In view of everything revealed in this record, I think, it was amply sufficient to answer the imputation of fraud. It is significant that the District Court of the Middle District of Georgia, in determining a similar issue for 1931, thought so too. The petitioner had acquired these stocks in an effort to build an estate. All of his 1930 sales were made to pay obligations. In 1929, he was worth $3,000,000. By 1930, the value of his net estate had shrunk to $100,000. He was not a tax expert. Under such circumstances, is it reasonable that he should have known he was in receipt of income during that year, in an amount much larger than his total net estate? Although the information from which the calculation was made, was always available to respondent, the same exhausted basis was used for the third and fourth times in his returns for 1931,1932, and 1933. In computing the gain on the sales of Commonwealth stock during those years, Nabors testified he had lost sight of the 5,000-share block and used such mistaken basis because, when he prepared the returns for those years, he had that figure firmly fixed in his mind as the cost, per share, of all the remaining Commonwealth stock. A deficiency and fraud penalty thereon were determined for 1931. Petitioner paid both of them and sued in the District Court of the United States for the Middle District of Georgia, to recover part of the deficiency and all of the 50 percent penalty for alleged fraud. Because of this consistent and continuous error of basis the understatement of income for that year was much greater even than that for 1930. It is true more detailed evidence was presented in this proceeding. Only the year 1931 was there involved, but the issue was the same as that upon which fraud has been found here — petitioner’s use of a cost basis in computing gain on sales, which basis had been exhausted by prior sales. The case was tried before the court, without a jury, and the court there had before it the fact that, in petitioner’s return for 1931, in computing his gain on sales of Commonwealth stock during that year, the petitioner had used as a basis therefor a cost of stock which had already been used in computing gains on sales made before 1930. It was not there noted, however, that the basis used even by the respondent in computing the contested income was wrong. Yet the court, at the conclusion of the trial, said in part, and included the same in its findings of fact:

Thh Court. I want to say, and I feel that it is only fair to Mr. Mitchell that I say it now; that is, any charge of fraud in the sense that is generally understood as being dishonest and for the purpose of evading the payment of taxes, as I understand it, is certainly not sustained in this ease and I do not hesitate to actually and promptly find against that contention now. If it means negligence there is room for argument probably that Mr. Mitchell, with his occupation and the many other duties in which he toot part, might not have found time to go more thoroughly into the matter. That need not be determined now; nor am I going into the question of the alleged Huntington Aircraft loss. But I am announcing now that I am so thoroughly in sympathy with his feeling of outrage at being charged with fraud and dishonesty that I take pleasure in making this statement at this time and I will incorporate it in my findings.

I do not think the record here warrants any different conclusion as to the year 1930.

       SEC. 118. LOSS ON SALE OP STOCK OR SECURITIES.
      In the case of any loss claimed to have been sustained in any sale or other disposition of shares of stock or securities where it appears that within thirty days before or after the date of such sale or other disposition the taxpayer has acquired, (otherwise than by bequest or inheritance) or has entered into a contract or option to acquire substantially identical property and the property so acquired is held by the taxpayer for any period after such sale or other disposition, no deduction for the loss shall be allowed under section 23 (e) (2) of this title; nor shall such deduction be allowed under section 23 (f) unless the claim is made by a corporation, a dealer in stocks or securities, and with respect to a transaction made in the ordinary course of its business. If such acquisition or the contract or option to acquire is to the extent of part only of substantially identical property, then only a proportionate part of the loss shall be disallowed.


author: Murdock: Leech,

text:
    W. W. Hoffman and Katherine M. Hoffman, Petitioners, v. Commissioner of Internal Revenue, Respondent. Katherine M. Hoffman, Petitioner, v. Commissioner of Internal Revenue, Respondent. W. W. Hoffman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 92414, 96741, 96742.
    Promulgated August 15, 1939.

      Elden MoFarlmd, Esq., W. H. West, Jr., Esq., and Stephen L. Healey, G. P. A., for the petitioners.

      Allen AMn, Esq., and W. G. Bn/yma/rm, Esq., for the respondent.
   OPINION.

Murdock:

The petitioners claim a deduction for 1934 under sec-tion23 (e) (2) of the Revenue Act of 1934. Although the respondent is willing to concede a capital loss in 1935$ whenititle waslosl, he contends 'that there could be no loss from the ownership of real estate while title was retained. The statute allows a deduction for any loss sustained during the taxable year, if incurred in a transaction entered into for profit and not compensated for by insurance or otherwise. It does not distinguish between real and personal property.

The fact is clearly established that the interest of these petitioners in the property became completely worthless in 1934. The mortgage, a first lien, was greatly in excess of the value of the property. There were, in addition, delinquent taxes and water rents. If ownership were to continue, repairs costing about $10,000 would have to be made. The total of these items was about one and one-half times the value of the property. The property had been operating at a loss and renting conditions were growing worse. Foreclosure proceedings were instituted during 1934 and it was known that they would be pressed to permit the mortgagees to gain title. The petitioners fully realized that their equity was completely and permanently lost. Indeed, they considered further ownership a liability and tried to give away their title. There was no reasonable hope that their equity would ever again have any value. The respondent does not call attention to any evidence indicating that the petitioners retained anything of value at the close of 1934. They did retain title to the premises, but that title was devoid of value to them. The mortgagees would not even take it as a gift. Subsequent events corroborate worthlessness in 1934.

