author: Kern:

text:
    Sterling Morton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91705.
    Promulgated December 6, 1938.

      Robert V. Jones, Esq., for the petitioner.

      Gcmroll Walker, Esq., for the respondent.
   OPINION.

Kern:

This proceeding involves that part of a deficiency in the sum of $18,190.45 determined by respondent in petitioner’s income tax liability for the year 1933 arising by reason of (1) respondent’s, disallowance of a deduction claimed by petitioner in the sum of $796.94 representing interest paid by him on an obligation of the 1260 Astor Street Building Syndicate, (2) respondent’s disallowance of a deduction claimed by petitioner on the ground that his investment in the 1242 Lake Shore Drive Syndicate became worthless in the taxable year, and (3) respondent’s inclusion in petitioner’s gross income of the income of certain trusts. Thus, there are three issues presented in this proceeding. The first two, i. e., the issue involving the deductibility of interest payments and the issue, involving the loss claimed by petitioner by reason of his investment in the 1242 Lake Shore Drive Syndicate, involve facts practically identical with the facts presented on similar issues in Sterling Morton, 38 B. T. A. 1270, covering petitioner’s income tax liability for the year 1932.

With regard to the first issue, the facts were stipulated. With regard to the second issue, most of the facts were stipulated, but there was also introduced at the hearing of this proceeding certain evidence which, by agreement of the parties, was also to be considered in disposing of the similar issue in Sterling Morton, supra. We adopt the facts stipulated by the parties as our findings herein, and with regard to the facts involved in the second issue and not covered by the stipulation, our findings will be the same as made by us in the similar issue involved in Sterling Morton, supra. For the reasons set out in that proceeding, we decide on the first issue for the petitioner and on the second issue for the respondent.

Upon the third issue presented by this proceeding, the facts have also been stipulated and we adopt them as our findings. They may be summarized as follows:

Under date of January 3,1933, the petitioner and the Chicago Title & Trust Co. executed an agreement whereby the petitioner created a trust identified in the records of the Chicago Title & Trust Co. as No. 30121. By this trust agreement petitioner endowed the trust with certain income-bearing securities and provided that the income therefrom should be accumulated during the continuance of the trust. There was reserved to the grantor (petitioner) the right to terminate the trust by giving a memorandum to the trustee of his intention to do so in one year, and another memorandum in the succeeding year, in which latter year the trust would terminate. The trustee was given the right to terminate the trust at any time. The trust, by the terms of its creation, would terminate upon the death of the grantor. Upon termination of the trust the accumulated income and all investments of such income were to be transferred by the trustee to grantor’s daughter, Suzette Morton. All the remainder and residue, consisting of the original endowments made by the petitioner, were to be returned to the grantor, or, if he were not then alive, to certain persons named in the trust instrument.

During the year 1933 the Chicago Title & Trust Co., acting under the agreement dated January 3,1933, identified as No. 30121, received income as follows: Tax-free covenant bond interest, $320; interest, $8,270.93.

On December 31,1929, petitioner and the Chicago Title & Trust Co. executed an agreement whereby petitioner created a trust identified in the records of the Trust Co. as No. 24299, to which petitioner transferred certain securities. The provisions of the trust instrument, while differing in minor respects from the provisions of the trust instrument in trust No. 30121, which we have just described, were, to a great extent, similar and may be treated for the purposes of our discussion as identical. The income of this trust during 1933 consisted of interest received in the sum of $5,771.15.

On December 31,1928, Joy Morton, father of the petitioner, created a trust by agreement with the Chicago Title & Trust Co., identified as trust No. 22146. The original trust agreement provided that the net income of the trust was to be accumulated until the termination date. When the trust was terminated the trustee was to convey the principal and undistributed income of the trust to the administrator or executor of the Joy Morton estate. These provisions of the trust were made subject to sections 2 and 3 of article V of the trust agreement, which provided as follows:

2. The Donor may, at any time, by a memorándum in writing signed by the Donor and delivered to the Trustee during the lifetime of the Donor, modify and amend this Trust Agreement so that; (a) all or any part of the net income of the trust herein created shall be paid to Joan Morton Gudahy, a daughter of the Donor and/or Sterling Morton, son of the Donor, and/or Margaret Morton, wife of the Donor, and/or their heirs and/or testamentary appointees and/or any one or more of the foregoing persons; or (b) all or any part of the net income of the trust herein created shall be accumulated for the benefit of any one or more of the persons above in clause (a) of this paragraph referred to; or (e) all or any part of the principal and undistributed income of the trust herein created shall be distributed by the Trustee on the termination, as herein provided, of the trust herein created, to any one or more of the persons above in clause (a) of this paragraph named or referred to; or (d) the trust herein created and/or as modified and amended in accordance with the terms of this paragraph shall continue for a period of twenty-one (21) years after the death of the Donor or for any period less than twenty-one (21) years.
3. Except as above in this Article V hereof provided, the trust herein created shall be irrevocable.

On January 26,1931, Joy Morton, under the powers reserved in the agreement of trust No. 22146, modified the same to provide that one-third of the income of the trust should be paid to Sterling Morton, the petitioner, one-third to his daughter, and one-third to his wife. It was further modified and amended to provide that the trust should not terminate until 21 years after the death of the donor.

That part of the income from the Joy Morton trust which was payable to petitioner for the year 1933 was as follows:

Tax-free covenant bond interest_ $200.00

Dividends- 7,500. 00

Interest_7,945.78

Under date of January 3,1933, the petitioner and the Chicago Title & Trust Co. executed an agreement whereby the petitioner created a trust identified in the records of the Chicago Title <& Trust Co. as No. 30122. By this instrument the petitioner sold, conveyed, assigned, transferred, and delivered to the Chicago Title & Trust Co. all the right, title, and interest of the grantor derived from and held under the Joy Morton trust No. 22146. The trustee was given large powers as to the control and management of the income and the manner in which it should be invested. This trust was to terminate upon the death of the petitioner. There was, however, reserved to the grantor power to terminate the trust in any succeeding year after notice of his intention. Upon the termination of the trust, the trustee was to transfer all right, title, and interest in the Joy Morton trust No. 22146 to the grantor. The trustee could terminate the trust at any time.

All the income of this trust (No. 80122) “shall be accumulated by the trustee during the continuance of the trust herein created, all such accumulations to be part of the trust estate.” In this trust, as in the others involved herein, the grantor also reserved the power to direct the trustee to make any investments desirable to the grantor and to make loans with or without securities, which the grantor should direct it to make, to such persons as the grantor should designate, and there was also a provision that the trustee should not be responsible for the validity or value of any such investment or loan so made, or liable for any loss thereon. All the accumulated income of the trust upon termination was to be transferred to the petitioner’s wife, Sophia P. Morton.

The respondent contends that the incomes of the trusts created by petitioner and identified as trusts No. 24299, No. 30121, and No. 30122 are taxable to petitioner as the income from revocable trusts, pursuant to the provisions of section 166 of the Revenue Act of 1932, set out in the margin, because the corpus of the trusts would revert to petitioner upon termination of the trusts, and the power of termination was in the trustee who was a “person not having substantial adverse interest in the disposition of * * * the corpus * * Respondent further contends that the income of trust No. 30122 is taxable to petitioner because the income of that trust represented income to which petitioner was entitled pursuant to the terms of the Joy Morton trust No. 22146, and was not subject to a valid assignment by him to trust No. 30122.

The contentions of the petitioner are (1) that the trustee, having in each trust the power to terminate and thereby to revest the corpus in the petitioner, is a person having a substantially adverse interest, and therefore, the trusts are not revocable, (2) that the interest of petitioner under the Joy Morton trust No. 22146 was validly assignable by Mm to trust No. 30122, and (3) the income received by trust No. 30122 from the Joy Morton trust No. 22146 was not taxable to petitioner since it represented a part of the income of the Joy Morton trust No. 22146, all of which was taxable to the grantor thereof, Joy Morton, pursuant to the provisions of section 167 of the Revenue Act of 1932, set out in the margin.

With regard to the question as to whether the trustee is a person not having a substantially adverse interest within the meaning of section 166, we consider the discussion of the Supreme Court in Reinecke v. Smith, 289 U. S. 172, to indicate clearly the view of that tribunal to the effect that the trustee is a person who does not have a substantially adverse interest. The Court in that case points out that the trustee “owes no duty * * * to resist alteration or revocation of the trust”, but merely owes a duty “to protect the trust res, faithfully to administer it, and to distribute the income”, and therefore, so far as revocation is concerned, the trustee may be considered as “a stranger to the trust.” In the instant case, the trustee owes no duty to refrain from terminating the trust, but has the express right so to do.

Petitioner insists that, since the trustee is a corporate trustee which is paid for its services, it has, as a practical matter, an interest in the continuation of the trust which would make it a person having an interest substantially adverse to that of the petitioner with regard to any termination of the trust and consequent revesting of the corpus in petitioner. We are not impressed by tMs argument since, in Reinecke v. Smith, supra, one of the trustees was a corporation and that fact in no way affected the decision of the Court. Whatever might be the “practical” aspects of the matter, it is our conclusion that there is no duty, legal or equitable, on the part of the trustee to refrain from terminating the trusts, and thereby revesting the corpus in the petitioner, and, therefore, that the trustee is a person not having a substantially adverse interest within the meaning of section 166.

A large part of the arguments of both petitioner and respondent are addressed to the problems incident to the income of the trust identified as trust No. 30122. That trust was created by petitioner, who granted to the Chicago Title & Trust Co., as trustee, all of his right, title, and interest as beneficiary under the Joy Morton trust No. 22146, the income in trust No. 30122 to be accumulated by the trustee during petitioner’s life, or until the termination of the trust, and then paid to petitioner’s wife. As wTe have pointed out before, the trustee had the right to terminate the trust at any time, and upon its termination during petitioner’s life he became entitled to the corpus of the trust. The interest which petitioner had in and to the net income and the property of the Joy Morton trust No. 22146 might be defeated upon certain contingencies, but at the time petitioner created trust No. 30122, and during the taxable year these contingencies had not occurred.

