author: MoRRis: McMahon,

text:
    The Penn Mutual Life Insurance Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 52577.
    Promulgated June 28, 1935.

      Robert Dechert, Esq., for the petitioner.

      De Witt M. Evans, Esq., for the respondent.
   OPINION.

MoRRis:

Four allegations of error, one being an affirmative allegation of the respondent, involve the deductibility of “ interest ” under section 245 of the Revenue Act of 1926, which, for our purposes, is identical with section 203 (a) (8) of the Revenue Act of 1928, providing:

(a) In the case of a life insurance company the term “net income” means the gross income less—
* ‡ sji * # >fc
(8) All interest paid or accrued within the taxable year on its indebtedness

In Fall River Electric Light Co., 23 B. T. A. 168, we had under consideration the language of section 234 (a) (2) of the Act of 1926, providing for the deduction of “All interest * * * on its indebtedness.” We there adopted the following definition: “ Interest on indebtedness has a definite and well accepted meaning as ‘the compensation allowed by law or fixed by the parties for use, or forbearance, or detention of money.’ [citations] ”, and in Lafayette Life Insurance Co., 26 B. T. A. 946; reversed, 67 Fed. (2d) 209, we quoted with approval the dictionary definition of the word “interest ” as “An agreed or stipulated compensation accruing to a creditor during the time that a loan or debt remains unpaid.” See also Joseph W. Bettendorf, 3 B. T. A. 378.

The Supreme Court of the United States, in Duffy v. Mutual Benefit Life Insurance Co., 272 U. S. 613, used some pertinent language. In that case the respondent was a mutual life insurance company having no capital stock, conducting its business upon the “ level premium plan ”, under which the estimated annual cost of insurance is averaged and the maximum annual contribution of each member is uniform through the life of the policy. The annual contributions during the early years of the policy are in excess of the natural premiums and such excess premiums, augmented by interest thereon, are held as a reserve to maintain insurance in the later years. The company was required by state law to maintain its assets at a sum not less than the amount of “ legal reserve ” required by such laws. The respondent there, in its return filed for the year 1917, included such reserve in its invested capital under the act then in force. The question of its inclusion was finally contested in the Supreme Court. It having been contended there that such reserve represented a present existing liability, the Court said in disposing of such contention:

* * * These assets, thus constituted, have never represented indebtedness any more than the capital of a stock corporation subscribed by its stockholders represents indebtedness. Until the maturity of a policy, the policyholder is simply a member of the corporation, with no present enforceable right against the assets'. Upon the maturity of the policy he becomes a creditor with an enforceable right. Then for the first time there is an indebtedness. * * * In the meantime, each member bears a relation to the mutual company analogous to that which a stockholder bears to the joint-stock company in which he holds stock. In either ease, the title to the assets is in the corporation and not in the members or stockholders. * * *

Because of the relationship which the respondent’s affirmative allegation bears to three similar issues raised by the petitioner, we shall dispose of this issue first. He claims to have erred in allowing the petitioner to deduct as “ interest on indebtedness ” the sums of $181,764.13 for the year 1926 and $10,117.19 for the year 1928, purporting to represent “ interest ” on deferred dividends paid to policyholders under the so-called “ accumulated-sürplus plan ” policy.

In support of this issue the respondent relies not only upon the total absence of a contractual obligation to pay interest to its policyholders under such policies, but upon our decision upon a very similar type of policy in Lafayette Life Insurance Co., supra. The petitioner, on the other hand, contends not only that there was an obligation to pay “ interest ”, but that the facts in the instant case are distinguishable from the case relied upon by the respondent, asserting, however, that even if the facts were identical it would still disagree with the conclusion there reached.

We have carefully considered the petitioner’s contentions urged by counsel at the trial and set forth on brief, but they fail to convince us of any statutory justification for the deduction claimed by it, and, in our opinion, erroneously allowed by the respondent. We base our conclusion upon a thorough consideration of the policy contract itself and the testimony respecting it, supported by Lafayette Life Insurance Co., supra, and Missouri State Life Insurance Co., 29 B. T. A. 401, in which we reiterated the position taken in the former proceeding, although reversed on that issue by the circuit court.

In the latter proceeding, after setting forth provisions of the policy strikingly similar to those here, the Board said:

The. method followed by petitioner with respect to the apportionment of the' deferred dividends on these policies was to set aside each year an amount as representing the profits of súeh year allowable to the policy, the total of these sums representing the sum apportioned as a deferred dividend at the close of the tontine period. In each year it also set aside on each policy an amount designated as interest and computed at 3% per cent compounded annually upon the amounts theretofore set aside as apportioned profits of prior years. The total of these sums was paid to the policyholder at the close of the period. The question here presented is whether those portions of the payments made in the taxable years which represented the so-called interest computed, were in fact payments of interest upon debts or obligations of petitioner or whether the entire payment in each case was one of deferred dividends.

In Lafayette Life Insurance Co., supra, we had a situation substantially similar to this before us. In that case we said:

Nor can it be said that the deferred dividends constituted debts owed by petitioner during the 20-year period of the tontine policies. A debt in its general sense is “ a specific sum of money which is due or owing from one person to another, and denotes not only the obligation of the debtor to pay, but the right of the creditor to receive and enforce payment.” J. 8. Cullinan, 19 B. T. A. 930. During the tontine period none of the deferred dividends constituted “ a specific sum of money due or owing ” from petitioner to a policyholder and enforceable by the latter. Not until the end of such period could it be determined who of the policyholders might be entitled to deferred dividends. Indeed, it is quite conceivable that none would be so entitled. It is clear, we think, that under such circumstances the so-called interest payments could not properly be deemed interest. They constituted additional dividends rather than interest.
It will be noted that there is no agreement in the policy here in question to pay interest upon deferred dividends, and we think it immaterial how petitioner computes the amount allocable to the policy for each year, the total of which it pays at the close of the tontine period, which is the date its obligation to make any payment accrues. Petitioner attempts to distinguish the above cited case upon the ground that the apportionment of profits for each year and the computation of interest thereon was made at the close of the tontine period, whereas in the present case it was made each year and the tentative credits to the policy then transferred from surplus. We see in that no material difference. It was at most, in our opinion, merely a different method of recording upon the corporate books a transaction in all respects similar to the one before us in Lafayette Insurance Co., supra. In both cases the obligation was similar and the payments made were identical in character.

We can not conclude .from the mere use of the terms “ surplus ”, “ accumulated-surplus ” or “ accumulated-surplus plan ”, without even the slightest suggestion in the contract of the payment of “ interest ”, that there was either moral or legal obligation to pay such interest, as the petitioner would have us do. Furthermore, the policy being payable only after the conclusion of the accumulated-surplus period, which might be anywhere from ten to twenty or more years, not only were the survivors to benefit under such plan unknown, but the amounts of the obligations thereunder were impossible of exact ascertainment when the contracts were entered into. If all policyholders completed their accumulated-surplus period, the amount payable under the contract would be one thing, but if only a very few did so it would be quite another thing.

