author: Seawell :

text:
    Interlake Iron Corporation (Formerly By-Products Coke Corporation), Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 20495.
    Promulgated February 25, 1932.

      Kemper K. Knapp, Esq., J. H. Hershberger, Esq., Andrew T. Smith, Esq., and Lewis H. Barnes, Esq., for the petitioner.

      John D. Foley, Esq., and James B. Maddox, Esq., for the respondent.
   OPINION.

Seawell :

The one issue which we are asked to decide in this case is what deduction, if any, is allowable to the petitioner for 1918 on account of the amortization of war facilities, and as to this issue most of the basic facts necessary for such a determination are not in dispute. Briefly, the facts are that after April 6, 1917, the petitioner began the construction of a coke oven plant for the production of articles contributing to the prosecution of the war and there was expended in the construction of such plant $8,089,411.85. Four-fifths of such cost were borne by the petitioner and one-fifth by the Semet-Solvay Company, but the parties are agreed that we should determine the amortization allowable, if any, on account of the entire plant, and proper allocation will be made in the final determination as between the petitioner and the Semet-Solvay Company. Some question was raised by the Commissioner in his brief that only expenditures made by the petitioner prior to the Armistice may be considered in determining the amortizable costs, but in view of the evidence to the effect that such expenditures were merely made, and were reasonably necessary, in the completion of this project, which was started after April 6,1917, we are unable to agree that these costs should be eliminated. United States Refractories Corporation et al., 9 B. T. A. 671. Besides, it would appear that the greater part of the expenditures made in 1919 and 1920 were on account of work done in 1918. There is also no disagreement that the amortization allowable on account of the entire plant is a proper deduction from gross income for 1918; that is, the amortization period does not extend beyond 1918 and any allowance on account of amortization is properly deductible from gross income for 1918.

The further facts involved and the questions presented may best be shown by considering the contentions of the respective parties. In the first place, it is contended by the Commissioner that no amortization deduction is allowable to the petitioner for the reason that on July 30,1919, the petitioner (and the other parties interested therein) sold the coke oven plant to the Steel and Tube Company of America under a contract by which the petitioner was either reimbursed or made capable of being reimbursed for all costs expended in the construction of the plant. The consideration named in the contract in question ivas $3,407,500 cash or such equivalent as might be agreed upon and 77,220 shares of common stock of the purchaser. The contract further provided that such price had been fixed on the assumption that the cost of constructing the said plant was $8,-015,000, of which $1,500,000 had already been charged off for amortization of excess cost, thus resulting in a saving in tax of $1,200,000, and making an estimated net cost to the petitioner of $6,815,000. It was further provided that in the event the cost as finally determined should differ from the cost then assumed a proper adjustment should be made either by the surrender of stock on the part of the petitioner, should the actual cost be less than the assumed cost, or the issuance of additional stock by the Steel and Tube Company of America, should the actual cost exceed the assumed cost. The actual cost exceeded the assumed cost by $74,411.85, and it is our understanding that the Steel and Tube Company of America delivered additional stock to the petitioner and the other party interested (Semet-Solvay Company) on account of such additional cost. A further provision in the contract was that, in the event the amortization claimed by the petitioner and considered in the contract to have resulted in a saving to it through a reduction in its Federal income and profits tax should be disallowed in whole or in part, additional stock of the Steel and Tube Company of America should be issued to the petitioner on account of any additional tax which it would be required to pay as a result of such disallowance. The stock adjustment, whether because of a change in the assumed net cost of the plant or because of any additional tax which might result from a disallowance of all or any part of the amortization allowance, was to be figured at the rate of 22.6611 shares for each $1,000 of cost or tax involved, that is, approximately $44 per share. On the basis of that-contract, the Commissioner contends that through the payment of cash and stock the petitioner (and the Semet-Solvay Company) recovered original costs to the extent of $6,889,411.85 and protected themselves against liability for any taxes which might result through the disallowance of all or any part of the amortization claimed, thus resulting in a situation where there could be neither gain nor loss on account of the sale and hence no amortization allowable.