The Board said in A. J. Schwarzler Co., 3 B. T. A. 535, that title to real estate can not be lost by abandonment alone. The statute does not make either abandonment or loss of title a condition precedent to the allowance of a deduction for loss. Still^evidence of abandonment may be material here, as in the case of personal property, to show that a permanent and complete loss has occurred from which there is no escape. These petitioners did about everything that they could to abandon their interest in the property. Cf. Reuben H. Donnelley Corporation, 26 B. T. A. 107. They notified the mortgagees of their intention to abandon. They refused to make the payments and repairs necessary to continued operation, although they were able to do those things. They surrendered possession and canceled all contracts with insurance and public utilities companies. They did all of those things voluntarily because they no longer desired to possess any interest in the property. They were moved, of course, by their knowledge that their interest was no longer of any value and, if retained, would require them to make additional expenditures which they deemed entirely unwise. These acts indicate clearly that they were attempting to terminate their ownership, possession, and control and that they no longer cared what became of the property. They had no intention to renew their interest in any way. No way has been suggested whereby they could have abandoned their interest more effectively. Even if there was not a complete legal abandonment, nevertheless, the evidence shows that these petitioners lost their investment in the property in 1934.

The Supreme Court has said that the loss provisions call for a practical, not a legal, test, and, where losses are reasonably certain in fact and ascertainable in amount, their deduction may be justified before they are absolutely realized. Lucas v. American Code Co., 280 U. S. 445. Another court said that a sale is unnecessary in estab-t lishing a loss where value has become extinct and there is no variable \ to determine. DeLoss v. Commissioner, 28 Fed. (2d) 803. Those two cases involved losses upon personal property. Deductions for loss upon the abandonment of worthless real estate have been allowed by the Sixth Circuit Court of Appeals even though the taxpayer retained title. Rhodes v. Commissioner, 100 Fed. (2d) 996, reversing 34 B. T. A. 212; Denman v. Brumbach, 58 Fed. (2d) 128. A loss upon a mineral lease is sustained when it is abandoned as worthless, Belridge Oil Co., 11 B. T. A. 127; C. H. Goodwin, 9 B. T. A. 1209, and the same is true of a mine owned in fee. Colorado & Utah Coal Co., 26 B. T. A. 588. Even the diminution in value of real property resulting from a casualty has been allowed as a loss. Ferguson v. Commissioner, 59 Fed. (2d) 893; Whipple v. United States, 25 Fed. (2d) 520; Mary Cheney Davis, 16 B. T. A. 65; F. C. Champlin, 1 B. T. A. 1255. But under other circumstances a mere diminution in value has been disallowed as a loss. Coalinga-Mohawk Oil Co., 25 B. T. A. 261; affd., 64 Fed. (2d) 262; certiorari denied, 290 U. S. 637.

The Commissioner states that the Board has held consistently that no loss can possibly be sustained as a result of the ownership of real estate as long as title is retained. Despite statements made in A. J. Schwarzler Co., supra, and in Greenleaf Textile Corporation, 26 B. T. A. 737, supporting the Commissioner, we think the rule contended for by the Commissioner is too broad. Hancock v. Commissioner, 105 Fed. (2d) 153. Yet it is not necessary to overrule the Schwarzler case or any other which followed it. Consolidated Bride Co., 17 B. T. A. 831; H. M. N. Muhle, 19 B. T. A. 1247; Frederick Krauss, 30 B. T. A. 62; J. C. Hawkins, 34 B. T. A. 918 (relied upon in the notice of deficiency); Derby Realty Corporation, 35 B. T. A. 335; Collateral Mortgage & Investment Co., 37 B. T. A. 630; and T. J. Bosquett, 39 B. T. A. 763, are easily distinguishable from the present case, either on the ground that they presented a failure of proof as to worthlessness and abandonment or because they involved an entirely different point. The Rhodes case was distinguished in the Bosquett case and the Brumback case was distinguished in the Green-leaf case. There was no worthlessness in the Coalinga-Mohawk Oil Co. case, merely a shrinkage in value.

The evidence in the Greenleaf case likewise showed only shrinkage in value, not worthlessness. Loss of title was not imminent and the evidence of abandonment was not strong. The Rhodes case was similar in many respects. There the property had been sold for taxes, but there was a period of redemption outlasting the taxable year. No finding of worthlessness of the taxpayer’s interest was made and the evidence of abandonment was not convincing. Nevertheless, the Board was reversed and a deduction was allowed.

Perhaps the most difficult case to distinguish is the Schwarzler case. There, as here, the liens exceeded the value of the property. However, the excess is not disclosed in the report. It may have been too slight to offset a possible increase in value of the property. This may have had added significance, since loss of title was not imminent. The report merely says in regard to abandonment that the taxpayer “attempted to abandon” the vacant lots. The present case is stronger for the taxpayer than any of the cases cited, including the Schwarzler, Brumback, and Rhodes cases.

Some of the language used by the Board in the Schwarzler case tends to support the broad rule which the Commissioner now proposes. It was there said that “losses from dealing in real or personal property, growing out of the ownership thereof, are deductible only when ascertained and determined upon an actual, completed, and closed transaction during the taxable year, and are not sustained through the mental process by which a taxpayer determines that the property is worthless and charges it off on his books while he still retains the title to the property itself.” But thereafter many deductions were allowed for losses on worthless personal property while the taxpayer still retained title, and in some cases the loss was allowed upon abandonment. See Law of Federal Income Taxation, Paul and Mertens, § 26.71 and cases there listed in footnotes. See also Morris Polin, 39 B. T. A. 951, where a loss was allowed upon the abandonment of mortgaged real estate. ' The allowance of a deduction for loss upon worthless property is not really an exception to the rule that losses are deductible only upon closed transactions. Hancock v. Commissioner, supra.