For the above and foregoing reasons we hold that the respondent’s allowance of the amounts set forth under this issue as deductions was incorrect, and his affirmative allegation in respect thereto is accordingly sustained.

Coming now to the petitioner’s first and second assignments of error. Under those issues two classes of alleged interest are claimed as deductions: (a) “guaranteed interest” at 3 percent included in the installments-certain, and (b) the “ excess ” or “ additional ” interest, both of which are provided for in section 1 of the policy contract first set forth hereinabove.

The type of policy involved under this issue becomes payable, upon the death of the insured, in a stated number of installments over a period of years to the beneficiary therein named. The so-called guaranteed interest is the difference between the commuted value at the date of death of the insured and the total amount the petitioner is obligated to pay as installments-certain.

A feature of this policy which must necessarily be borne in mind is that although it matures upon the death of the insured, neither the beneficiary nor his estate has any contractual claim against the petitioner for the payment of installments-certain until each installment falls due and becomes payable and that the amount of such installment is determined at the time the contract is entered into, and does not change, and the reserve required by law to be set aside for such payment is based upon the amount found under “ The American Experience Table of Mortality with interest at 3 per cent, per annum, according to the net level premium method.” The 3 percent interest provided for in section 7 has no independent significance in the policy. It effects no change or alteration in the original basis of determining the installment-certain. Such provision was inserted there, according to our construction of the contract, for the sake of clarity, and so that there may be no dispute as to the rights of the beneficiary’s estate, in the event of his death prior to receiving the full number of installments, to receive the remainder of such installments, computed upon the same basis as theretofore employed in the case of the beneficiary himself.

In principle this case is no different from Missouri State Life Insurance Co., supra. There is no agreement in this contract to pay interest, as such, and the fact that the petitioner in writing its contract separates the component parts of the reserve to be set aside for the ultimate payment of such installments into strict reserve, as determined by the American Experience Table of Mortality, and the amount of interest required to maintain such reserve at a level sufficient to insure payment upon maturity, is merely a matter of computation which, in our opinion, is quite immaterial. The amount so arrived at and paid to the policyholder constitutes a policy obligation and as such is not “interest paid or accrued on indebtedness within the meaning of section 245 (a) (8) of the applicable Revenue Acts.” Reserve Loan Life Insurance Co., 18 B. T. A. 859.

It is obvious from what we have said respecting the two preceding issues that the so-called excess interest deductions deserve the same treatment, for there is considerably less justification for their deduction than for those where there is at least an obligation to pay the amounts claimed as deductions. Under this issue there was no obligation on the part of the board of trustees ever to award additional amounts. At any rate, what was paid amounted to nothing more than voluntary distributions of earnings.

The “ ordinary life policy ”, under which the disputed amounts arise in allegation of error numbered three, provided in section I thereof for certain options available to the beneficiary, or to the insured during his lifetime, among which there was one permitting such beneficiary upon the death of the insured to leave the “ net proceeds * * * with the company at interest at the rate of 3 per cent per annum, increased annually by such additions as may be awarded by the Board of Trustees * *

The respondent disallowed the deductions claimed under this issue and he opposes the petitioner’s efforts in this action to have such amounts allowed upon the sole ground that they have been included in the reserves required by law and the 4 percent mean thereof allowed as a deduction under the statute in the computation of net taxable income. He asserts as a fact that such amounts were included in the reserve, but we are unable to so conclude from the proof offered. However, whether the amounts were included in the reserve required by law or not — such inclusion might have been made erroneously under the statute, though it is unnecessary to decide that question in this proceeding. See Standard Life Insurance Co. of America, 13 B. T. A. 13; affd., 47 Fed. (2) 218; Continental Assurance Co. v. United States, 8 Fed. Supp. 474, and Helvering v. Inter-Mountain Life Insurance Co., 294 U. S. 686.

The respondent concedes that the arrangement under this contract “ is somewhat similar to a beneficiary loaning the insurance company a sum certain at 3 per cent interest ” and he says “ It may even be conceded that under certain circumstances the payments made to the beneficiaries, particularly the 3 percent,'might possibly be deducted as interest on indebtedness.”

It will be observed that the arrangement under the provisions of the contract here discussed are supplementary to the policy obligation. The petitioner agrees that if the beneficiary will forego the right to receive the net proceeds payable to him under the contract immediately upon the death of the insured and if he will permit the petitioner to retain such amount for a stated period of time, it will compensate him by the payment of 3 percent interest. A new relationship between new and different parties springs into being — an indebtedness actually arises upon the death of the insured and the immediate satisfaction thereof is postponed by the debtor, on the one hand, and the creditor on the other. There is no life contingency involved in this new transaction. An indebtedness arises under the contract between the petitioner and the beneficiary and the interest is paid upon such indebtedness. Therefore, we are of the opinion that the guaranteed interest payments of 3 percent are allowable deductions under the provisions of the applicable sections of the act hereinbefore set forth and discussed. There was no obligation upon the petitioner to pay any amounts in excess thereof, and such excess is not deductible.

Issues numbered four and five pertain to the disallowance of deductions from gross income, for the taxable year 1928, of realty taxes, maintenance expenses and depreciation upon the petitioner’s home office building and to the inclusion in its gross income of an amount representing the assumed rental value of space occupied by it in its said building during the year 1926. Deductions may not be allowed to a life insurance company for depreciation, taxes, and expenses incurred in connection with a building owned by it, unless there is also included in gross income the rental value of the space occupied by it. Helvering v. Independent Life Insurance Co., 292 U. S. 371 and Rockford Life Insurance Co. v. Commissioner, 292 U. S. 382, decided after the submission of this proceeding. There is therefore no merit in the petitioner’s present contention that it erroneously included such rental value in its return for 1926. As to the year 1928, the petitioner is entitled to the claimed deductions but, in order to compute the net benefit which it is entitled to, the rental value of the space occupied by it must be included in its gross income. Peoples Life Insurance Co., 31 B. T. A. 706; see also Commonwealth Life Insurance Co., 31 B. T. A. 887.

Beviewed by the Board.

Decision will be entered wider Rule 50.

Matthews dissents.

McMahon,

dissenting: I dissent from the holding of the majority in this proceeding that any portion of the amounts of $81,747.68 and $175,292.12, representing so-called “ interest ” paid by the petitioner in the respective years 1926 and 1928 to beneficiaries upon the proceeds of ordinary life insurance policies which had matured by death of the insured and which had been left with the petitioner under Option D of the policies is deductible as interest under the Revenue Acts of 1926 and 1928. Each of these figures is made up in part of a sum calculated at 3 percent and in part of a sum calculated at 1.85 percent. The majority holds that the portion of those amounts which represents the 3 percent guaranteed so-called “ interest ” is deductible as interest under the revenue acts, but that the portion of such amounts representing the 1.85 percent additional so-called “ interest ” is not deductible under the statutes. No part of either amount is deductible under such acts as interest.

