author: Kjern :

text:
    J. Howard Porter, John C. Porter and Paul D. Porter, Trustees, Identified under the Trade Name Porter Property Trustees, Ltd., Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95762.
    Promulgated September 5, 1940.

      Benjamin W. Henderson, Esq., and Wilford G. Edling, O. P. A., for the petitioners.

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

Kjern :

The principal issue is whether the petitioner, Porter Property Trustees, Ltd., was an association taxable as a corporation, or a trust. On the theory that it was an association, respondent claims the personal holding company surtax and nonfiling penalty.

The question is no longer novel, having received consideration from the Supreme Court in several cases, in the latest of which, Morrissey v. Commissioner, 296 U. S. 344, the Court reviewed at length the course of its earlier decisions and the dependent Treasury regulations seeking to interpret them, and laid down criteria which must guide us here. Cf. Swanson v. Commissioner, 296 U. S. 362; Helvering v. Combs, 296 U. S. 365; Helvering v. Coleman-Gilbert Associates, 296 U. S. 369, all decided on the same day as Morrissey’s case. Both parties cite the Morrissey case as authority for their opposite contentions. A glance at it will suffice to show the governing principles. The Court said:

“Association” implies associates. It implies the entering into a joint enterprise, and, as the applicable regulation imports, an enterprise for the transaction of business. This is not the characteristic of an ordinary trust * * *. Such' beneficiaries do not ordinarily, and as mere cestuis que trustent, plan a common effort or enter into a combination for the conduct of a business enterprise. * * * But the nature and purpose of the cooperative undertaking will differentiate it from an ordinary trust. In what are called “business trusts” the object is not to hold and conserve particular property, with incidental powers, as in the traditional type of trusts, but to provide a medium for the conduct of a business and sharing its gains. Thus a trust may be created as a convenient method by which persons become associated for dealings in real estate * * *.

The Court then went on to mention other forms of business enterprise in which the association might be used. It then pointed out that “The inclusion of associations with corporations implies resemblance; but it is resemblance and not identity.” “Mere formal procedure” was not to be made “a controlling test.” The revenue act’s definition embraces more than joint stock companies. And “while the use of corporate forms may furnish persuasive evidence of the existence of an association, the absence of particular forms, or of the usual terminology of corporations, cannot be regarded as decisive.” Trustees may act as directors, and the trust terms serve as bylaws. Control by the beneficiaries, the Court pointed out, had in the earlier case of Hecht v. Malley, 265 U. S. 144, been rejected as nonessential, and, hence, meetings of the beneficiaries were unnecessary, as was likewise the transferability of beneficiary interests to constitute such a group an “association.” The trust mechanism, the Court said, permitted the title to property to be held by a continuing body, with centralization of management, the ready transfer of beneficial interests without affecting the trust’s continuity, the spread of these interests among many participants, and the limitation of the personal liability of the participant to the property embarked in the enterprise — all advantages which flow from the nature of trusts but approximate closely those afforded by the corporation. To insist on their nature as trust advantages would be to ignore the postulate that only those trusts were sought to be assimilated to corporations for tax purposes which “have the distinctive feature of being created to enable the participants to carry on a business and to divide the gains which accrue from their common undertaking ⅜ *

Having laid down these principles, the Court then proceeded to examine the facts of the case before it, of a trust created for the development of a tract of land by building golf courses and club houses, surveying and selling lots, and the like, which was effected by issuing transferable certificates of beneficial interest. The Court thought it a business enterprise, even if no new tracts were acquired: “Its character was determined by the terms of the trust instrument. It was not a liquidating trust; it was still an organization for profit, and the profits were still coming in. The powers conferred on the trustees continued and could be exercised for such activities as the instrument authorized.”

The companion cases decided by the Supreme Court the same day dealt with situations not unlike that of the Morrissey trust. In Swanson's case, swpra, a trust was created by two landowners, the trust res being an apartment house, and the assignable beneficial shares, although originally divided among the landowners, were held in the taxable year by their wives. The Court held it an “association.” In the Coleman-Gilbert case, supra, five coowners of about 20 apartment houses had conveyed them to trustees, with powers to improve, lease, and sell and to pay income to beneficiaries. The Court again held the trust an “association.” In Combs's case, supra, the Court thought that a trust created to finance and drill an oil well, the beneficial interest certificate holders being 18 persons, was likewise an “association.”

Further citations seem unnecessary in view of the fundamental test so clearly laid down by the Supreme Court. That is, whether there is a business purpose back of the trust’s creation and continuance. A glance at the history of the present trust leaves no doubt that there was here such a purpose. James Porter and his wife owned certain agricultural lands in California and Minnesota, some of which were actively farmed. In 1930 they created a corporation and took its shares in exchange for these lands, the only other shareholders being Porter’s two sons, daughter and son-in-law, and an outside nominee. The use of the corporate form no doubt had its advantages, but it also had certain disadvantages from the standpoint of tax rates. In 1935 a trust was substituted for the corporation, taking over all its assets except the Porter Homestead, which apparently went to Porter’s wife, for her name does not reappear among the holders of the trust’s “expectancy fractions.” The new trust beneficiaries are still the members of Porter’s family, although their relative interests have changed somewhat since the corporation was dissolved. All these facts show, we believe, one increasing purpose to retain the advantages of centralized control, limitation of liability, and others associated with the corporate form in carrying on actively the business of farming lands and distributing the income therefrom.

We may stop a moment here to note those provisions of the trust to which petitioner points as distinguishing it from a business association. It is said that the trustees have exclusive management and may fill vacancies, and that the beneficiaries have no voice in the trust’s control; that the trustees may not sell any interests in the trust estate and that the beneficiaries’ interests are nontransferable; that the trustees have had no formal meetings and that the beneficiaries have never been consulted on the affairs of the trust. The claim of nontransferability of “expectancies” has not, we think, been clearly established. But we do not think these points are vital, for they go merely to the outward form of the trust, which, on one side, may approximate the form of a corporation or, on the other, that of a strict trust; and it is not the particular form of doing business so much as the business purpose which must determine. In other words, the statute is intended to hit a trust even strict in form if it is at the same time conducted for profit. Such is the teaching in Morris-sey's case, as we understand it. Outside the statute’s reach lie trusts created to safeguard and conserve the property of -widows and infants, or to liquidate such property, the so-called “ancestral” trusts. Although the beneficiaries here were the members of Porter’s family, there is no evidence to convince us that the trust’s primary purpose was to hold the farms during the children’s infancy or liquidate them in the process of administration. In so far as appears from the testimony, none of the children was an infant when the trust was created; and the only testimony pointing toward an intention to liquidate was Porter’s rather vague statement that “we would have offered it [some of the trust lands] for sale or trade if we could get what we considered right for it.” The family relationship of the grantors, trustees, and beneficiaries does not in itself establish the trust as “ancestral” or determine the category in which it should fall for tax purposes any more than it would affect the corporate character or tax classification of a corporation similarly constituted. That relationship is merely evidence of the purpose of the trust, which will weigh much or little, depending on other facts and circumstances. The other facts here indicate a family corporation which it was thought could be operated as a trust under the so-called “Hulbert Plan”, without paying corporate rates. In view of the principles later laid down by the Supreme Court, we think it unnecessary to discuss or attempt to distinguish the cases of Commissioner v. Guitar Trust Estate, 72 Fed. (2d) 544 (C. C. A., 5th Cir.), and Blair v. Wilson Syndicate Trust, 39 Fed. (2d) 43 (C. C. A., 5th Cir.), upon which petitioner relies. Active association of the beneficiaries together in creation of the trust is not an indispensable factor, as petitioner contends, in the creation of a business trust, especially where it is a family trust and the settlors are the father and mother; but if it should be thought so, we need look only beyond the creation of the trust to the prior corporation to find parents and children happily associated together under the form of a corporation in carrying on their farming operations. In the transmutations which followed it would seem of little moment that certain members of tbe family passed from the active role of shareholders to the passive one of beneficiaries.

We are of the opinion that petitioner was an association and therefore taxable as a corporation.

Assuming, without deciding, that because petitioner was an association taxable as a corporation it should also be considered as a corporation within the meaning of section 351 (b) (1) of the Eevenue Act of 1934, which defines “personal holding company”, it is necessary, in order to conclude that petitioner was such “personal holding company”, to find that “80 per centum of its gross income for the taxable year is derived from royalties * * It appears from the stipulation of the parties that petitioner’s gross income for the taxable year was $74,794.64. Of this amount respondent determined that $63,596.29 was derived from oil royalties. However, it appears from the respondent’s determination of deficiency that of this latter amount $50,800 represented bonuses paid to petitioner as lessor by the Standard Oil Co. and the Texas Co. As to the bonus paid by the Standard Oil Co., amounting to $46,000, we have evidence in the record and stipulations to the effect that a dry hole was drilled on the property leased, that no oil or gas was produced from the leased premises, and that three years after the taxable year the lessee reconveyed the premises to petitioner by quitclaim deed. Thus, it is apparent that the bonus received by petitioner in return for the lease in question was not paid and could not have been paid from any share in the oil or gas produced under the lease reserved by the lessor, that it was not “payable proportionately to the use made of the right by the grantee”, and was not “based upon the amount of mineral or oil taken from the ground”, and was not “a share of the product * * * reserved by the owner for permitting another to use the property.” Therefore, we conclude that such a bonus payable to the lessor in a definite sum and in no way contingent upon or payable from the production of oil or gas from the leased premises is not a “royalty” within the meaning of section 351 of the Revenue Act of 1934. Kiesau Petroleum Corporation, 42 B. T. A. 69; Logan Coal & Timber Association, 42 B. T. A. 529. Cf. Grace M. Barnett, 39 B. T. A. 864. It follows that 80 per centum of petitioner’s gross income for the taxable year was not derived from royalties and that petitioner was not a personal holding company within the definition of the statute. It also follows that petitioner is not liable for any penalty on account of failure to file a return as a personal holding company.