The respondent argues that the petitioners did not abandon their interest since they did not expressly waive their right to any proceeds of foreclosure over and above the debt and costs. They never thought either of releasing or retaining those rights because they knew there was not even a remote possibility of there being any excess. The respondent also argues that a practical difficulty would arise if losses were to be allowed while title to real property remained in the taxpayer, since every case could be settled only by litigation. No such difficulty has arisen in regard to losses on personal property, although they have been allowed when property became worthless and was abandoned. The Government frequently disallows losses on personalty in one year on the ground that the property was worthless in a prior year.

The interest of these petitioners in the property actually became worthless within the taxable year 1934. The events of that year were sufficient to identify the occurrence of a loss in that year. They thus sustained an ordinary loss of $66,833.34 in that year from a transaction entered into for profit and are entitled to a deduction of that amount for 1934. Cf. Hancock v. Commissioner, supra; Morris Polin. supra. The issue for 1935, raised in the alternative, need not be discussed.

Beviewed by the Board.

Decision will he entered under Bule 50.

Hill dissents.

Leech,

dissenting: Beginning with A. J. Schwarzler Co., 3 B. T. A. 535, followed by many other cases, including Greenleaf Textile Corporation, 26 B. T. A. 737; Frederick Krauss, 30 B. T. A. 62, and Morris Polin, 39 B. T. A. 951, the Board has consistently held that no deductible real estate loss is sustained by a taxpayer so long as he retains title to the real estate. The correctness of this ruling has been affirmed, at least, in Greenleaf Textile Corporation, supra, and no case, of which I know, is contradictory, except possibly Rhodes v. Commissioner., 100 Fed. (2d) 966.

Proceeding upon the basis of that long established and consistently followed theory, the Board then held that no such loss could be sustained by the mortgagor of real estate, upon foreclosure, so long as an equity of redemption existed. J. C. Hawkins, 34 B. T. A. 918; affd., 91 Fed. (2d) 354. This holding has likewise been consistently followed and affirmed. Derby Realty Corporation, 35 B. T. A. 335; T. J. Bosquett, 39 B. T. A. 763; Morton v. Commissioner, 104 Fed. (2d) 534.

Despite the factual distinction between the first mentioned line of cases and this one, which the majority attempts to draw, I think the basic issue is the same in both and that the holding here is directly contra to the rule adopted and followed here..

Undoubtedly there are impressive reasons for the application of the so-called “practical test” in determining when a real estate loss is sustained. But such reasons, as well as those supporting our original position, existed and were considered by the Board and courts before that original position was adopted. I see no reason now to change that position. But, if it is to be reversed, I think that reversal should be clear and unmistakable.

Disney agrees with this dissent.

       Although obviously immaterial here in my judgment, there appears to be no period of redemption in the State of New York. Sec. 548, Real Property Law of New York, McKinney’s Consolidated Laws of New York. vol. 49, p. 876.


author: Van Foshan :

text:
    Cooperative Publishing Company, a Corporation, and Charles Gossett, Carl F. Chase, Cecil R. Peckam, Harry L. Brandt and E. N. Hanson, as Liquidating Trustees of Said Corporation, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 94725.
    Promulgated August 18, 1939.

      George H. van de 8teeg, Esq., for the petitioners.

      II. R. Ilorrow, Esq., for the respondent.
   OPINION.

Van Foshan :

The petitioner contends that the tax on the undistributed profits in 1936 was not properly assessable because it had a deficit at the end of that year and because it was “actually insolvent and virtually in receivership” by reason of the bondholders’ suit then pending against it. Neither reason is persuasive. It was said in Crane Johnson Co., 38 B. T. A. 1355, that Congress has the power to tax the current income of all corporations, whether they have deficits or not. Foley Securities Corporation, 38 B. T. A. 1036. The petitioner has advanced no argument that alters that view.

Section 14 (d) (2) of the Revenue Act of 1936 exempts from the imposition of the surtax on undistributed profits (section 14 (b)) “Domestic corporations which for any portion of the taxable year are in bankruptcy under the laws of the United States, or are insolvent and in receivership in any court of the United States or of any State, Territory, or the District of Columbia.” The petitioner argues that it was insolvent in 1936, that its condition culminated in its compulsory dissolution in 1937, and that the situation in which it had been forced was equivalent to a receivership. The Idaho statutes, which constitute the directors of a corporation in dissolution trustees for the creditors and stockholders to settle the affairs of the corporation, are cited to support the argument.

A receivership is a distinct legal status, arising from appropriate proceedings in a court of jurisdiction. Here no such action had been taken. Petitioner was in dissolution but not “in receivership.” The statute is in the conjunctive. To come within its scope a corporation must be “insolvent and in receivership.” The exemption granted can not be enlarged to include situations not contemplated by Congress.

The petitioner further contends that it could declare no dividends for either 1936 or 1937 because it was prevented from so doing by the statutes of Idaho, which prohibit the payment of dividends except out of surplus. We considered this contention in Crane Johnson Co., supra, and held that in a similar situation, under North Dakota statutes, the petitioner was not entitled to a deduction under section 26 (c) (1) of the Revenue Act of 1936. Our decision there controls the disposition of that issue in the case at bar.

