author: Murdock: Arnold,

text:
    James Lee Johnson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 82263.
    Promulgated January 21, 1938.

      Stanley S. Waite, Esq., and Abraham Lowenhaupt, Esq., for the petitioner.

      B. H. Neblett, Esq., and H. F. Noneman, Esq., for the respondent.
   OPINION.

Murdock:

The law is well settled that transactions such as this must be closely scrutinized. But here careful scrutiny fails to reveal any justification for denying the loss. The Investment Co. was a separate taxpayer from the petitioner, regardless of the extent to which he controlled it. It actually bought the stock, paid for it, became the owner, and continued to be the owner. The price was right. There was no subsequent reacquisition by the petitioner or option or agreement to acquire. There is nothing to indicate that the wife did not fully benefit from her interest in the corporation acquired with funds given her by her husband. The natural inference is the other way. The petitioner took no undue advantage of his power to control the purchaser. The fact that he organized or used the corporation to serve his purpose of minimizing his taxes becomes immaterial. The petitioner,' as a taxpayer, made an actual bona fide sale to another taxpayer and sustained a loss which he is entitled to deduct. Seymour H. Knox, 33 B. T. A. 972; Marjory Taylor Hardwick, 33 B. T. A. 249; Edwards Securities Corporation, 30 B. T. A. 918; affd., 83 Fed. (2d) 1007; James E. Wells, 29 B. T. A. 222; David, Stewart, 17 B, T. A, 604. See also the following cases, which hold generally that deductions are allowed on sales to or by closely held corporations where no exceptional circumstances justify disregarding the separateness for tax purposes of the stockholders and their corporations, where the price was fair, and where no plan for reacquisition by the seller appeared, regardless of the fact that the sale may have been for the purpose of minimizing taxes. Rands, Inc., 34 B. T. A. 1094; Ralph Hochstetter, 34 B. T. A. 791; William, H. Albers, 33 B. T. A. 373; A. S. Eldridge, 30 B. T A. 1322; affd., 79 Fed. (2d) 629; Jones v. Helvering, 71 Fed. (2d) 214; Commissioner v. McCreery, 83 Fed. (2d) 817. Nor is the gift to the wife fatal to the contention of the petitioner. Thomas W. Behan, 32 B. T. A. 1088; affd., 90 Fed. (2d) 609.

The new corporation continued to exist. It had at least one other transaction. The wife had a substantial interest in it different from that of her husband. The steps taken and the reality of the corporation can not be disregarded. Cf. Gregory v. Hel/oering, 293 U. S. 465.

Reviewed by the Board.

Decision will te entered wader Rule 50.

TtjeneR dissents.

Arnold,

dissenting: I am unable to agree with the majority opinion in this case and think that the cases there cited are distinguishable on their facts and are not controlling here.

While there is no doubt that the Eleanor Investment Co. was incorporated under the Missouri law as a business corporation and the requisite forms of such a corporation were complied with, the record clearly establishes that it was not organized for the purpose of carrying on a business and in fact did not carry on a business, but was organized and used by petitioner as a device solely for the purpose of establishing a tax loss by transferring to it stock over which he did not intend to relinquish dominion and control and which he would not have sold to outside parties.

Petitioner testified on cross-examination:

Q. Now, is it not a fact, Mr: Jolinson, that you had no intention of allowing these stocks to get out of the Johnson family?
A. Mr. Neblett, at the time the corporation was formed 1 had no intention of selling those stocks to somebody else, and at the present time nothing has come up and I can’t say about the future.
Q. Is it not a fact that if the corporation had not been set up and vehicle for conveying the stocks to Mrs. Johnson didn’t exist, you would not have made sale of those stocks?
A. That’s correct.

These facts bring this case squarely within the principle laid down in Gregory v. Helvering, 293 U. S. 465. There, it was earnestly contended. by the taxpayer that since every element of organization required by the statute had been complied with a statutory reorganization was effected. The corporation was organized and utilized solely for the purpose of bringing the transaction within the reorganization provisions of the statutes to evade tax liability. In its decision the Supreme Court emphasized the fact that if “a reorganization in reality was effected within the meaning” of the statute the purpose to thereby escape taxation would be disregarded; “but the question for determination is whether what was done, apart from the tax motive, was the thing which the statute intended.” The Court pointed out:

When subdivision (B) speaks of a transfer of assets by one corporation to another, it means a transfer made “in pursuance of a plan of reorganization” (section 112 (g)) of corporate business; and not a transfer of assets by one corporation to another in pursuance of a plan having no relation to the business of either, as plainly is the case here. Putting aside, then, the question of motive in respect of taxation altogether, and fixing the character of the proceeding by what actually occurred, what do we find? Simply an operation having no business or corporate purpose — a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to the petitioner. No doubt, a new and valid corporation was created. But that corporation was nothing more than a contrivance to the end last described. It was brought into existence for no other purpose; it performed, as it was intended from the beginning it should perform, no other function. When that limited function had been exercised, it immediately was put to death.
In these circumstances, the facts spealr for themselves and are susceptible of but one interpretation. The whole undertaking, though conducted according to the terms of subdivision (B), was in fact an elaborate and devious form of conveyance masquerading as a corporate reorganization, and nothing else. The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction upon its face lies outside the plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.

Here, as in the Gregory case, there was no business or corporate purpose and the sole object sought to be accomplished was not to organize a business corporation, but to transfer a parcel of corporate shares according to a preconceived plan to the corporation so organized in order to effectuate a tax loss. Here, as there, there was never any intention of creating a corporation to engage in business; the intention was to create a tool to be used by petitioner in establishing a tax loss and the corporation so organized “performed, as it was intended from the beginning it should perform, no other function.” Here, as in the Gregory case, the transaction on its face lies outside the plain intent of the statute. Cf. Electrical Securities: Corporation, 34 B. T.. A. 988; affd., Electrical Securities Corporation v. Commissioner, 92 Fed. (2d) 593; Helvering v. Elkhorn Coal Co., 95 Fed. (2d) 732; Commissioner v. Riggs, 78 Fed. (2d) 1004; Commissioner v. Dyer, 74 Fed (2d) 685; certiorari denied, 296 U. S. 637; United States v. Lehigh Valley Railroad Co., 220 U. S. 257; Miller & Lux, Inc. v. East Side Canal & Irrigation Co., 211 U. S. 293.

In Electrical Securities Corporation v. Commissioner, supra, the court said:

* * * The transactions were not a sham in the sense that a contract made in jest is a sham, creating no obligations whatever. Here as well we do not doubt that the United Gas Improvement shares actually passed to and out of the Diselin Corporation, a lawfully created corporate person, capable like any other such, of receiving, holding and transferring any kind of property. But that company, however unassailable its existence and its powers, must have been one which Congress meant to exempt by § 112, and it does not in the least follow that it was, because it was a regularly constituted juristic person. The purpose of the section is apparent; it was meant to allow businesses to be reconstructed when the resulting interests were substantially unchanged; but it presupposed that the enterprises were in fact businesses; financial, commercial, industrial and the like. The avoidance or suspension of taxes is not a business. * * *

If the avoidance or suspension of taxes is not a business and a corporation organized and used for that purpose is not effective to suspend taxes under the reorganization provisions of the statute, for the same reason a corporation so organized should not be effective to establish a loss under the deduction provisions of the statute.

While it is true the Eleanor Investment Co. later purchased 10 first mortgage 6 percent bonds of the Vicksburg Bridge & Terminal Co. for $4,420, this purchase was not made until after September 14, 1934, when it was developed in a deposition given by petitioner that the corporation had done no other business and thereafter the bonds were purchased and the purchase ratified by the board of directors January 20, 1935. In the same deposition petitioner was asked:

Q. Wliat was tbe purpose of creating tbis corporation?
A. Primarily, to show a tax loss. To show a loss for tax purposes.

To permit an individual to create a corporation which he controls and use it for the sole purpose of circumventing a statute is to put him in a preferred class not intended by the statute and not justified by any theory of corporate fiction. WNile it is not questioned that one in control of a corporation through stock ownership has the right to use such control for the purpose of a bona fide separate administration of the corporation’s business, it is not to be supposed that he may so abuse such power in his personal dealings with the corporation as to accomplish by indirection a result contrary to the intendment of the statute. Cf. United States v. Lehigh Valley Raiload Co., supra. Losses to be deductible must be realized. A mere paper loss based on legal technicalities is not enough and an attempt to evade tbe payment of income taxes by a purported sale of property which does not result in a realized loss is without both the letter and the spirit of the law. Cf. Schoenberg v. Commissioner, 77 Fed. (2d) 446. It is well settled that the mere fact that petitioner wanted to establish a loss for income tax purposes would not prevent the deduction of a loss actually sustained, cf. United States v. Isham, 17 Wall. 496, 506; Gregory v. Helvering, supra, but the sale must be actual and the taxpayer must intend to part not only with the title to the property but the dominion and control over it and that intention must be consummated. Cf. Commissioner v. Behan, 90 Fed. (2d) 609; Commissioner v. Dyer, supra; James Nicholson, 32 B. T. A. 977; affd., Nicholson v. Commissioner, 90 Fed. (2d) 978. Petitioner, through his control of Eleanor Investment Co., could at any time cause it to be dissolved, the assets distributed in kind, and thus repossess all thé stock transferred except the shares which his wife received through his gift to her of $49,900 without sustaining any loss whatever. .