If, as held by the majority, the portion representing the 1.85 per cent is not deductible as interest, then, looking to substance and not to form, as we must do, the same reasoning requires a holding that no portion of either amount constitutes deductible interest. The holdings of the majority as to these two percentages are irreconcilable. The source and nature of the 3 percent and the 1.85 percent are the same. Speaking figuratively, they are cut out of the same cloth. Both came from surplus and both represent earnings or profits upon funds held by the petitioner. The denial of the deduction of the 1.85 percent is jutifiable only on the ground that it is in the nature of a distribution of earnings. The same is true of the 3 percent. Such earnings or profits of a mutual life insurance company, such as petitioner, operated upon a participating plan of insurance, are derived from numerous sources, including (1) “ saving in mortality ”, where the mortality conditions experienced prove to be more favorable than those assumed, (2) returns on investments, (3) “ profit from loading ” of premiums or, more simply stated, from overcharges in premiums, (4) surrender of policies, (5) lapse of policies, and (6) investment or capital transactions. All these earnings or profits go into what is termed “ surplus.” Three percent is the minimum amount which experience has shown that a well managed solvent life insurance company is thus able to earn and pay even under unfavorable conditions. The same experience has also shown that under normal conditions such a company can earn considerably in excess of 3 percent. The 1.85 percent herein involved represents excess over 3 percent. The payment of the full amount of 4.85 percent undoubtedly would have been assured under Option D except that the company could not be positive that 4.85 percent could be earned and paid. However, the fact that only 3 percent was assured does not mean that the company was not bound to pay more than that if more than that were earned and safely payable. Under the laws of Pennsylvania, tinder which the petitioner was organized, the petitioner may maintain a surplus or safety fund, hut the same may not be in excess of 10 per centum of its reserve, or $100,000, whichever is greater, and the excess of the market value of its securities over their book value. Furthermore, the laws of Pennsylvania require that all such policies shall contain a provision that the policy shall participate in the surplus of the company, while it remains in force. It is doubtful whether any state would permit petitioner to continue to issue policies therein if it did not pay over under Option D all it could earn and safely pay, which, in the instant proceeding, has been demonstrated to be at least 4.85 percent.

All the policies involved in the instant proceeding participated in surplus, and this is true as to both insured and beneficiaries. The ordinary life policy expressly provides that the 3 percent per annum payable under Option D shall be increased annually by such additions as may be awarded by the board of trustees. The rights of the beneficiary are such as are conferred primarily by the policy or contract of insurance. 37 Corpus Juris 577. When a beneficiary is named in a policy he is as much entitled to rely upon its provisions for the protection of his rights as the insured or the company. Taff v. Smith, 144 S. C. 306; 103 S. E. 551. All of the features of the policy in question from this standpoint inure to the benefit of the beneficiary. In Penn Mutual Life Insurance Co. v. Norcross, 163 Ind. 379; 72 N. E. 132, the Supreme Court of Indiana had under consideration a surplus participating policy of this petitioner. The court there held that where the policy had been delivered and had become effective, the beneficiary had an interest therein which could not be divested by the insured without her consent.

It is clear that the 1.85 percent did not constitute a purely voluntary payment as in effect held by the majority; but it was paid by virtue of a policy or contract obligation imposed by statute.

The holding of the majority that the 3 percent paid under Option D of the ordinary life policies is deductible as interest is irreconcilable with its holding that the 3 percent included as part of installments paid under ordinary life policies which had been converted to the installment basis of payment by the exercise of Option A therein is not deductible as interest. Both holdings of the majority pertain to the same type of policy, ordinary life, and the same 3 percent; upon the death of the insured, the proceeds of Option D and of Option A are each equivalent substantially to the proceeds of the face value of the policy and hence are equivalent substantially to each other; the factor of 3 percent is identical; and both holdings should be the same and to the effect that the 3 percent paid under Option D as well as the 3 percent paid under Option A is not deductible.

The holding of the majority that the 3 percent paid under Option D is deductible is also irreconcilable with its holding that the 3 percent included as part of installment payments made under trust certificate or installment policies is not deductible as interest. Upon the death of the insured the proceeds of this latter type of policy are identical with the proceeds of Option A under the ordinary life type; the factor of 3 percent is identical in the proceeds of each; and both holdings should be the same and to the effect that the 3 percent paid under Option D as well as the 3 percent paid under the trust certificate or installment type of policy is not deductible.

From the policy of this type in evidence it clearly appears that the $18,380, which is the cash surrender or “ lump sum ” value at the date of death of the insured, is the sum which at 3 percent so-called compound “ interest ” will return a total of $24,000 to the beneficiary when paid in 240 equal monthly installments of $100 each.

Under all of the petitioner’s policies, in evidence here, participating as to policyholders or beneficiaries, or both, the amounts ultimately received under the various options or provisions are all the equivalent substantially of the face value or of the present worth or commuted value at the date of death. Otherwise there would be unjustifiable discrimination between participating policies of a mutual life insurance company.

Options A and D are each equivalent to the face value of the policy and therefore A is equivalent to D. Since no part of the installment payments made by petitioner to beneficiaries under Option A of ordinary life policies (or under trust certificate or installment policies) constitutes interest, as the majority correctly holds, then no part of the payments made under Option D is interest.

Likewise, the holding of the majority that the so-called “ interest ” paid upon deferred dividends under the ordinary life accumulated surplus plan policies is not deductible is irreconcilable with its holding that the 3 percent paid under Option D is deductible. The majority bases its holding as to so-called “ interest ” upon these deferred dividends upon the ground that there is no indebtedness because there is no certainty as to who will survive and ultimately receive all of the deferred dividends. However, it may be pointed out that there is even more uncertainty as to who will ultimately receive all of the proceeds left with the company under Option D. To illustrate, the proceeds in whole or in part may be payable to a person or persons not yet born at the time of the death of the insured.

It has been held that whether and to what extent deductions shall be allowed depends upon legislative grace; and that only as there is clear provision therefor can a deduction be allowed. New Colonial Ice Co. v. Helvering, 292 U. S. 435. In Helvering v. Inter-Mountain Life Insurance Co., 294 U. S. 686, the Supreme Court, with respect to statutory provisions allowing another type of deduction to life insurance companies, stated in part:

* * * It is intended to define a deduction which they are permitted to mate in the calculation of the net amount to be taxed. The rule that ambiguities in statutes imposing taxes are to be resolved in favor of taxpayers does not apply. Deductions are allowed only when plainly authorized. Ilfeld Co. v. Hernandez, 292 U. S. 62, 66. New Colonial Co. v. Helvering, 292 U. S. 435, 440.

The fact that the 3 percent is sometimes designated as interest ” in the ordinary life policy or is treated as interest by the petitioner does not determine the question of whether it is deductible interest under the Federal statutes, Baltimore & Ohio R. R. Co., 29 B. T. A. 368, 312, and Irving N. Klein, 31 B. T. A. 910; and it is sometimes designated as interest income in the same policy. That it is not exclusively designated as interest in the policy, but is also designated primarily as income there, is significant. Nor does the fact that it is guaranteed or assured determine that it is interest under such statutes any more than the fact that certain dividends are assured to a .certain extent on preferred corporate stocks renders such dividends interest and not earnings by way of dividends. Under Option D the 3 percent rate is merely a minimum rate of earnings and not interest; and in such preferred dividends the rate fixed is merely a maximum of earnings and not interest. The figure and words “ 3 percent ” are also used in the policy in describing the reserve basis upon which petitioner operates.