Respondent contends that petitioner could not “make a valid assignment of income-producing property prior to the time his right to receive it became a reality.” In our opinion, however, petitioner was entitled, during his life, subject to certain contingencies, to a certain part of the net income of the property held in the Joy Morton trust No. 20146, and thus became the owner subject to a condition subsequent of an equitable interest in the corpus of the property. Such an interest is subject to a valid assignment. Blair v. Commissioner, 300 U. S. 5. It should be noted that that case involved the law of Illinois, and that the settlor, trustee, and beneficiaries of the two trusts subject to our consideration are citizens of Illinois, and that these trusts were created pursuant to its laws.

However, in view of our opinion that trust No. 30122 is a revocable trust within the meaning of section 166, the income therefrom must be held taxable to petitioner even though we conclude, as we have done, that the assignment of petitioner’s interest under the Joy Morton trust No. 22146 to the trustee in trust No. 30122 Avas valid, unless the other circumstances of the case require a different result.

Petitioner contends that the income received by trust No. 30122 from the Joy Morton trust No. 22146 is not taxable to petitioner, since it represented a part of the income of trust No. 22146, all of which was taxable to the grantor of that trust, Joy Morton, pursuant to the provisions of section 167 (a) (1) of the Revenue Act of 1932 set out in the margin (footnote No. 2, supra). This contention is predicated on the argument that either the income of that trust was to be accumulated for future distribution to the grantor, or the grantor had the power to so modify the trust instrument as to provide for the accumulation of the income of the trust for such future distribution. The original trust instrument executed by Joy Morton on December 31, 1928, did provide that the trustee was to accumulate the trust income and upon the termination of the trust was to pay over the accumulated income to the executor or administrator of the grantor. However, the trust instrument reserved the power to the grantor of modifying the trust in four possible respects. That section of the trust instrument has already been quoted.

Pursuant to this power of modification reserved to the grantor, he did modify the terms of the trust pursuant to the clauses of that section of the trust instrument quoted above which are designated as (a) and (b) therein. This modification was made under date of January 26, 1931, and thereafter, and during the taxable year, all of the net income of trust No. 22146 was payable and was paid by the trustee in equal parts to the son, daughter, and wife of the grantor, Joy Morton. No part of the net income of this trust was accumulated or could be accumulated for future distribution to the grantor pursuant to the trust instrument as modified. Therefore, if one looks at the trust instrument as modified, which sets out the rights of the grantor as they existed during the taxable year, it is apparent that section 167 would not be applicable and that the income of the trust would not be taxable to Joy Morton unless he had a right to modify the terms of the trust instrument in such a way that it again would provide for the accumulation of income for future distribution to him. We are of the opinion that he had no such right during the taxable year. The sole right of modification reserved to the grantor is set out in the section of the trust instrument which we have quoted, and is limited to the four possible modifications which it describes. Beyond these modes of modification the trust is expressly made irrevocable. Once having modified the trust instrument as the grantor did, there is no right given or reserved to the grantor by the trust instrument again to modify it in such a way as again to provide for accumulations of the net income of the trust for future distribution to him. Cf. Day v. Commissioner, 92 Fed. (2d) 179.

The fact that he could modify the trust instrument to provide for a different proportion in the distribution of the net income of the trust as between his daughter, son, and wife, even to the exclusion of any of them from its distribution, or to provide for an accumulation of the income for their benefit rather than a distribution, might well call for the inclusion of the corpus of the trust in computing the value of grantor’s estate for estate tax purposes, pursuant to section 302 (d) of the Revenue Act of 1926, set out in the margin, despite the fact that he could not revest the corpus or income in himself, cf. Porter v. Commissioner, 288 U. S. 436, but no such power of modification would be relevant to the question of whether the income of the trust was taxable to the grantor pursuant to section 167 of the Revenue Act of 1932.

Since there is no claim that the grantor had any right during the taxable year to revest in himself any part of the corpus of the trust, the case of Corliss v. Bowers, 281 U. S. 376, is not pertinent.

Petitioner, in his brief, states that respondent has asserted an income tax liability against Joy Morton for the year 1934 by reason of including in his gross income for that year the income of trust No. 22146. There is nothing in the record, however, concerning this claim on the part of respondent or its basis. Obviously, we can not consider this fact in this proceeding.

Upon this issue we find for the respondent.

Decision will he entered, v/nder Rule 50.

       SBC. 166. REVOCABLE TRUSTS.
      Where at any time during the taxable year the power to revest in the grantor title to any part of the corpus of the trust is vested—
      (1) in the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, or
      (2) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom,
      then the income of such part of the trust for such taxable year shall be included in computing the net income of the grantor.

       SEC. 167. INCOME FOR BENEFIT OF GRANTOR.
      (a) Where any part of the income of a trust—
      (1) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, held or accumulated for future distribution to the grantor; or
      (2) may, in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income, be distributed to the grantor; or
      (3) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, applied to the payment of premiums upon policies of insurance on the life of the grantor (except policies of insurance irrevocably payable for the purposes and in the manner specified in section 23 (n), relating to the so-called “charitable contribution” deduction) ;
      then such part of the income of the trust shall be included in computing the net income of the grantor.
      (b) As used in this section, the term “in the discretion of the grantor” means “in the discretion of the grantor, either alone or in conjunction -with any person not having a substantial adverse interest in the disposition of the part of the income in question.”

       Sec. 302. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
      *******
      (d) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power, either by the decedent alone or in conjunction with any person, to alter, amend, or revoke, or where the decedent relinquished any such power in contemplation of his death, except in case of a bona fide sale for an adequate and full consideration in money or money’s worth. The relinquishment of any such power not admitted or shown to have been in contemplation of the decedent’s death, made within two years prior to his death but after the enactment of this Act without such a consideration and affecting the interest or interests (whether arising from one or more transfers or the creation of one or more trusts) of any one beneficiary of a value or aggregate value, at the time of such death, in excess of $5,000, then, to the extent of such excess, such relinquishment or relinquishments shall be deemed and held to have been made in contemplation of death within the meaning of this title.


source: Caselaw Access Project

author: Sternhagen :

license: Public Domain

text:
    John Abbott, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91141.
    Promulgated December 6, 1938.

      Charles M. Rogerson, Esq., for the petitioner.

      Paul E. "Waring, Esq., for the respondent.
   OPINION.

Sternhagen :

From the findings, which are substantially a narrative of the evidence, it is beyond doubt that the petitioner’s regular business included serving for pay as a trustee and as an executor. In the course of this business and as an incident thereof he was required to pay $10,000 as a liability growing out of the conduct of the business. Clearly such circumstances of the payment support its deduction, and it should have been allowed. Kornhauser v. United States, 276 U. S. 145. Respondent cites Stuart v. Commissioner, 84 Fed. (2d) 368, and Stephen H. Tallman, 37 B. T. A. 1060, to support the dis-allowance ; but in both, the ground of the disallowance was that the particular occasion for the taxpayer’s payment was liability in an isolated fiduciary activity which was not itself or incidental to a trade or business regularly carried on. They are, therefore, unlike this case and distinguishable from it in crucial facts.

Since this item of deduction is the only adjustment upon which the deficiency rests, the determination is reversed.

Decision will be entered for the petitioner.


text:
    Joshua C. Kelley, Petitioner, v. Commissioner of Internal Revenue, Respondent. Herbert W. Kelley, Petitioner, v. Commissioner of Internal Revenue, Respondent. E. Florence Kelley, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 89876, 89877, 89878.
    Promulgated December 6, 1938.

      Joseph W. Worthen, Esq., and Erland B. Cooh, Esq., for the petitioners.

      Bernard, D. Daniels, Esq., and John E. Mahoney, Esq., for the respondent.
   OPINION.

Sternhagen :

The only question presented for decision is whether the partnership was entitled, as it claims, in computing its partnership income for 1935, to the deduction of the attorneys’ fee paid in that year for services in connection with the tax litigation in respect of deficiencies determined as to the predecessor trust for prior years. The partnership books and return were on an accrual basis, and it is clear that the obligation for the attorneys’ fee had not become fixed or determinable before 1935 and could not be said to have accrued prior to that year. The partnership itself retained the attorneys and was directly liable for their fee for services rendered to it. As petitioners say, the partnership was largely actuated to carry on the litigation by a desire to avoid a lien upon the assets acquired from the predecessor trust which might have been held liable for the tax. Thus the circumstances are sufficiently similar to call for the same decision as has been made in H. E. Bullock, 16 B. T. A. 451; Benjamin Paschal O’Neal, 18 B. T. A. 1036; Flemmon E. Gloyd, 19 B. T. A. 966; affirmed on another point, 63 Fed. (2d) 649; certiorari denied, 290 U. S. 633; Isabel G. Sproehnle, Executrix, et al., 20 B. T. A. 417; dismissed (C. C. A., 7th Cir.); and Fred T. Ley, 21 B. T. A. 216, wherein it was held that such attorneys’ fees are properly deductible as ordinary and necessary expenses of the successor taxpayer, notwithstanding that the subject matter of the litigation is the tax of the predecessor. The respondent cites F. Tinker & Sons Co., 1 B. T. A. 799; Athol Manufacturing Co., 22 B. T. A. 105; affd., 54 Fed. (2d) 230; Automatic Sprinkler Co. of America, 27 B. T. A. 160; Sigmund Spitzer, 23 B. T. A. 776; dismissed (C. C. A., 3d Cir.); and Caldwell & Co., 26 B. T. A. 790; affd., 65 Fed. (2d) 1012, but those cases all involved the right of the successor to deduct the amount of a predecessor’s liability which the successor had assumed. They did not involve the deductibility of the attorneys’ fees directly incurred by the successor for services in litigating such principal liabilities of the predecessor.