Taxation is a practical matter and deals in actualities. To recognize a loss on a transaction when in fact a loss was not realized, results in an inequitable distribution of the tax burden which was never intended by Congress.

Hill and Harron agree with this dissent.


source: Caselaw Access Project

author: Mellott:

license: Public Domain

text:
    Estate of Eliot W. Mitchell, Deceased, Manufacturers & Traders Trust Company and Alice Frank Mitchell, Executors, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 76401.
    Promulgated January 21, 1938.

      William C. Warren, Jr., Esg., for the petitioners.

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

Mellott:

The petition alleges that the respondent erred in disallowing the claimed deductions. It is alleged, apparently in conformity with ftule 5 (e) of the Board’s rules of practice which requires “clear and concise numbered statements of the facts upon which the petitioner relies”, that “Eliot W. Mitchell, during said calendar year 1931, sold certain securities on which he sustained a loss in the total amount of $44,634.64.” The evidence fails to support such allegation; but inasmuch as both parties at the hearing construed the issue to be whether or not valid sales of the stock had been made by decedent and his wife, we have done likewise in making our findings and shall discuss briefly the principles of law deemed pertinent to such issue. Cf. Frank B. Gummey, 26 B. T. A. 894.

It has been said many times that transactions between a husband and wife, or members of a family, are to be subjected to the closest scrutiny, Frederick H. Hoffmann, 3 B. T. A. 964; James L. Robertson, 20 B. T. A. 112; Slayton v. Commissioner, 76 Fed. (2d) 497; John E. Zimmerman, 36 B. T. A. 279; and, where the transaction is made “for the avowed purpose of reducing taxation and apparently would not have been consummated otherwise at this time, every requirement of a sale must be met.” Mrs. Niels (Mellie) Esperson, Executrix, 13 B. T. A. 596, 609; affd., 49 Fed. (2d) 259. Taxation is an eminently practical matter and tax laws deal with realities. Helvering v. Security Savings Commercial Bank, 72 Fed. (2d) 874. “A man can not make a sale to himself”, Mrs. Niels (Mellie) Esperson, Executrix, supra, nor is an actual loss sustained “unless when the transaction is concluded the taxpayer is poorer to the extent of the loss claimed.” Shoenberg v. Commissioner, 77 Fed. (2d) 546; certiorari denied, 296 U. S. 586.

Upon brief petitioners say, “For a long time it has been well established that a sale may be made for the sole and express purpose of decreasing tax liability.” The statement is correct. United States v. Isham, 17 Wall. 496; Gregory v. Helvering, 293 U. S. 465; Nace Realty Co., 28 B. T. A. 467. It is also true, as petitioners point out upon brief, that where husband or wife, in good faith, actually makes a sale of stock to the other spouse, the gain or loss will be recognized for tax purposes. Benjamin T. Burton, 28 B. T. A. 1242; Carl P. Dennett, 30 B. T. A. 49; Joseph E. Uihlein, 30 B. T. A. 399; affd., Commissioner v. Brumder, 82 Fed. (2d) 944; Charles F. Fawsett, 31 B. T. A. 139; Frank M. Arguimbau, 31 B. T. A. 604; Thomas W. Behan, 32 B. T. A. 1088; affd., Commissioner v. Behan, 90 Fed. (2d) 609; and F. Stanley Porter, 36 B. T. A. 475; and this is true, where an actual sale is made through a broker even though a portion of the funds used in making the purchase were, as a matter of convenience, furnished to the purchaser by the one making the sale. In such a case, however, it is necessary that it be shown that “each was financially able to buy and pay for all purchases made”, and the furnishing of the funds was a mere convenience and not a necessity without which such purchases could not have been made. John, E. Zimmerman, supra; Thomas W. Behan, supra; F. Stanley Porter, supra; and George Mackubin, 36 B. T. A. 255.

In the instant proceeding it can not be found as a fact that the furnishing of the funds by the decedent to the wife was a “mere convenience and not a necessity.” The wife, testifying as a witness, was asked whether she had any other securities or property. She responded “Aside from that found in the box?” Her counsel then said, “Aside from what was shown in the box. I am just asking whether you had”, to which she replied, “No.” When asked about the deposit by the husband of $19,000 in the joint bank account and whether she “needed about nineteen thousand to make up this check of $20,657.15”, she replied “Yes.” This testimony, together with •other evidence in the record, might not be sufficient to justify us in concluding that the furnishing of the funds was a necessity without which the purchase could not have been made, but, in the face of it, we are not justified in finding that it was not such a necessity— a finding which must be made if petitioner is to prevail. Our conclusion, however, rests upon other facts and circumstances, in addition to the furnishing of the funds, so we pass this phase of the case without further discussion.

This proceeding, upon its facts, is quite similar to, and requires the application of the rule enunciated and applied by the Board in George E. Morse, 34 B. T. A. 943. Here, as in that case, the transactions were carried out solely on the order of the husband. The obvious object of all of them was, not to make sales of securities in the normal way, but to establish losses for tax purposes. The decedent and his wife during both years, merely shifted the legal title to the stocks but apparently never intended to divest the husband of his equitable title to them. Though they went through the form of making sales, the decedent never relinquished dominion and control over the securities; they were kept in his safety deposit box and were never even seen by the wife. He decided which should be shifted from his account with the broker to his wife’s account with the same broker. When it suited him to do so he caused the same property to be shifted back again. If funds were needed for such purpose he furnished them. She “knew very little about” stock transactions and was satisfied tot let him take care of all the details. She, as she expressed it, relied upon him “Entirely.” “My husband gave the order. He handled all that business.” He wrote the letter instructing the broker to sell the stock standing in her name and all that she did was to sign it. Someone other than the wife prepared the check to the brokers for her signature, for it is obvious from an examination of the check that the handwriting of the body of the check and the signature are different. When she was asked whether “the proposition of buying this stock and selling it” was ever discussed between her and her husband she replied “Well, yes; he would advise me doing it.” To the next question, “He advised you to buy it?” she responded, “Because I knew very little about it.” When asked whether she had ever had them in her possession she said, “No, my husband had a safe deposit box and they were kept in there.” “I really left that up to him to take them and put them where they belonged. I knew nothing about it. I always, when buying and selling, took his advice and let him handle it.”

It is unnecessary to extend, this discussion. The evidence is not sufficient to convince us that the decedent relinquished dominion and control over the securities sufficiently to establish a loss within the purview of section 28 (e) of the revenue act. In addition and in conclusion, the language used by this Board in George E. Morse, supra, may well be repeated.

* * * Not only did the husband fail to part with dominion and control over the shares, but even if we were to hold that he sold the shares, he would not be entitled to the deduction, because the account in the name of his wife was in reality his own account. Therefore, he would be held to have purchased substantially identical property within thirty days of the date of the sale, and, under the wash sales provision of the statute, he would not be entitled to a deduction in any event. Sec. 118, Revenue Act of 1928.

The respondent did not err in determining the deficiency.

Reviewed by the Board.

Judgment will be entered for the respondent.

Leech and Disney concur only in the result.

Smith dissents.


author: Sternhagen :

text:
    Estate of Archibald M. Chisholm, Archibald M. Chisholm, Jr., et al., Executors, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 85255.
    Promulgated January 21, 1938.

      D. 8. Holmes, Esq., Robert L. Mayall, Esq., and FrcmJe W. Wilson, G. P. A., for the petitioners.

      E. O. Algire, Esq., and R. E. Brygley, Esq., for the respondent.
   OPINION.

Sternhagen :

The petition assigns as error in the Commissioner’s determination:

(b) Excessive valuation included in gross estate of 14,558 shares of the common capital stock of Shattuck-Denn Mining Company to the extent of $16,377.75.

The notice of deficiency contains no mention of Shattuck-Denn stock or its value and the estate tax return is not in evidence. It is, there-, fore, not possible from the record to say whether the value used by the Commissioner of 2% per share is a readjustment of that stated by the petitioners in their return or an adoption by the Commissioner of the petitioners’ return figure voluntarily used.