The word interest ” is used in petitioner’s type of ordinary life policy only once in its true sense. It is provided therein that interest at 6 percent shall be paid to the petitioner by any policyholder who borrows from petitioner against his policy and upon the security thereof. Hence, it appears from the language of this type of policy that the term “ interest ” as applied to proceeds of policies left with the company under Option D is not used in the same sense as it is used in describing interest upon money loaned by the petitioner upon the security of its policies.

The proceeds were not borrowed by the petitioner from the beneficiaries. Ordinarily money at interest is borrowed for the use of the borrower in his business or for his other purposes. This is not true in the instant proceeding. Under the provisions of the policy the proceeds were “ left with ” the petitioner, 'fhe petitioner, so far as the record shows, did not need or use these proceeds for its own purposes, but simply conserved them for the benefit of the beneficiary in accordance with the provisions of the policy. To constitute interest there must be definite terms with respect to designation of the person or persons to whom the principal and interest are to be paid, the time and place of payment, the amount of the principal, and the rate. A fair test of whether the terms are definite enough to constitute interest is whether the borrower may make payment of the principal and interest at some definite agreed time and place or make legal tender thereof, and thus stop the running of the interest. Here the evidence does not show that there were any such definite or certain terms in reference to any policy.

Under the statute of Pennsylvania whenever, under the terms of any policy of life insurance or under any written agreement supplemental thereto, the proceeds are retained by the company at maturity or otherwise, no person entitled to any part of such proceeds or any so-called interest due thereon is permitted to commute, anticipate, encumber, alienate, or assign the same or any part thereof if such permission is expressly withheld by the terms of the policy or supplemental agreement; and the company shall not be required to segregate such funds, but may hold them as a part of its general corporate funds. This supports the view that there was no indebtedness owing from the petitioner to the beneficiary within the meaning of the Federal revenue acts and that the 3 percent paid under Option D did not constitute deductible interest.

There is in reality, in the exercise of Option D, no new contract entered into between the petitioner and either the insured or the beneficiary. The Pennsylvania statute requires that each policy shall constitute the entire contract. In any event, election of this sort of payment is founded primarily upon the provisions of, and is made by virtue of, the original contract of insurance out of which any obligation or change thereof in this respect arises. Hence, it is immaterial whether there is a new or supplemental agreement. Even if we assume, for purposes of discussion, that there was a new contract between the insurer and the beneficiary in those instances where the beneficiary made the election, such assumption would not reach those instances in which the insured made the election; and in these latter instances each and every payment made to the beneficiary was the discharge of a policy obligation, without the payment of any interest. The record contains no basis for determining what portion of the 3 percent paid under Option D was paid pursuant to election made by the insured, in his lifetime, and what portion was paid pursuant to election made by the beneficiary.

The 3 percent paid under Option D is more in the nature of income or earnings of a trust fund than interest as upon money loaned. Whether the insured or the beneficiary made the election of Option D the proceeds were, in a sense, placed in trust with the petitioner and the 3 percent, as well as the additional 1.85 percent, represents earnings upon the principal amount. The funds were in the custody of a board of trustees, and they made the awards in excess of the guaranteed or assured 3 percent. It should be borne in mind that we are dealing with a participating ordinary life insurance policy issued by a mutual company primarily for protection. We are concerned with that protection as it relates to the beneficiary after the death of the insured. The policy contemplates conservation of assets of the nature of a trust fund. This has a double aspect. One is to preserve the assets, the other is to increase them by earnings. The insurer being on the 3 percent American Experience Table of Mortality reserve basis, it is contemplated that the annual increase will be at least 3 percent. Under the arrangements here the proceeds of the policies were left with the insurer, with the duty upon it to keep them intact so that at an appointed time they might be paid over to the beneficiaries, the insurer in the meantime paying over to the beneficiaries the annual increment.

That the 3 percent paid by petitioner under Option I) in 1926 and 1928 is not deductible as “ interest ” under the applicable provisions of the revenue acts is sustained in principle by Edith M. Kinnear, 20 B. T. A. 118, wherein it is held that so-called “ interest ” such as we have presented here constitutes “ earnings ” and as such is included in gross income of the beneficiaries within the meaning of section 213 (b)(1), Revenue Act of 1926 (similar to section 22 (b) (1), Revenue Act of 1928), construed in the light of the statement accompanying the Conference Report to the House of Representatives submitted with the Revenue Bill of 1926, which, in effect, treats amounts left with life insurance companies in the maimer provided for in Option D as being “ placed in trust upon the death of the insured ”, and the holding of the majority as to the 3 percent under Option D is contrary, in principle, to that case.

In Edith M. Kinnear, supra, the insurance company paid a fixed •amount of 3 percent and approximately 1.85 percent in addition thereto, which is approximately the same as that paid by petitioner under Option D.

Sometimes instead of leaving the proceeds of policies with insurance companies, such proceeds are transferred to a trustee, thus creating what is known as a “ life insurance trust ”, the advantages being that usually a somewhat higher rate of income may be realized and that the trustee will have more latitude and assume broader discretionary powers. Where proceeds are left with a life insurance company, as they were under Option D, the situation is more nearly like that created by these “ life insurance trusts ” than it is like the situation of debtor and creditor. That earnings or increment of such life insurance trusts is interest is untenable.

It is true that the Revenue Act of 1928 makes provision for the deduction by life insurance companies, such as the petitioner, of interest. This does not contemplate the payments of 3 percent made under Option D. It comprehends only interest in its true sense; that is, amounts paid for the use of money actually borrowed. As heretofore stated, under Option D we are dealing with an insurance obligation and not a borrowing of money by .the petitioner. Even though the petitioner, under its charter, may not have the authority to borrow money, there is always the possibility that at some time it may have such authority and may borrow. Furthermore, judgments may be talien against the petitioner where policies are contested and interest may then have to be paid at a legal rate.

ISTo provision of the statutes and nothing in the statutory scheme of Federal taxation has been called to our attention which discloses an intention on the part of Congress to allow the deduction of any portion of the 3 percent paid under Option D. Compare Rockford, Life Insurance Co. v. Commissioner, 292 U. S. 382; Penn Mutual Life Insurance Co., infra; Commonwealth Life Insurance Co., 31 B. T. A. 887; and Illinois Life Insurance Co., 30 B. T. A. 1160, wherein it was held that life insurance companies may not deduct depreciation upon furniture and fixtures which are not used in connection with their investment business, the income from which is taxed, as distinguished from its underwriting business, the income from which is not taxed.