Following the precedents cited above, the Board holds that the partnership was entitled to deduct the $4,250 attorneys’ fee, and the Commissioner’s determination disallowing the deduction is reversed.

Decision will be entered wnder Bule 50.


author: Black :

text:
    A. D. Saenger, Petitioner, v. Commissioner of Internal Revenue, Respondent. Abraham D. Saenger, Petitioner, v. Commissioner of Internal Revenue, Respondent. Saengers, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 85631, 88079, 88080.
    Promulgated December 6, 1938.

      S. L. Devoid, Esq., for the petitioners.

      B. P. Hertzog, Esq., for the respondent.
   OPINION.

Black :

In view of the respondent’s concession in his brief that, due to the fact that Saengers, Inc., purchased all of the remaining assets of the Saenger Corporation at the sheriff’s sale for a full and adequate consideration, “there is no basis for holding Saengers Inc. liable for any portion of the deficiencies involved”, we need not discuss the errors assigned in that proceeding. The respondent’s determination in Docket No. 88080 is accordingly reversed.

In Docket No. 85631 petitioner A. D. Saenger contends that he is not liable as a transferee for any part of the $65,808.05 deficiency finally determined against A. D. Saenger, Inc., and that the Board should so decide.

In Docket No. 88019 petitioner Abraham D. Saenger (same person as A. D. Saenger) concedes that he is liable as a transferee for any deficiency that may finally be determined against A. and J., Inc., for the year 1931, but only to the extent, however, of the $54,041.57 transferred to him without consideration by the newly consolidated company, the Saenger Corporation, on January 4, 1934.

Although the respondent in Docket No. 85631 determined that petitioner was liable as transferee for a deficiency determined against A. D. Saenger, Inc., in the amount of $65,808.05, and although the respondent in Docket No. 88079 determined that petitioner was liable as transferee for a deficiency determined against A. and J., Inc., in the amount of $161,346.17, or a total transferee liability against petitioner of $227,154.22 for deficiencies determined against A. D. Saen-ger, Inc., and A. and J., Inc., the respondent in his brief now merely contends that in view of the fact that A. D. Saenger has only received assets having a net value of $54,047.57, “it is evident that A. D. Saenger should be held liable for the deficiencies of A. & J. Inc., and A. D. Saenger, Inc., to the extent of said sum of $54,047.57 and respondent requests the Board to so hold.”

It is therefore apparent that the only remaining difference between the parties involved in these proceedings is whether petitioner A. D. Saenger is liable as a transferee for any part of the $65,808.05 deficiency finally determined against A. D. Saenger, Inc. Since the petitioner in Docket No. 88079 concedes that he is liable for any deficiency that may finally be determined against A. and J., Inc., to the extent of $54,047.57, and since the respondent concedes that he is not entitled to collect any more than $54,047.57 on account of the total deficiencies of $227,154.22 determined against A. D. Saenger, Inc., and A. and J., Inc., the question of whether A. D. Saenger is liable as a transferee for any part of the $65,808.05 deficiency finally determined against A. D. Saenger, Inc., would be a moot question except for the fact that the deficiency of $161,346.17 against A. and J., Inc., for the year 1931 determined by the respondent and approved by this Board has not yet become final. On the other hand, if A. D. Saenger is liable as a transferee to the extent of $54,047.57 on account of the deficiency of $65,808.05 finally determined against A. D. Saenger, Inc., the question of the correctness of our decision in the proceedings of A. and J., Inc., Docket No. 80815 would likewise become moot for the reason that the respondent concedes that he is not entitled to collect any more than $54,047.57 on account of the total deficiencies he has determined against A. D. Saenger, Inc., and A. and J., Inc., for the years 1929 and 1931, respectively.

The respondent in Docket No. 85631 determined that A. D. Saenger was liable to the extent of $65,808.05, plus interest, as a transferee of assets of A. D. Saenger, Inc. This determination was grounded upon the transfer of all of the assets of A. D. Saenger, Inc., to the Saenger Corporation on August 16, 1932, and a simultaneous receipt by petitioner of all of the capital stock, except qualifying shares, of the Saenger Corporation, thus leaving A. D. Saenger, Inc., without any assets to pay its $65,808.05 liability for taxes due the United States. In making this determination the respondent was evidently relying upon such cases as Woodley Petroleum Co., 16 B. T. A. 253, 263; E. H. Dobrin, 27 B. T. A. 611; and Homer S. Warren et al., Administrators, 31 B. T. A. 1041. But regardless of the basis for the respondent’s determination he now contends that A. D. Saenger is liable in Docket No. 85631 as well as in Docket No. 88079 as a transferee of property of Saenger Corporation to the extent of the $54,047.57 received by him from that corporation without consideration on January 4, 1934, and apparently he relies upon no other ground.

As far as Docket No. 85631 is concerned, petitioner has limited his discussion in his brief to the contention that he did not become liable as a transferee of property of A. D. Saenger, Inc., by reason of the consolidation which took place on August 16, 1932. He argues this point in his brief as follows:

The documentary evidence shows that on August 16, 1932, the three corporations were consolidated. At that date A. D. Saenger, the present petitioner, owned all the stock of A. D. Saenger, Inc., and of J. H. Saenger, Ine. As a result of the merger, [sic] he owned all of the stock of the consolidated corporation, which was given the name and style of Saenger Corporation. No assets whatever were transferred to him in this reorganization. He owned all of the stock in A. D. Saenger, Ine., and J. H. Saenger, Ine., respectively. These two corporations owned all of the stock of A. & J. Inc. The result of the consolidation was that A. D. Saenger then owned all of the stock of Saenger Corporation, which was nothing but A. & J. Inc., with a new name. He received no assets of any kind or character; he was in no different position, so far as respected assets,’ from that which he occupied at the moment prior to the reorganization. He simply changed his position from that of a stockholder in the holding company to a stockholder in the operating company. By the simplification of the corporate structure he simply put himself one step nearer immediate and direct ownership. In no sense could it be said that he was a transferee.

The consolidation in question was consummated under the provisions of sections 47 to 51, inclusive, of Act 250 of the Legislature of Louisiana of 1928 (secs. 1127 to 1131, inclusive, ch. I, title XIV, Dart’s Louisiana General Statutes, 1932), the material parts of which we have set out in the margin. These provisions of the law of Louisiana relating to the consolidation of existing corporations are substantially the same as sections 7 to 11, inclusive, of the Business Corporation Law of the State of New York. Book 6, McKinney’s Consolidated Laws of New York. Section 11 of the New York law, just as section 1131 Y of the Louisiana law, provides that “such new corporation shall succeed to and be liable to pay and discharge all such debts and liabilities of each of the corporations consolidated in the same maimer as if such new corf oration had itself incurred the obligation or liability * * (Italics supplied.) In Oswego Falls Corporation, 26 B. T. A. 60; affd., 71 Fed. (2d) 673, we considered the effect of section 11 of the New York law and held that the newly organized consolidated corporation was directly and primarily liable for the deficiencies in tax, if any, of its components as taxpayer, and that it was not secondarily liable as a transferee of the assets of its consolidating corporations. Cf. United States v. Oswego Falls Corporation (Not reported.); Bowman Hotel Corporation, 24 B. T. A. 1193. We think the same principles are applicable in the instant proceedings and that under section 1131 V of the Louisiana law, the Saenger Corporation became directly and primarily liable as a taxpayer rather than as a transferee for the deficiency of $65,-808.05 determined against A. D. Saenger, Inc., as well as for the deficiency of $161,346.17 determined against A. and J., Inc.

On January 4,1934, the Saenger Corporation still owed the United States $223,404.22, exclusive of interest, on account of the two deficiencies determined against two of its consolidating corporations. Without paying any part of this liability, it distributed to petitioner A. D. Saenger without consideration assets having a net value of $54,047.57. At that time the balance of its assets, with the possible exception of $23,012.21, was in the official possession of the sheriff of Caddo Parish, who had seized them to satisfy a judgment obtained against the Saenger Corporation for $64,271.33. On January 10, 1934, the Saenger Corporation transferred the remaining assets of $23,012.21 to the Saranac Investment Corporation, all the stock of which was in the official possession of the sheriff on January 4, 1934, when the $54,047.57 was transfei'red to petitioner. The assets in the possession of the sheriff were sold on January 17,1934, for an amount insufficient to satisfy the judgment and the existing mortgages. Thereafter the Saenger Corporation was without any assets. Upon these facts petitioner A. D. Saenger concedes that he is liable as a transferee of assets of the Saenger Corporation to the extent of $54,-047.57, providing it is finally determined that the $161,346.17 deficiency against A. and J., Inc., is correct. It is our opinion, however, and we hold accordingly, that the petitioner A. D. Saenger is liable as a transferee of assets of the Saenger Corporation to the extent of $54,047.57 in any event for the reason that, as expressed above, the Saenger Corporation became directly and primarily liable as a taxpayer for the full deficiency of $65,808.05 that has been finally determined against A. D. Saenger, Inc., as well as for the full deficiency of $161,346.17 which we have recently approved against A. and J., Inc. The Saenger Corporation’s liability for each of these deficiencies is primary and not secondary. Cf. Oswego Falls Corporation, supra.

In Docket No. 85631 the respondent is entitled to a decision holding petitioner liable as a transferee of assets of the Saenger Corporation to the extent of $54,047.57 plus interest thereon provided by law from January 4, 1934, with the provision, however, that, if and when petitioner pays any part of the liability of $54,047.57 in Docket No. 88079, the liability in Docket No. 85631 will be reduced pro tanto. Cf. Henry Cappellini, 16 B. T. A. 802. In Docket No. 88079 the respondent is entitled to a decision holding petitioner liable as a transferee of assets of the Saenger Corporation to the extent of $54,047.57, plus interest thereon provided by law from January 4, 1934, with the provision, however, that, if and when petitioner pays any part of the liability of $54,047.57 in Docket No. 85631, the liability in Docket No. 88079 will be reduced pro tanto. In Docket No. 88080 there is no transferee liability.