The basic question relating to the year 1937 is whether or not a taxable gain was realized by the petitioner upon the forced sale of its assets on August 7 of that year. The respondent determined that the petitioner had realized such a gain, amounting to $22,265.84, by subtracting from the purchase price the adjusted cost basis of the tangible assets. In his computation, he ignored such intangible assets as good will, the cost of securing subscriptions, and of increasing circulation, the value of publishing legal notices, etc. He also failed to allow the expense of the sale, amounting to $1,320.90, which he now concedes to be a correct deduction. The net gain in question, therefore, is reduced to $20,944.94.

The petitioner contends that the cost of the good will and other intangibles was greater than the difference between the adjusted cost basis of the tangible assets and their sale price. The petitioner’s books do not support this theory. They contain no account showing any cost of securing subscriptions or increasing circulation or of any other intangible item generally classified as “good will.” The petitioner argues, however, that the stockholders’ and bondholders’ investments, loans and accounts payable, less depreciation taken, amount to over $38,000 and that, since no dividends were ever paid to the stockholders, its invested capital was used and absorbed to produce and preserve its assets and, consequently, such capital represents the cost of the intangibles, after the adjusted cost of the tangible assets is deducted.

The fallacy of this argument is manifest from the fact that it gives no consideration to losses incurred in almost 20 years of operation, to mismanagement, and to many other such factors which might retard instead of develop good will. Cost' must be proved with reasonable accuracy. In the absence, therefore, of any positive and satisfactory proof of the cost of the intangibles, we must sustain the respondent’s action.

The petitioner further maintains that, at the most, only the $6,990 which it received after the preferred creditors and the costs of suit were paid, should be taxed as its income. The suit was brought to subject the petitioner’s property to the payment of its own debts, secured by liens. Other debts remained to be settled after the $6,990 was paid over. The application of the sale price of the petitioner’s assets bears no relation to the capital gain derived from their sale. We see no merit in this argument.

We sustain the action of the respondent, as modified by the record.

Decision will be entered imder Rule 50.

       (b) Imposition op Tax. — There shall be levied, collected, and paid for each taxable year upon the net Income of every corporation a surtax equal to the sum of the following, subject to the application of the specific credit as provided in subsection (c) :
      7 per centum of the portion of the undistributed net income which is not in excess of 10 per centum of the adjusted net income.

       (c) Contracts Restricting Payment on Dividends.—
      (1) Prohibition on payment on dividends. — An amount equal to tlie excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account.


author: Arnold:

text:
    National Bank of Commerce of San Antonio, Texas, Petitioner v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93164.
    Promulgated August 18, 1939.

      Robert S. Durno, Esq., for the petitioner.

      R. P. Hertzog, Esq., and F. B. ScKlosser, Esq., for the respondent.
   OI’INION.

Arnold:

This proceeding requires a classification of the loss sustained by the petitioner in connection with the making of loans over a period of years. During the taxable year the petitioner took over the property securing the total loans at a time when the agreed value of the property was $30,701.04 less than the indebtedness secured thereby. The respondent contends that the petitioner had a capital net loss, and is limited by section 117 (d) of tbe Revenue Act of 1934 to a deduction of $2,000. Tbe petitioner contends that tbe $30,701.04 is deductible either as (1) a bad debt, or (2) an ordinary loss.

It has been stipulated that the loans were made by petitioner in tbe ordinary course of its banking business and that tbe loans were made for profit. Tbe facts here distinguish this proceeding from tbe decided cases involving tbe purchase or sale of real estate and tbe giving or taking back of a mortgage or deed of trust to secure tbe unpaid balance. See Betty Rogers, 37 B. T. A. 897; affirmed by tbe Ninth Circuit in Rogers v. Commissioner, 103 Fed. (2d) 790, which involved a purchase of real property, and tbe subsequent conveyance of the property back to tbe vendor in consideration of release from liability and tbe cancellation and surrender of the note for tbe unpaid balance; and Marry Payne Bingham, 38 B. T. A. 913, on appeal to tbe Second Circuit, which involved tbe sale of real property for cash and notes secured by a mortgage, and upon default tbe reacquisition of tbe real property at a value less than tbe amount of the notes.

Tbe debtor of tbe petitioner was successively tbe estate of Van A. Webster, deceased, and tbe trust estate created by tbe deed of June 2, 1931. Tbe notes renewed after June 2, 1931, were executed by a trust officer of tbe petitioner, who was acting for and in behalf of tbe petitioner bank in its fiduciary capacity. In other words tbe bank in its own right was lending money to itself in its capacity as trustee, and tbe petitioner bank had agreed that it would look only to tbe property securing tbe indebtedness for recovery of the sums loaned. Marie Carter Sturges was not personally liable for the payment of tbe amount due petitioner. It was not her indebtedness. She neither executed tbe notes nor did she make herself personally responsible in any way for the payment thereof.

The deed, dated May 18, 1935, indicates that tbe petitioner had advanced from time to time after June 2, 1931, further and additional sums to tbe trust estate for tbe upkeep, maintenance, and payment of taxes upon tbe real property securing tbe total indebtedness. Tbe deed was executed to tbe petitioner in its own right “in payment and full satisfaction of all tbe said indebtedness” owing petitioner, “and in satisfaction, release and settlement of all obligations, duties and liabilities agreed to be performed and/or assumed by” petitioner, as trustee.