The question of whether the petitioner is here entitled to a deduction of the 3 percent paid under Option D is not affected by the fact that it is not entitled to a deduction of 4 percent of the mean of the reserve to cover proceeds of matured ordinary life policies left with, petitioner under Option D, as held in Penn Mutual Life Insurance Co., 32 B. T. A. 876 (Docket No. 59670). Upon the question involved in the payments of the 3 percent under Option D we are concerned only with whether there is express statutory authority for permitting the deduction of the 3 percent. The question of the deduction of reserves is governed by wholly different statutory language. Furthermore, if petitioner were entitled to the deduction of such payments of 3 percent upon the ground that it is not entitled to deduct 4 percent of the mean of such reserve, then the same reasoning would also require the allowance of the deduction of the 1.85 percent paid under Option D, which has been denied by the majority.

We are not here concerned with a question of policy. That is for Congress. We are concerned only with a question of statutory authority. Until Congress legislates to allow the deduction we are bound to deny it.

Upon the entire record, the conclusion that the petitioner has not sustained its burden of showing that the respondent erred in holding that the payments of the 3 percent made by it under Option D are not deductible for 1926 and 1927 is unavoidable. On the contrary, the evidence confirms the correctness o,f the determination of the respondent in this respect.

In the case of Duffy v. Mutual Benefit Life Insurance Co., 272 U. S. 613, relied upon by the majority, wherein it is stated that upon the maturity of a policy in a mutual company the policyholder becomes a creditor with an enforceable right and for the first time there is an indebtedness, the question presented was wholly different from any question presented here. The question there presented was whether the funds constituting the legal reserve of a life insurance company were invested capital within the meaning of section 207 (a) of the Revenue Act of 1917, which imposed a war excess profits tax. The Court held that the reserves did not constitute a present existing liability or indebtedness. The Court there used the word “ indebtedness ” in the broad general sense o.f “ obligation ”, rather than in any restricted technical sense. See City of Perry v. Johnson, 106 Okla. 32; 233 Pac. 679, 680; In re Board of Rapid-Transit Commissioners, 49 N. Y. S. 60, 69; and Wilcoxon v. City of Bluffton, 153 Ind. 267; 54 N. E. 110, 115.

         See discussion of “ Dividends ” in Life Insurance, hy Joseph B. Maclean, 3d Ed., 1932, ch. 11, p. 226.

       In Life Insurance, hy Joseph B. Maclean, 3d Ed., 1932, p. 173, it is stated: “At the present time the net rate earned by the companies varies from 4% to over 5 per cent, which is approximately the rate yielded by high class securities.” (Emphasis supplied.)

       Section 614 of Title 40 of Purdon’s Pennsylvania Statutes, Annotated, Permanent Ed., 1930. (1921, May 17, P. L. 682, Art. XV, see. 429.)

       Section 510 (f) of Title 40 of Purdon’s, Pennsylvania Statutes, Annotated, Permanent Ed., 1930 (1921, May 17, P. L. 682, Art. IV, sec. 410).

       The Essence of Life Insurance, by William Breiby, 1924, p. 87, and Life Insurance, by Joseph B. Maclean, 3d Ed., 1932, pp. 49, 50.

       Section 514 of Title 40 of Pardon’s Pennsylvania Statutes, Annotated, Permanent Ed., 1930 (1923, April 26, P. L. 104, see. 1).

       Section 510 of Title 40, Purdon’s Pennsylvania Statutes, Annotated, Permanent Ed., 1930 (1921, May 17, P. L. 682, Art. IV, sec. 410).

       To tile effect that proceeds of policies left with a life insurance company under options similar to Option D are held by the company “ as a trust fund ”, see The Essence of Life Insurance, by William Breiby, supra.

       Life Insurance, by Joseph B. Maclean, 3d Ed., 1932, p. 172.


source: Caselaw Access Project

author: McMahon:

license: Public Domain

text:
    John Crocker, Petitioner, v. Commissioner of Internal Revenue, Respondent. George Conover, Petitioner, v. Commissioner of Internal Revenue, Respondent. A. Louise Black, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 60018, 61095, 61096.
    Promulgated June 28, 1935.

      Robert P. Vail, Esq., for the petitioners.

      Bernard D.- Daniels, Esq., for the respondent.
   OPINION.

McMahon:

The respondent contends that the Maroa Co. was organized as a corporation in 1892 for a period of 20 years; that it operated as a de jure corporation in the conduct of a public utility until it forfeited its charter, not later than 1910; and that thereafter the stockholders of the corporation continued to operate as a public utility in the name of the corporation until sold in 1927, and therefore it is taxable as an association within section 2 (a) (2) of the Revenue Act of 1926 and article 1502 of Regulations 69, and in particular within the last sentence of article 1502, which is as follows:

* * * A corporation which, has ceased to exist in contemplation of law but continues its business in quasi-corporate form is an association or corporation within the meaning of section 2.

Section 2 (a) (2) has been a part of revenue acts enacted prior, and subsequent to the Act of 1926. The above statement appears in substantially the same form in regulations promulgated prior and subsequent to 1926.

It has been repeatedly held that the substantial reenactment in later revenue acts of provisions theretofore construed by the Treasury Department in its regulations is persuasive evidence of legislative approval of the construction contained in such regulations. Helvering v. Bliss, 293 U. S. 144; McCaughn v. Helvering, 283 U. S. 488; and Brewster v. Gage, 280 U. S. 327.

The petitioners contend, however, that under the Illinois law the assets of the Maroa Co., upon forfeiture of its charter, without formal conveyance, became the property of its stockholders, owned by them in undivided shares in proportion to their stockholdings at the time of such forfeiture, as tenants in common, citing County of Franklin v. Blake, 283 Ill. 292 (119 N. E. 288); and Fletcher Cyclopedia Corporation (1931), sec. 8134; that there was no continuance of a corporate business carried on “ in corporate form ” after the forfeiture or expiration of its charter, as a de facto corporation, with meetings of shareholders and directors, election of directors and officers, keeping of minutes, and the giving of directions to officers as to the management of its corporate affairs; but that the several owners of certain properties, many of which had never been owned by the corporation, merely turned the business over to one of their number and let him run it for them; and that when the properties and business were sold, the owners sold it, made the conveyances and received the proceeds.

In County of Franklin v. Blake, supra, the court merely rejected the common law rule, as applied to a charitable corporation, that upon dissolution of a corporation its lands revert to the grantors or their heirs, and held that the land of such charitable organization for which it had paid escheated to the county and did not revert to the grantors or their heirs. This case is distinguishable from the instant proceeding and is of no aid here.

It has been held that even the entry upon the records of the office of the secretary of state of the) cancellation of an Illinois charter for failure to file its annual report does not of itself work a forfeiture of a corporate charter, but is simply prima facie evidence of nonuser which may be availed of by the state as a basis for an appropriate proceeding in a court of competent jurisdiction to forfeit the charter: Kelly v. Lehman, 130 N. E. (Ill.) 375; People v. Rose, 69 N. E. (Ill.) 762; Fletcher Cyclopedia Corporations (1931), vol. 16, pp. 757-758.