. ' We turn now to the next issue. Eespondent contends that petitioner derived income to the extent of $1,627.10 in the taxable year from land sale contracts, and that the evidence adduced at the hearing was insufficient to establish error in respondent’s determination of this sum. The respondent, in his deficiency notice, determined that petitioner received land contract payments in 1935 in the aggregate amount of $5,749.50, and he accordingly treated a certain percentage of each payment as representing a reportable profit during that year, with the result reached above.

The land held had been sold by the James Porter Investment Co. on the installment plan and the contracts were transferred by that corporation to the trust on February 28, 1935. The question turns on the proof of fair market value of these contracts on that basic date, and respondent submits that his determination has not been overcome by adequate proof.

Petitioner introduced evidence to the effect that the land contracts were -worth on the basic date an amount not less than the face amount of the outstanding balance then due on them. James Porter testified that he had sold substantial tracts of land in Canada and about 35,000 acres in California on his own account on installment contracts, although he had never discounted them or bought them. He had, however, as a banker some knowledge of the value of such contracts put up by borrowers as collateral security. Porter testified that he knew personally the contract purchasers and the tracts sold, and that the land contracts taken over by petitioner were worth not less in the market than the face amount still due on them. James Howard Porter was then called by petitioner and testified as to the amounts due on various specific contracts on dates near February 28, 1935.

Respondent introduced no evidence on this point.

On this issue we sustain petitioner’s contention.

The last question may as quickly be disposed of. Petitioner claims a deduction of $2,202.50 for the taxable year in respect of the payment in that year of that amount on account of a double liability assessment levied against the shareholders of a bank. The James Porter Investment Co. was the owner of an uncertain number of shares of the stock of the Morrison Savings Bank, of Morrison, Iowa, before February 28, 1935, which on that day were transferred to petitioner. The bank went into receivership in 1932 or 1933, and the assessment was levied on shareholders accordingly, the petitioner receiving a notice of the assessment in 1935, and it thereupon paid the sum claimed in deduction. The petitioner trust paid the assessment immediately in 1935 on the first call made upon the bank’s shareholders.

This is all the evidence and it is obviously insufficient to establish this expenditure as a deductible loss. Ordinarily, the payment of an assessment on bank stock is to be considered as a contribution to capital, and is not deductible, any loss in such a case being incurred when the stock is sold or becomes worthless. Rauncy v. Commissioner, 46 Fed. (2d) 283. There is no evidence here as to when, if ever, tbis stock became worthless. In this state of uncertainty we may not overturn respondent’s determination as erroneous, and must, therefore, sustain it by denying the deduction.

No evidence being before us as to the deduction of $4,516.72 claimed for legal fees and expenses in the same year, it must also be denied.

Decision will be entered vmder Rule 50.


source: Caselaw Access Project

author: MtjRdock :

license: Public Domain

text:
    Antoinette K. Brown, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97743.
    Promulgated September 10, 1940.

      S. Leo Ruslander, Esq., for the petitioner.

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

MtjRdock :

The Commissioner determined a deficiency of $11,133.06 in the petitioner’s income tax for 1935. The only issue for decision is whether the Commissioner erred by including in the income of the petitioner the income of a trust established by her on January 1, 1927. The facts have been stipulated.

The petitioner created the trust and made her brother, Joseph P. Knapp, trustee, with power to control and manage the trust property. The trust was to terminate at the death of the petitioner. The income was payable $35 per month to Margaret Kane, a retired servant, and the residue to Josephine Ballard, a friend of the petitioner. The corpus was distributable to the estate of the petitioner. Stock dividends, extraordinary cash dividends, rights, and proceeds of sales were to be considered principal. The petitioner retained no power to revoke but retained the power to modify or alter in these respects only:

(A) Increasing the principal of tbe trust fund by adding to the property and securities set forth in said “Property Schedule,” property and securities, which the Trustee shall receive, hold, manage, sell and invest and reinvest and dispose of, in the same manner and with the same limitations as herein specified in respect of the respective properties and securities enumerated in the said Schedule and forming the original trust estate.
(B) Disposing of the income of the trust estate as originally constituted, or as it may exist from time to time, otherwise than as originally provided in this Indenture by the said “Schedule of Income Distribution,” by altering the proportion or amount of income to be paid to or applied to the use of any one or more of the beneficiaries, by canceling any benefaction to any one or more beneficiaries, by substituting any beneficiary or beneficiaries in the place of any one or more of them, by adding to the number of beneficiaries, by providing for the proportion or amount of income to be paid or applied to the use of such additional or substituted beneficiaries; provided, however, that in no event shall any such modification or alteration direct that the said income be paid to or applied to the use or benefit of the party of the first part.
(C) Directing the distribution of the principal of the trust estate as the same shall be constituted at the termination thereof, otherwise than as is originally provided in this Indenture by the said “Schedule of Disposition of Principal upon Termination of Trust,” by altering the proportion or amount of the principal of said trust estate to be assigned, paid and set over to any one or more of the beneficiaries mentioned in said schedule, by canceling any benefaction to any one or more of said beneficiaries, by substituting any beneficiary or beneficiaries in the place of any one or more of them, by adding to the number of said beneficiaries, by providing for the proportion or amount of the principal of the trust estate to be assigned, paid and set over to such additional or substituted beneficiary, or for the manner in which all or any part of said principal shall be divided or distributed upon the death of said Antoinette K. Brown.

and to change the trustee.

She did not exercise any of her reserved rights until after 1935, when she changed the trustee and provided that the income in excess of $35 per month should be paid to Paul G. Brown.

The income of the trust for 1935 amounted to $26,130.92, including capital gain of $3,283.50. That income, exclusive of the capital gain, was distributed to Margaret Kane and Josephine Ballard, in accordance with the terms of the trust. The petitioner did not receive or report any of the trust income, but the Commissioner included all of it in her income in determining the deficiency. The Commissioner explained that the income was taxable to the grantor under sections 166 and 167 of the Kevenue Act of 1934.

The Commissioner argues that the trust was revocable because it provided for no estate in remainder. He cites Silverthau v. United States, 26 Fed. Supp. 242, but that case is distinguishable because the grantor there retained the income for herself and, being the only one interested, she could revoke the trust. A reversionary interest or a possibility of reverter is not a “power to revest.” Blanche G. Penn, 39 B. T. A. 787; John Edward Rovensky, 37 B. T. A. 702; Marrs McLean, 41 B. T. A. 565; Frederic H. Frazier, 41 B. T. A. 146. Here the grantor had no power to revoke and no one had power to revest any part of the corpus in the grantor. Section 166 is not applicable.

The Commissioner contends that section 167 (a) (1) applies, since stock dividends, extraordinary cash dividends, and proceeds of sales of rights were to be added to the corpus, which would go eventually to the estate of the grantor. He says it is immaterial whether or not there was any such income in 1935. However, it would be material, since section 167 (a) (1) provides only that “such part of the income of the trust” as may go to the grantor “shall be included in computing the net income of the grantor.” The stipulation shows that there was no income during 1935 of the kind mentioned by the respondent in this argument. Furthermore, had there been any, it would never have reached the petitioner but, at most, would merely have reverted to her estate. So in no event would section 167 (a) (1) apply. William E. Boeing, 37 B. T. A. 178; reversed on another point, 106 Fed. (2d) 305; J. S. Pyeatt, 39 B. T. A. 774; Genevieve F. Moore, 39 B. T. A. 808. None of the income could ever come to the grantor or be used for her benefit and section 167 is not applicable.

The present trust is in many respects similar to the one created by the brother of the petitioner, the trustee herein, and considered in Knapp v. Hoey, 104 Fed. (2d) 99. Although Knapp reserved power to change the distribution of income and principal, and to change the beneficiaries and the trustees, nevertheless, the court held that none of the income was taxable to him, since in no event could the income be paid to him or be used for his benefit. The Commissioner fails to distinguish the two cases by the fact that Knapp named recipients of the reversion. See also Phebe Warren McKean Downs, 36 B. T. A. 1129; Ellsworth B. Buck, 41 B. T. A. 99.

The Commissioner resorts for the first time in his brief to section 22 (a) for support for his determination. The petitioner has never had,1 an opportunity to be heard upon that point (cf. Commissioner v. Richter, 114 Fed. (2d) 452; Helvering v. Wood, 309 U. S. 344; Rhodes v. Commissioner, 111 Fed. (2d) 53), and the decision should not go against him until he has had that opportunity. Here, however, the Commissioner has failed to make a case. He cites Helvering v. Clifford, 309 U. S. 331. The case is not in point. It involved a short term trust over which the grantor reserved broad powers of control and management. The petitioner did not retain similar powers over this substantial lifetime trust. Cf. Knapp v. Hoey, supra; Ellsworth B. Buck, supra; Dunlevy Milbank, 41 B. T. A. 1014.

Decision will be entered under Rule. 50.


author: Sternhagen :

text:
    Joseph A. Guthrie, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100716.
    Promulgated September 12, 1940.

      Joseph A. Guthrie, Esq., pro se.