At the time Marie Carter Sturges executed the deed of May 18, 1935, to the petitioner and at the time petitioner accepted the conveyance, the trust estate was insolvent, and her rights therein, which were subject to petitioner’s rights, were of no value whatsoever. In so far as Marie Carter Sturges was concerned, therefore, she parted with nothing of value by her last conveyance, and was relieved of no obligation thereby.

In our opinion this proceeding is governed by the same principle as that applied in James R. Stewart, 39 B. T. A. 87; Harold S. Denniston, 37 B. T. A. 834, and Charles T. Carlson, 39 B. T. A. 185. The interest of Marie Carter Sturges in the property securing the notes was conveyed to the petitioner in settlement and satisfaction of the indebtedness of the trust estate. To the extent that the security failed to extinguish the indebtedness the loans of the petitioner represented worthless debts. Since there is no question about the charge-off of the remainder of the debts in the taxable year, the deduction claimed should have been allowed.

Some of the decided cases have held that the compromise of notes for less than their face value results in an ordinary loss. Hale v. Helvering, 85 Fed. (2d) 819; Commissioner v. Freihofer, 102 Fed. (2d) 787, affirming Sol Greisler, 37 B. T. A. 542; Lloyd Jones, 39 B. T. A. 531; Commonwealth, Inc., 36 B. T. A. 850. Much of the language used in these decisions would be applicable here if we should , rest our decision upon a determination that an ordinary loss as distinguished from a capital loss resulted. But we prefer to rest our decision upon the classification of this deduction as a bad debt.

For the foregoing reasons it is our opinion that no sale or exchange within the meaning of section 117 occurred, and the deduction claimed should be allowed as a bad debt ascertained to be worthless and charged off in the taxable year.

Decision will be entered wider Rule 50.


author: Mellott:

text:
    Title Guarantee and Trust Company, Executor, Estate of Mary A. Bedford, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88006.
    Promulgated August 18, 1939.

      Holt B. McKinney, Esq., for the petitioner.

      Conway Kitchen, Esq., for the respondent.
   OPINION.

Mellott:

Section 42 of the Bevenue Act of 1934 requires that amounts accrued up to the date of the death of a decedent be included in computing his net income for the taxable period in which falls the date of his death. Pursuant to this section the respondent has included in decedent’s income for the period from January 1 to March 16,1934, the interest upon the Prudence Co. bonds. Some of the interest, as shown by our findings, was represented by coupons due but unpaid and some by coupons attached to bonds in the trust estate but which were not yet due. The parties upon brief make no distinction between the two classes, and we shall make none. Petitioner contends that none of the interest should be accrued because at the time of the death of decedent “there was then not only a lack of certainty as to future payments of interest * * * but it was then highly probable that a substantial part of the principal investment would never be paid.” In other words, it relies upon the rule, frequently enunciated and applied by the courts and this Board, that income need not be accrued when there is a substantial doubt as to its collectibility. North American Oil Consolidated v. Burnet, 286 U. S. 417; Burnet v. Logan, 283 U. S. 404; Turners Falls Power & Electric Co., 15 B. T. A. 983; Great Northern Railway Co., 8 B. T. A. 225; affd., 40 Fed. (2d) 372; certiorari denied, 282 U. S. 855; Corn Exchange Bank v. United States, 37 Fed. (2d) 34; American Central Utilities Co., 36 B. T. A. 688; Seattle First National Bank v. Henrickson, 24 Fed. Supp. 256; appeal dismissed, 100 Fed. (2d) 1015. Many of the cases bearing upon the general question are collated in the last cited case.

Respondent contends that on the date of the death of the decedent there was every reasonable expectation not only that the interest would be paid but also that the bonds would be paid in full at maturity. He determined the deficiency in tax on that theory and his determination is presumptively correct. The question, therefore, is primarily whether or not petitioner’s proof has been sufficient to overturn the presumption. We think that it has not been.

We have set out in our findings not only facts material to the issue but also several based upon evidence the materiality of which is doubtful. .The subsequent reorganization of the Prudence Co., the finding of the court that it was insolvent in 1938, and the ultimate loss through the exchange of the bonds in the trust for bonds and cash having a lesser aggregate fair market value — events occurring .several years after decedent’s death — furnish very little aid in determining whether or not, at the time of decedent’s death, there was no likelihood that the interest would be paid. Offsetting any slight doubt which might arise from such circumstances is the fact that the coupons which were due at the time of her death were paid shortly thereafter, while the coupons not then in default were also paid within a few months. The amounts paid were — and we think properly — credited by the trustee to income. Under the circumstances existing at the date of the death of the decedent, we think the trustee would have been unduly pessimistic if it had considered the Prudence Co. to be insolvent or if it had determined that the interest then due was uncollectible. It is somewhat significant that the trust officer who was called as a witness in the instant proceeding gave no intimation that he had any such feeling on the date of decedent’s death. On the contrary he caused all of the interest, when collected, to be credited to trust income.

We are of the opinion, and hold, that the respondent did not err in including the interest upon the Prudence Co. bonds in the gross income of the decedent for the period in question.