In Dochet No. 88080 decision will be entered that there is no liability• as transferee. In Docket Nos. 85681 and 88079 decision will be entered as directed in the last paragraph of the foregoing opinion.

       1127. Merger and Consolidation.
      X. Any two or more domestic corporations formed for the purpose of carrying on the same or similar business * * * may be
      (a) merged into one of such domestic corporations, or
      (b) consolidated into a new corporation to be formed under this act * * *.
      1128. Merger or Consolidation — Joint Agreement. The merger or consolidation of corporations can be effected only as a result of a joint agreement entered into and filed as follows * * * [not necessary to set out in detail here].
      *******
      1131. Effect of Merger or Consolidation, upon the consummation of the merger or consolidation as provided in the last preceding section, the effect of such merger or consolidation shall be that:
      I. The several parties to the joint agreement shall be one corporation, which shall be
      (a) in the case of merger, that one of the constituent corporations into which it has been agreed the others shall be merged and which shall survive the merger for that purpose, or
      (b) in the case of consolidation, the new corporation into which it has been agreed the others shall be consolidated ;
      II. The separate existence of the constituent corporations shall cease, except that of the surviving corporation in the case of merger.
      III. The surviving or new corporation, as the case may be, shall possess all the rights, privileges and franchises possessed by each of the former corporations so merged or consolidated except that such surviving or new corporation shall not thereby acquire authority to engage in any business or exercise any right which a corporation may not be formed under this act to engage in or exercise.
      IV. All of the property of whatsoever hind or description of each of the constituent corporations, and all debts due on whatever account to any of them, including subscriptions for shares and' other choses in action belonging to any of them shall be taken and be deemed to be transferred to and invested in such surviving or new corporation, as the case may be, without further act or deed.
      V. The surviving or new corporation shall be responsible for all the liabilities and obligations of each of the corporations merged or consolidated, in the same manner as if such surviving or new corporation had itself incurred such liabilities or obligations; but the liabilities of such constituent corporations or of their shareholders, directors or officers shall not be affected, nor shall the rights of the creditors thereof or of any persons dealing with such corporations be impaired by such merger or consolidation, and any claim existing or action or proceeding pending by or against any of such constituent corporations may be prosecuted to judgment as if such merger or consolidation had not taken place, or the surviving or new corporation may be proceeded against or substituted in its place. [Acts 1928, No. 250, §51.]

       11. Bights of creditors of old corporations. — The rights of creditors of any corporation that shall be so consolidated shall not in any manner be impaired, nor any liability or obligation for the payment of any money due or to become due to any person or persons, or any claim or demand for any cause existing against any such corporation or against any stockholder thereof be released or impaired by any such consolidation; but such new corporation shall succeed to and be held liable to pay and discharge all such debts and liabilities of each of the corporations consolidated in the same manner as if such new corporation had itself incurred the obligation or liability to pay such debt or damages and the stockholders of the respective corporations consolidated shall continue, subject to all the liabilities, claims and demands existing against them as such, at or before the consolidation; and no action or proceeding then pending before any court or tribunal in which any corporation that may be so consolidated is a party, or in which any such stockholder is a party, shall abate or be discontinued by reason of such consolidation, but may be prosecuted to final judgment, as though no consolidation had been entered into; or such new corporation may be substituted as a party in place of any corporation so consolidated, by order of the court ⅛ which such action or proceeding may be pending.


author: Txson:

text:
    Rocky Mountain Development Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 83849.
    Promulgated December 6, 1938.

      Harry O. Weeks, Esq., for tbe petitioner.

      John H. Pigg, Esq., for the respondent.
   OPINION.

Txson:

For the calendar year 1933 the respondent determined a deficiency of $1,374.23 in income tax and of $215.09 in excess profits tax.

The errors assigned by petitioner are:

(1) That respondent erred in his method of determining petitioner’s taxable income received from certain “oil payments.”

(2) That respondent erred in failing to allow depletion with respect to sums received from “oil payments.”

(3) That respondent erred in determining that petitioner was liable for any excess profits tax.

The respondent admits the petitioner’s first assignment of error, denies petitioner’s second and third assignments, and affirmatively alleges that he erred in not determining that petitioner derived gross income from “oil payments” during 1933 in the amount of $18,927.23; that from such gross income petitioner is entitled to a deduction for depletion in the amount of $6,552.66; and that petitioner derived and/or realized a net income from “oil payments” and/or from the property during 1933 in the amount of $12,374.67.

The respondent also affirmatively alleges that there are additional deficiencies in income and excess profits taxes in the respective amounts of $238.95 and $86.89 and that the correct deficiencies in controversy in this proceeding are $1,613.18 in income tax and $301.98 in excess profits tax and prays that the Board redetermine the deficiencies to be in such increased amounts for the year 1933.

In its reply the petitioner denies each of the respondent’s affirmative allegations of his own error and also the latter’s allegation as to additional income and excess profits taxes.

This proceeding has been submitted upon the pleadings and a stipulation of facts which is incorporated herein by reference. Only such parts thereof as are deemed necessary to decision are set out herein.

The petitioner, a Texas corporation, organized in 1932, is engaged in the business of exchanging oil well equipment for stipulated amounts to be paid from portions of the oil produced from the property upon which the exchanged equipment is to be installed. Such payments were contingent and receivable by petitioner only as, if, and when oil was produced and saved from such property.

In pursuing such business, and by such method, petitioner acquired, during 1932 and 1933, 11 of the 13 oil payment contracts here involved and acquired the other two contracts from its incorporators through the issuance to them of all its capital stock. The cost to the incorporators of each of the two contracts was the actual cost, to them, of oil equipment exchanged therefor.

The parties are in agreement as to the petitioner’s cost basis, which in each of the 13 contracts is the actual cost of the oil equipment exchanged therefor. The stipulation sets forth a tabulation which shows as to each of the 13 oil payment contracts acquired during 1932 and 1933 (A) the lease to which the oil payment contract applied, (B) the gross amount of the oil payment contract, (C) the cost to petitioner, or its incorporators, of the equipment exchanged, and (D) the amounts of the payments received (collected) by petitioner during each of the years 1932 and 1933.

In determining the deficiencies in income and excess profits tax as shown in the deficiency notice the respondent included in income the excess of the fair market value of the oil payment contracts acquired in 1933 as determined by him, over the cost thereof to petitioner, and added thereto the total oil payments received in 1933 less the portion of such payments determined by the respondent to represent a return of cost to petitioner.

The respondent now contends that the total amount of oil payments received (collected) by petitioner on all of its contracts during 1933 should be included in gross income and that on such amount the petitioner is entitled to a deduction for depletion measured either by cost depletion or percentage depletion, whichever is the greater.

The petitioner contends that the oil payments received should first be applied to the recoupment of cost, that only the excess of such payments over cost should be included in income, and that upon such latter amount it is entitled to depletion at the rate of 27½ percent.

Upon authority of Cook Drilling Co., 38 B. T. A. 291, we hold that the respondent erred in his determination that for 1933 the petitioner realized a taxable gain in an amount computed by the respondent as representing the difference between the cost of the oil payment contracts acquired in 1933 and his determined fair market value of such contracts when acquired and, further, in adding thereto the total oil payments received in 1933 less the portion of such payments determined by respondent to represent a return of cost to petitioner.

The oil payment contracts acquired during 1932 and 1933 by petitioner, in exchange for oil well equipment, provided for contingent future payments out of the proceeds of oil if, as, and when produced and saved from the properties to which those contracts applied. The petitioner’s right to receive such future oil payments and thus recoup its cost and realize taxable profits, if any, was wholly contingent upon the happening of future events which, because indeterminable, might never occur. The consideration received by petitioner for its sales of equipment during 1932 and 1933, being the right to receive such contingent oil payments, was not the equivalent of cash because the promise to make such oil payments had no definitely ascertainable fair market value. The transactions were not closed in either of those years and the gain or loss on them could not have been then ascertained with any degree of certainty. As to each of its oil payment contracts, the petitioner was entitled to recover the cost thereof before being chargeable with any taxable gain thereon. Burnet v. Logan, 283 U. S. 404; Commissioner v. Speyer, 77 Fed. (2d) 824, affirming James Speyer, 30 B. T. A. 517; Teck Hobbs, 26 B. T. A. 241; and E. F. Simms, 28 B. T. A. 988. We hold that, for the purpose of determining the petitioner’s taxable gain from all of its various oil payment contracts during the taxable year 1933, the payments actually received (collected) by petitioner during that year under each contract, respectively, must first be applied to petitioner’s recoupment of its cost of each contract, respectively, and, further, that any excess of such payments received on each contract during 1933 over the cost of such contract, respectively, must be included in petitioner’s gross income for that year.

The petitioner’s contention that it is entitled to a deduction for depletion at 27½ percent on the excess of payments received over the cost of its contracts must be denied. In Cook Drilling Co., supra, we said:

The statutory allowance for depletion is predicated upon the receipt of gross income from the operation of oil and gas wells, by one who has a capital investment in the oil and gas in place and may not be allowed to one who has no such capital investment but only an income derived from production, through a contractual relation or personal covenant with the owner of the mineral deposit. Helvering v. Bankline Oil Co., 303 U. S. 362; Helvering v. O’Donnell, 303 U. S. 370; Helvering v. Elbe Oil Land Development Co., 303 U. S. 372.