      B. P. Hertzog, Esq., and Gme W. Reardon, Esq., for tbe respondent.
   OPINION.

Sternhagen :

Tbe Commissioner determined a deficiency of $244.07 in income tax of petitioner for 1937. He held that tbe gain realized by petitioner in tbe distribution to him of a share of the proceeds of the sale by the executor of the residue of an estate, which share petitioner had acquired by purchase, was not a capital gain with a limited recognition, but was an ordinary gain the entire amount of which must be recognized.

The facts are stipulated and are found as stipulated. The proceeding was submitted under Rule 30.

By the will of Cyrena D. Parker, probated immediately after her death in 1933, the net proceeds of the residuary estate were distributable in five parts. The executor was to pay over to Geneva Babcock “one share consisting of one-fifth (1/5) interest in the said net proceeds of my estate.” Before distribution, Geneva Babcock in November 1935 sold her “right, title and interest in and to the estate of Cyrena D. Parker, deceased,” to W. D. Wolfe; and in January 1936 Wolfe sold to petitioner “all of the right, title and interest of every kind whatsoever, legal or equitable, in and to the estate of Cyrena D. Parker, deceased, the same being one (1) share consisting of a one-fifth (1/5) interest in the net proceeds of the residue of said estate as specified in said last Will and Testament of the said Cyrena D. Parker, deceased.” The cost to petitioner was $7,500 plus a commission of $287.50. The residuary estate consisted of two parcels of real estate and a small amount of cash. The executor in May 1936 sold one parcel and distributed to petitioner $12,000 as his share of the proceeds. The other parcel was sold by the executor in March 1937 and petitioner in May 1937 received $4,955.22 as his share of the final distribution. After proper allocation of the cost between 1936 and 1937 (as to which there is no controversy) petitioner treated the gain of 1937 as capital gain. This conception respondent rejects.

Much of the argument as to the nature of what petitioner purchased from Wolfe may be laid to one side, since it does not reach the crucial question. It may be accepted that petitioner purchased a capital asset as that term is defined in section 117 (b) of the Revenue Act of 1936, cf. Blair v. Commissioner, 300 U. S. 5, and that the gain realized in 1937 was upon a capital asset held for more than one year but not for more than two years, section 117 (a) . But the limitation upon the percentage of gain recognized is prescribed only in respect of gain recognized “upon the sale or exchange” of a capital asset. Unless there has been a sale or exchange, the gain is fully recognized, even though the gain is derived from an investment in a capital asset. Hale v. Helvering, 85 Fed. (2d) 819; John H. Watson, Jr., 27 B. T. A. 463; George A. Hellman, 33 B. T. A. 901; Cobbs v. Commissioner, 111 Fed. (2d) 644; Ralph Perkins, 41 B. T. A. 1225; Bingham v. Commissioner, 105 Fed. (2d) 971; Fairbanks v. United States, 306 U. S. 436.

The cases just cited support the proposition that as to petitioner the gain was not derived from a sale or exchange of his asset. He sold or exchanged nothing. Whether what he acquired from Wolfe be called property, a right to receive, an interest, an expectancy, a claim or what you will, it was neither sold nor exchanged. Petitioner merely got what he paid for. For present purposes, it was not unlike the receipt of the proceeds of a bond or insurance policy at maturity or redemption. Cobbs v. Commissioner, supra; Ralph Perkins, supra; George A. Hellman, supra; Fairbanks v. United States, supra; John H. Watson, Jr., supra; Arthur E. Braun, Trustee, 29 B. T. A. 1161. The sale of the real estate in the residuary estate was by the executor and can not be imputed to petitioner. Anderson v. Wilson, 289 U. S. 20.

The Commissioner correctly held that the percentage provision was not applicable to petitioner’s gain and that the amount received by him in the distribution of 1937 was taxable as ordinary income. The deficiency is sustained.

Decision will be entered for the respondent.

       (b) Definition of Capital Assets. — For tbe 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.

       (a) General Rule. — In the ease of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net income :
      100 per centum if the capital asset has been held for not more than 1 year;
      80 per centum if the capital asset has been held for more than 1 year but not for more than 2 years;


author: Arnold:

text:
    Majestic Securities Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93280.
    Promulgated September 19, 1940.

      Ellsworth G. AVoord, Esq., G. 8. Dobson, Esq., and Floyd F. Toom&y, Esq., for the petitioner.

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

Arnold:

This proceeding involves deficiencies for the calendar years 1934 and 1935 in the following amounts:

The issue presented is the basis to be used in computing gain or loss from the sale of securities acquired in 1932 and 1933.

The facts, except for an exhibit received in evidence, were stipulated. We adopt the stipulated facts as our findings and hereinafter set forth that portion thereof deemed necessary to determine the issue presented.

The petitioner is a corporation organized, on June 22, 1932, under the laws of the State of Delaware, for the purpose of buying, owning, and selling stocks, bonds, and other securities. Its principal office and place of business are located at Joplin, Missouri. Its Federal income tax returns for the calendar years 1934 and 1935 were filed with the collector of internal revenue at Kansas City, Missouri.

The original capital stock issued by the petitioner amounted to 429 shares of the par value of $1,000 per share, for which the petitioner received $425,000 in cash and a note for $4,000. Of the 429 shares issued by the petitioner upon its organization, 295% shares were issued to stockholders of the Conqueror First National Bank of Joplin, Missouri (hereinafter referred to as the bank), 99% shares and 33% shares were issued to the daughter and wife, respectively, of J. G. Starr, the principal stockholder of the bank, and one-half share was issued to the assistant cashier. Prior to April 29, 1933, petitioner acquired the shares issued to the daughter and wife of J. G. Starr, 16¾ shares issued to the Starr Investment Co., and the one share issued to J. G. Starr, or a total of 150 shares. Ownership of stock in petitioner was not in proportion to ownership of stock in the bank.

On June 24,1932, the bank “sold to the petitioner certain securities and the petitioner paid to the [bank] the sum of $521,120.40. The respective amounts paid by the petitioner to the [bank] at the time the said securities were sold was equal to the cost thereof to the bank, and were all in excess of the respective prevailing market prices for said securities on June 24, 1932.”

On April 29,1933, the bank “sold to the petitioner certain securities and the petitioner paid to the [bank] the sum of $434,359.05. The respective amounts paid by the petitioner to the [bank] at the time the said securities were sold was equal to the cost thereof to the bank, and were all in excess of the respective prevailing market prices for said securities on April 29,1933.”

During the calendar year 1934, the petitioner sold securities in the open market (including some of the securities acquired from the bank on June 24, 1932 and April 29, 1933) receiving therefor $76,370.69. In its Federal income tax return for 1934 petitioner deducted a loss of $1,195.82 on account of the sale of securities during that year. In computing the loss of $1,195.82 petitioner used as its basis for the securities acquired from the bank on June 24,1932, and April 29,1933, the amounts paid to the bank representing the equivalent of the original cost thereof to the bank. The respondent determined that petitioner realized a gain of $16,532.40 from the sale of the same securities in 1934. In computing the gain of $16,532.40 the respondent used as the petitioner’s basis for the securities acquired from the bank on June 24,1932, and April 29, 1933, the prevailing market prices therefor on such dates.

During the calendar year 1935 the petitioner sold securities in the open market (including some of the securities acquired from the bank on June 24, 1932, and April 29, 1933) receiving therefor $155,191.63. In its Federal income tax return for 1935 petitioner included a gain of $5,384.25 on account of the sale of securities during that year. In computing the gain of $5,384.25 petitioner used as its basis for the securities acquired from the bank on June 24,1932, and April 29,1933, the amounts paid to the bank representing the equivalent of the original cost thereof to the bank. The respondent determined that petitioner realized a gain of $49,704.40 from the sale of the same securities in 1935. In computing the gain of $49,704.40 the respondent used as petitioner’s basis the prevailing market prices of the securities acquired from the bank on June 24,1932, and April 29,1933.

Schedules attached to and made a part of the stipulated facts show the securities sold during each taxable year by the petitioner, the date of acquisition, the amount paid therefor, the prevailing market price, the amount received, and the gain or loss resulting from the sale of each security based on cost and based on the market price. The exhibit received in evidence confirms the sale to petitioner by the bank in June 1932 of the securities therein listed, and is receipted as paid in full, June 30, 1932/

Respondent’s explanation for his adjustment as to each taxable year is as follows:

Certain securities sold were purchased from the First National Bank, Joplin, Missouri, at the bank’s purchase price, irrespective of market price. Most of the securities were listed on exchanges and had a specific price on the date of transfer. It therefore appears that, since the securities so acquired could have been purchased on the open market, the amount paid in excess of the market price was for a purpose other than the acquisition of securities and the increase over market does not represent a part of the cost of the securities. Sections 22 (a) and 111 (a) of the Revenue Act of 1934.

Section 111 (a) of the Revenue Act of 1934 provides for the computation of gain or loss. It reads in part as follows:

The gain from the sale * ⅜ * of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113 (b) for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized.

Section 113 (b) of the 1934 Act provides:

The adjusted basis for determining the gain or loss from the sale * * * of property, whenever acquired, shall be the basis determined under subsection (a), adjusted as hereinafter provided.

None of the adjustments provided for in subsection (b) apply in this proceeding.

Section 113 (a) of the 1934 Act provides that “The basis of property shall be the cost of such property; except that * * '

None of the exceptions specified are applicable to this proceeding.

The Commissioner stated in his notice of deficiency that the amount paid was in excess of the market price and that the securities could have been purchased in the open market for less, and, therefore, determined that the amount paid in excess of the market price was “for a purpose other than the acquisition of securities and the increase over market does not represent a part of the cost of the securities.” The Commissioner’s determination has the support of a presumption of correctness and the petitioner has the burden of proving it to be wrong. Welch v. Helvering, 290 U. S. 111; Burnet v. Houston, 283 U. S. 223.