The remaining issue is the taxability to the estate of Mary A. Bed-ford of a portion ($4,208) of the amount received by her as an annuity ($8,750). Respondent has held that such amount must be included in her gross income under section 22 (b) (2) of the Revenue Act of 1934 and article 22 (b) (2)-2 of Regulations 86. Petitioner contends that none of the amount represented taxable income to the decedent; that the amount which she received was a bequest from the estate of her deceased husband; that the amount expended by the husband in the purchase of the annuity had been included in his gross estate and the tax upon it had been paid; that even if the amount paid for the annuity had not been included in the husband’s estate the amount received by the wife would still be exempt as a gift; and that section 22 (b) of the Revenue Act of 1934 is unconstitutional because it arbitrarily fixes as income, and imposes a tax upon, 3 percent of the total cost of purchasing the annuity.

We have heretofore expressed the opinion that the statute is constitutional. F. A. Gillespie, 38 B. T. A. 673; Anna L. Raymond, 40 B. T. A. 244. The discussion and reasoning contained in those opinions need not be repeated. Petitioner’s argument will, however, be stated and discussed.

Petitioner cites the definition of income contained in Eisner v. Macomber, 252 U. S. 189, and Bowers v. Kerbaugh-Empire Co., 271 U. S. 170, and says that the 3 percent of the cost of an annuity, taxed under section 22 (b) (2), supra, does not come within such definition; that it does not represent actual gain, is not severed from capital, or received or draAvn by the taxpayer for his separate use and disposal; and that it is simply an arbitrary figure, determined by a mathematical formula. It concludes its argument with the assertion that “if Congress has the arbitrary power to tax 3% of the cost of an annuity as ineome it would also have the power to tax 93% of the cost as income,” which, it asserts, demonstrates the unconstitutionality of the section.

The argument loses much of its apparent force when the taxation of annuities and the antecedent history of the section is considered. Under the Revenue Acts from 1918 to 1926 (sec. 213, Act of 1918) the amount received by the insured as a premium or premiums paid by him under life insurance, endowment or annuity contracts was not required to be included in gross income. By amendment in 1926 (sec. 213 (b) (2), Act of 1926) it was provided that “Amounts received * * * under a life insurance, endowment, or annuity contract [should not be included in gross income] ; but if such amounts (when added to amounts received before the taxable year under such contract) exceed the aggregate premiums or consideration paid * * * then the excess shall be included in gross income.” This resulted, as pointed out by the Ways and Means Committee (Rept. No. 704, 73d Cong., 2d sess., p. 21) in “an increasing amount of capital going into the purchase of annuities, with the result that income taxes are postponed indefinitely.” To remedy that situation section 22 (b) (2) was enacted, placing “the return of this form of investment on the same basis as other forms of investment by taxing that portion of each payment which in fact constitutes income.” (Ways and Means Committee report, supra. See also Eeport of Finance Committee, No. 558, 73d Cong., 2d sess., p. 23.) The same Congress enacted section 22 (b) (1), providing that “Amounts received under a life insurance contract paid by reason of the death of the insured, whether in a single sum or otherwise, (shall be exempt from taxation); but if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income.” The report of the Finance Committee, supra, states that this section “makes it clear that the proceeds of a life insurance policy payable by reason of the death of the insured in the form of an annuity are not includible in gross income.”

An annuity has been defined to be “an allowance or payment from the income of a fund at specific periods and during a prescribed term”; Continental Illinois Bank & Trust Co. v. Blair, 45 Fed. (2d) 345; “the obligation by a person or company to pay to the annuitant a certain sum of money at stated times during life or a stated number of years in consideration of a gross sum paid for such obligation.” Security Trust & Smings Bank, Trustee, 11 B. T. A. 833, 835. “Payments to annuitants are, in fact, based upon mortality tables which purport to reflect a rate of return sufficient to enable the annuitant to recover his cost, and in addition thereto a low rate of return on his investment.” Eeport of Finance Committee, supra. This was the concept of Congress when the Senate concurred in the House Bill, which, as pointed out in the Eeport of the Finance Committee, “continues the policy of permitting the annuitant to recoup his original cost tax-free but requires him to include in his gross income a portion of the annual payments in an amount equal to 3 percent of the cost of the annuity.”

We are of the opinion that Congress clearly had the power to enact the legislation and that in doing so it did not act arbitrarily. It is perhaps not inaccurate to say that such enactment merely gave legislative sanction to a rule frequently applied in tax cases, i. e., that an amount received may be, and frequently is, in part a return of capital and in part gain, in which event only the part which is gain is taxable. Cf. Guaranty Trust Co. of New York, Executor, 15 B. T. A. 20, 25. Although the 3 percent specified in the act may not be the exact amount which will, in every instance, be realized as income, it is no doubt as close an approximation as can be made. In any event it is not so grossly out of line as to justify a conclusion that it was “arbitrarily” fixed. We conclude and hold that the section is not unconstitutional.