The petitioner’s oil payment contracts called only for certain payments out of oil in consideration for the equipment sold by the petitioner and did not grant or convey to petitioner an interest in the leases themselves or the oil and gas in place. The record does not disclose any assignments to petitioner of an interest in the oil and gas in place or the leases themselves. Consequently, neither prior to nor by reason of its acquisition of the oil payment contracts in question, did the petitioner own any interest in the oil and gas in place or the leases to which those contracts applied. Upon authority of Cook Drilling Co., supra, we hold that the petitioner is not entitled to depletion on that part of the oil payments received during the taxable years which was in excess of the cost to petitioner of its respective oil payment contracts.

The petitioner’s assignment of error as to its liability for excess profits tax merely relates to the amount of such tax, which, being dependent upon the redetermination of the correct amount of petitioner’s taxable income, if any, for the year in question, will be determined upon the recomputation under Bule 50.

Decision will he entered v/nder Bule 50.


author: Turner:

text:
    Elizabeth Earhart Kennedy, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88180.
    Promulgated December 6, 1938.

      James A. Kennedy, Esq., for the petitioner.

      Edward O. Adams, Esq., for the respondent.
   OPINION.

Turner:

Under the terms of the trust instrument the trustee was empowered to distribute to the petitioner during her lifetime such part of the ¡net income of the trust as he deemed necessary for her needs. She had no power to anticipate or alienate any income of the trust and she had no right to receive any of the corpus; of the trust. All income not distributed currently but accumulated by the trustee retained the status of surplus income and could be distributed by the trustee, in his discretion, to the petitioner at any time. Upon the petitioner’s death the corpus and the accumulated surplus income went to certain remaindermen.

Between January 1 and December 11, 1933, the trust realized net taxable income in the sum of $18,447.24 before deduction of any amount distributed to the beneficiary. Between December 12 and December 31, 1933, the trust realized net taxable income of $10,310.50 without the deduction of any amount paid to the beneficiary. Between January 1 and December 11,1933, the trustee distributed to the petitioner an amount substantially in excess of $28,757.74, the total of the two sums just described. No distribution was made by the trustee to the petitioner in 1933 subsequent to December 11, 1933. The net income realized by the trust in the year 1933 prior to December 11, together with the accumulated surplus income of prior years, was more than sufficient to cover all distributions made from the trust to the petitioner during that year.

The petitioner concedes that the trustee, in making a distribution, had to first exhaust the income of the trust realized during the current year up to the time of the distribution, but contends that after such income was exhausted further distributions came from accumulated income of prior years upon which the trust had already paid income taxes. The respondent contends that petitioner’s income from the trust must be computed on the basis of a full calendar year and that the income received by the trust during the calendar year subsequent to the last distribution was nevertheless in effect paid to the petitioner and must be included in computing her income under sections 162 (b) and (c) of the Bevenue Act of 1932. The pertinent provisions of the statute are set forth in the footnote.

The statutory provisions show that Congress contemplated the taxation of the entire net income of a trust, the tax to be paid in some cases by the fiduciary and in others by the beneficiary. If the income of the trust is to be distributed “currently” by the fiduciary to the beneficiary, such income is taxable to the beneficiary under section 162 (b) whether actually distributed or not. If the income may be either distributed to the beneficiary or accumulated, in the discretion of the fiduciary, such income “properly paid or credited” to the beneficiary is taxable to the beneficiary under section 162 (c), but if such income is accumulated it is taxable only to the fiduciary. Helvering v. Butterworth, 290 U. S. 365; Freuler v. Helvering, 291 U. S. 35. The only question we have to decide is whether the income realized by the trust during the calendar year subsequent to the last distribution was “properly paid or credited during such year” to the petitioner. We do not think it was. Since the petitioner had no power to anticipate or alienate any of the income of the trust, obviously she had no right to such income prior to its receipt by the trust, and obviously the trustee could not “properly” pay to or credit the petitioner with income before it was received. To do so would have constituted a violation of the trust. Since the trustee’s distributions during the calendar year more than exhausted the current income of the trust up to the time of the last distribution, additional distributions over and above such current income necessarily came out of surplus income accumulated from prior years upon which the trust has already paid income taxes. We think the income of the trust received during the calendar year subsequent to December 11, 1933, must be treated as accumulated in trust and taxable to the trustee under section 161 of the act. It is not taxable to the petitioner. Cf. Mason L. Dean, 35 B. T. A. 839.

The respondent has cited and relies upon Letts v. Commissioner, 84 Fed. (2d) 760, but that case is clearly distinguishable in that the income of that trust was “currently”distributable to trust beneficiaries and under section 162 (b) of the Revenue Act of 1932 such income was taxable to the beneficiaries whether distributed or not. In the present case the income was not distributable “currently” but was to be distributed in the discretion of the trustee. It is not governed by section 162 (b) but by section 162 (c), which provides that only that part of the income of the trust which is “properly paid or credited” to the beneficiary shall be included in computing the income of the beneficiary.

We therefore hold that "the respondent was in error in his determination that income of the trust received during the calendar year subsequent to the last distribution was income taxable to the petitioner as beneficiary of the trust.

Decision will loe entered wider Bule 50.

       SEC. 161. IMPOSITION OF TAX.
      (a) Application of Tax. — The taxes imposed by this title upon individuals shall apply to the income of estates or of any kind of property held in trust, including—
      (1) Income accumulated in trust for the benefit of unborn or unascertained persons or persons with contingent interests, and income accumulated or held for future distribution under the terms of the will or trust;
      (2) Income which is to be distributed currently by the fiduciary to the beneficiaries, and income collected by a guardian of an infant which is to be held or distributed as the court may direct;
      *******
      (4) Income which, in the discretion of the fiduciary, may be either distributed to the beneficiaries or accumulated.

        SEC. 162. NET INCOME.
      The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that—
      *******
      (b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. Any amount allowed as a deduction under this paragraph shall not be allowed as a deduction under subsection (c) of this section in the same or any succeeding taxable year;
      (c) In the case of income received by estates of deceased persons during the period of administration or settlement of the estate, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary or accumulated, there shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is properly paid or credited during such year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir, or beneficiary.


author: Turner :

text:
    Claude H. Stevens, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89430.
    Promulgated December 7, 1938.

      Claude H. Stevens, Esq., pro se.

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

Turner :

The petitioner contends that this compensation from the city of Highland Park was exempt from Federal income tax by reason of the constitutional limitation upon the power of the Federal Government to tax state instrumentalities. The respondent contends that the petitioner was not an “officer” or an “employee” of the city of Highland Park and for that reason the limitation referred to has no application. Regulations 86, art. 116-2.

The Michigan statutes relating to appointment of officers of municipal corporations provide that the mayor, by and with the consent of the council, shall appoint a city attorney, city marshal, city commissioner, city surveyor, city assessor, and a chief engineer. There is no provision for the appointment of counsel to the city attorney. There is a provision, however, that the council may by ordinance provide for the appointment of other officers whose election or appointment is not by the statutes specifically provided, all such appointments to be made by the mayor by and with the consent of the council. The statute further provides that the powers and duties of such officers shall be prescribed by ordinance and that all officers appointed or elected shall within ten days take and subscribe to the oath of office prescribed by the state constitution. In the instant case the council passed no formal ordinance creating the office or position of counsel to the city attorney, neither is there any ordinance prescribing the duties to be performed. At the most there is a resolution providing that the petitioner “be retained as Counsel to the City Attorney.” Furthermore petitioner did not subscribe to the oath required of all municipal officers by the statute and prescribed by the state constitution. Helvering v. Curren, 90 Fed. (2d) 621, relied on by the petitioner, is clearly distinguishable. We conclude that petitioner was not an officer of the city of Highland Park. Metcalf & Eddy v. Mitchell, 269 U. S. 514.

We think it is equally clear that the petitioner was not an employee of the city of Highland Park. His services were not continuous, but were occasional and were not subject to the direction or control of the council or any city official. He was not required to keep regular office hours and had no regular duties. He was free to engage and did engage in general practice of the law and most of his time was devoted to the business of other clients, which business also produced the major portion of his income. It is true that his compensation was fixed and limited and he received it semimonthly, but that fact alone is not sufficient to determine that the relationship between the city of Highland Park and the petitioner was that of employer and employee. In our opinion the facts of record clearly show that the relationship between the petitioner and the city of Highland Park was that of an attorney on retainer from a client and not that of an employee of the city on a salary. Metcalf & Eddy v. Mitchell, supra; Register v. Commissioner, 69 Fed. (2d) 607; Haight v. Commissioner, 52 Fed. (2d) 779; certiorari denied, 285 U. S. 537; Burnet v. Jones, 50 Fed. (2d) 14; Burnet v. McDonough, 46 Fed. (2d) 944; and J. E. Houston, 33 B. T. A. 237.

The petitioner being neither an officer nor an employee of the city of Highland Park, we conclude and hold that the compensation in question was not exempt from tax. Clark McK. Whittemore, 35 B. T. A. 757; Howard Ewart, 35 B. T. A. 692; George H. Gabel, 25 B. T. A. 60; Blair v. Byers, 35 Fed. (2d) 326. Cf. Sydney R. Wrightington, 38 B. T. A. 1230.

Decision will be entered for the respondent.

       Michigan Statutes Annotates, vol. 4 (1936), ch. 48, title 5 (Municipalities), seca 5.1623, 5.1629, and 5.1632, pp. 30, 31, 32, 33, 35.


author: Smith : Arundell,

text:
    Henry F. duPont, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 85519.
    Promulgated December 7, 1938.

      William L. Hennessy, Esq., for the petitioner.

      James D. Head, Esq., and Joseph D. Hughes, Esq., for the respondent.
   OPINION.