It is alleged and admitted that in the determination of the gross estate the Commissioner used a value of $30,935.75 for the 14,558 shares of Shattuck-Denn stock, or 2% a share. The petitioners assail this as too high, but it can not be said from the evidence that the contention is adequately supported. The proof consists of the testimony of a stock broker whose conjectural opinion was elicited to the effect that if all the petitioners’ shares had been offered for sale the market would, in his opinion, have thereby been depressed, and that he doubted whether a price in excess of 1% could have been obtained. Through this witness exhibits were introduced showing the actual prices in transactions which had taken place in Shattuck-Denn shares on the New York Curb Exchange for a period of approximately four months beginning before and ending after the date of death. From this record of actual market performance it can not be said that the value of 2% is too. high. All of the sales were at prices as high, or higher than this figure except during one week m October, when an aggregate of 800 shares were sold at 2. Whether this was in one block does not appear. The total number of shares shown by the statement was more than 16,000 and the larger number of these were dealt in at prices above 2%. There is no evidence as to the financial condition of the corporation, its operations, assets, or earnings, its history or prospects.

The petitioner relies upon Safe Deposit & Trust Co. of Baltimore, Executor, 35 B. T. A. 259 (on review, C. C. A., 4th Cir.), and treats that decision as if it laid down as a rule the doctrine that the value of a large block of shares must be regarded as lower than the unit market prices of small lots. That decision, however, lays down no such rule, but expressly holds that whether a large block is to be valued at the same unit value as a small lot actually sold on the market is not a question to be dogmatically answered, but one which must be considered in each case upon evidence specifically applicable to the problem in hand. .“If the value of a given number of shares is influenced by the size of the block, this is a matter of evidence and not of doctrinaire assumption.”

The evidence in this proceeding fully supports the figure said to have been used by the Commissioner in his determination, namely, $30,935.75, and the fair market value so used has been found as a fact. This figure shall be used in a recomputation.

The petitioners claim as additional deductions, $8,595.04 alleged to have been incurred after October 22, 1935, as additional expenses of administration, Revenue Act of 1926, sec. 303 (a) (1). The amounts are described in the findings. That they are proper administration expenses seems apparent. The respondent, opposing the allowances, argues that because the estate had been in large part already distributed, only a comparatively small amount being withheld in reserve to take care of the ultimately determined tax liability, the rent of the office and the services of accountant and secretary were not necessary. But the estate was still unsettled, and it was not arbitrary or unreasonable for the executors to maintain an office and a secretary and employ an accountant. Cf. First National Bank of Birmingham, Guardian, 31 B. T. A. 847; J. H. Anderson, 30 B. T. A. 1275.

The amount stated in the findings is properly deductible in the final computation. Arthur M. Lamport et al., Executors, 28 B. T. A. 862; William Rhinelander Stewart, Jr., et al., Executors, 31 B. T. A. 201.

Although the notice of deficiency does not clearly set forth the item here in question, it is said that the Commissioner erroneously included in the gross estate the face amount, reduced by loans and increased by dividends, of the insurance policies, despite the fact that under each policy the decedent had during his lifetime exercised the election to have the proceeds paid in installments and not in a lump sum. The petitioners claim that by virtue of section 302 (g) of the Eevenue Act of 1926, in effect at the time of death, the amount to be included in the gross estate in respect of these insurance policies is the commuted value on a 4 percent rate at the date of death. The only controversy argued by the parties is the question of law, whether the gross estate shall include the face amount of the policies or the commuted value of the periodic payments provided for.

The controlling statute is as follows:

Sec. 302. The value of the gross estate of tlie 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—
*******
(g) To the extent of the amount receivable by the executor as insurance under policies taken out by the decedent upon his own life; and to the extent of the excess over $40,000 of the amount receivable by all other beneficiaries as insurance under policies taken out by the decedent upon his own life.

The language of this provision is the same as that of section 402 (f) of the Eevenue Act of 1918 and of the Eevenue Act of 1921, and section 302 (g) of the Eevenue Act of 1924. It also goes forward into the Eevenue Acts of 1928,1932, and 1934. Although the general scheme of these estate tax statutes is to tax the transfer from the decedent and is, therefore, generally speaking, measured by the value transferred upon the occasion of death, a clear and express exception is made in respect of insurance. As to this, the statute provides that the gross estate shall include, with the value of property owned by the decedent at the time of his death and transferred, the amount, over $40,000, “receivable” by beneficiaries as insurance. The question at issue here, therefore, is what, as a matter of law, is to be regarded under this statute as the value at the time of death of the amounts receivable by the beneficiaries under the several policies set forth in the findings.

At the time of his death, the decedent had effectually elected to leave to the beneficiaries only the right to receive future periodical payments during their several lives. No right was given to them to do otherwise. They were expressly prevented from commuting the installment payments. Thus, it is beyond argument that to each beneficiary the right which he received to future installments had a value substantially less than the face amount would have had if presently receivable. Whether this would have been so if the beneficiary at the time of death had a right to elect as between a present lump sum payment and a series of periodical installments is not of concern in this proceeding, because the beneficiary had no such election. Each beneficiary had but a right to periodic payments in the future.

The valuation of such a right or expectancy is a commonplace problem, Simpson v. United States, 252 U. S. 547. There is no dispute as to the determination through the use of mortality tables of the period of payments to be adopted as to each beneficiary, and in article 20 of Kegulations 70, in effect at the time of the decedent’s death, the factor of discount and the resulting commuted value is correctly set forth. There is no reason, therefore, why a correct computation can not be made in the conventional manner of the value at the date of death of the future payments to be received by each beneficiary.

Kegulations 70 were in effect at the time of the decedent’s death, and article 28 is in accord, as have been its predecessors, with this opinion. The respondent relies upon Kegulations 80, in which the article is substantially modified. It would, however, be error to apply the rule of the later regulation to the determination of the estate of this decedent, who died before its promulgation, and it would be no more than obiter to consider in this opinion whether the later article is correct in prescribing the use of the face -amount of the policies in cases where the insured at the time of death had omitted to exercise an election to have the insurance paid in a lump sum.

The respondent cites Estate of A. Murat Willis, 28 B. T. A. 152. That opinion, however, does not reach the present question. It dealt with an insurance fund directed by the decedent to be withheld from the beneficiary, interest to be paid, however, during the period of withholding. This was held to be not an annuity and to require no commutation to arrive at the value receivable at the time of death. In the present case, however, the face amount of the insurance was itself to be paid in periodic installments, and thus involved a substantially different right received by the beneficiary.

4. Other issues presented by the petition have been either abandoned or made the subject of a mutual settlement by the parties, and they need not, therefore, be set forth or considered in this opinion.

Judgment will be entered under Bule 60.


author: HaRRon :

text:
    The Gladstone Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 68333.
    Promulgated January 25, 1938.

      H. Henry Hamm-, Esq., for the petitioner.

      8. L. Young, Esq., for the respondent.
   OPINION.

HaRRon :

The question involved in this proceeding is, What is the correct basis to the petitioner corporation of the five notes of International Coal Products Corporation which were sold in the taxable year for determining the amount of the loss resulting? The petitioner contends, first, that the cost to the petitioner of the “International” notes is the same as the cost of the notes to the stockholders of petitioner, relying upon sections 112 (b) (5) and 113 (a) (8), Revenue Act of 1928. In the alternative, petitioner contends that the cost base of the notes in question is the actual value of such notes at the time of transfer to petitioner under section 113 (a) and the petitioner contends that the actual value of the notes was $134,400, relying on the stipulation that if the president of International Coal Products Corporation were called upon to testify he would testify that the notes had at least the value of the face amounts of the notes as of January 1, 1927.

All of the capital stock of the petitioner corporation was issued to its stockholders in return for the assets they transferred so that immediately after the exchange they were in control of the corporation as “control” is defined in section 112 (j).

Determination of the issue in this proceeding turns on whether the exchange came within the provisions of the last part of section 112 (b) (5), which reads:

* * * but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.

The table set forth below shows in the case of each transfer the value of the assets to each transferor at the time of the transfer; the percentage of the interest of each transferor in the total assets transferred to the petitioner by each; the percentage of stock in the petitioner corporation received by each in the exchange.