The parties have stipulated that the petitioner was organized for the purpose of buying, owning, and selling bonds and other securities; that 295¾ shares of petitioner’s 429 shares of stock were held by stockholders of the bank, although not in proportion to their respective bank stockholdings; that petitioner’s remaining shares were owned by parties closely related to the stockholders of the bank or closely associated with the bank, all of which, except the one-half share of the assistant cashier, were acquired by petitioner prior to April 29,1933; that petitioner acquired the securities from the bank at the cost of the securities to the bank, which was in excess of prevailing market prices at the time of acquisition; and that the schedule attached to and made a part of the stipulation shows the gain or loss on subsequent sales based (1) on the amount paid the bank, and (2) on the prevailing market prices at the time of acquisition. Upon these stipulated facts petitioner contends that it has fully met its burden, notwithstanding the Commissioner’s determination that the excess paid was for a purpose other than the acquisition of the securities, and that the excess did not represent a part of the cost of the securities acquired from the bank.

The purchase price is ordinarily considered the proper basis for determining gain or loss on subsequent disposition, but there are exceptions to this rule, depending on special facts and circumstances. Pennsylvania Indemnity Co., 30 B. T. A. 413; affd., 77 Fed. (2d) 92; certiorari denied, 296 U. S. 588; Donald McDonald, Jr., Administrator, 28 B. T. A. 64; Harry F. Robertson, 5 B. T. A. 748; Rubay Co., 9 B. T. A. 133; Frederick Ayer, 6 B. T. A. 152; affd., 25 Fed. (2d) 534; E. D. Knight, 28 B. T. A. 188. The general rule that the price paid is the basis for determining gain or loss on future disposition presupposes a normal business transaction. Pennsylvania Indemnity Co. v. Commissioner, 77 Fed. (2d) 92. As petitioner was organized for the purpose of buying, owning, and selling stocks, bonds, and other securities, we must assume it carried on the business for which it was organized for profit. To pay for the securities acquired from the bank more than it could have purchased them for in the open market is inconsistent with normal business transactions. The stipulation is silent as to why petitioner paid the bank a price in excess of the market. If we take judicial notice of the fact that at the time petitioner was organized and the purchases were made there was a general business depression, Great Northern Railway Co. v. Weeks, 297 U. S. 135, and banks generally were seriously impaired, it would seem from the relationship of petitioner’s stockholders to the bank that the purpose of causing the securities to be purchased from the bank at a price in excess of their market value at the time may have been to maintain the bank’s solvency. Petitioner was controlled by certain stockholders of the bank through common stock ownership. The fact that petitioner’s stockholders were all stockholders of the bank from which the securities were purchased, with the exception of the assistant cashier of the bank and the wife and daughter of one of the principal stockholders of the bank, coupled with the fact that petitioner was used to purchase at a total price of $77,566.51 securities which could have been purchased for $59,838.29 in the open market, clearly shows the purchases were not normal business transactions. These facts indicate that part of the amount paid was for a purpose other than the acquisition of the securities, and that the excess paid was no part of the cost of acquiring the securities. Likewise, as to the securities sold in 1935, petitioner was used to purchase securities at a total price of $149,807.38 which could have been purchased in the open market for $105,487.23. We think it is a fact of considerable importance that petitioner did not' pay in excess of the market price for securities acquired through other sources.

The stipulation does not state that the price paid was the “cost” of acquiring the securities from the hank; but petitioner would have us so infer. If the excess paid for the securities was not for a purpose other than acquiring the securities, petitioner should have produced evidence to that effect; otherwise the Commissioner’s determination stands uncontroverted. Cf. W. B. Brooks, 12 B. T. A. 31; affd., Brooks v. Commissioner, 35 Fed. (2d) 178. Proof of essential facts can not be left to speculation and conjecture. Cf. Swayne Lumber Co., 25 B. T. A. 335; Wood Corporation of Delaware, 22 B. T. A. 1182; affd., 63 Fed. (2d) 1023. The real question raised by the Commissioner’s determination is whether the price paid in excess of the market was for a purpose other than the acquisition of the securities. We do not think the facts as stipulated are sufficient to overcome the Commissioner’s determination. We think it was incumbent upon petitioner to go further and show that the amount paid was for no purpose other than the acquisition of the securities. This the petitioner has not done. If the rule that the price paid represents the basis for determining gain or loss -was without exceptions, and if the Commissioner had not made a definite determination that the excess price paid was for a purpose other than the acquisition of the securities, there would be merit in petitioner’s contention.

Our conclusion is supported by the stipulated changes in stock ownership in the petitioner and in the bank that occurred between June 22,1932, and April 29,1933. At the date of incorporation stockholders of the bank owned 68.94 percent of petitioner’s stock; less than a year later stockholders of the bank owned 99.88 percent of petitioner’s capital stock, and the only other stockholder was the assistant cashier of the bank. The elimination of nonbank stockholders from ownership of petitioner’s stock was apparently accomplished by petitioner purchasing the stock so field, as it owned 150 shares of its own stock and 1,000 shares of the stock of the bank on April 29, 1933. These facts, together with the facts aforementioned, show that petitioner was used by stockholders of the bank for the benefit of the latter. This use of petitioner indicates the business transactions were not normal, as the interests were not adverse and the acquisitions of the securities from the bank at a price in excess of the market were not arm’s length transactions.

Furthermore, it should be noted that petitioner’s transactions during the taxable years were primarily in securities acquired from the bank. The schedule attached to the stipulated facts shows that 10 of the 19 securities sold in 1934 and 20 of the 30 securities sold in 1935 were securities acquired from the bank. These circumstances, together with the other facts and circumstances herein, convince us that respondent correctly determined that part of the amount paid the bank did not represent cost of the securities, but was for a purpose other than the acquisition of the securities.

Petitioner has made no contention with regard to the surtax deficiency or the penalty, and respondent’s determination with respect thereto is approved.

Decision will be entered for the respondent.


author: MuRdock :

text:
    Beacon Auto Stores, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97821.
    Promulgated September 19, 1940.

      Fred L. Bosenbloom, Esq., for the petitioner.

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

MuRdock :

The Commissioner determined the following deficiencies:

The only issue for decision is whether the Commissioner erred by including in income for each year amounts of undrawn salaries for the preceding year credited to surplus in the taxable years. The facts have been stipulated.

The petitioner was engaged in the retail auto supplies business during the taxable years. It reported its income upon an accrual method of accounting. The salaries authorized in January of the taxable years, the salaries credited upon the books, the amounts withdrawn during each year, and the remainders for 1933 and 1934 were as follows:

The net income reported for those years, after deducting the salaries authorized and credited, was $184.14 and $373.40. The individuals had the right to withdraw the salaries credited to them.

The undrawn amount of $2,513.59 for 1933 was extinguished in September 1934 by debits to the accounts of the three individuals and a credit to surplus. The undrawn amount of $4,402.52 for 1934 was extinguished in the same way on September 30, 1935. Undrawn salaries for 1935 were extinguished in similar fashion in 1936.

Theodore Rovins reported $2,600 as salary for 1933 and $5,200 as salary for 1934. He claimed credits of $3,700 for each year. Bernard Rovins filed no returns for 1933 and 1934 until December 4, 1937, when he reported the full amount credited to him for those years and no tax due after deducting credits of $2,900. Sue Greenberg-had no income from other sources and filed no returns. She was unmarried.

Theodore Rovins owned 29 shares, Bernard Rovins 5 shares, and Sue Greenberg 1 share of the 37 outstanding shares of stock of the petitioner.

The Commissioner, in determining the deficiencies, included the $2,513.59 in income for 1934 and the $4,402.52 in income for 1935.

This petitioner, upon an accrual basis, claimed and was allowed deductions for salary obligations which later events showed it never had to meet by payments. Cf. Chicago, Rock Island & Pacific Railway Co., 13 B. T. A. 988; modified, 47 Fed. (2d) 990; certiorari denied, 284 U. S. 618; Charleston & Western Carolina Railway Co., 17 B. T. A. 569; Houbigant, Inc., 31 B. T. A. 954; Estate of William H. Block, 39 B. T. A. 338; affd., 111 Fed. (2d) 60. The Commissioner adjusted its accounts for income tax purposes when it appeared in the taxable years that the obligations would never have to be paid. The petitioner contends that payment of the undrawn salaries was gratuitously forgiven under circumstances which amounted to a contribution of capital without income tax significance, under AutoStrop Safety Razor Co., 28 B. T. A. 621; affd., 74 Fed. (2d) 226. The record does not justify this factual conclusion. The stipulation merely states that the corporation extinguished the undrawn salary credits by a debit to the individual accounts and a corresponding credit to surplus account. The consistency of that practice and the disproportion in amounts compared to stockholdings are facts not without significance. Furthermore, the court in the recent case of Helvering v. Jane Holding Corporation, 109 Fed. (2d) 933, reversing 38 B. T. A. 960; certiorari denied, 310 U. S. 653, regarded as of primary importance the fact that, as here, the corporation had received the benefit of a deduction to which, in the light of later events, it was not entitled. The petitioner fails to make anything of importance out of the inconsistency of the individuals in reporting or failing to report the full amount credited to them.

Decision will l>e entered for the respondent.


author: Van Fossan:

text:
    South Atlantic Steamship Line, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98844.
    Promulgated September 20, 1940.