Smith :

The respondent has determined a deficiency of $204,148.59 in petitioner’s income tax for the calendar year 1932. The allegations of error set forth in the petition are as follows:

(A) In determining the taxable net income of the petitioner for the year 1932, the Commissioner erroneously included as ordinary gain the profit on the sale of a block of 62,500 shares of duPont common stock which had been owned by the petitioner for more than two years and the profit realized upon the sale was reported by the petitioner in his income tax return as capital gain. The 62,500 shares of duPont common stock was acquired in 1915 and had a unit cost of $21,709 per share. The corrected cost is $1,356,812.38, sale price April 21, 1932, $1,999,250.00 capital gain $642,437.62.
(B) In determining the taxable net income of the petitioner for the year 1932, the Commissioner would not allow as a deduction from income $46,875.00 which represented a bookkeeping entry for “short dividends” charged to petitioner’s brokerage account and supposed to represent a cash dividend paid by the duPont Company on June 15, 1932, on the 62,500 shares of stock sold and delivered on April 21, 1932.
(C) In determining the taxable net income of the petitioner for the year 1932, the Commissioner would not allow as a deduction from income as an ordinary and necessary expense short dividends in the amount of $52,237.50 paid by the petitioner on account of short sales made during 1932.

The facts have been stipulated in great detail and we adopt the written stipulation as our findings of fact.

The petitioner filed with the collector at Wilmington an income tax return for 1932 which showed capital gains and losses from the sale of shares of stock held two or more years as follows:

He also reported in schedule C of the return a net loss of $263,990.20 from the sale of shares of stock taxable at ordinary rates.

Upon the audit of the return the respondent determined that the petitioner’s profits and losses from the sale of shares of stock were all ordinary gains and losses and not capital gains and losses. The petitioner does not question the correctness of such determination except as it relates to the sale of 62,500 shares of duPont common stock. The petitioner contends that that profit was a capital gain.

Certain errors of computation made by the petitioner in the compilation of his income tax return have been corrected by the stipulation of facts filed in this case. From this stipulation the gain or loss from the sale of shares of stock by the petitioner in 1932, without taking into account the question whether the gain or loss was a capital gain or a capital loss, was as follows:

The sales of the shares of stock in items 1 to 12, inclusive, are shown by both the broker’s and the petitioner’s books of account as having been short sales. The gains and losses from the sales shown in items 13, 14, and 15 were from sales of long stock held for a period of less than two years. The short sales shown by items 4, 7, and 9 were covered by purchases during 1932. At the time when the short sales were made, represented by items 1 to 11, inclusive, the petitioner had, in long accounts with the same broker who made the short sales, equivalent amounts of shares of long stock. All of the outstanding short accounts were closed out upon instructions from the petitioner not later than October 19, 1932, by transfers to the short accounts from the long accounts. In most cases the shares thus transferred from the long accounts had been owned by the petitioner for a period of more than two years at the date of transfer.

In the above tabulation the gain or loss has been determined by adding to the cost base (proceeds from the short sales) short dividends charged against the petitioner while the short contracts were outstanding. The short dividends added were as follows:

In this proceeding the petitioner contests, so far as the question of capital gain or ordinary gain is involved, only the respondent’s determination, that the gain on the sale of 62,500 shares of duPont common stock (item 11) was ordinary gain. He contends that that gain was capital gain.

The petitioner is a resident of Winterthur, Delaware.

During 1932 the petitioner was not engaged in the trade or business of buying and selling securities. He was not a member of or connected with any stock exchange or brokerage firm. He was, however, a holder of substantial blocks of stock of the duPont Co., General Motors Corporation, and other corporations. He purchased and sold large quantities of stock during 1932. He had offices in the duPont Building at Wilmington. J. F. Otwell, his secretary, was in charge of the office.

Raymond W. Ellis for a number of years prior to 1932, and during all of the period from January 1 to September 30, 1932, was an employee of Laird, Bissell & Meeds, a firm of stock brokers and member’s of the New York Stock Exchange, with offices located in the duPont Building at Wilmington and also in New York City. During all of the period from January 1 to September 30, 1932, Ellis was employed as a customers’ man by Laird, Bissell & Meeds. He had a clientele of his own and maintained an office separate and apart from that of Laird, Bissell & Meeds but located in the same building.

The petitioner was accustomed during the year 1932 and for several years prior thereto to rely upon the advice of Ellis as to all matters concerning the purchase and sale of securities. Neither the petitioner nor his secretary, Otwell, was familiar with the provisions of the Federal income tax laws, but Ellis was considered an expert in that field. It was petitioner’s custom in buying and selling securities either personally or through Otwell to advise Ellis of the transactions he wished to make. Petitioner was not accustomed to instruct Ellis as to the manner in which purchases or sales should be made, nor as to which one of his accounts purchases or sales should be made for, but relied upon Ellis to handle such transactions in whatever way would be most advantageous to petitioner from the standpoint of income taxes or other taxes. In consideration of Ellis’ services in this connection petitioner placed all of his orders for the purchase and sale of securities during the year 1932 through Ellis and paid Ellis a yearly fee of $1,000 for such services. The petitioner’s Federal income tax return for 1932 was prepared for the petitioner by Ellis and the petitioner verified the return before Ellis as a notary public of the State of Delaware. Ellis died on March 24. 1933.

The petitioner maintained five accounts during the calendar year 1932 with the Wilmington office of his brokers, Laird, Bissell & Meeds. These accounts were designated respectively “H. F. duPont” (sometimes referred to hereinafter as the “regular” account), “H. F. duPont Special”, “H. F. duPont Short”, “H. F. duPont Short No. 2”, and “H. F. duPont Special Short.”

Orders for all of the above listed sales of stocks in 1932 (with the exception of the 62,500 shares of duPont common stock) were placed with the Wilmington office of Laird, Bissell & Meeds by Ellis pursuant to oral instructions from the petitioner and then sent by telephone to Laird, Bissell & Meeds’ New York office, and the sales were made by the brokers on the floor of the New York Stock Exchange in the ordinary course of business. Deliveries to purchasers were made on the following full business day out of shares belonging to Laird, Bissell & Meeds or their customers, or from shares borrowed by them from other brokers. The proceeds of the sales were credited to petitioner’s respective accounts as directed by Ellis. Any dividends declared on shares sold short between the date of the sale and the closing date were debited to the short accounts.

As of April 1, 1932, the) petitioner was indebted to the Bankers Trust Co. of New York in the amount of $4,000,000. The indebtedness was secured by collateral which included 90,000; shares of the common stock of the duPont Co. The Bankers Trust Co. requested the petitioner to deposit additional collateral or else to reduce the indebtedness. The Bankers Trust Co. was willing to release 62,500 shares of the duPont stock upon the payment to it of $2,000,000. The petitioner contracted to sell to the Christiana Securities Co. 62,500 shares of duPont common stock at that price. The Christiana Securities Co. made an arrangement with J. P. Morgan & Co. of New York to lend it $2,000,000 upon the security of 62,500 shares of duPont stock.

On or about April 20, 1932, the petitioner advised Ellis of the arrangements which he had made with the Bankers Trust Co. and the Christiana Securities Co. and requested Ellis “to handle the matter” for petitioner through Laird, Bissell & Meeds. On the same day Ellis wrote and transmitted to the New York office of Laird, Bissell & Meeds a memorandum of instructions reading as follows:

April 20, 1932.
MEMORANDUM To: Mr. John Ross
Fbom: R. W. Ellis
You are to pay to the Bankers Trust Company two million dollars ($2,000,-000), receiving sixty two thousand five hundred (62,500) shares duPont Common in the name of H. F. duPont. You are to place in the name of Laird, Bissell & Meeds the sixty two thousand five hundred (62,500) shares duPont Common.
We will make delivery in Wilmington of sixty two thousand five hundred (62,500) shares duPont Common, preferably in stock other than certificates which you receive from the Bankers Trust Company. In fact, to eliminate any possible chance of being taxed on the sale, we must see to it that none of the Bankers Trust certificates are used in making this delivery.
[Signed] R. W. Enas

On April 21, 1982, Ellis, in Ms own handwriting and using the form of buy and sell orders used by Laird, Bissell & Meeds for investment purchases and sales for its own account (as distinguished from the form of buy and sell orders for the accounts of customers), made out a buy order showing that Laird, Bissell & Meeds purchased 62,500 shares of duPont Co. common stock for $2,000,000 from “H. F. duPont Short No. 2” account, and a sell order showing that Laird, Bissell & Meeds sold for $2,000,000 to the Christiana Securities Co. 62,500 shares of duPont Co. common stock.

Upon receipt of the memorandum of instructions from Ellis, the New York office of Laird, Bissell & Meeds received from the Bankers Trust Co. through the Stock Clearing Corporation 62,500 shares of common stock of the duPont Co. The certificates were all registered in the name of the petitioner and were accompanied by blank powers of attorney for transfer properly endorsed by the petitioner. At the same time the Bankers Trust Co. billed Laird, Bissell & Meeds through the Stock Clearing Corporation for $2,000,000 against tMs delivery of 62,500 shares of the common stock of the duPont Co. and payment was made by Laird, Bissell & Meeds to the Bankers Trust Co. through the Stock Clearing Corporation in their daily settlement check (which check represents the net difference between their purchases or items received for payment through the Stock Clearing House). The certificates which Laird, Bissell & Meeds received from the Bankers Trust Co. were delivered to the transfer agent of the duPont Co. on April 21,1982, and new stock certificates were received by Laird, Bissell <& Meeds from the transfer agent the same day, all in the name of Laird, Bissell & Meeds.

On the same day, namely, April 21, 1932, Laird, Bissell & Meeds delivered to J. P. Morgan & Co. stock certificates for 62,500 shares of the common stock of the duPont Co. and received from J. P. Morgan & Co. a check drawn to the order of Laird, Bissell & Meeds in the amount of $2,000,000, which check was deposited to the credit of Laird, Bissell & Meeds in the Guaranty Trust Co. Of the stock certificates delivered by Laird, Bissell & Meeds to J. P. Morgan & Co. on April 21, 1932, certificates representing 40,500 shares of the common stock of the duPont Co. were part of the certificates previously on the same day issued in the name of Laird, Bissell & Meeds by the transfer agent of the duPont Co. The remaining certificates, representing 22,000 shares of the common stock of the duPont Co. were either in the name of Laird, Bissell & Meeds or in street names but were not out of the series which Laird, Bissell & Meeds had on the Same day received from the transfer agent.