In Fletcher Cyclopedia Corporations (1931), vol. 8, p. 156, it is stated that “ in some states, corporations continuing to exercise corporate powers after expiration of their charter have been recognized as corporations de facto, on the ground that there is color of authority ”, citing People v. Wayman, 99 N. E. (Ill.) 941, and Bushnell v. Consolidated Ice Machine Co., 27 N. E. (Ill.) 596. In the latter case the Supreme Court of Illinois stated that for the mere exercise of a corporate franchise beyond the period for which a corporation was organized the state alone can complain and that the settled rule of Illinois is that the legal existence of a corporation de facto can not be questioned collaterally.

In People v. Wayman, supra, the court held that the relator was entitled to a writ to compel the state attorney to file a petition in quo warranto proceedings against a corporation, since it was the only remedy which the relator had to prevent a threatened wrong, as the corporation had commenced condemnation proceedings against the relator in which proceeding the relator could not interpose his defense that the charter of the corporation had expired by limitation. Hence, it appears that a corporation continuing operations as a corporation after the expiration of its charter is recognized as a de facto corporation in Illinois.

It is elementary that a de facto corporation is entitled to possession of its property until deprived of it by a proper proceeding in a court of competent jurisdiction. Fletcher Cyclopedia Corporations (1931), vol. 8, pp. 186-188.

In Olmstead v. Distilling & Cattle Feeding Co., 73 Fed. 44 (Cir. Ct., N. Dist. Ill.), wherein it appears that, pursuant to quo warranto proceedings brought in an Illinois court to deprive an Illinois corporation of its charter, a judgment of ouster had been rendered by the state court, the court stated that within the sense of the Illinois statute, the corporation itself became a trustee as soon as the judgment of ouster was rendered; that the property of the corporation thereupon became at once a trust property; that prior to the judgment of the circuit court, the defendant corporation owned its property legally and equitably; and that after the judgment the equitable ownership ceased in the corporation, and became at once vested in the creditors, and, subject to their rights, in the stockholders. Hence, it appears that even after the entry of judgment of ouster an Illinois corporation continues to exist at least as trustee and continues to hold legal title to its property. See Gulf Lines Connecting R. R. v. Golconda Northern R. R., 125 N. E. (Ill.) 357.

In roe Stephens Manufacturing Co., 12 B. T. A. 1254, petitioner was incorporated in May 1886 under the laws of Michigan, for 30 years. After the expiration in 1916 of the charter formal notice of dissolution was filed. From the date of the expiration of the charter to January 1919, when the business was reincorporated, it was conducted in the same manner and under the same corporate name that had theretofore been used, and the same books of account and forms of billheads and letterheads were used. The stockholders, a father, the principal stockholder, and his three sons, considered that they were operating as a partnership after the expiration of the charter. The contention was made by them that the powers of the corporation to do business ended with the term of its corporate existence and thereafter the assets of the corporation belonged to the stockholders as tenants in common, and several cases were by them cited in support thereof wherein it was held that the relations of stockholders in an expired corporation are analogous to those of partners. The Board stated that those cases dealt with a rule of property and not a rule of taxation and were not determinative of the issue presented, citing B. F. Joel, 9 B. T. A. 1027, and Burk-Waggoner Oil Association v. Hopkins, 269 U. S. 110, wherein the Supreme Court of the United States stated that the power of Congress to tax associations is not affected by the fact that, under the law of a particular state, the association can not hold title to property, or that its shareholders are individually liable for the association’s debts, or that it is not recognized as a legal entity. Hence, even if, as contended by petitioners herein, under the Illinois laws, ownership of all the corporate property vested in the stockholders immediately upon forfeiture or expiration of the charter, this would not be controlling under the facts and issue presented herein. Pierce Oil Corporation, 32 B. T. A. 403.

While it appears that after the expiration the business was conducted and managed solely by John Crocker in his own discretion, that no stockholders’ or directors’ meetings were held, and that no officers were elected and no minute book kept, there is no showing that the business was not conducted and managed by John Crocker in the same manner prior to the forfeiture or expiration of the charter as it was conducted thereafter. On the contrary, the facts indicate that the business may have been conducted prior to the forfeiture in the same manner as thereafter and that John Crocker was in control thereof. The members of his family apparently looked to him in the management of their affairs. John Crocker was in'the banking business at Maroa, Illinois. He acted as executor for his mother’s estate and also for the estate of George L. Crocker, his brother. Instead of using the formalities inherent in corporate entities, the stockholders, all except two members of the same family, permitted one of them to conduct the affairs of the corporation in his discretion, no doubt in the realization that under all the circumstances a more strict adherence to corporate form would be a mere idle gesture and waste of time and energy.

It is to be noted that although the Maroa Co., in its annual report to the Illinois Commerce Commission, stated that it was subsequently disincorporated ” and had no directors, and although it is stated in the application to that commission for authorization of the sale of its property to the Illinois corporation that the business was originally the property of the Maroa Co., but such company had not been kept in good standing and had consequently been dissolved, the commission in its order of November 10, 1927, found, after a hearing, that the Maroa Co. in 1927 was a corporation duly organized and existing under and by virtue of the laws of Illinois and that it owned and operated an electric utility in Maroa, Illinois, and was duly authorized by its articles of incorporation so to do.

In Waldron Co., 2 B. T. A. 715, wherein it appears that the business of an individual which had been incorporated was carried on thereafter without formality of corporate meeting, the individual dictating and directing the conduct of the business at all times, sometimes purchasing merchandise in the corporate name and sometimes in the name of the individual, it was held that the business was the business of the taxpayer corporation. In R. L. Brown Coal & Coke Co., infra, the Board held that even if not legally organized to carry on business with the public under the laws of the State of Kentucky, the record warranted the conclusion that the corporation was an association and required to make returns as a corporation for the years in question.

In Joseph E. Swanson et al., Trustees, 29 B. T. A. 1123, we held that a quasicorporate form of organization is not a controlling factor or an indispensable element of an association, pointing out “ that each case must be determined upon its own peculiar facts.”

In our opinion the Maroa Co., was in 1927 an “ association ” within the provision of section 2 (a) (2) of the 1926 Act and article 1502 of Regulations 69.