The above figures show that the amount of the stock in the petitioner corporation received by each transferor is substantially in proportion to his interest in the property prior to the exchange. The variations between the percentage of the value of assets transferred by each of the transferors and the percentages of stock received by each, are slight and the variation is less than 1 percent in each case. It therefore appears that the exchange of certain assets for stock in the petitioner corporation came within the provisions of section 112 (b) (5). The slight variation in the percentage of the value of the assets transferred by each and the percentages of stock received by each does not here result in any material disproportion between the value of the assets owned by separate trans-ferors, prior to the transfer, and the value of their respective beneficial interests in the combined assets after the transfer. Cf. United Carbon Co. v. Commissioner, 90 Fed. (2d) 43. While it appears that there is a slight variance in each case of the interest in assets, before the transfer and after, it was the intention of the transferors, as appears from the testimony of the secretary of the Gladstone Corporation, that by certain adjustments made before the exchange of assets for stock took place, the proportionate share of each transferor in the total assets to be transferred should be equalized. To achieve this objective, certain payments were made out of the cash paid into a joint fund, to C. Ledyard Blair, the father, in payment of the indebtedness of the transferors to Mm and other payments were made to certain of the transferors. When these adjustments had been made and the assets transferred to the petitioner, in exchange for all of its capital stock, it appears that the condition of the trans-ferors was substantially the same after as before the exchange, so that the condition set forth in section 112 (b) (5) has been met and it is so held.

It is accordingly also held that the petitioner received on January 1, 1927, property in exchange for its stock, pursuant to an exchange within the provisions of section 112 (b) (5) and that since the notes of International Coal Products Corporation were part of the property received, the cost basis for determining the loss resulting from the sale thereof is the same for the petitioner as it would be in the hands of the transferors, namely, $134,400, pursuant to the provisions of section 113 (a) (8).

Having so held, it is not necessary to consider the alternative contention of the petition that under section 113 (a) the cost base to it of the notes in question is the actual value of such notes at the time of transfer to petitioner.

Decision will be entered for the petitioner.

       Sec. 112. (b) 'Exchange solely in hind.—
      *******
      (5) Transfer to corporation controlled by transferor. — No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation ; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.
      *******
      Sec. 113. (a) Property acquired after February 28, 1913. — The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property ; except that—
      (8) Same — Corporation controlled by transferor. — If the property was acquired after December 31, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5) (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities), then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.


author: ÁRundell:

text:
    William E. Boeing, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88167.
    Promulgated January 25, 1938.

      Elmer E. Todd, Esq., and Lowell P. Mickebwait, Esq., for the petitioner.

      James O. Maddox, Esq., for tbe respondent.
   OPINION.

ÁRundell:

The two issues are whether certain gains and losses from the sale of timber constitute gains and losses from the sale of capital assets as defined by the statute, and whether the income of the three trusts described in our findings of fact is taxable to the petitioner as grantor.

As to the first issue, the petitioner realized a gain of $5,906.25 during the taxable year from sales of timber pursuant to the contract with the Crescent Logging Co., and a loss of $1,004.41 from sales pursuant to the contract with the Greenwood Logging Co., and the question is whether these gains and losses resulted from the sale of “capital assets” within the statutory definition. (Sec. 117 (b), Revenue Act of 1934.) That definition is as follows:

(b) Definition of Capital Assets. — For the purposes of this title, “capital assets” means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which, would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.

There is no question that “sales” of timber occurred as required by section 117 (a) of the same act, rather than mere “leases” as is the case in the disposition of oil where the land is retained. See Burnet v. Harmel, 287 U. S. 103; cf. John W. Blodgett, 13 B. T. A. 1388, and J. J. Carroll, 27 B. T. A. 65; affd., 70 Fed. (2d) 806. The controversy is limited to whether or not the timber sold constituted “stock in trade of the taxpayer” or “other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year”, or “property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.” In any attempt to apply the descriptive clauses of the statute to the property here involved, it is plain that none of them apply. The timber was not stock in trade of the petitioner for he was not engaged in the trade or business of buying and selling timber. If timber can in any event be included in inventory, it could not-be included in the inventory of this taxpayer inasmuch as he was not engaged in a business which permits the use of inventories for tax purposes. The timber was not held for sale to customers in the ordinary course of the taxpayer’s trade or business. This clause connotes a business regularly carried on and property continuously held out for sale rather than as here — casual sales. Cf. Phipps v. Commissioner, 54 Fed. (2d) 469, and Richards v. Commissioner, 81 Fed. (2d) 369.

The record shows that during the taxable year the petitioner was not actively engaged in any trade or business as those terms are ordinarily understood. His chief business had formerly been aviation, but he had retired from business and was absent from the state almost the entire year. His business, if any, during the taxable year could be described only as management of his investments. So far as the record shows he had never been in the business of buying and selling timber or timber lands. The original tracts here involved had been obtained by inheritance and tracts which were purchased later had been held along with the former for investment purposes since 1912. The sales here were not part of a business of buying and selling timber, but merely a liquidation of part of the petitioner’s investments in timber. The timber was not held primarily for sale to the customers of any established trade or business of the petitioner’s. There was no continuous course of dealing with a group of regular buyers which would be necessary to the conclusion that the timber was held for sale to customers in the ordinary course of trade or business. The sales of timber from the tracts of land here in question were isolated transactions by the petitioner, involving merely casual buyers, as distinguished from “customers.”

The respondent’s argument that the petitioner wras engaged in the trade or business of buying and selling timber is based on the fact that the petitioner used employees, agents, or independent contractors in effectuating this liquidation of his investment. We do not think the respondent’s conclusion can be predicated upon those facts alone. It is true that the petitioner engaged independent contractors, the logging companies, to put the timber in salable condition by cutting it and delivering it at tidewater, and that his employees or agents recorded and checked up on the performance of the contracts. But employees, agents, or brokers are often employed to effectuate a sale by one who is not in the regular business of buying and selling. Common examples are the retention of real estate agents or stockbrokers to sell property which has been held purely for investment. Even independent contractors, such as repairmen, are often employed to put investment property in salable condition, but that fact alone would not operate to put the seller into the trade or business of buying and selling such property. However, even if the utilization of the services of others in effectuating isolated transactions of sale could be said to require the conclusion that the owner of the property is engaged in trade or business, we are of the opinion that there was not in the case at bar any such regularity and continuity of dealing in the specific property as is required by the statutory provision invoked by the respondent. Such regularity and continuity of dealing are in our opinion necessary to the concept of sales to customers in the ordinary course of business which is embodied in the statute. For the foregoing reasons, we are of the opinion that the timber sold was not stock in trade, or property which should properly be inventoried, or property held primarily for sale to customers in the ordinary course of petitioner’s trade or business. Since the property does not fall within the exceptions contained in section 101 (c) (8) quoted above, it constituted capital assets and its sale gave rise to capital gain under one contract and resulted in a capital loss under the other.

In cases relied on by tlie respondent, the corporations were not merely liquidating investments, but were engaged in the regular business of mining. Stratton's Independence, Ltd. v. Howbert, 231 U. S. 399; Von Baumbach v. Sargent Land Co.. 242 U. S. 503. Cases in which sales of timber have been held to constitute sales of capital assets within the statutory definition are John W. Blodgett, supra, and J. J. Carroll, supra. Similar to the instant case, those were cases of sales of timber held for investment by persons not in the regular business of buying and selling timber. The fact that in those cases the timber was sold directly to loggers or to vendees who would themselves remove it does not, in view of what we have said above, serve to distinguish those cases in principal from the present one.

In regard to the second issue, arising from the respondent’s determination that the income of the three trusts described in our findings is taxable to the petitioner, the deficiency notice states only that the trusts “come within the purview of trusts defined in sections 166 and 167 of the Revenue Act of 1934.” On brief the respondent waives argument on this issue except to point out that in the W. E. Boeing, Jr., trust there is a possibility that the current income which is being accumulated for the benefit of W. E. Boeing, Jr., will be distributed to the petitioner along with the rest of the trust estate if W. E. Boeing, Jr., dies before he reaches 30 and the petitioner is himself alive at that time. Respondent argues that this places the trust income within the provisions of section 167 (a) (1) of the Revenue Act of 1934, which provides:

(a) Where any part of the income of a trust—
(1) is, * * * held or accumulated for future distribution to the grantor;
*******
then such part of the income of the trust shall be included in computing the net income of the grantor.

In our opinion this provision does not cover the case before us. We do not think that the language of this section covers or was intended to cover the situation where there is no definite provision for such future distribution to the grantor, but only the bare possibility that upon certain contingencies over which the grantor has no control the corpus and accumulations may revert to him. This is what has been called a mere “possibility of reverter” in the estate tax cases (Helvering v. St. Louis Union Trust Co., 296 U. S. 39; Becker v. St. Louis Union Trust Co., 296 U. S. 48), and we do not think that where such bare possibility exists the income of the trust may be said to be “held or accumulated for future distribution to the grantor”, within the meaning of section 167. That section, being one which cuts across the usual concept of the separate entity of trusts, should not, we think, be given any broader interpretation than its terms require (cf. Preston R. Bassett, 33 B. T. A. 182), and if article 167-1 of Regulations 86 purports to include in the scope of the statute such a trust as the one before us we think the regulation is an erroneous interpretation of the statute.