      T. J. O'Brien, C. P. A., and William, Hugh Stephens, Esq., for the petitioner.

      Franh L. Van Haaften, Esq., for the respondent.

       SEC. 112. RECOGNITION OF GAIN OR LOSS.
      ****** *
      (b) Exchanges Solely in Kind.—
      *******
      (3) Stock for stock on reorganization.—
      No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
      * ******
      (e) Gain fkom Exchanges no® Solely in Kind.—
      (1) If an exchange would be within the provisions of subsection (b) (1), (2), (3), or (5) of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then the gate, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of siich other property.

   OPINION.

Van Fossan:

The first issue for our determination is whether or not new preferred stock of the Fertilizer Co. received by petitioner in accordance with a recapitalization of that company was a dividend taxable to petitioner under section 115 of the Eevenue Act of 1936. Petitioner contends that the change in capital structure of the Fertilizer Co. constituted a reorganization and gain is recognizable on the exchange of the old stock for new stock, bonds, and cash only to the extent of the cash received. Respondent argues, however, that the noncumulative preferred stock was received by petitioner in exchange for arrears in dividends on the old stock and is taxable as a corporate dividend. The second issue, which respondent urges in the alternative, is whether or not petitioner realized recognizable gain on the receipt of new preferred stock, debenture bonds, and cash other than to the extent of the cash received.

The latter issue is the more broad and, since its determination will narrow the field of inquiry, will be considered first. Petitioner contends that gain is recognized on the transaction only to the extent of the cash received. In order that petitioner may be sustained on this point it must show that there was a reorganization within the meaning of the statute and that the exchange comes within one of the specific exceptions to the recognition of gain under section 112 of the Revenue Act of 1936.

The readjustment of the Fertilizer Co.’s capital structure is clearly a recapitalization and is within the statutory definition of reorganization provided by section 112 (g) (1) (D) of the Revenue Act of 1936. There was a definite plan of reorganization for the Fertilizer Co. and the exchange of securities here under consideration was made pursuant to that plan. We are of the opinion that the exchange of cumulative preferred stock for securities and cash of the Fertilizer Co. comes squarely within the terms of section 112 (b) (3) and 112 (c) (l), which provide that, where stock or securities of a corporation are exchanged pursuant to a plan of reorganization for stock or securities of that corporation plus cash or other property, gain may be recognized, but only to the extent of the cash or fair market value of the other property received.

Respondent argues that even if we should find that there was a reorganization, the receipt of stock, bonds, and cash by petitioner is not within the terms of section 112 (c) (1). Fie contends that although gain will not be recognized where stock or securities of the corporation in reorganization are exchanged for stock or securities of that corporation, in the present case not only stock but also a right to receive arrears in dividends was given in exchange for new securities and cash. His position is that the right to undeclared accumulated dividends is separate and apart from the preferred shares and consequently outside the statutory exception.

In Commissioner v. Food Industries, Inc., 101 Fed. (2d) 748, the holders of preferred shares of a corporation upon which dividends were accrued but unpaid received common stock of a new corporation in exchange for the preferred stock and also received sinking fund debentures of the new corporation for the arrearages in dividends. The Circuit Court of Appeals for the Third Circuit held that by vir-. tue of section 112 (b) (3) of the Revenue Act of 19281 the receipt of common stock and sinking fund debentures was not taxable. The \ right to arrears and dividends was not considered apart from the stock upon which the arrearages arose. The same reorganization with respect to other shareholders was considered by the Circuit Courts of Appeals for the First, Second, Fourth, and Ninth Circuits with the same result. Commissioner v. Whitaker, 101 Fed. (2d) 640; Helvering v. Schoellkopf, 100 Fed. (2d) 415; Helvering v. Leary, 93 Fed. (2d) 826; Commissioner v. Kolb, 100 Fed. (2d) 920. Here the problem is more simple than that before the courts in the cited cases. The dividends of the Fertilizer Co. were in arrears but had not been declared. Although common stock dividends could not be paid without prior payment of arrears in preferred stock dividends, the right of \ the shareholders to the undeclared dividends was not in the nature of ] a debt. In brief, the right of the preferred shareholders to receive the dividend arrears was not one which could be divorced from the shares upon which it was based.

Respondent has raised the question of whether the 25-year debenture bonds received by petitioner in exchange for its stock were “stock or securities” or “other property.” Debenture bonds are securities of the issuing corporation. Karl B. Segall, 38 B. T. A. 43; Commissioner v. Food Industries, Inc., supra. Petitioner, therefore, comes within the terms of section 112 (c) (1).

Section 112 (c) (2) of the Revenue Act of 1936 is not applicable. There is no indication that receipt of new stock or securities by petitioner had the effect of a taxable dividend. The fact that the new preferred shares were received in exchange for the right to dividend arrears does not give the new shares the effect of a taxable dividend.

We now turn to the first issue. Respondent urges that since the new preferred stock was received in exchange for the dividend arrears on the old shares it is either a dividend taxable under section 115 (a) of the Revenue Act of 1936 or a redemption of stock taxable as a dividend under section 115 (g).4

In either case, the taxable distribution is limited to the extent that it represents a distribution out of earnings and profits of the corporation accumulated after February 28,1913, or out of earnings and profits of the taxable year. The effect of subsections (a) and (g) of section 115, however, is limited by subsection (h) of section 115. The latter section provides that a distribution by a corporation of its stock or securities shall not be a distribution out of earnings or profits if no gain to the distributee from the receipt of the stock or securities is recognized by law. We have already determined that by virtue of section 112 (c) (1) gain to petitioner is recognized only to the extent of the cash received. It follows, therefore, that the preferred stock received by petitioner was not a dividend under section 115 (a) nor “essentially equivalent to the distribution of a taxable dividend” under section Í15 (g).

We hold that receipt of the noncumulative preferred shares by petitioner was not a dividend nor essentially equivalent to a taxable dividend. We further hold that the Fertilizer Co. in the course of reorganization distributed stock, securities, and cash to petitioner and that gain on that distribution is recognized to petitioner only to the extent of the cash received.

Decision will be entered, under Rule 50.

       This section is identical with section 112 (b) (3) of the Revenue Act of 3936.

       SEC. 112. RECOGNITION OB' GAIN OR LOSS.
      * * # * * * *
      (c) Gain From Exchanges Not Solely in Kind.—
      * * * * * * *
      (2) If a distribution made in pursuance of a plan of reorganization is within the provisions of paragraph (1) of this subsection but has the effect of the distribution of a taxable dividend, then there shall be taxed as a dividend to each distributee such an amount of the gain recognized under paragraph (1) as is not in excess of his ratable share of the undistributed earnings and profits of the corporation accumulated after February 28, 1913. The remainder, if any, of the gain recognized under paragraph (1) shall be taxed as a gain from the exchange of property.

         SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
      (a) Definition of Dividend.—
      The term “dividend” when used in this title (except in section 203 (a) (3) and section 207 (c) (1), relating to insurance companies) means any distribution made by a corporation to its share holders, whether in money or in other property, (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings or profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made.
      * * * * * * *
      (g) Redemption of Stock.—
      If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend.

       SEC. 115. distributions BY CORPORATIONS.
      *******
      (h) Effect on Eaeninss and Pbopits of Distributions of Stock.—
      The distribution (whether before January 1, 1936, or on or after such date) to a dis-tributee by or on behalf of a corporation of its stock or securities or stock or securities in another corporation shall not be considered a distribution of earnings or profits of any corporation—
      (1) if no gain to such distributee from the receipt of such stock or securities was recognized by law, or
      (2) if the distribution was not subject to tax in the hands of such distributee because it did not constitute income to him within the meaning of the Sixteenth Amendment to the Constitution or because exempt to him under section 115 (f) of the Revenue Act of 1934 or a corresponding provision of a prior Revenue Act.
      As used in this subsection the term “stock or securities” includes rights to acquire stock or securities.


author: Keen:

text:
    Seaboard Small Loan Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98375.
    Promulgated September 24, 1940.

      Norman B. Frost, Esq., for the petitioner.

      Philip A. Bayer, Esq., for the respondent.

       Originally entered as a memorandum opinion of same date.

   OPINION.

Keen:

The questions raised in this proceeding were recently considered by the Circuit Court of Appeals for the First Circuit in the case of Noteman v. Welch, 108 Fed. (2d) 206 (December 22, 1939), affirming 24 Fed. Supp. 437, and decided contrary to the contentions of tbe petitioner.

On tbe authority of that case and because of tbe reasons therein given,

Decision will he entered for respondent.


author: Hill:

text:
    Morrison Bond Company, Ltd., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 93362, 95986.
    Promulgated September 24, 1940.

      Dana Latham,, Esq., for the petitioner.

      Byron M. Goon, Esq., for the respondent.
   SUPPLEMENTAL OPINION.

Hill:

A report in these consolidated proceedings was promulgated March 28, 1940 (41 B. T. A. 669) in which we held, on authority of our prior decision in District Bond Co., 39 B. T. A. 739, that interest received on bonds issued under (a) the California Improvement Act of 1911, approved February 7, 1911, (b) the California Street Opening Bond Act of 1911, approved April 27, 1911, and (c) the California County Improvement Act of 1921, approved June 3, 1921, was subject to Federal income tax. In the report promulgated herein March 28, 1940, we also held, on authority of our prior decision in Susanna Bixby Bryant, 38 B. T. A. 618, that interest on bonds issued under the California Improvement Act of 1893, approved February 27, 1893, was subject to Federal income tax. In the same report we further held that interest on bonds issued under the California Boundary Line Act of 1911, approved April 21, 1911, was subject to Federal income tax. The bonds last mentioned were issued under the terms of the California Improvement Act of April 7, 1911.