We now return to the question whether the petitioners are transferees of the Maroa Co. The petitioners contend that they and other stockholders of the Maroa Co., and not the Maroa Co., were the owners of all of the property sold in 1927 and hence the distribution received was received as owners of the property sold and not as transferees of the Maroa Co. This contention is based solely upon the ground that upon forfeiture or expiration of the charter of the Maroa Co., its title thereto vested, without formal conveyance, in the petitioners and other stockholders. As heretofore stated, under the laws and decisions of Illinois, the state alone can question the legal existence of a corporation organized under its laws. There is no evidence showing that the Maroa Co. was ever dissolved voluntarily or by a proceeding instituted for that purpose. It continued to conduct its business without material change in the name of the Maroa Co. until the sale in 1927. Hence any property held by it at the time of forfeiture or expiration of its charter and not disposed of by it and constituting a part of the property sold in 1927 remained the property of the Maroa Co. up to the sale in 1927. It was stipulated that prior to 1910 the Maroa Co. owned the 34 by 60-foot lot on which the original plant and equipment were located. The Maroa Co. made no formal transfer of any of its property to its stockholders or any of them, and this lot, plant, and equipment constituted a part of the property sold to the Illinois Corporation. No transfer of this property having been eifected in any way after the forfeiture or expiration of the charter of the Maroa Co., this property belonged to the Maroa Co. at the time of the sale in 1927. The original franchise to operate a public utility and the original contract to light the streets of Maroa were secured by John Crocker and assigned by him to the Maroa Co. The new franchise to operate a public utility and the new contract to light the streets of Maroa, which were sold or assigned to the Illinois Corporation, were secured by John Crocker in his name in 1909. However, when he secured these, the old franchise and the old contract had some four years to run. There is no showing that the Maroa Co. was compensated in any way for the cancellation of the old franchise and contract or that they were canceled on account of any breach thereof on the part of the Maroa Co. Furthermore, it was stipulated that the new franchise and contract were held and used by John Crocker for the benefit and use of the “ same persons who had owned and/or controlled Maroa Electric Light Company in the same proportion as their interests therein.” It is apparent therefore that John Crocker personally did not own the new franchise and contract. It is reasonable to infer from the whole record that the new franchise and contract merely took the place of the old franchise and contract, since the Maroa Co., although the old franchise and contract assigned to it were canceled, continued to operate and conduct its public utility business after their cancellation in 1909 until 1927, when the sale occurred.

It was further stipulated that “ in 1910 ” the transformer and switches were installed on a 16 by 30-foot lot “owned by John Crocker”, adjoining the 34 by 60-foot lot, and “ in a small building erected by him.” However, it was also stipulated that “At the time of the sale {19%7)” the interest of John Crocker in the business and property sold, which included this 16 by 30-foot lot and building, amounted to 58/120 thereof. It also appears from the agreement of sale made with the Illinois Corporation that John Crocker represented to the Illinois Corporation that he owned only an undivided interest in the property agreed to be sold, which included this 16 by 30-foot lot and building; that all the property sold to the Illinois Corporation, including this 16 by 30-foot lot and building thereon, was and had been used in the business of the Maroa Co.; that it was sold as a unit with the public utility business operated and conducted by the Maroa Co.; and that all this was paid for as a unit. No part of the sale price was treated as belonging to John Crocker or any of the other shareholders, but as belonging to the Maroa Co., subject first to the payment of its obligations. Furthermore, no claim is made by petitioners that respondent has omitted from the basis used in determining the profit realized on the sale of the property, including the 16 by 30-foot lot and building thereon, the cost or value of this 16 by 30-foot lot and building thereon. There is no dispute as to the basis used by him for tangibles. The only question raised by petitioners as to the amount of the deficiency is that the respondent failed to include in the basis any value for intangibles. Furthermore, the statement attached to the report of the findings of the internal revenue agent in charge dated May 15,1930, petitioner’s exhibit 1, containing an explanation of the changes or adjustments made in the taxable income of the Maroa Co., indicates that the 16 by 30-foot lot and building thereon were carried as an asset on the books of the Maroa Co. and that the account of John Crocker on such books was credited with the amount of $615 representing the sale price of such lot. The action taken by John Crocker in first paying the corporate creditors out of collections, if any, and the $60,000 received from the Illinois Corporation before distributing the balance to the stockholders, including himself, shows that all those interested as stockholders in the Maroa Co. regarded all the property sold to the Illinois Corporation as the property of the Maroa Co., in which they had an undivided interest in proportion to their stockholdings, subject to the payment of corporate debts. Furthermore, the sale of the properties and business of the Maroa Co. was consummated in 1927. Ordinarily gain realized from the sale of property is returnable and taxable to the owner in the year in which the sale is consummated. In John Orocher, Docket No. 53974, the disposition of which, upon stipulation, is dependent upon the decision herein, it is alleged in the petition that John Crocker in his return for 1928 reported a capital gain of $10,308.48, representing his share of “ a realization from the sale in 1928 ” of properties and business operated under the name of the Maroa Co., in which he held a 58/120 interest. This reflects the distribution to him in 1928 of his proportion of net proceeds from the sale in 1927. Hence, John Crocker did not return the profit in 1927, the year of the sale, as he should have done had he regarded himself as owner thereof, but in 1928, when he received his share of the distribution. This action on the part of John Crocker leads to the same conclusion.

While John Crocker may have owned the 16 by 30-foot lot and building thereon in 1910, the whole record leads to the unavoidable conclusion that he did not own the 16 by 30-foot lot and building thereon in 1927, but that John Crocker’s interest therein was that of a stockholder in proportion to his stockholdings, and that the Maroa Co. owned it in 1927. Cf. Taylor Oil & Gas co. v. Commissioner, 47 Fed. (2d) 108, affirming 15 B. T. A. 609; Hellebush v. Commissioner, 65 Fed. (2d) 902, affirming 24 B. T. A. 660; Boggs-Burnam & Co. v. Commissioner, 71 Fed. (2d) 999, affirming 26 B. T. A. 988.

Furthermore, there is no showing of a landlord and tenant relationship between the Maroa Co. and its stockholders. The fact that the Maroa Co. executed no conveyance is of no significance in view of the fact that all of its outstanding certificates of stock were transferred to the purchaser as required by the agreement of sale, the purchaser thereby becoming the sole stockholder of the Maroa Co.

R. L. Brown Coal & Coke Co., 14 B. T. A. 609, cited by the petitioners, is distinguishable from the instant proceeding on the facts. It may be pointed out that in that case the intention was to form a corporation to operate a coal mine on property, in which property E. L. Brown had acquired a leasehold interest in 1918. Although the corporate charter was obtained in 1919 and the corporation operated the coal mine on such property, the lease was never conveyed to the corporation. In the instant proceeding the Maroa Co. owned at the time of sale all the property sold. While it was stipulated that John Crocker owned the 16 by 30-foot lot and building thereon in 1910, it was also stipulated that at the time of sale in 1927 he had only a 58/120 interest, represented by his stockholdings, which stipulation, together with other evidence presented, clearly establishes that ownership of this lot and building was transferred from him to the Maroa Co. prior to 1927. Furthermore, in R. L. Brown Coal & Coke Co., supra, the Board stated that “ The evidence indicates that E. L. Brown received no liquidating dividend from the corporation in 1921 ”, whereas in the instant proceeding the evidence shows that John Crocker, after paying the debts of the corporation, made distribution to himself and the other shareholders of all moneys remaining in 1928, the year after the sale, as a corporation ordinarily makes a liquidating distribution.