The argument just discussed could only apply to the W. E. Boeing, Jr., trust, since under the terms of the other two trusts there was not even a possibility of the accumulated income reverting to the grantor. Upon termination of those trusts upon any of the contingencies specified in the trust instruments, the distribution of the corpus and accumulated income was directed to go to others than the grantor.

In view of the blanket determination by the respondent that all three trusts fall within sections 166 and 167, it remains for us to point out that no power is retained under any of them to revest title in the grantor, wherefore section 166 does not apply, nor is there any provision for current or future distribution of the income to the grantor or for its application to the payment of premiums on insurance on his life, wherefore section 167 does not apply.

Decision will be entered under Bule 50.


author: Murdock:

text:
    Estate of Theodore Ebert, Jr., Deceased, Edith H. Ebert, Executrix, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 74351.
    Promulgated January 25, 1938.

      Edith R. Ebert, Executrix, pro se.

      0. G. Holmes, Esq., and E. G. Webber, Esq., for the respondent.
   OPINION.

Murdock:

The Commissioner determined a deficiency of $1,568.06 in the income tax of Theodore Ebert, Jr., for the year 1930. The only issue presented for decision is whether the gain of $24,367.28, realized by Ebert from an exchange of real property should be recognized in full, as contended by the respondent, to the extent of $13,367.23, as reported by Ebert in his return, or only to the extent of $10,367.23, as contended by the petitioner in her brief. The facts have been stipulated go that no findings of fact are necessary.

Ebert acquired a property on Diversey Parkway, Chicago, Illinois, on April 29,1922. He placed a mortgage of $45,000 on that property on July 11, 1929. The depreciated ,cost of the property to him on January 2,1930, was $37,632.77. The fair market value of the property on that date was $65,000. The mortgage was still outstanding. He exchanged the property on January 2,1930, for another on Green-view Avenue, Chicago, Illinois. The fair market value of the Green-view property at the time of the exchange was $30,000. There was a mortgage of $16,000 on it at that time. The properties were exchanged subject to the two then existing mortgages. Ebert received in the exchange, as additional consideration for the property which he transferred, a second mortgage on that property in the amount of $6,000. The stipulation is that the second mortgage had a fair market value of $3,000 at the time received by Ebert. Ebert, on his income tax return filed with the collector of internal revenue at Chicago, reported a profit of $13,367.23 from the exchange. The Commissioner, in determining the deficiency, included in income a profit of $32,000 from the transaction.

The parties are now in agreement that the profit realized from the exchange was $24,367.23. The following is a computation of that profit:

Amount realized:
Fair market value of property received_$30, 000.00
Less mortgage on that property- 16,000. 00
14,000. 00
Fair market value of second mortgage received_ 3, 000. 00
Mortgage on property transferred by Ebert_ 46,000.00
62, 000. 00
Less basis of property transferred_ 37, 632.77
Profit realized- 24,367.23

The controversy arises over how much of that profit is recognized for income tax purposes in 1930. The petitioner contends that it may be recognized only to the extent of $10,367.23 under sections 112 (b) (1) and (c) (1) of the Revenue Act of 1928. The $10,367.23 consists of $3,000, the fair market value of the second mortgage, and $7,367.23, the difference between $45,000, the mortgage on the Diver-sey Parkway property, and $37,632.77, Ebert’s basis for gain or loss on that property. She concedes that this $10,367.23 was “other property or money” within the meaning of section 112 (c) (1). If, as she concedes, a part of the benefit which the petitioner received from transferring the Diversey Parkway property subject to the mortgage of $45,000 was “other property or money,” it is difficult to understand how the remainder would differ.

The Commissioner contends that the entire profit of $24,367.23 must be recognized as income of 1930; Ebert placed the mortgage of $45,000 on the property, received the proceeds, and at that time derived the benefits from the use of that money; since he transferred the property subject to the mortgage and the property was worth $65,000 at the date of the transfer it is reasonable to conclude that he thereby relieved himself of the necessity of repaying the $45,000; this was equivalent for income tax purposes to the receipt of property worth $45,000; in addition, he received for his property a second mortgage worth $3,000 and an equity in another property, which equity was worth $14,000; thus the total amount realized was $62,000, which exceeded the basis for gain or loss by $24,367.23; the profit ivas real and in no sense fictitious, so there is good reason to recognize all of the profit realized. He relies upon the decision of the Board in the case of Brons Hotels, Inc., 34 B. T. A. 376.

The Board pointed, out in that case that unless the entire profit were recognized a portion of the profit would forever escape tax. The petitioner attempts to distinguish the cases because there the mortgages were assumed by the new owners of the properties, whereas here the properties were exchanged subject to the mortgage without assumption of those mortgages by the new owners. The petitioner, however, fails to show how this difference in the facts serves to distinguish the cases. Although the Board, in deciding the Brons Hotels, Inc., case, mentioned and relied upon the fact that the transferee had assumed the payment of the mortgage on the transferred property, nevertheless the real reason for the decision was the statutory difficulties standing in the way of the petitioner’s argument that a part of the profit should not be recognized. Those same difficulties stand in the way of the petitioner’s argument in this case.

This can be easily demonstrated by accepting the petitioner’s contention for the purpose of illustration. She concedes that a profit of $24,367.23 was realized, but she would recognize only $10,367.23 of it in computing income for 1930. Under that theory the property received in the exchange would take the same basis for gain or loss as the property exchanged, decreased in the amount of any money received and increased in the amount of gain that was recognized upon the first exchange. Sec. 113 (a) (6). No money was received, but perhaps the second mortgage should be treated as the equivalent of money to the extent of $3,000, its fair market value. The basis of the property exchanged was $37,632.77. If it should be decreased by the $3,000, it would then be $34,632.77. That amount would be increased by the amount of gain recognized on the first transfer, to -wit, $10,-367.23. Thus the basis for gain or loss applicable to the property received in the exchange would be $45,000. That property consisted of a second mortgage worth $3,000 and a piece of real estate worth $30,000 subject to a mortgage of $16,000. Assume a prompt disposition of this property for its fair market value. Three thousand dollars is received for the second mortgage and the real estate is sold for $14,000 subject to the $16,000 mortgage. Suppose further that shortly after this sale the purchaser pays off the mortgage of $16,-000. On that sale the seller received $17,000 in cash for property having a basis of $45,000, and thus, for income tax purposes, realized a loss of $28,000. Going back now and looking at the entire transaction, it is apparent that a profit of $24,367.23 was realized, yet, for income tax purposes, a gain of $10,367.23 and a loss of $28,000 have been reported. The loss reported exceeded the gain by $17,632.77 on transactions which clearly resulted in a profit of $24,367.23.

How could such an absurd result be avoided ? The nonrecognition provisions were not intended to exempt profits from tax but merely-to postpone the tax until later when the property received might be disposed of and the balance of the profit consolidated and recognized. Helvering v. Minnesota Tea Co., 89 Fed. (2d) 711. Since $14,000 of the gain realized on the first exchange was not recognized for tax purposes under the petitioner’s theory, and since the property received in the exchange was worth only $17,000, it is apparent that in some way the basis for gain or loss on the property received would have to be reduced to $3,000 in order that a gain of $14,000 might be recognized upon the subsequent disposition of the property received in the first exchange. However, there are no provisions in the revenue act for reducing the basis to $3,000. The result would be only more absurd if no gain whatsoever were recognized on the first transaction.

We pointed out in the Brons Hotels, Inc., case that such absurd results were never intended by Congress, and in order to avoid an interpretation permitting them it is necessary to recognize all of the gain from the first exchange at the time it is realized. In principle the Brons Hotels, Inc., case and this one are not distinguishable. Following the decision in the Brons Hotels, Inc., case, we hold that the entire profit of $24,367.23 must be recognized as income of 1930. Cf. Lucas v. Schneider, 47 Fed. (2d) 1006; certiorari denied, 284 U. S. 622; Harvey M. Toy, 34 B. T. A. 877; H. T. Robinson, 35 B. T. A. 1080. Possibly contra United States v. Hendler, 91 Fed. (2d) 680, affirming 17 Fed. Supp. 558.

Decision will be entered under Rule SO.


author: Murdock: Leeoh,

text:
    Joseph Frost, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 73712.
    Promulgated January 25, 1938.

      B. L. Rawlins, Jr., Esq., for the petitioner.

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

Murdock:

The Commissioner determined a deficiency of $1,583.36 in the petitioner’s income tax for the year 1930. The only issue here is the correctness of the method used by the Commissioner in computing gain or loss upon the repossession by-the petitioner of six pieces of real estate in the taxable year, as to which he had entered into contracts to sell in prior years on the deferred payment plan. The facts have been stipulated.