In Bryant v. Commissioner, 111 Fed. (2d) 9, the United States Circuit Court of Appeals for the Mnth Circuit, on April 12, 1940, reversed our decision in Susanna Bixby Bryant, supra, and the same court on June 28, 1940, 113 Fed. (2d) 347, reversed our decision in District Bond Co., supra, on the point here involved, holding that interest on bonds issued under all of the California improvement acts above mentioned was not subject to Federal income tax.

On the authority of the above court decisions we hereby modify our report herein of March 28. 1940, respecting the taxability of interest on the bonds herein involved and hold that such interest is not subject to Federal income tax.

Reviewed by the Board.

Decisions will be entered wader Bule 50.


author: MuRdock:

text:
    O’Sullivan Rubber Company, Inc. (in Dissolution), Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97399.
    Promulgated September 24, 1940.

      Edward I. Devlin, Jr., Esq., and Peter V. D. Voorhees, Esq., for the petitioner.

      Oonway N. Kitchen, Esq., for the respondent.
   OPINION.

MuRdock:

The debtor which owed the petitioner the $3,400 “was chronically suffering from financial embarrassment” and the “petitioner was in imminent danger, not only of not collecting the interest” but of losing the principal payments due it. Cf. Turners Falls Power & Electric Co., 15 B. T. A. 983, 992. The petitioner had no reasonable anticipation at the close of 1935 of receiving the interest when it became due. Since collection was so doubtful, it did not have to accrue the item of $3,400. Cf. Great Northern Railway Co., 8 B. T. A. 225, 269; appeal dismissed, 40 Fed. (2d) 372; certiorari denied, 282 U. S. 855; Corn Exchange Bank v. United States, 37 Fed. (2d) 34; American Central Utilities Co., 36 B. T. A. 688.

The evidence does not show that at the close of 1935 there was any uncertainty about the collection of the interest on the Boston & New York Airline Railway bonds. The petitioner actually accrued the interest in the amount of $416.67. The mere fact of nonpayment is insufficient to show that it was not properly accrued. The reason given by a revenue agent for disallowing a loss for 1938 on that item is likewise insufficient to show that the accrual was improper for 1935. He may have been in error in denying the deduction for 1936.

The petitioner quotes the legislative history of section 351 of the Revenue Act of 1934 to show that the purpose of Congress was not to penalize such a taxpayer as this one, which was not tainted with the faintest trace of the evil at which Congress aimed and which could not make a distribution taxable to its shareholders as an ordinary dividend. However, the only means of escape from the plain language of section 351 suggested by the petitioner is that it is not a corporation within the meaning of that word as used in section 351 of Title IA. It is inconsistent in not making the same contention in connection with its income tax liability, under Title I, since section 351 (b) (4) of Title IA provides that “the terms used in this section shall have the same meaning as when used in Title I.” The stockholding and income for the year bring it squarely within the definition of a personal holding company, if it is a corporation. See sec. 351 (b) (1).

The term “corporation” when used in the act, includes associations. Sec. 801 (a) (2). The Commissioner has provided in article 801-2 of Regulations 86 that a corporation becomes an association if it continues to conduct its affairs after the expiration of its charter or after the termination of its existence. The petitioner argues that there can be no association taxable as a corporation within the statute and the regulations where, as here, the dissolved corporation is carrying on no business but is merely winding up its affairs and liquidating. It attempts to find some analogy between itself and a liquidating trust. Cf. Morrissey v. Commissioner, 296 U. S. 344; Broadway-Brompton Buildings Liquidation Trust, 34 B. T. A. 1089; Fidelity National Bank & Trust Co., 37 B. T. A. 473. We do not think, however, that either the regulation or the term “association” is necessary to bring this taxpayer within the term “corporation.” This was not a trust but an actual corporation. The law of New York provides that after dissolution “Such corporation shall continue for the purpose of paying, satisfying and discharging any existing liabilities or obligations, collecting and distributing its assets and doing all other acts required to adjust and wind up its business and affairs, and may sue and be sued in its corporate name.” Sec. 105, Stock Corporation Law of New York. See also Fletcher’s Cyclopedia of the Law of Private Corporations, Permanent Ed., vol. 16, secs. 8113 and 8158. Thus, the petitioner was continued under the law as a corporation for the very purpose of doing those things which it did in 1935 (Jaffee v. Commissioner, 45 Fed. (2d) 679; Giovannangeli v. Levich & Pollach, Inc., 134 Misc. 245; 235 N. Y. S. 28) and, clearly, it comes within the words “any corporation” used in section 351 (b) (1) as those words are commonly understood. Cf. Will T. Caswell, 36 B. T. A. 816. Since the words of the act are clear, we can not change them to relieve this taxpayer, even though we may feel that those words include more than was actually necessary to accomplish the purpose which Congress had in mind. The correction, if any is necessary, should come from Congress.

The petitioner cites the regulations in an effort to show that interest in section 351 means only interest on loans, and reasons that, since its interest on the Langdon notes was not from loans, less than 80 percent of its income was from interest. We disagree with that argument. Interest there means the same as it does in Title I. Sec. 351 (b) (4). The penalty for failure to file a return is mandatory where no return is filed. Sec. 406, Revenue Act of 1935. Collateral Mortgage & Investment Co., 37 B. T. A. 630; Noteman v. Welch, 108 Fed. (2d) 206.

Reviewed by the Board.

Decision will Toe entered wider Rule 50.


author: Mellott:

text:
    W. C. Robinson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99038.
    Promulgated September 25, 1940.

      Charles D. Hamel, Esq., L. I. Park, Esq., and C. F. Rothenburg, “ Esq., for the petitioner.

      William A. Schmitt, Esq., for the respondent.
   OPINION.

Mellott:

As stated above, the sole question is whether the transaction whereby Phelps Dodge transferred, to a group of its stockholders, 290,000 shares of National stock for 290,000 shares of its own stock was a distribution in partial liquidation of Phelps Dodge, as respondent contends, or a sale or exchange of a capital asset, as petitioner contends. If the respondent’s contention is correct, the entire amount of the gain or loss must be recognized for tax purposes under the provisions of section 115 (c) of the Eevenue Act of 1934, while if petitioner’s contention is correct, the amount of gain or loss to be taken into account in computing his net income, is limited by the provisions of section 117 (a) of the same act, pertaining to capital gains and losses.

Section 115 (i) of the Revenue Act of 1934 defines the term “amounts distributed in partial liquidation” as meaning “a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock.” If the transaction in issue comes within this definition, respondent’s determination must be sustained; if not, then petitioner must prevail.

Respondent takes the position that Phelps Dodge, for reasons satisfactory to itself, disposed of an undesirable but substantial portion of its business and assets; that by thus limiting its field of endeavor and restricting its business activities, it effected a partial liquidation; that the disposal of all of the Rational stock, together with the transfer of the legal title to the land, plant, and equipment, constituted liquidation in every sense of the word; that the reacquisition of 290,000 shares of its stock by Phelps Dodge constituted a redemption of the stock without the necessity of cancellation or any other affirmative act of retirement and despite any intent to reissue; and that the fact the reacquired stock has been carried on its books as treasury stock is immaterial, inasmuch as the record shows no definite intent or fixed purpose to reissue. \33⅛ also contends that under the provisions of section 115 (c) and 115 '(i) , supra, a “partial liquidation” has taken place whenever a corporation'fias distributed money or assets in redemption of a part of its outstanding stock, even though a “winding up” of the affairs of the company is not contemplated, and that the distribution here under consideration was such a distribution.

Petitioner contends that the transfer to him of 164,605 shares of National stock for an equal number of shares of stock of Phelps Dodge was not a distribution in partial liquidation of the latter corporation. In support of this contention he points to the provisions of section 115 (i), supra, defining such a distribution to mean a distribution by a corporation in complete cancellation or redemption of a part of its stock, and urges that the statutory definition is not satisfied where as here the stock was placed in the corporation’s treasury for future use and was not retired. He also urges that Phelps Dodge did not liquidate any part of its business and, in executing the contract with petitioner, it was not motivated by a desire to liquidate any part of its business. Petitioner takes the position that Phelps Dodge intended to consummate, and did consummate, a sale or exchange of the outstanding stock of National for 290,000 shares of Phelps Dodge stock, and calls attention to the fact that the parties have stipulated that he, pursuant to the contract with Phelps Dodge, “exchanged [his] 164,605 shares of stock of the Phelps Dodge corporation for 164,605 shares of stock of” National, and that the word “sale” was used in the written contracts between the parties, in the minutes of the board of directors of Phelps Dodge, and in recording the transaction on its books.

Prior to the passage of the Kevenue Act of 1934, gains resulting from distributions in partial liquidation were treated and taxed as capital gains. Therefore, whenever a shareholder relinquished part of his stock in a corporation and received in exchange therefor money or assets, any gain resulting to him was taxable as a capital gain, unless the distribution was “essentially equivalent to the distribution of a taxable dividend”, in which event it was taxable as a dividend finder section 201 (g) of the 1926 Act or under section 115 (g) of the 1928 and subsequent acts.

The necessity for determining whether there was a sale or exchange of all or a part of a shareholder’s stock to a corporation, or whether he received a distribution in partial liquidation, arises from the change made by section 115 (c) of the 1934 Act, requiring that in cases of distributions in partial liquidation 100 per centum of the gain realized is to be taken into account in computing net income. In other words, prior to 1934 a distribution in partial liquidation was treated the same as a sale or exchange of the stock and the amount of the gain or loss to be taken into account in computing net income was limited by the capital gains provisions of the various acts, whereas under the 1934 Act, in the case of a partial liquidation, such gain is no longer limited by the capital gains provisions and 100 percent thereof is subject to both normal tax and surtax.