But, assuming for the purpose of this phase of the discussion that there was a recovery of costs to the extent of $6,889,411.85 through the receipt of cash and stock, does the fact that, in the event of the disallowance of all or any part of the amortization claimed, the Steel and Tube Company of Amez’ica would be required to issue additional stock on a specified basis on account of the additional tax resulting from such disallowance mean that the petitioner is thereby assured a complete recovery of its amortizable costs? In other words, does the aforementioned provision assure the petitioner that it will not suffer through the disallowance of the amortization claimed and that if the Government does not allow it the benefit of a saving in tax through the amortization deduction, any additional tax will be paid by the Steel and Tube Company of America? We think it is clear that the contract does not so provide. It is true that the contract provides that the Steel and Tube Company of America “ shall compensate By-Products to the extent of any additional Federal Income Tax which it is obliged to pay as a result of such disal-lowance,” but in the following sentence it provides how such compensation shall be effected, namely, through the issuance of stock to petitioner at approximately $44 per share. Obviously, that is very different from saying that whatever additional tax results from such disallowance will be paid by the Steel and Tube Company of America. The purchaser does not agree to pay the tax, but only to issue to petitioner stock on a certain basis in the event petitioner is required to pay additional tax on that account. At most, such provision contains only the possibility of reimbursement. If the stock should be. worth the agreed basis when petitioner is required to pay the additional tax there would be an exact reimbursement. On the other hand, if the stock should be worth less at such time of payment the petitioner would not be fully compensated, but, if the stock should be worth more, the petitioner would gain through the disallowance.

On the other hand, we are likewise unwilling to accept the contention of the petitioner that the sale on June 30, 1919, may be disregarded. The petitioner says that when it prepared its return for 1918 it had the undisputed right to a deduction for amortization and that this right could not be destroyed by a subsequent contract. But we think this suggestion overlooks the fact that the amount of amortization is not finally determinative alone upon the basis of a comparison of original costs made after April 6, 1911, and values as they existed at the end of 1918, but, on the contrary, conditions and circumstances arising prior to March 3, 1924, must be taken into consideration. (Section 234 (a) (8) of the Revenue Act of 1921 and Manville Jenckes Co., 4 B. T. A. 765.) The necessity for considering subsequent events arising during the post-war period is well illustrated in the foregoing cited case where a question of value in use was involved and the amortization allowable was determined upon the basis of the value in use or employment of the taxpayer’s facilities in its post-war business. In other words, original or war costs would be compared with value in use during the post-war period. While a sale after the end of the amortization period and prior to March 3, 1924, is somewhat different from post-war value in use, we think it is likewise something of evidentiary value which must be considered in fixing the amortization allowable. For example, if in the case at bar the petitioner had sold its plant on July 30, 1919, for cash in the amount of $8,089,411.85, the original cost, we do not think it would be seriously contended that the petitioner is entitled to any amortization, since through the sale it had recovered its entire war-time investment and hence there was no unbalanced investment, no war-time burden, from which relief need be sought. And, further, it would be most convincing evidence that at July 30, 1919, the war facilities were worth the amount incurred in their construction and acquisition and therefore no occasion for the application of the amortization provision could then be shown. The purpose of the statute is to relieve taxpayers of unbalanced investments incurred during the war and beyond their peace-time needs (John Polacheck, 8 B. T. A. 1), but where it is shown that the value at the time a taxpayer disposes of a given war facility prior to March 3, 1924, is equal to its war-time cost, no need for the application of the amortization provision exists. It is generally recognized that “ value is the price at which a willing seller and a willing buyer would agree to trade if they both were aware of the facts” (James Couzens, 11 B. T. A. 1040), and where we have a trade on such a basis there is no occasion to resort to expert testimony or retrospective appraisals in order to determine value on the date when the sale took place. In other words, the selling price becomes the recognized value on the date when the sale took place, and a consideration of the value which the parties thus fixed for the property in question will show whether there was an unbalanced investment after the close of the war and when the property was disposed of from which relief need be sought.