The petitioner was engaged in business in Chicago, Illinois, in the construction and sale of residences during the taxable year and for some years prior to that time. He sold his properties on a deferred payment basis. Each purchaser made a cash payment of a portion of the agreed purchase price, assumed the mortgage, if any, and agreed to make subsequent cash payments at stated intervals. The petitioner retained title until the cash payments approximated the cash cost of the property to the petitioner, at which time he would transfer title to the purchaser and receive a purchase money second mortgage as security for the unpaid balance of the purchase price. No note or evidence of indebtedness, other than the contract of sale, was given by the purchaser prior to his receipt of title. None of the obligations evidenced by such contracts of sale were sold by the petitioner and only in rare instances were purchase money second mortgages, when taken, discounted and sold by the petitioner.

Six properties which had been the subject of sales contracts 'executed in prior years, and with respect to which the purchasers were in default under their contracts of purchase, were repossessed by the petitioner during the taxable year. The stipulation shows the original cost of each of these properties to the petitioner, the sale price, the payments made by the purchaser, and the fair market value of the property at the time repossessed by the petitioner.

The petitioner at the date of repossession had not transferred legal title to five of these properties. Title to the sixth had been conveyed and a second mortgage taken.

No part of the cash payments received by the petitioner in years prior to 1930 on four of the properties in question was reported as profit from those transactions on his income tax returns for those years. He reported a small profit on the other two, but not on the installment basis. He assigned no value to the contracts of purchase obligating the purchasers to pay and did not choose to use the installment basis of reporting his income from the transactions. The method chosen by the taxpayer in those years was a proper choice under the statutes and was not questioned by the Commissioner. The theory of it was that the payments were first to offset the petitioner’s bases for gain or loss, four of the transactions had, so far, not resulted in any gain, and as they were not yet completed, gain or loss would depend upon future events which would bring the transactions to a close.

The petitioner contends that he realized no gain from repossessing the properties because the cash he received reduced but did not exceed his bases and he now has the properties with reduced bases for gain or loss upon future dispositions. The Commissioner has computed the deficiency in accordance with the second paragraph of article 354 of Regulations 74, but he made claim for an increased deficiency upon the ground that section 44 (d) applies.

Since the petitioner never chose to use the installment basis of reporting his income from these transactions, and since the use of that method is not obligatory, he can not be taxed upon repossessions as if he had chosen that method. Max Viault, 36 B. T. A. 430. Section 44 (d) applies and was intended to apply only in case the installment basis has been used by the taxpayer. The contracts of sale which the petitioner had were not installment obligations within the meaning and intendment of section 44 (d), since he was not using the installment basis, and there would be no good reason to characterize them as installment obligations. The section was enacted as a part of the 1928 Act to prevent evasion under the installment method of reporting income and was not intended to apply where some other unrelated method of reporting had been used. There would be absolutely no justification for applying it in this case.

The method used by the Commissioner in determining the deficiency was in accordance with the law. The payments forfeited on properties as to1 which title had not passed were properly included in income of the year in which the forfeiture occurred, to the extent that they had not been reported as income previously. Calvin T. Graves, 17 B. T. A. 1318. The gain on the repossession of the sixth property was computed in accordance with the decision in Henry Heldt, 16 B. T. A. 1035. See also Nat Webb, Jr., 22 B. T. A. 1249; Laurens Trust Co., 3 B. T. A. 331; Home State Bank, 15 B. T. A. 121; Title & Trust Co., 33 B. T. A. 25. The case of Boca Ratone Co. v. Commissioner, 86 Fed. (2d) 9, reversing 31 B. T. A. 1060, is distinguishable because there the installment basis had been selected and used by the taxpayer, in accordance with its rights under the statute.

The amounts expended by the petitioner in reconditioning some of the properties after repossession are deductible as ordinary and necessary expenses of the petitioner’s business, since the parties are agreed that they did not result in improvements, the cost of which should be capitalized.

Beviewed by the Board.

Decision toill be entered under Rule 50.

Tyson dissents.

Leeoh,

dissenting: The petitioner sold certain pieces of property. In years prior to the taxable year he received payments on account, which, in the case of each sale, amounted to less than his cost of the property sold. Petitioner treated these payments as recoveries of capital on the ground that the obligations of the purchasers to make such payments had no fair market value. The majority opinion formally approves' this treatment which had, in fact, been approved by the Commissioner. In the taxable year the petitioner repossessed each property in satisfaction of the unpaid purchase price. The question is the gain or loss sustained by the petitioner on such repossession.

The majority opinion holds that in computing gain or loss upon repossession there is a material distinction between those cases in which the taxpayer has sold the property on a deferred payment basis and retained the legal title as security for the future payment, and where he has conveyed legal title and retains a mortgage conveyance for the same purpose. As to the basis for such distinction the opinion is silent.

I can conceive of no theory upon which such a distinction can be justified. In both cases the result to the seller is identical. The loss or gain realized is in fact the same. Both are cases of sales of property. I can not accept a theory under which the taxpayer, merely through-the mechanics he has employed to secure payment of the purchase price, will realize a taxable gain, in the event the property is repossessed, but would be held to have sustained a deductible loss in the same transaction, if he used slightly different mechanics to do the same thing.

For purposes of illustration let us assume that the taxpayer here owned two lots which cost him $5,000 each and which he sold to the same purchaser on the same day for $10,000 each. On each lot the purchaser made a cash payment of $2,000 and agreed to pay the balance in equal periodic installments. In the sale of one lot the taxpayer executed a deed and took back a purchase money mortgage. In the sale of the other, the parties executed a contract under which it was agreed that the taxpayer would retain legal title until the final payment was made. In both cases the taxpayer treated the cash payments as recoveries of capital, as was done in the case at bar. Let us assume further that the purchaser defaults in the following year and his offer to reconvey, to the taxpayer, his interest in the two lots for the surrender of his notes is accepted, and this is done. The lots have each a fair market value of $2,000 as of the date of repossession.

So far as the taxpayer is concerned, the result in each case is, in fact, the same and yet the application of the theory of the majority opinion would require an entirely different computation. In the case of the lot upon which the taxpayer had taken back a purchase money mortgage, the rule recognized in Henry Heldt, 16 B. T. A. 1035, and other similar cases cited in the majority opinion would be applied and the taxpayer would be held to have sustained a deductible loss of $1,000. This would be the excess of his basis, which is $5,000, less $2,000 recovered in the cash payments made, or $3,000, over the $2,000 fair market value of the property at the time repossessed. In the sale of the other lot, identical in all respects except for the fact that the seller used a slightly different method for securing the payment of the deferred installments, our decision of some years back in Galvin T. Graves, 17 B. T. A. 1318, would be invoked. The fair market value of the property repossessed would be disregarded and the taxpayer would be held to have realized a taxable gain of $2,000, composed of the payments on account which were “forfeited” to him on repossession.

In the recent case of Boca Ratone Co. v. Commissioner, 86 Fed. (2d) 9, reversing 31 B. T. A. 1060, even though the respondent’s regulations had approved it, the court specifically rejected this very distinction upon which the majority opinion is predicated. In this opinion the court states:

* * * Taxation is a practical matter. Tlie reasoning of the Board in an effort to justify the distinction made in the Regulations is too technical, refined, and legalistic. The Regulations as to this distin'ction exceed the provisions of the Statute and are invalid. If there is any doubt about this, it should be resolved in favor of the petitioner. Gould v. Gould, 245 U. S. 151, 153, 38 S. Ct. 53, 62 L. Ed. 211; Crocker v. Malley, 219 U. S. 223, 253, 39 S. Ct. 270, 63 L. Ed. 573, 2 A. L. R. 1601; United States v. Field, 255 U. S. 257, 262, 41 S. Ct. 256, 65 L. Ed. 617, 18 A. L. R. 1461.

The decision of the Third Circuit in Boca Ratone Co. v. Commissioner, supra, has been accepted and followed by us in the recent case of Eggerman Investment Co., 36 B. T. A. 1196. It is directly in point here. The majority opinion attempts' to distinguish this case with the mere statement that there the taxpayer had elected to return his gain on the installment basis. This is a distinction without a difference. The principle announced by the court is in no wise affected or controlled by the method used by the taxpayer in reporting the income realized on the sale. It is evidently overlooked that section 44 affects, only, the year in which the income from a given transaction is to be taxed. Its application does not increase or decrease the amount of the gain realized. The gain or loss upon repossession of property, where payments made have been reported upon the installment basis, is the same amount as in cases where that basis has not been used except for the reduction of the amount of gain or the increase of the amount of loss by the sum of that portion of prior payments which had been included in income.

I think that the gain realized in all of the pending transactions should be computed in accordance with the rule laid down in Henry Heldt, supra, and similar cases cited in the majority opinion. Section 44 (d) applies that rule in cases where the income realized prior to the repossession had been returned upon the installment basis. It is my opinion that this method of computation should be used in both the classes of sales here and gives the actual gain realized. The method the majority opinion applies to five of the pending transactions and which disregards, as an element in the computation of gain or repossession, the fair market value of the property repossessed, is erroneous.