The accounting records of Laird, Bissell & Meeds show 62,500 shares of duPont Co. common stock received from the New York office for tbe “H. F. duPont Special” account (a long account) at a charge of $2,000,000. They also show 62,500 shares of the duPont stock delivered to the New York office for the Christiana Securities Co. acount at a charge of $2,000,000.

On April 21, 1932, Laird, Bissell & Meeds delivered confirmation notices to the petitioner notifying him that his “TI. F. duPont Short No. 2” account was credited in the sum of $1,999,250 as the proceeds of the sale of 62,500 shares of duPont Co. common stock, and that his “H. F. duPont Special” account was charged in the sum of $2,000,000 against receipt of 62,500 shares of the same stock. Upon receipt of these confirmation notices entries were made on petitioner’s books in accordance therewith as shown in petitioner’s ledger accounts entitled “Laird Bissell and Meeds — H. F. duPont Short Account #2” and “Laird Bissell and Meeds — H. F. duPont Special Account.”

The investment ledger of Laird, Bissell & Meeds reflects purchases and sales by Laird, Bissell & Meeds for its own account as principal. On April 21, 1932, an entry was made in the Laird, Bissell & Meeds investment ledger account entitled “E. I. duPont de Nemours & Co. Common Stock”, showing a purchase on that date from “H. F. duPont Short No. 2” account of 62,500 shares for $2,000,000 and a sale on that date to the Christiana Securities Co. of 62,500 shares at a price of $2,000,000. The sale by petitioner of 62,500 shares of duPont Co. common stock is recorded in the ledger account entitled “H. F. duPont Short No. 2” under date of April 22, 1932. The receipt of 62,500 shares is recorded in the account entitled “H. F. duPont Special” under date of April 21,1932.

On August 19,1932, petitioner through Ellis instructed his brokers, Laird, Bissell & Meeds, to transfer the entire balance of 62,500 shares of common stock of the duPont Co. in his “H. F. duPont Special” account to his “H. F. duPont” or “regular” account. These instructions were executed by the brokers on the same day. Likewise, on August 19, 1932, petitioner through Ellis instructed his brokers, Laird, Bissell <& Meeds, to transfer to his “EL F. duPont Short No. 2” account, to be applied against the sale in that account on April 21, 1932, of 62,500 shares of common stock of the duPont Co. as shown in the preceding paragraph, 62,500 shares of the common stock of the duPont Co. in his “H. F. duPont” or “regular” account. These instructions were executed by the brokers on the same day and the sale of 62,500 shares of common stock of the duPont Co. in the “H. F. duPont Short No. 2” account, as shown in the preceding paragraph, was closed by such transaction.

A dividend at the rate of 75 cents a share was declared on the duPont Co. common stock, payable June 15, 1932, to stockholders of record of May 25, 1932. On June 15, 1932, Laird, Bissell & Meeds charged the “H. F. duPont Short No. 2” account in the sum of $46,875 representing an amount equal to the dividend paid June 15, 1932, on 62,500 shares of duPont Co. common stock. On the same day Laird, Bissell & Meeds credited the “H. F. duPont Special” account in the sum of $46,875 representing June 15, 1932, dividends on 62,500 shares of duPont Co. common stock. The sum of $46,875 shown in this account under date of June 15, 1932, as dividends on 62,500 shares of duPont Co. common stock was included in the total sum of $573,977.95 reported by the petitioner in his Federal income tax return for the year 1932 as “dividends on stock of domestic corporations.”

The rule of the New York Stock Exchange in force during all of the year 1932 in respect to margin requirements is contained in chapter XII, section 1, of the rules of the New York Stock Exchange, and reads as follows:

Seo. 1. The acceptance and carrying of an account for a customer, whether a member or a non-member, without proper and adequate margin, may constitute an act detrimental to the interest or welfare of the Exchange.

For the purpose of computing the margin for carrying the accounts of the petitioner during the year 1932, his brokers, Laird, Bissell & Meeds, considered his “H. F. duPont” or “regular” account, “H. F. duPont Short”, “H. F. duPont Special”, “H. F. duPont Short No. 2”, and “H. F. duPont Special Short” as one consolidated account.

Chapter VII, section 10, of the rules of the New York Stock Exchange which were in force during all of the year 1932 reads as follows:

Seo. 10. An allowance for interest on short sales of stock shall not be more than the loan market rates for the stocks borrowed or used for such short sales.

On April 8, 1932, the committee on business conduct of the New York Stock Exchange promulgated a rule covering reports on overnight short positions which reads in material part as follows:

To Members of the Exchange :
As of the close of business April 9, 1932, the Committee on Business Conduct rescinds all circular letters on the subject of reports on overnight short positions, and in lieu thereof directs that members report the short position, including odd lots, in each stock, for each account or customer, giving the name of the owner of the account, as of the close of business every clearing day commencing April 8, 1932.
Do not include as short positions the following:
(1) Sales for “Cash” with stocks not yet received from the seller.
(2) Sales or “short” positions against “long” positions in the same stocks where definite instructions have been given to deliver other certificates.
(3) Sales or “short” positions where it is actually known, without further inquiry, that the seller has the same long stocks in his possession or has an offsetting position against his short sales in the same stocks.

During all of tbe year 1932 Laird, Bissell & Meeds maintained daily records showing the long and short positions of its customers. These records consisted of large sheets of paper, one side of which was designated with the name of the stock involved , and the word “long” and the other side was captioned with the name of the stock and the word “short.” The names of the customers were listed alphabetically on each side of these sheets with the number of shares long or short at the close of the business day covered by each sheet. The petitioner and the respondent are agreed that all of the sales listed in items 1 to 11, inclusive, of the complete tabulation of sales of stock by the petitioner in 1932, including the sale of the 62,500 shares of common stock of the duPont Co. shown in the “H. F. duPont Short No. 2” account, were listed on the long and short position record of Laird, Bissell & Meeds as short sales, and that each of such entries bears the penciled word “offset”, which was intended to show that the petitioner had long positions equal to or in excess of his short positions on the days in question. The parties are further agreed that neither the sale of the 62,500 shares of common stock of the duPont Co. nor any of the transactions listed in the above referred to items 1 to 11, inclusive, were reported by Laird, Bissell & Meeds to the New York Stock Exchange in its reports of overnight short positions required under the rule of the committee on business conduct promulgated April 8,1932.

Upon this background of the stipulated facts the petitioner contends that there was no short sale of the 62,500 shares of duPont Co. common stock in April 1932 and that the transaction does not come within the provisions of section 23 (s) of the Revenue Act of 1932, which provides in material part as follows:

SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
* * * * * * *
(s) Same — Short Saxes. — For the purposes of this title, gains or losses (A) from short sales of stocks and bonds, or (B) attributable to privileges or options to buy or sell such stocks and bonds, or (O) from sales or exchanges of such privileges or options, shall be considered as gains or losses from sales or exchanges of stocks or bonds which are not capital assets.

The petitioner contends that the profit realized from the sale of the 62,500 shares was from the sale of shares of stock owned by him for a period of more than two years and that he is entitled to be taxed thereon at capital gain rates.

The essential facts bearing upon this point are that in April 1932 the petitioner was carrying in a long account with his brokers, Laird, Bissell & Meeds, more than 62,500 shares of duPont common stock. He was also the owner of 90,000 shares of duPont common stock which were deposited as collateral with the Bankers Trust Co. of New York. The Bankers Trust Co. agreed with, the petitioner to release 62,500 shares of the duPont common stock upon the payment of $2,000,000. The petitioner contracted to sell to the Christiana Securities Co. 62,500 shares of duPont common stock for $2,000,000. The petitioner informed Ellis, his agent, and also an employee of Laird, Bissell & Meeds, to “handle the matter.” Ellis handled the matter after this fashion: He made a short sale for the petitioner of 62,500 shares of duPont common stock, the purchaser of the shares being Laird, Bissell <& Meeds. On the same day, Laird, Bissell <⅞ Meeds acquired from the Bankers Trust Co. 62,500 shares of duPont common stock, paying therefor $2,000,000. Although these shares were immediately transferred to the name of the brokers, they were credited to the “H. E. duPont Special” account, which was a long account and the petitioner was charged $2,000,000 therefor. On the same day, Laird, Bissell & Meeds, as principal, sold 62,500 shares of duPont common stock to the Christiana Securities Co., delivering them to J. P. Morgan & Co. and receiving $2,000,000 therefor. All of the above transactions took place on April 21, 1932. At the close of the day the petitioner was shown by the broker’s books of account as being “short” 62,500 shares duPont Co. common stock and “long” an equal amount of stock representing the shares acquired from the Bankers Trust Co. The petitioner was informed of the “short” sale and of the purchase of long stock made by the brokers for him. He knew that the brokers had charged him with a short sale of the 62,500 shares and that his long account was augmented by an equal number of shares.

Counsel for the petitioner submits that the attempt of Ellis to set up long and short positions in respect of the sale and acquisition of the 62,500 shares of stock in question was “uncalled for, unnecessary and to say the least, very unethical.” These are questions which we are not required to pass upon. The facts do not show that the acts of Ellis and of the brokers were not within the authority granted by the petitioner and that their records of the transactions are not genuine and correct.