When we come to examine the contract, the conclusion seems inescapable that the parties were trading on the basis of a value then attaching to the assets equal to their cost. In any event, it is evident that the petitioner was seeking to recover through the sale or otherwise (through an amortization allowance) its entire amortizable costs and we think it is likewise evident that there was an indicated willingness on the part of the purchaser to pay, if necessary, an amount equal to petitioner’s original cost in order to acquire tbe property. Specifically, what the contract provided was that the Steel and Tube Company of America would pay to petitioner $3,407,-500 in cash and would issue to it stock figured at approximately $44 per share in the amount of the difference between the foregoing amount of cash paid and the net cost to petitioner of the facilities after such cost had been decreased by a reduction in tax of $1,200,000 on account of amortization claimed of $1,500,000. It was further agreed that, in the event the amount claimed for amortization should be disallowed in whole or in part, the Steel and Tube Company of America would compensate petitioner to the extent of additional tax resulting from such disallowance by issuing to it stock on the same basis as theretofore issued. The total cost of the amortizable facilities was $8,089,411.85, and we think the answer to our problem follows from a comparison of that cost with the total foregoing recited considerations. First, there was cash in the amount of $3,407,500 and, second, there was stock issued to petitioner at approximately $44 per share, which when added to the cash received makes a total of $6,889,411.85. The petitioner objects to the addition of the stock at that price for the reason that it says the stock did not have a fair market value of that amount or of any other amount. The evidence to support this contention was largely to the effect that the stock was closely held, was not dealt in at or about that time (aside from the transactions here involved), was not listed on a stock exchange and was of a speculative character. We think, however, that this contention overlooks the fact that the parties themselves placed a value on the stock which can not be ignored. A merger or consolidation was taking place in which various interests were being brought together in one concern to be known as the Steel and Tube Company of America. Adverse interests were involved and we think it reasonable to consider that the value fixed for the.stock gave due regard to the assets for which the stock was being issued. Particularly do we think such an interpretation should be placed on the price fixed when we have no evidence as to the manner in which the stated price was figured other than shown from the contract and no evidence as to the negotiations leading to the execution of the contract. Clearly, with this contract before us, we are not justified in reaching a different conclusion as to the value fixed for the stock and presumably for the assets back of the stock merely because expert witnesses now say that the assets for which the stock was issued did not have the value which the parties thus appear to have placed thereon at the time the transaction was consummated.

But the foregoing amount of $6,889,411.85 was not all that the Steel and Tube Company of America agreed to pay in order to acquire the assets and therefore it would not be proper to determine an amortization allowance as the difference between such amount as representing the value of the property when disposed of and the original cost. What was further agreed was that in the event all or any of the amortization originally claimed should be disallowed, the Steel and Tube Company of America would issue to petitioner additional stock at approximately $44 per share in order to compensate petitioner for the additional tax resulting from such disallowance. In considering this feature it should be noted at the outset that the difference between the aforementioned amount of $6,889,411.85 (cash paid and stock issued for the assets) and the original cost of $8,089,411.85 is $1,200,000, the saving in tax referred to in the contract, and not $1,500,000, the amount of amortization referred to as having been claimed. Accepting $6,889,411.85 as the amount received in cash and stock upon the execution of the contract, it would follow that at least $300,000 in amortization would be disallowed, since the part of the war-time investment which was not recovered through the sale was $1,200,000 and not $1,500,000, the amortization claimed. But with the disallowance there would be additional tax to the petitioner and additional cost to the Steel and Tube Company of America, which in turn would reduce the amortization, and by carrying this process to its conclusion all amortization would be disallowed and the Steel and Tube Company of America would be required to issue stock to petitioner at approximately $44 per share in the amount of $1,200,000. It may well be, as we have heretofore indicated, that a different value might attach to the stock when the petitioner is required to pay the additional tax from what it was when the contract was executed, so that the amount received by the petitioner and paid by the Steel and Tube Company of America would be more or less in value than $1,200,000, but we do not regard that as material. Suffice it to say that as far as we know it may not be more or less and, in any event, what we are seeking to determine is not a value based on conditions now or later existing, but rather the value existing when the petitioner disposed of the property in question. And when looked at in this manner, the amount of the obligation then assumed, in terms of the value of the stock then fixed, was $1,200,000, which, when added to the amount of $6,889,411.85, makes $8,089,411.85, the original cost of the assets.