Petitioner emphasizes the fact that the value of the annuity in the instant proceeding was included in the estate of the donor, Edward T. Bedford, and subjected to Federal estate tax. It argues that it therefore constitutes, under the tax law, a part of the donor’s gross estate and, for the purposes of taxation, must be deemed to be a bequest to Mary A. Bedford. The fact that the value of the annuity was included in the gross estate of the deceased husband is, in our opinion, immaterial. It was included because he, prior to his death, had made a gift in contemplation of death which was a substitute for testamentary disposition. The fact that it was thus treated for estate tax purposes does not make the total amount received by the wife a bequest though it is true that a portion of it falls within this classification. While the contracts were not introduced in evidence, apparently as a result of the husband’s investment of $280,583 the wife and children acquired the right to receive over a period of years amounts which eventually would exceed the amount invested. If the husband had filed a gift tax return at the time the gift was made, the amount includible therein would have been the then present worth of the right to receive the payments over the period of years specified in the contract. This, in all probability, would not have exceeded the cost of the contracts, even though a larger amount would ultimately be paid by the insurance company to the annuitants. The difference, or the excess over the amount paid in, is interest paid by the insurance company for the use of the amount invested. If Mary A. Bedford and her children — donee-annuitants—include: within their gross income the interest to be received upon the sum invested by the deceased husband and father for their benefit, they will receive the principal sum tax-free as provided in section 22 (b) (3) ; but if the interest upon the amount is not included in their gross income it entirely escapes taxation. This result was never contemplated by Congress when it enacted section 22 (b) (3), supra. The section, it will be noted, specifically requires that the income from property received as a gift, bequest, devise, or inheritance must be reported for taxation. A careful analysis of the three sections discloses that Congress had the same thought in mind in enacting each — in effect to permit the receipt of the insurance, gift, or principal of an annuity without tax, but to tax the amount received as income. There is nothing in the legislative history to indicate that Congress intended to place the recipient of an annuity in any more favorable position than the donee of a gift, who realizes income through its investment, or than one who, being entitled to receive insurance upon the life of another, chooses to allow it to be held by the insurer under an agreement to pay interest.

We have not overlooked petitioner’s argument based upon Burnet v. Whitehouse, 288 U. S. 148, and Helvering v. Pardee, 290 U. S. 365. In the former the will of a deceased husband had provided for the payment to his wife of a definite sum annually, “payable at all events during each year so long as she should live.” The court distinguished the case upon its facts from Irwin v. Gavit, 268 U. S. 161, in which payments were to be made out of income, and upheld this Board in its determination that the payments were bequests and exempt from the income tax. Helvering v. Butterworth, 290 U. S. 365, held that the election by a widow to accept the benefits of a will rather than to take under the state statutes of descent and distribution did not constitute the purchase by her of an annuity. Helvering v. Pardee applied the rule of the other two cases and held (1) that the widow’s election to accept the annuity granted by her husband’s will did not constitute the purchase by her of an annuity and (2) that she was not subject to tax upon the amounts, since “her claim was payable without regard to income received by the fiduciary.” Cf. Mary Ink, 35 B. T. A. 846.

It should be borne in mind that the cited cases do not exempt income from taxation. As the Supreme Court pointed out in the Butterworth case, “The evident general purpose of the statute was to tax in some way the whole income of all trust estates” and “Congress did not intend any income from a trust should escape taxation unless definitely exempted.” The issue was whether the amount admittedly received was taxable to the recipient as income distributable to her (see sec. 162, Revenue Act of 1934 and corresponding section of earlier acts), as a result of which the fiduciary was entitled to credit against the tax otherwise payable by it upon the “net income of the estate or trust”, or whether it was taxable to the fiduciary as its income. Under the facts before us there is no “estate or trust” to be taxed upon the income received from the insurance company as interest. Unless it is included in the gross income of the one who receives it, it escapes taxation altogether.

It may well be that Congress’ desire to avoid any such result motivated it in the enactment of the legislation in question. However that may be, the section seems to require the taxation of the portion of the annuity which the respondent has included in decedent’s income.

Judgment will be entered for the respondent.

       SEC. 42. PERIOD IN WHICH ITEMS OP GROSS INCOME INCLÜDED.
      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. In the case of the death of a taxpayer there shall be included in computing net income for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly includible in respect of such period or a prior period.

       (2) * * * Amounts received as an annuity under an annuity or endowment contract shall be included in gross income; except that there shall be excluded from gross income the excess of the amount received in the taxable year over an amount equal to three per centum of the aggregate premiums or consideration paid for such annuity (whether or not paid during such year), until the aggregate amount excluded from gross income under this title or prior income tax laws in respect of such annuity equals the aggregate premiums or consideration paid for such annuity. * * *

       Akt. 22 (b) (2)-2. Annuities. — Amounts received as an annuity under an annuity or endowment contract include amounts received in periodical installments, whether annually, semiannually, quarterly, monthly, or otherwise, and whether for a fixed period, such as a term of years, or for an indefinite period, such as for life, or for life and a guaranteed fixed period, and which installments are payable or may be payable over a period longer than one year. If an annuity is payable in annual installments, there shall be included in gross income only such portion of the amounts received in any taxable year as is equal to 3 percent of the aggregate premiums or consideration paid for such annuity, whether or not paid during such year. If an annuity is payable in two or more installments over each 12-month period, such portion of each installment shall be taxable as is equal to 3 percent of the aggregate premiums or consideration paid for such annuity, whether or not paid during the taxable year, divided by the number of installments payable during such year. As soon as the aggregate of the amounts received and excluded from gross income equals the aggregate premiums or consideration paid for such annuity, the entire amount received thereafter in each taxable year must be included in gross income. * * *

       (b) Exclusions from Gross Income. — The following items shall not be included in gross income and shall be exempt from taxation under this title :

      (3) Gifts, Bequests, and Devises. — The value of property acquired by gift, bequest, devise, or inheritance (but the income from such property shall be included in gross income).


author: Murdock:

text:
    Queen Insurance Company of America, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92996.
    Promulgated August 18, 1939.

      John 8. Breokinridge, Esg., for the petitioner.