On brief petitioners state that in W. H. Reisner Manufacturing Co., 13 B. T. A. 841, and United States v. Board, 14 Fed. (2d) 459, where both the capital stock and assets were transferred, it was held that the gain arose out of the sale by the stockholders of their stock and not out of the sale by the corporation of its assets. Those cases are not applicable here, since the contract of sale herein is not ambiguous and clearly shows that the thing contemplated therein to be sold was “ the property constituting the electric plant and distribution system ”, consisting of and including “ the real estate herein-’ after described, each, all and every part of the plant, distribution system, transformers, meters, lighting equipment, materials and supplies, franchises, licenses and easements, and all structures and appliances constituting, held for and/or operated as a part of or in connection with, the said electric utility in and about the City of Maroa, Illinois ”, and that the certificates of stock were to be assigned and transferred “ for the purpose of effectuating such sale and conveyance of said property.” As we construe the agreement of sale, it was primarily a sale of the property of the corporation and the passing of the shares was merely incidental to the sale of the assets ” for the purpose of effectuating such sale and conveyance ”, putting the title beyond recall or controversy on the part of the Maroa Co. That John Crocker entered into the agreement of sale with the Illinois Corporation and received the check is immaterial here, as the Maroa Co. could not act except through John Crocker, who had been and was authorized to act for the Maroa Co. and to conduct' its affairs in his sole discretion. We look to the substance of the transaction rather than the form and the latter must yield to the former.

Since the Maroa Co. owned all the assets sold m 1927 and distributed all its funds remaining after the payment of its debts to its shareholders in 1928, leaving it without assets to pay its tax liability for 1927, and since the petitioners received without consideration amounts in excess of the deficiency of $6,253.77 involved herein, they are transferees of the Maroa Co.

The next question to be considered is whether the profit realized by the Maroa Co. from the sale in 1927 of all its property is correctly computed or determined by the respondent.

The respondent in computing such gain used as a basis the book value of the tangibles only in the amount of $8,683.66. There is no dispute about the basis used for the tangibles. However, the petitioners contend that the intangibles, consisting of a franchise to operate a public utility and a contract to light the streets of Maroa, both obtained in 1909 for a term of 24 years, and a contract to purchase electricity at wholesale to be distributed at retail, had a value as of March 1, 1913, of at least $22,223.40 and at most of approximately $40,000.

Section 204 (b) of the Revenue Act of 1926 provides that the basis for determing the gain or loss from the sale or other disposition of property acquired before March 1, 1913, shall be U(A) the cost of such property * * *, or (B) the fair market value of such property as of March 1, 1913, whichever is greater.”

No value was assigned to the intangibles on the books of the Maroa Co. at any time. Nothing was paid for these contracts so far as the record shows.

The respondent determined that the intangibles had no value as of March 1, since the average profit from 1908 to 1912, inclusive, of $684.76 equaled approximately only a 5 percent return upon the average tangible investment over the same period of $13,477.19. In determining the average profits the respondent deducted from the profit of each year used in his computation $620' for depreciation, as no depreciation had been taken on the books of the Maroa Co. from 1908 to 1913. Obsolescence and accrued depreciation were taken out of capital and surplus in December 1913.

It is contended by the petitioners that the respondent, in determining the value of the contracts involved, included, in his computation of the average profit, profits of years prior to 1910 in which such contracts had not been acquired; that it was not until October 14,1910, that it began operation under its new contracts and ceased to generate its own electricity; and that therefore the average profit used by him did not correctly reflect profits resulting from such contracts. It is further contended that the respondent in his computation of the average investment used the book value of the capital and surplus as of January 1 of each year from 1908 to 1912; that due to the fact that property scrapped in 1910 was not charged off until late in 1912 the*books did not correctly reflect the investment; and that the respondent also erred in deducting from profit depreciation on all depreciable assets, including those scrapped as well as those used after 1910.

' The parties stipulated as to the profits and depreciation deductible therefrom from 1908 to 1913, inclusive, and from 1922 to 1926, inclusive, the value of the tangibles before October 14, 1910, the value of those used thereafter, and also the value thereof as of other dates, but in view of the conclusion reached herein, we deem it unnecessary to set them forth herein.

The petitioners computed the minimum value attributed to intangibles of $22,223.40 as follows:

Average investment, tangibles only, 1911-1&12-$7,277. 91
Return thereon at 5%_ 363.89
Average profits, 1911-1912_ 1,919. 51
Profits due to intangibles (difference between $1,919.51 and $363.89). 1, 555. 62
Profit due to intangibles capitalized at 7%- 22,223. 40

which computation, it is argued, is in accord with A. K. M. 34, C. B. No. 2, p. 31. There is no general rule for the determination of the value of intangibles. While the Committee on Appeals and Review of the Bureau of Internal Revenue in A. R. Mi 34 suggested certain methods as an aid in this respect, it stated that it was unable to lay down any specific rule of guidance for determining the value of intangibles which would be applicable in all cases and under all circumstances. However, the methods suggested in A. R. M. 34 do not contemplate a return of only 5 percent on tangibles, as used by the petitioners in their computation of the value of the intangibles.

The evidence herein shows that the Maroa Co. commenced to operate as a distributor on October 14,1910, under its new franchise and contract with the city of Maroa secured in 1909 and its contract with the predecessor of the Illinois Corporation. These contracts are not in evidence. It is contended on brief that the business immediately began to make profits instead of losses and such profits are attributed to such contracts. The original franchise and the new franchise granted the right to the Maroa Co. to operate a public utility in Maroa. Under the old contract the Maroa Co. agreed to light the streets of Maroa with arc lights and under the new contract it agreed to use incandescent lights. Prior to October 1910 it generated its own electricity and thereafter it purchased the electric current for distribution. So far as we know the terms of the old and the terms of the new franchise are the same except as to their effective period of time. The terms of the old and the terms of the new contract with the city to light its streets, so far as we know, are the same except that the first probably provided for lighting the streets with arc lights and the second probably provided for lighting the streets with ..incandescent lights. While it appears that the population of Maroa in 1910 was 1,160, we do not know the number of customers of the Maroa Co. or the rates charged them by such company before and after the cut-over from generated to pux-chased current, which occurred on October 14, 1910. We observe that Maroa’s population was 1,154 in 1930, remaining practically static for 20 years. Since the old and new contracts, so far as the record discloses, are substantially alike, it can not be assumed that the increased profits are directly traceable to them. Nor does the record disclose the terms and provisions of the contract with the predecessor of the Illinois Corporation. From the evidence submitted we are unable to say that it had any greater or other value than any other ordinary agreement to purchase commodities dealt in in any other business. Any formula for determining value based upon profits is of little, if any, aid where such profits are not, at least to some degree, traceable to the property the value of which is in question. See Charles W. Ballard, 25 B. T. A. 591. From the evidence presented it is reasonable to infer that the increase in profits resulted from the change in the business itself brought about by the change from producer to purchaser of electric current, for distribution.

From the evidence before us we are unable to determine that these intangibles had any value on March 1, 1913, and hence we are unable to fix or find a value or values therefor as of that date to be used as a basis for the determination of gain or loss and thus the determination of the respondent, which is presumed to be correct until shown to be erroneous, can not be disturbed.

Reviewed by the Board.

Pedsion will be entered for the respondent.