In support of his contention, respondent cites and relies upon a number of cases involving the question of whether a corporation had made a distribution in partial liquidation or had made a distribution in cancellation or redemption of a part of its stock “at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend.” Commissioner v. Quackenbos, 78 Fed. (2d) 156; Commissioner v. Cordingley, 78 Fed. (2d) 118; James D. Robinson, 27 B. T. A. 1018; affd., 69 Fed. (2d) 972; Alfred E. Fuhlage, 32 B. T. A. 222. It is true, as respondent points out upon brief, that holding was made in some of the cited cases that a “partial liquidation” had occurred although a “winding up” of the affairs of the corporation was not contemplated (Commissioner v. Quackenbos, supra; Commissioner v. Cordingley, supra), and even though there was no intention on the part of the corporation to liquidate (Salt Lake Hardware Co., 27 B. T. A. 482). It is not without significance, however, that, in every instance where it was held that a distribution in partial liquidation had been effected, it was accompanied by a retirement of a part of the corporation’s stock.

In the instant proceeding neither party contends that the distribution received by petitioner was taxable as a dividend. The parties have stipulated that petitioner exchanged his shares of Phelps Dodge stock for an equal number of shares of National, and the transaction must be treated as a “sale or exchange” for tax purposes unless it falls within the definition of a distribution in partial liquidation contained in section 115 (i), supra.

Obviously, Congress did not intend that all transfers of money or assets by a corporation to its stockholders in exchange for a portion of its stock held by them should be treated as distributions in partial liquidation. If such had been its intention, it would not have limited such distributions to those made in “complete cancellation or redemption” of a part of a corporation’s stock. Moreover, the fact that the distribution resulted in the cessation of a part of the corporation’s business, as argued by the respondent, or did not do so, as argued by petitioner, is not controlling. The question is not whether there was a partial liquidation in the sense in which these words are generally used, but whether there was a partial liquidation as defined in the statute.

While neither party argues that the phrase “complete cancellation or redemption” is ambiguous, their divergent views as to its meaning justify some reference to the reports of the congressional committees at the time the [Revenue Act of 1924 was under consideration. The following excerpt from these reports tends to support the petitioner’s contention that there can be no “complete cancellation or redemption” of a part of a corporation’s stock unless it is retired:

The theory of liquidating dividends is extended to distributions in partial liquidation. If a corporation retires a portion of its capital stock, the transaction is treated, from the point of view of the stockholders as a sale of its stock. If a corporation distributes an amount in partial retirement of its capital stock, the amount thereof is to be considered as a return of capital, and taxable only if, and to the extent that, it exceeds the basis of the stock. [House Rept. No. 179, 68th Cong., 1st sess.; Senate Rept. No. 398, 68th Cong., 1st sess. Italics ours.]

Moreover, the respondent has tacitly adopted this interpretation of the quoted phrase in his regulations. In article 115-5 of Regulations 86 it is said:

* * * A complete cancellation or redemption of a part of the corporate stock may be accomplished, for example, by the complete retirement of all the shares of a particular preference or series, or by taking up all the old shares of a particular preference or series and issuing new shares to replace a portion thereof, or by the complete retirement of any part of the stock, whether or not pro rata among the shareholders. [Italics ours.]

The Circuit Court of Appeals for the First Circuit apparently had the same view; for it stated, in Commissioner v. Cordingley, supra, that “The statute contemplates partial liquidation of corporations, accompanied by partial retirement of outstanding stock.” [Emphasis supplied.]

Since the passage of the Revenue Act of 1934, two published opinions have been promulgated by this Board in which the question was whether stockholders had made sales of their stock or whether they liad received distributions in partial liquidation. William A. Smith, 38 B. T. A. 317, is relied upon by the petitioner, while Benjamin R. Britt, 40 B. T. A. 790, is relied upon by the respondent. In William A. Smith, supra, the facts were somewhat similar to those now before us. Smith was the owner of 45 of the 1,000 outstanding shares of the capital stock of a corporation. Being in need of money, he offered to sell his shares to the corporation for $1,000 per share. The corporation accepted and paid him $45,000. After receiving the stock the corporation did not cancel or retire it, but carried it on its books as treasury stock. It was held that the transaction constituted a sale of the shares by Smith to the corporation, and that it was not a distribution in partial liquidation.

In Benjamin R. Britt, supra, a corporation redeemed its preferred stock at $110 a share, and it was held that the stockholders received a distribution in partial liquidation. In distinguishing this case from William A. Smith, supra, it was said:

But, in the Smith case, all the elements of a sale were present. The reacquired stock was not retired, but was held in the treasury of the corporation subject to reissuance. The last sentence of paragraph (b) of the stock certificates, involved here, provides that preferred stock purchased or redeemed or discharged shall not be reissued. The redemption, in other words, was to be complete. It is proper to presume, therefore, that that procedure was followed when petitioner’s stock was reacquired in 1934. ⅜ ⅜ * This factual situation prevents, in our opinion, the application of the Smith case here.

The 290,000 shares of stock received by Phelps Dodge from petitioner and his associates were neither canceled nor retired. They were placed in its treasury as treasury stock and have been continuously so held. The evidence discloses that they were placed in the treasury with the intention that they would be used to purchase additional properties, and that officials of the corporation, preliminary to taking this action, received the advice of counsel to the effect that under the laws of the State of New York treasury stock could be used for the acquisition of properties without regard to any preemptive rights of Phelps Dodge stockholders. Notwithstanding this evidence, respondent argues that an intention to retire the stock is manifested by the fact that none of it has been used by Phelps Dodge during the five years which have elapsed since it was acquired, even though the corporation has bought large properties and expanded its business. He therefore contends that for the purposes of the instant case the stock should be considered in effect as canceled or retired.

It is true that since Phelps Dodge placed the 290,000 shares in its treasury it has expended a substantial sum in expanding its plant facilities and purchased the properties of the United Yerde Copper Co. as set forth in our findings. It is also true that it did not use the treasury stock for either of these purposes. However, we know of no rule of law, and respondent has not cited any, holding that treasury stock acquired by a corporation for the purpose of using it to purchase properties will be considered to have been completely canceled or retired if it is not used for that purpose within a certain period of time after its acquisition. The 290,000 shares are still available as treasury stock for the purchase of properties, and the continued treatment of these shares as treasury stock indicates an intention not to cancel or retire them, rather than to do so.

The stipulated facts indicate, and it is accordingly held, that Phelps Dodge did not make a distribution “in complete cancellation or redemption of a part of its stock.” Petitioner therefore did not receive a distribution in partial liquidation when on March 21, 19B5, he exchanged his 164,605 shares of Phelps Dodge stock for an equal number of shares of National, and the amount of the gain or loss to be taken into consideration in computing his net income is governed by the provisions of section 117, supra.

Reviewed by the Board.

Judgment will be entered under Bule 50.

ARNOLD and OrrER concur only in the result.

         SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
      *******
      (c) Distributions in Liquidation. — Amounts distributed in complete liquidation oí a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Despite the provisions of section 117 (a), 100 per centum of the gain so recognized shall be taken into account in computing net income. In the case of amounts distributed (whether before January 1, 1934, or on or after such date) in partial liquidation (other than a distribution within the provisions of subsection (h) of this section of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or profits within the meaning of subsection (b) of this section for the purposes of determining the taxability of subsequent distributions by the corporation.

       SBC. 117. CAPITAL GAINS AND LOSSES.
      (a) General Rule. — In the ease of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognizee! upon the sale or exchange of a capital asset shall be taken into account in computing net income:
      100 per centum if the capital asset has been held for not more than 1 year;
      80 per centum if the capital asset has been held for more than 1 year but not for more than 2 years;
      60 per centum if the capital asset has been held for more than 2 years but not for more than 5 years;
      40 per centum if the capital asset has .been held for more than 5 years but not for more than 10 years;
      SO per centum if the capital asset has been held for more than 10 years.


text:
    Estate of Mildred K. Hyde, Deceased, Willis O. Hyde, Administrator, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95182.
    Promulgated September 25, 1940.

      Raymond, O. Gushwa, Esq., for the petitioner.

      Gerald W. BrooJ&s, Esq., for the respondent.
   OPINION.

Hill:

The first issue for decision in this case is whether or not the sum of $3,000, which was paid to petitioner’s decedent on January 8, 1936, as interest on the alimony note for $100,000 referred to hereinabove, constituted taxable income. The deficiency determined by respondent results from his addition of the amount of $3,000 to the net income disclosed by petitioner’s return.

Petitioner contends in substance that the amount represented alimony or a payment in lieu of alimony, and hence did not constitute taxable income to decedent, citing in support of its position Longyear v. Helvering, 77 Fed. (2d) 116, which affirmed 28 B. T. A. 1086.

It is now settled beyond controversy that an amount received by a divorced woman as alimony or in lieu of alimony is not taxable income. Gould v. Gould, 245 U. S. 151; Mary R. Spencer, 20 B. T. A. 58; Maud H. Bush, 33 B. T. A. 628; Princess Lida of Thurn and Taxis, 37 B. T. A. 41. This doctrine is not questioned here by either party; the issue relates solely to the true character of the payment involved.