      B. M. Brodsky, Esg., for the respondent.
   OPINION.

Murdock:

The Commissioner determined a deficiency of $4,656.36 in the income tax of the petitioner for 1934. He allowed a deduction of $5,398.68 for “Canadian premium taxes” and a credit of $1,519.11 under section 131 (a) (1) of the Revenue Act of 1934 for Canadian income taxes. The petitioner claims that the entire amount paid as taxes to the Dominion of Canada, $6,924.05, should be allowed as a credit. The parties have filed a stipulation settling a number of other issues and stating the facts relating to the single issue left for decision. The stipulation of facts is adopted as the findings of fact.

The petitioner is a domestic stock insurance company transacting a fire and marine insurance business in the United States and Canada. It incurred and paid tax liabilities in Canada for 1934 under part III of the Special War Revenue Act of 1915, as amended, and the Income War Tax Act of 1917, as amended. The actual amount paid under the former was $5,404.94, representing 1 percent of the net premiums received in 1934 on insurance in Canada. The actual amount paid under the Income War Tax Act was $1,519.11. That law imposed a tax of 13% percent upon the net income of the petitioner in Canada. Its net income, computed in accordance with the act, was $51,289.23, and the tax at 13% percent was $6,924.05. But the Income War Tax Act further provided in section 7 that:

A taxpayer shall be entitled to deduct from the tax that otherwise would be payable by him under this Act, the amount paid for corresponding periods under the provisions of Parts II and III of the Special War Revenue Act.

Since the petitioner had paid $5,404.94 for the corresponding period (1934) under the provisions of part III of the Special War Revenue Act, that amount was deducted from the tax liability under the Income War Tax Act and only the excess of the liability over the amount already paid was required to discharge the full tax liability of the petitioner.

The Revenue Act of 1934 provides, in section 131 (a) (1), that “the tax imposed by this section shall be credited with:

Citizen and domestic cokpobation. — In the case of a citizen of the United States and of a domestic corporation, the amount of any income, war-profits, and excess-profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States.

The respondent concedes that the Income War Tax Act of Canada imposes an income tax and the payment of $1,519.11 was a payment of an income tax within the meaning of section 131 (a) (1). He has allowed that amount as a credit. The point which he attempts to make is that the payment of $5,404.94 was not an income tax payment, but an excise tax payment under the Special War Revenue Act, and, therefore, not a proper credit under section 131 (a) (1). His counsel has obviously spent a great deal of time and thought in preparing a lengthy brief on the point that the Canadian tax on insurance premiums under the Special War Revenue Act is an excise tax rather than an income tax. The petitioner says that this argument is beside the point, since the petitioner concedes that it would not be entitled to any additional credit if the payment of $5,404.94 had “merely satisfied and discharged its premium tax liability.” The contention of the petitioner is that the payment of $5,404.94 constituted a payment of income tax by reason of the provision of section 7 of the Income War Tax Act. The respondent has not met this argument.

Although the Commissioner has heretofore conceded that the Canadian tax on insurance premiums is an income tax, United States Fidelity & Guaranty Co., 5 B. T. A. 23, nevertheless, we shall assume for the purpose of this discussion that the premium tax, standing alone, is an excise tax. The payments in question were made, in the first place, to discharge liability for that tax. But they also served another purpose, since they served to discharge the liability of the petitioner for Canadian income tax. Under such circumstances, did they represent merely a payment of premium taxes, or did they represent also a payment of income taxes within the meaning of section 131 (a) (1) % “The primary design of the provision was to mitigate the evil of double taxation” and a further purpose in the case of domestic corporations was “to facilitate their foreign enterprises.” Burnet v. Chicago Portrait Co., 285 U. S. 17. Any such provision should be interpreted “so as to achieve, and not defeat, its aim.” Idem.

Section 131 (a) (1) does not require that the payments shall be made direct and in cash before they can be credited. The entire provision of section 7 of the Canadian Act and its effect must be considered and not merely the words “deduct from the tax.” The income tax liability of the petitioner in Canada for 1934 was $6,924.05, and it paid that exact amount of tax. It would have paid the same amount had there been no Special War Revenue Act or had the petitioner been a life insurance or a noninsurance company not subject to any tax on premiums. The obvious effect of the two acts, if not the purpose, was to tax insurance companies either upon premiums or income, whichever would result in the greater tax, but to require no duplication in payment of the two taxes. In other words, any amount paid would discharge a like amount of liability under both acts to the extent of such liability. Words need not be stretched to say that in fact this petitioner paid and discharged an income tax liability to Canada in the amount of $6,924.05, within the meaning of section 131 (a) (1). The method provided by the Canadian laws resulted in “the substantial equivalent of payment of the tax” of 13% percent on income. Cf. Biddle v. Commissioner, 302 U. S. 573. Such an interpretation carries out the intent of Congress and leads to no unintended benefits. The result of the interpretation urged by the respondent would be that a life insurance company or a noninsurance company with income exactly equal to that of the petitioner would pay exactly the same amount of tax to Canada (all under the Income War Tax Act) but its income tax in this country would be credited with $6,924.05, whereas the tax of this petitioner in this country would be credited with only $1,519.11. Congress could have had no reason or desire for such partiality and the provision should not be interpreted to bring about that result unless no other reasonable interpretation of the words is possible. Fortunately, they permit the more reasonable interpretation which we have adopted. No contention is made that the limitation of section 131 (b) has any effect in this particular case.

Decision will be entered wnder Rule SO.