The Board in several recent cases has had occasion to pass upon the question whether sales made under circumstances somewhat similar to those obtaining in the instant case were “short” sales within the meaning of the quoted provisions of the statute. A thorough exposition of the question, particularly with reference to the factors which distinguish short sales from ordinary sales, is found in Frances Bartow Farr, Executrix, 33 B. T. A. 557. We held in that case that, where a taxpayer made several sales of shares of stock through a broker during 1931, the sales being treated as short sales, and the sales were covered in 1932 by the transfer of shares of the same stock which the taxpayer had held for more than two years, the sales were short sales within the meaning of the statute and the gains thereon were taxable in 1932 as ordinary gains. In our opinion in that case we said:

Thus, a short sale may be made, not only by one who does not own any securities of the kind which he sells, but also by one who actually owns securities of the kind he sells. Short sales must frequently be made by brokers who are not informed whether or not their principal is the owner of shares which he could sell and deliver if he so desired. One of the chief differences between a regular sale and a “short sale” is that, in the former, the seller delivers his own shares to the purchaser and thus closes the transaction, while in the latter, he delivers “borrowed” shares and the transaction is not closed so far as the seller is concerned until he delivers shares to repay the “loan.” If the shares sold are not furnished by the seller at the time of the sale but are supplied by the broker, the transaction is a short sale and sets in motion the short sale process. * * *

Petitioner cites C. R. Dashiell, 36 B. T. A. 313, in support of his contentions in this proceeding that the petitioner made no short sale of his 62,500 shares of duPont Co. common stock on April 21, 1932. There, the taxpayer while visiting in Florida instructed his broker in Chicago to sell certain specified shares of stock represented by certificates held in his safe deposit box in Chicago. The sale was actually made on the following day through another broker in New York, with delivery of borrowed shares. On the same day the Chicago broker credited the proceeds of the sale to the taxpayer and charged him with the shares sold. About a month later the taxpayer on his return to Chicago obtained the certificates from his safe deposit box and delivered them to his broker, as he had previously agreed to do. We held, contrary to the Commissioner’s determination, that the sale of the shares in question was a cash sale and not a short sale. It was conceded that the facts in the Dashiell case were similar to those in Dee Furey Mott, 35 B. T. A. 195, where a like result was reached. In that case we said:

* * * “A short sale is a contract for the sale of shares which the seller does not own or the certificates for which are not within his control so as to be available for delivery at the time when, under the rules of the Exchange, delivery must be made.” Provost v. United States, 269 U. S. 443. Here the petitioner owned the shares and they were within her control and available for delivery. She intended to sell the shares that she owned, and it is stipulated that they were sold. Mere failure to deliver certificates is not alone enough to establish a short sale. C. B. Ferree, 32 B. T. A. 725; affd., 84 Fed. (2d) 124. Accordingly, it is held that the sales of Westinghouse and United States Steel shares were not short sales.

C. B. Ferree, 32 B. T. A. 725; affd., 84 Fed. (2d) 124, involved similar facts. There, the taxpayer instructed his broker to sell for him 800 shares of Continental Can Co. stock, the certificates for which were in his safe deposit box. The broker sold 800 shares of the stock for taxpayer’s account and later received certificates for 800 shares out of lots of the same stock which he had purchased for the taxpayer. In our opinion we said:

* * ⅜ But the evidence shows that the petitioner intended to sell the 800 shares which he owned, that he instructed the broker to sell such shares, and, in view oí the fact that the broker promptly sold 800 shares, the conclusion is inescapable that the broker was carrying out the instructions and sold the shares he was directed to sell. There is not the slightest reason to believe that either the petitioner or the broker was considering a short sale, and the mere failure of petitioner to deliver the certificates is not alone sufficient to establish one.

In all of tbe above cases where it was held that the sales were not short sales the evidence showed that at the time of the transaction the taxpayer had a clear intention to sell the specific shares which he then held, and so instructed his broker. No such facts obtain in the proceeding at bar. The petitioner did not instruct Ellis as to how the transactions should be carried out. The general authority under which Ellis acted warranted him in making a short sale of the 62,500 shares of duPont Co. common stock if he desired to do so. He certainly made what he considered was a valid short sale. We think it was. In duPont v. Commissioner (C. C. A., 3d Cir.), 98 Fed. (2d) 459, the court stated:

James Edward Meeker, Economist to the New York Stock Exchange, states in his book “Short Selling,” “A short sale may be briefly but comprehensively defined as a sale which creates a debt in terms of goods.” ⅜ * *

Judged by this definition, the brokers made a short sale on April 21, 1932, of 62,500 shares of duPont Co. common stock for the account of the petitioner. The effect of the transaction reflected on the broker’s books under date of April 21, 1932, in “H. F. duPont Short No. 2” account was to create “a debt in terms of goods” owing by the petitioner to the brokers. We do not think that it can be doubted that, if the petitioner had in August 1932 instructed his brokers to close his short account by a covering purchase of 62,500 shares of duPont common stock and the purchase had been made, the gain or loss upon the transaction reflected in the short account would be the difference between the proceeds from the short sale and the cost of the covering purchase. Compare Helvering v. Rankin, 295 U. S. 123, in which it was held that the “first in, first out” rule was inapplicable in determining taxable gain on the sale of corporate stock purchased on margin where the margin trader had through his broker designated the securities to be sold as those purchased on a particular date and at a particular price. The intention of the customer as shown by instructions to his broker either personally or through an agent is to be given effect.

The petitioner in his brief makes an extended argument that, since under the rules of the New York Stock Exchange long accounts and short accounts with a broker may be consolidated for the purpose of determining margins, the long and short accounts are likewise to be consolidated for the purpose of determining whether a short sale has been made. In short, the argument is that a man can not make a short sale of shares of stock through a broker who is carrying for him long stock of an equivalent amount. This was the point in issue in duPont v. Commissioner, supra. The court held that a person might sell shares short through a broker who was carrying an equivalent amount of long stock for the customer and that, where the short contract was closed by a transfer from the long account to the short account of shares of stock which had been owned by the customer for a period of more than two years, the gain was, under the same provision of the statute as is involved herein, an ordinary gain and not a capital gain.

Upon the authority of duPont v. Commissioner, supra, we sustain the respondent’s contention that the profit realized by the petitioner from the sale of the 62,500 shares of duPont Co. common stock was not from the sale of capital assets within the meaning of the taxing statute.

The remaining question for our consideration is whether the short dividends charged against the petitioner and treated by him and by the respondent in the determination of the deficiency as additions to the cost basis of the shares sold were properly so treated or should be regarded as ordinary and necessary expenses deductible from gross income. The evidence shows that the petitioner was not a broker nor engaged in a business of buying and selling securities. The decision of the Board in Gladys G. Terbell et al., Executors, 29 B. T. A. 44; affd., 71 Fed. (2d) 1017, is dispositive of the issue and confirms the treatment of the short dividends made both by the petitioner in his return and the respondent in the determination of the deficiency.

Beviewed by the Board.

Judgment will be entered under Bule 50.

Arundell,

dissenting: The majority holding of a short sale is based on the negative proposition that the facts do not show that the acts of Ellis and the brokers were not within the authority granted by the petitioner and that their records are not genuine and correct. Stated otherwise, the holding is predicated on a presumption of authority in Ellis and the brokerage firm to act as principal and of entries in accordance with such authority. Against this is the presumption that the brokers were acting as agents. A broker in securities to whom an order to buy or sell is entrusted may not, without the full knowledge and consent of his customer, sell to or buy from himself. Meyer, Law of Stockbrokers and Stock Exchanges, § 51 and cases cited therein. The rules of New York Stock Exchange, with limited exceptions that do not apply here, prohibit a member while acting as a broker from buying or selling for his own account securities for which he or his firm has accepted an order to buy or sell. Ch. XI of the rules of the stock exchange. The effect of the holding in this case is to say that the brokerage firm violated the rules of the exchange, and this I think we should hesitate to do without clear evidence of the fact.

I realize fully that a short sale may be made by one who actually owns securities of the kind he sells. Francis Bartow Farr, Executrix, 33 B. T. A. 557, 561. But a sale of the same kind of securities is not the same as a sale of the specific securities. The latter isi a long sale, even though delivery of the certificates is temporarily delayed. Dee Furey Mott, 35 B. T. A. 195; Ruml v. Commissioner, 83 Fed. (2d) 257. Here, as I understand the facts, the petitioner owned 90,000 shares of duPont stock, the certificates for which were held by a bank as security for a loan. The petitioner contracted to sell 62,500 of those shares to the Christiana Securities Co. for cash.

The course of dealings establishes quite clearly that the shares in the hands of the bank, and not some other shares, were the subject of the contract to sell. The bank was demanding either additional collateral or a reduction of the loan, and petitioner arranged to take up 62,500 shares from the bank upon payment of $2,000,000 which he was to receive from the Christiana Securities Co. He did not arrange with the Christiana Securities Co. to sell it other duPont shares, nor did he contract with any one else to sell the shares held by the bank. It seems to me that this is the only possible conclusion on the facts given in the majority opinion; indeed the majority opinion does not hold otherwise. When petitioner had made the contract his agent carried it out by delivering duPont stock and collecting the sale price agreed upon between the seller and the buyer. This, it seems to me, was an ordinary sale within the rules of the Mott case, supra, and its character was not changed by reason of book entries made by the agent. It is not without significance that all of the transactions within the taxable year shown on the books of Laird, Bissell & Meeds as short sales, except the one here in question, were actually put through as short sales on the floor of the Stock Exchange in the ordinary course of business. This difference in procedure indicates that no short sale was made or intended in connection with tbe shares purchased by the Christiana Securities Co. and leads to the conclusion that the brokers had no intention of buying any stock on their own account, but merely effected delivery to the Christiana Securities Co. of stock sold to that company by the petitioner. Intent to pass title is one of the governing factors in question concerning sales of specific goods. Dee Furey Mott, supra. Petitioner intended and contracted to sell his specific shares to the Christiana Securities Co. I think the majority opinion errs in disregarding the agreement of sale between the petitioner and the Christiana Securities Co. and in putting the decision on the records of the agent.

TurNer and Arnold agree with this dissent.