       SEC. 44. INSTALLMENT BASIS.
      (a) Dealers in personal property. — under regulations prescribed by the Commissioner with the approval of the Secretary, a person who regularly sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year which the gross profit realized or to be realized when payment is completed, bears to the total contract price.
      (b) Sales of realty and casual sales of personalty. — In the case * * * (2) of a sale or other disposition of real property, if in either ease the initial payments do not exceed 40 per centum of the selling price, the income may, under regulations prescribed by the Commissioner with the approval of the Secretary, be returned on the basis and in the manner above prescribed in this section. As used in this section the term “initial payments” means the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable period in which the sale or other disposition is made.
      *******
      (d) Gain or loss upon disposition of installment obligations. — If an installment obligation is satisfied at other than its face value or distributed, transmitted, sold, or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and (1) in the case of satisfaction at other than face value or a sale or exchange — the amount realized, or (2) in case of a distribution, transmission, or disposition otherwise than by sale or exchange — the fair market value of the obligation at the time of such distribution, transmission, or disposition. The basis of the obligation shall be the excess of the face value of the obligation over an amount equal to the income which would be returnable were the obligation satisfied in full.

       Akt. 3-54. Deferred-payment sale of real property not on installment plan. — In transactions included in class (2) In article 352, the obligations of the purchaser received by the vendor are to be considered as the equivalent of cash to the amount of their fair market value in ascertaining the profit or loss from the transaction.
      If the vendor had retained title to the property and the purchaser defaults in any of his payments, and the vendor repossesses the property by agreement or process of law, the difference between (1) the entire amount of the payments actually received on the contract and retained by the vendor and (2) the sum of the profits previously returned as income in connection therewith and an amount representing proper adjustment for exhaustion, wear and tear, obsolescence, amortization, and depletion of the property while in the hands of the purchaser, will constitute gain or loss, as the case may be, to the vendor for the year in which the property is repossessed, and the basis of the property in the hands of the vendor will be the original basis at the time of the sale. If the vendor had previously transferred title to the purchaser, and the purchaser defaults in any of his payments and the vendor reacquires the property, such repossession shall be regarded as a transfer by the vendor, in exchange for the property, of such of the purchaser's obligations as are applied by the vendor to the purchase or bid price of the property. Such an exchange will be regarded as having resulted in the realization by the vendor of gain or loss, as the case may be, for the year of repossession, measured by the difference between the fair market value of the property and the basis in the hands of the vendor of the obligations of the purchaser (generally, the fair market value thereof which was previously recognized in computing income) which were applied by the vendor to the purchase or bid price of the property. The fair market value of the property shall be presumed to be the amount for which it is bid in by the vendor in the absence of clear and convincing proof to the contrary. If the property so acquired is subsequently sold, the basis for determining gain or loss is the fair market value of the property at the date of acquisition.
      If the obligations received by the vendor have no fair market value, the payments in cash or other property having a fair market value shall be applied against and reduce the basis of the property sold, and, if in excess of such basis, shall be taxable to the extent of the excess. Gain or loss is realized when the obligations are disposed of or satisfied, the amount being the difference between the reduced basis as provided above and the amount realized therefor. Only in rare and extraordinary eases does property have no fair market value.

       See House Report No. 2, 70th Cong., 1st 'sess., pp. 14-16; Senate Report No. 960, 70th Cong., 1st sess., pp. 22-24.


author: Leech,

text:
    Virginia Iron Coal & Coke Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 87010.
    Promulgated January 26, 1938.

      P. B. Kavanagh, Esq., for the petitioner.

      D. A. Taylor, Esq., for the respondent.
   OPINION.

Murdock: The Commissioner determined for the year 1933 a deficiency of $51,178.95 in income tax and a deficiency of $4,229.42 in excess profits tax of the petitioner and its affiliated companies. The sole issue for decision is whether or not the Commissione»»erred in including in consolidated income for 1933, $425,000 representing payments received by the affiliated companies in prior years under a contract with the Texas Gulf Sulphur Co. The facts have been stipulated and no findings of fact need be made.

The petitioner owned practically all of the stock of its subsidiary, the New York & Virginia Mining & Mineral Co., hereinafter referred to as Mineral. Mineral owned about 6,500 acres of mineral lands and rights in Carroll County, Virginia. The petitioner, on July 7, 1930, entered into a written contract with the Texas Gulf Sulphur Co., hereinafter referred to as Texas. The contract provided that Texas had the right to purchase all of the stock of Mineral owned by the petitioner or the mineral lands and rights owned by Mineral for the sum of $3,750,000. Texas could retain the option from year to year until 1935 by paying $300,000 on August 1, 1930, and $125,000 on the first day of August in each succeeding year, up to and including August 1, 1934. Texas could make the purchase at any time by paying the purchase price. All of the annual payments were to be credited as a part of the purchase price in case the option was exercised. There was a provision for continuing the option beyond August 1, 1935, by the payment of $150,000 on the first day of August of each year, but those payments were not to be credited as a part of the purchase price. Texas was permitted to explore the lands and remove ore for test purposes. Texas was not obligated to make further payments in case it failed to exercise the option and allowed it to lapse, but in that event the petitioner “shall retain” all payments already made.

The first payment of $300,000 was received on or about August 1, 1930. A second payment of $125,000 was received on or about August 1, 1931. The contract was not carried out precisely in accordance with its terms. Several supplemental contracts were entered into in order to include additional lands to be acquired by advances from the purchaser, to provide for the placing of a deed in escrow, and to provide for some changes in the payments to be made in order to continue the option. Advances of small amounts were made, additional lands were acquired, and deeds were placed in escrow. The Texas Co. failed to make a required payment of $125,000 on August 1, 1932. But thereafter, on September 21, 1932, a supplemental contract was entered into which continued the option, with some modifications or changes, and by this and other supplemental contracts, the last of which was entered into on August 1, 1933, the time for further payment was extended until February 1, 1934. No further payment was ever made. The Texas Co. notified the petitioner in writing on December 26, 1933, that the option would not be exercised, no further continuance was desired, and repayment of advances made for the purchase of additional lands was demanded. The payments and expenditures made by Texas and its subsidiary were charged off their books as a loss at that time. Early in the following year, the escrow deeds were returned to the petitioner and the advances were returned to the Texas Co.

When the Texas Co. abandoned the option in 1933, the $425,000 theretofore received by the petitioner was freed of the requirement that it be applied as a part of the purchase price in case of the exercise of the option. Those two payments had been mentioned in the original consolidated returns filed for 1930 and 1931 as nontaxable income, representing amounts received under an option agreement covering the sale of real property. Amended consolidated returns for 1930 and 1931 were filed on May 10, 1934, in which the above stated amounts were included in taxable income for the years in which received. The tax shown to be due by those amended returns was paid. The petitioner and its affiliates kept their books and made their income tax returns in accordance with an accrual method of accounting.

Mineral had acquired the properties prior to March 1, 1913. The fair market value of the properties on March 1, 1913, was in excess of cost and both the cost and the fair market value on March 1, 1913, were in excess of $425,000.

The Commissioner in determining the deficiencies included in the consolidated income for 1933 the total payments of $425,000 received in 1930 and 1931 under the agreement. He explained that the transaction was not completed for income tax purposes until Texas, in 1933, surrendered its rights under the option to buy the lands and to have the payments in question applied as a part of the purchase price. He held that the entire amount was realized as income in 1933. He then scheduled an overassessment for the income taxes paid on the $425,000 under the amended returns filed for 1930 and 1931. The issue for decision is whether those two payments received in 1930 and 1931 were taxable income for 1933.

The petitioner argues that the payments were either income when received, or were a return of capital which should have been irrevocably applied as a recovery of a part of the basis of the property, so that in neither event would the payments represent income in 1933. Neither of these arguments offers a proper solution of this case. It was impossible to tell in 1930 and 1931, when the payments were received, whether they would ultimately represent income to the petitioner or a return of capital. They were to be applied against the purchase price in case of the exercise of the option. Had the option been exercised, they would have represented a return of capital, that is, a recovery of a part of the basis for gain or loss which the property had in the hands of the seller. In that event they would not have been income and their return as income when received would have been improper. Cf. Higgins Estate, Inc., 30 B. T. A. 814. But in case of termination of the option and abandonment by the Texas Co. of its right to have the payments applied as a part of the purchase price, it would be apparent for the first time that the payments represented clear gain to the petitioner. In that case, since no property would be sold, there would be no reason to reduce the basis of that retained.