In the Longyear case, supra, a settlement agreement made in lieu of alimony provided for the payment to the divorced wife of $12,500 out of a special fund; a further sum equal to interest at the rate of 6 percent per annum upon $150,000 from a stated date to the date of the agreement, and a note for $150,000 bearing interest at 6 percent per annum. We held that the interest payments were a part of the agreement made in lieu of an alimony award, and were not deductible by the husband as interest on an indebtedness. In affirming our decision, the Court of Appeals for the District of Columbia said:

A claim made by petitioner for a deduction of such part of the payments made to Mrs. Longyear as interest paid upon the note held by her can not be sustained. The note represented alimony secured to her by agreement between herself and her former husband. The obligation did not lose the character of alimony when incorporated in the note. Gilman v. Commissioner, (CAA) 53 F. (2d) 47, 50 * * *

Respondent insists that the $3,000 payment in controversy here was merely compensation for the use of money, that is to say, interest paid by Archibald to his divorced wife for use of the $100,000 alimony which he was obligated by their agreement to pay to her on or before December 31,1931, but which he did not pay when due, and in lieu of which he delivered to her the nonnegotiable promissory note for $100,000, bearing interest at 5 percent per annum, set out in our findings of fact above.

Respondent points to the fact that the settlement agreement between Archibald and his wife contained no provision for the payment of any interest and that the payment of interest was made pursuant to a subsequent agreement embodied in the note, and on this ground he attempts to distinguish the present proceeding from Longyear v. Helvering, supra.

Respondent’s position, we think, is untenable. The distinction urged is unimportant here. The parties have stipulated, and we have found the fact to be, that Archibald’s note was delivered to decedent in lieu of the alimony payment. The interest provided for to the extent paid was, therefore, a payment in lieu of alimony, and, aside from the affirmative stipulation of the parties, this appears to be true.

By the original settlement agreement Archibald was obligated to pay his divorced wife $100,000 alimony not later than December 31, 1931. If he had made such payment on that date, he would have complied with his agreement, but the payment of that amount one year later, as provided in the note, would not have been the equivalent in value of $100,000 paid on the original due date, if paid without interest. Obviously, the present worth at December 31, 1931, of a promise to pay $100,000 one year after that date was less than $100,000. The diminution in value was exactly equivalent to the fair value of the use of that sum of money for the period payment was deferred. Archibald agreed to pay interest at 5 percent per annum, which may be assumed to have been a fair rate. It follows that the interest and principal of the note, if and when subsequently paid, could not in any event have exceeded in total value the amount of the alimony provided for in the settlement agreement. The interest paid on January 8, 1936, in the amount of $3,000 was less than the amount of interest due at the stipulated rate. Such amount was a payment in lieu of alimony, and did not constitute taxable income to petitioner’s decedent. Respondent’s action on this issue is reversed.

The second issue arises from petitioner’s allegation that respondent erred in failing to determine that the amount of $30,000 which decedent received in 1936 from the Chicago Fannie May Candy Co. and the Archibald Candy Corporation constituted alimony payments and not taxable income. The amount was included in gross income' reported in decedent’s tax return for 1936, and by reason thereof petitioner contends that its tax for that year has been overpaid in the amount of $3,494.71.

In the alternative, petitioner contends that under section 22 (b) (2) of the Revenue Act of 1936 the annuity of $30,000 received by decedent in 1936 was not taxable in its entirety, but only to the extent of 3 percent of the excess over cost. Petitioner also argues that the transaction amounted in effect to an exchange in 1930 by decedent of her interest in the stock of the two candy companies for an annuity, and, if any profit was realized from such exchange, it was taxable in the year 1930. Petitioner further contends in the alternative that the annuity received in 1936 should be treated as proceeds of a capital gain and under section 117 (a) of the applicable statute only 60 percent thereof may be included in gross income.

On brief petitioner argues that the payments made under the contract of June 5, 1930, were in part consideration for the release by decedent of claims against the candy companies, and in part consideration for her agreement not to compete. We are urged to adopt this construction on the ground that any other interpretation of the contract would render it void as contrary to public policy, and that if possible it should receive such interpretation as would render it valid. For purposes of the present proceeding, we need not attempt to decide whether or not the contract was valid. Income derived from an executed contract, even if void and unenforceable, is nevertheless subject to tax. Christian H. Droge, 35 B. T. A. 829. See also United States v. Sullivan, 274 U. S. 259.

The evidence we think wholly fails to sustain petitioner’s principal contention that the $30,000 received by decedent in 1936 did not represent payments made solely in consideration of her agreement not to enter into competition with Archibald’s candy corporations.

It is shown that decedent had been trained in retail merchandising, particularly in the food lines; she was of an aggressive business type; she had been active in the management of the candy companies from the inception of the business; after rupture of relations between herself and Archibald the business of the candy companies began to suffer very materially, and Archibald, in connection with the negotiation and preparation of the settlement agreement between himself and his wife, particularly desired to prevent her entering into competition with the candy companies subsequent to divorce. This appears to have been the motivating cause for the inclusion in the agreement of the provisions of paragraph 3 set out hereinabove. Other facts appearing in the record lead to the same conclusion.

While it is true that the settlement agreement of July 5, 1930, to which each of the candy companies were parties, formerly required decedent to execute a release of all claims which she had “in and to any of the property and effects belonging to” such companies, in addition to her agreement not to compete, there is no evidence i|n the record to indicate the character or extent of her claims, if any. In decedent’s action against Archibald for an accounting, she apparently claimed' only an equitable ownership of one-half of the capital stock of each company, which was not a claim “to any of the property and effects belonging to” the corporations.

That the annual payments by the candy companies were in fact to be made exclusively as consideration for decedent’s agreement not to compete, is clearly indicated by the testimony of the witness, Roemer, who was secretary of each of the corporations mentioned, and also Archibald’s personal attorney, representing him in the negotiation of the settlement agreement. He testified that the candy companies each agreed to pay Mrs. Archibald $15,000 annually “to keep her out of business;” that since the contract related also to other matters, it was desired that the entire controversy be cleared up, and to that end it was provided “that whatever consideration ran from one to the other, released all of the claims that each might have against the other.” The witness further stated that the release by. decedent of any claim she might have, had nothing to do with the payments to be made by the corporations.

We may here point out that one-half of :the $30,000 received by decedent in the taxable year 1936 was paid by the Chicago Fannie May Candy Co., which corporation was not a party to the settlement agreement. This corporation on June 1, 1932, acquired at public sale the assets of the Fannie May Candy Shops, Inc., and it is not shown that it assumed any of the liabilities of the latter company. The resolution adopted by the board of directors of the Chicago Fannie May Candy Co. authorizing the payment of $15,000 per annum to decedent, affirmatively stated that it was in consideration of her agreement to refrain “from engaging in any candy business, either directly or indirectly, for a period of years.”

In respect of the sum of $15,000 paid in 1936 by the Chicago Fannie May Candy Co., we think there can be no doubt that it was solely consideration for decedent’s agreement not to enter into competition. In respect of the like sum paid by the Archibald Candy Corporation, wo can reach no other conclusion, from a careful consideration of the whole record, than that it was also exclusively for the same purpose. We so hold.

This brings us to a discussion of the alternative contentions of the petitioner. The first such contention is that under section 22 (b) (2) of the Revenue Act of 1936, the annuity of $30,000 received by petitioner in 1936 is not taxable in its entirety, but only to the extent of the excess over 3 percent of the cost basis.

-Tile cited statute provides, so far as material here, that there shall be excluded from gross income amounts received as an annuity under an annuity or endowment contract to the extent of the excess of the amount received in the taxable year over an amount equal to 3 percent of the aggregate premiums or consideration paid for such annuity.

Petitioner argues that the cost basis of the annuity involved was its value at the time of acquisition, which the parties have stipulated to be $369,142.50, and that only the excess over 3 percent thereof, or $18,925.72, is taxable as income received in 1936. The cogency of petitioner’s argument depends upon the assumption that decedent did in fact purchase an annuity in 1930. In Hooker v. Hoey (U. S. Dist. Ct., N. Y.) 27 Fed. Supp. 489; affirmed per curiam on opinion below (C. C. A., 2d Cir.), 107 Fed. (2d) 1016, the court said:

The exemption as to annuities in tlie income tax statutes does not cover cases where an annuity is not in reality purchased, even though the transaction may be somewhat analogous to the purchase of an annuity. Helvering v. Butterworth, 290 U. S. 365, * * *

In the present case decedent, by her agreement not to enter into competition with the candy companies, can not be said to have pu/r-chased an annuity any more so than if the contract had provided on similar terms for the payment to her of compensation for personal services. Such compensation, even though somewhat analogous to an annuity, as in the case of bonuses or pensions, is nevertheless taxable income. Hooker v. Hoey, supra.

Petitioner’s argument that decedent purchased an annuity is bottomed on the premise that she exchanged therefor in 1930 her interest in the stock of the two candy corporations. This contention is disposed of by the conclusion we reach hereinabove that the amount of $30,000 received by decedent in 1936 represented payments to her solely in consideration of her agreement not to compete. The same conclusion also disposes of the contention that any gain from the transaction was taxable in 1930.

The remaining alternative contention of petitioner that the $30,000 received by decedent in 1936 should be treated as proceeds of a capital gain can not be sustained. Consideration received under an agreement not to compete is taxable as ordinary income, and is in no sense capital gain. Estate of John D. Beals, 31 B. T. A. 966, 971; affd., 82 Fed. (2d) 268; Cox v. Helvering, 71 Fed. (2d) 987; Salvage v. Commissioner, 76 Fed. (2d) 112; affd., 297 U. S. 106.

Decision of no deficiency a/nd no overpayment of taw will he entered.