Thus it was impossible for either the taxpayer or the Commissioner to determine in 1930 and 1931 whether or not the payments would eventually represent income and how they should be reported. Obviously those years could not be held open for income tax purposes to await the final outcome of such contracts. The taxpayer in this case, after the option to purchase had been surrendered, filed amended returns reporting the payments as income for the years in which received. But returns must be filed in the light of facts known at the time the returns are due. Some other, taxpayer might not choose to file amended returns. Then the statute of limitations would foreclose the Commissioner and prevent the collection of taxes lawfully due. If the Commissioner is to make an orderly and uniform collection of taxes in such cases, the tax liability for those earlier years must be determined and closed by collection, without waiting to see whether or not the option is exercised.

Thus it is necessary to exclude such payments from the income of the year in which received and to include them for the later year when, for the first time, a satisfactory determination' of their character for income tax purposes can be made. The other party to the contract in the taxable year for the first time released and abandoned its right under the agreements to have the payments applied against the purchase price, and charged off its loss. The recipient then knew for the first time that it could retain the payments without any obligation to apply them against the purchase price. Its property was then free of the option. It had lost nothing, but had retained everything with- which it started and had acquired $425,000 in addition. The $425,000 was then income.

The taxpayer argues that, since the funds were received in 1930 and 1931 with the right to retain them forever and to use them without restriction, they should have been accrued as income for those years. Although they were received without any obligation to return them, there was one condition attached to their receipt. That is, they had to be applied against the purchase price in case the option was exercised. That one condition is the determining factor in this case. Until it was removed in 1933, the question of the liability of the recipient for income tax upon the payments had to be held in abeyance. Similar cases of forfeiture arise under contracts of sale and are treated the same way. Calvin T. Graves, 17 B. T. A. 1318; Henry Heldt, 16 B. T. A. 1035; Nat Webb, Jr., 22 B. T. A. 1249; Laurens Trust Co., 3 B. T. A. 331; Home State Bank, 15 B. T. A. 121; Title & Trust Co., 33 B. T. A. 25; Joseph Frost, 37 B. T. A. 190.

Since the petitioner never elected to use the installment method of reporting its profit from the proposed sale, the possibilities of the use of that method need not be discussed. The argument is made that the payments were solely for the purpose of retaining the option and, since the option cost the petitioner nothing, the payments were pure gain at the time received. If this argument were supported by the facts it would be' unanswerable, but the facts show that these particular payments were not merely for the purpose of continuing the option but were to be a part of the purchase price in case the option was exercised. Cases involving royalties are distinguishable. Royalties have been held to be income at the time received where they represent a payment for the right to remove or use some of the property even though they are to be applied against the purchase price. The owner, of course, offsets this income by depreciation and depletion deductions which permit him to recover his basis tax-free despite the fact that the entire amount of the royalties is included in income. Here the payments were not of that character. The method originally adopted by the petitioner in reporting these payments and that adopted by the Commissioner are consistent and proper.

The final argument advanced by the petitioner is that the option, under which payments aggregating $425,000 were made, lapsed in 1932, and, if the Commissioner’s theory that gain was realized on the option when it expired is correct, the income in this case was realized in 1932 rather than in 1933. It is true that thei payment of $125,000 due on August 1,1932, was not paid, but shortly thereafter in that same year the parties, by further agreement, revived the option and continued it, so that the payments theretofore made were not forfeited at that time. The petitioner at the end of that year still could have been required to apply these payments as a part of the purchase price in case the Texas Co. later chose to exercise its existing rights under the option to buy the property.

Reviewed by the Board.

Decision will be entered for the respondent.

Leech,

dissenting: The problem here is whether the taxpayer realized taxable gain, and its amount, in 1933, because of the release, in that year, of the taxpayer’s conditional obligation to sell the Texas Co. real estate at a certain price. In deciding this question, doubt, if any there be, must be resolved in favor of the taxpayer.

The annual period is fundamental in income tax law and its administration. Thus, money received by a taxpayer, as its own, subject to its unfettered command — which no contingency can affect — constitutes gross income for the year of such receipt. It is either returned capital or gain or both. The holding of the majority not only grossly distorts income but directly contradicts that principle.

The rule is apparently recognized in one paragraph with this sentence:

* * * If tlie Commissioner is to make an orderly and uniform collection of taxes in suck cases [the proceeding at bar], the tax liability for those earlier years must be determined and closed by collection, without waiting to see whether or not the option is exercised.

But, in the very next paragraph, the law thus invoked is violated. It is said:

Thus it is necessary to exclude such payments from the income of the year in which received and to include them for the later year when, for the first time, a satisfactory determination of their character for income tax purposes can be made. * * *

The opinion then proceeds to “exclude” the disputed payments from income for the respective years of their receipt and taxes them to the recipient in a later year when nothing could or did happen, changing, in any way, the taxpayer’s unconditional right to such payments which the taxpayer had possessed, absolutely, since it received them. In doing this, the opinion labors but fails to escape an inevitable dilemma. That is, to reach its result, the majority must decide either that these contested payments were forfeited to the petitioner in 1933, or that the money value to the taxpayer of the release, in that year, of its obligation to sell property to the Texas Co., is determined, conclusively, by tie sum oí those payments. Since neither premise is sound, the conclusion the opinion reaches is wholly untenable.

Thus, the first alternative, namely: that the two annual payments, the one of $300,000 made in 1930 and the other of $125,000 made in 1931, were forfeited in 1933 at the time the Texas Co. notified the petitioner that it would not exercise the option, is obviously impossible to sustain. These funds were the absolute property of the taxpayer since their receipt in 1930 and 1931. Nothing could or did occur in 1933 or at any other time, changing that controlling fact. So there neither was nor could have been a forfeiture of such funds in 1933, the year before us.

And the second alternative is just as clearly wrong. It is evident that, if the release, in the tax year, of the taxpayer’s obligation to convey real estate, did result in taxable gain, that gain, if any, would not be measured by the amount of the contested payments, as the respondent and the majority have done. That gain would be measured, only, by the monetary value of the release to the taxpayer when the release occurred. That would be the only realized gain. And that value, in turn, would be the excess of the fair market value of the property at the time the taxpayer’s obligation was released, over the price at which the taxpayer was obligated to convey it. The taxpayer would then have realizable asset value in that amount freed to it by the release.

No evidence appears in this record that the fair market value of the property at the time the option was released, exceeded the option price. Therefore, there is no evidence here of gain realized through the release of the option and the taxpayer would be entitled to a judgment of no deficiency.

None of the authorities cited 'in the prevailing opinion is in point. The Higgins case might be so if the present contract were a sale agreement and not a mere option. But even then it would contradict the prevailing view that the funds in dispute were neither capital nor gain when received.

Undoubtedly the pending contract, covering the later years, where the annual payments were not to be credited against purchase price, constituted only an option. So too, I think, it was for the earlier years, when such payments were to be so credited. The only effect of the latter condition was to decrease the purchase price if the option were exercised in those earlier years. That price was just as definite whether or not that condition was applicable. The taxpayer parted with nothing more and the Texas Co. received nothing more because of it. With or without the condition, the taxpayer did not sell any title in the property nor did the Texas Co. acquire any. This is obvious because, under the contract, no payment made by the Texas Co. to the petitioner could be a part of the consideration for the optioned property imless a/nd v/ntil the option was exercised and the property purchased. But, the option was not exercised and the property was not purchased.

So, I think the answer here is that the taxpayer sold a bare option in 1930 for $300,000, and extended that option in 1931 for $125,000. Since it had no cost or other basis for either the option or its extension, those amounts are taxable as income in their entirety for the respective years when the taxpayer received them. In its amended returns for those years, the taxpayer so treated them, and paid the resulting income taxes. In my judgment, that was right.

Disney agrees with this dissent.

       The agreement provided for payments of $100,000 annually merely to continue the option after August 1, 1935. Had any such payment been made it could have been income for the year received because it was in no event to be applied as a part of the purchase price.

        Gould v. Gould, 245 U. S. 151.

       See Burnet v. Sanford & Brooks Co., 282 U. S. 359.

        Brown v. Helvering, 291 U. S. 193; Burnet v. North American Oil Consolidated, 286 U. S. 417; Blum v. Helvering, 74 Fed. (2d) 483; Burnet v. Logan, 283 U. S. 404; Commissioner v. Speyer, 77 Fed. (2d) 824; Jennings & Co. v. Commissioner, 59 Fed. (2d) 32; Automobile Underwriters Inc., 19 B. T. A. 1160.

       See United States v. Kirby Lumber Co., 284 TJ. S. 1.

        Helvering v. Taylor, 293 U. S. 507.

        Higgins Estate, Inc., 30 B. T. A. 814.

        Helvering v. San Joaquin Fruit & Investment Co., 297 U. S. 496.