In view of the foregoing, we do not see how it can be said that at the time the petitioner disposed of the war facilities in question there were excess war costs from which relief need be given. What happened later and what results would follow therefrom on account of subsequent events are not matters with which we are concerned in this proceeding. What we have here is a contract apparently entered into at arm’s length between a willing seller and a willing purchaser in which the seller was evidently seeking to have returned to it its investment in certain war facilities and the buyer expressly indicated a willingness to pay that amount, if necessary, in order to acquire the facilities. Whether the purchaser would have paid $8,089,411.85 instead of $6,889,411.85 coupled with the obligation to pay $1,200,000 more if so required, we do not know. If the former course had been pursued there would be no occasion to say that there had been any shrinkage in value of the assets from the time they were constructed by the petitioner for war purposes until they were disposed of after the end of the war, and we think the same conclusion must follow when the latter course was taken. Certainly no better evidence could be found of the value of the assets than that placed thereon by the parties themselves, and, as we view their actions as expressly set out in the contract, we are brought to the conclusion of the recognition by them of a post-war value at the date of disposition equivalent to the war cost. Nor do we regard this as a strained construction of the contract, but rather the only construction which can be placed thereon. Whether they were fully cognizant of all the consequences which would flow from such a contract we do not know, but each party is presumed to know the law and we can not do other than apply the statute to what occurred rather than attempt to reach a more advantageous conclusion to the petitioner on the basis of a course of action which was neither undertaken nor carried out. When we view all of the foregoing considerations, no occasion for the granting of the relief sought can be found and accordingly the action of the Commissioner in denying all amortization claimed is sustained.

Reviewed by the Board.

Judgment will be entered under Rule 50.

VaN FossaN, AeuNdell, and Teammell dissent.


source: Caselaw Access Project

author: Tkammell :

license: Public Domain

text:
    Waterproofed Products Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 27419.
    Promulgated February 26, 1932.

      W. H. J ames and W. F. Williamson, Esq., for the petitioner.

      J. A. Lyons, Esq., and E. L. Updike, Esq., for the respondent.
   OPINION.

Tkammell :

The correctness of the income-tax deficiencies determined in the total amount of $39,366.99 against the taxpayer is not disputed by the petitioner. It merely contends that it is not liable at law or in equity for payment of such liability, as it was a purchaser for value, the stock issued by it to the taxpayer having a par value and actual value in excess of the net value of the assets it acquired.

Petitioner acquired the assets of the taxpayer corporation in exchange for its capital stock, which had a value equal at least to that of the assets, and claimed by the taxpayer to be in excess of that value, and agreed as a part of the consideration to pay certain specific liabilities, these being all of the known liabilities of the taxpayer. These liabilities did not include that now asserted for Federal taxes.

It is well settled that where one corporation sells its assets to another for stock of the latter which is issued directly to the stockholders of the seller, thus leaving the seller without assets to satisfy its creditors, the purchaser is liable to the.creditors of the seller to the extent of the value of the assets received, as such a sale is a fraud upon the creditors and the purchaser is a party to the fraud. Woodley Petroleum Co., 16 B. T. A. 253; United States v. Capps Manufacturing Co., 15 Fed. (2d) 528; McWilliams v. Excelsior Coal Co., 298 Fed. 884. This rule has been applied to cases where the consideration paid was capital stock of the purchasing corporation delivered to the seller where the transaction resulted in a fraud upon creditors. Hibernia Insurance Co. v. St. Louis & New Orleans Transportation Co., 13 Fed. 516; American Railway Express Co. v. Commonwealth, 190 Ky. 638; 228 S. W. 433. It is also well established that where a new corporation is organized to take over assets of another corporation for stock, the new company being simply a reincorporation or reorganization of the old, with the same assets and business, the new corporation is liable for the debts of the old. See Central Ry. v. Paul, 93 Fed. 878; Hibernia Ins. Co. v. St. Louis & New Orleans Transportation Co., supra; Northern Pacific Ry. v. Boyd, 228 U. S. 482. See also Thompson on Corporations, sec. 6517, and cases cited in notes in 11 L. R. A. N. S. 1119; 32 L. R. A. N. S. 616; 47 L. R. A. N. S. 1058.

In this case the evidence discloses that the directors of the Gold Medal Waterproofing Company, the old corporation, organized the new corporation to carry on the business formerly carried on by the old company with the same assets, except for a tract of land, valued at about $2,000. This land, while conveyed to the new company, was reconveyed to the Gold Medal Company and it disposed of it. The old company was kept in technical legal existence, although it had no assets, and failed to pay its franchise tax to California. As a result it became suspended as a corporation. For all practical purposes it was the same as if it had been legally dissolved.

We think that the facts in this case distinguish it from our decision in the Metropolitan Securities Corporation, 19 B. T. A. 299. See Signal Gasoline Corporation, 25 B. T. A. 532.

Here the new corporation was in every substantial sense a reincorporation or reorganization of the old, with the same assets and business acquired for stock. The decisions of the courts are practically uniform in holding that under such circumstances the creditors can follow the assets into the new corporation. The new corporation under this principle is liable to the extent of the value of the assets received, to wit, $33,000.

We therefore hold that the petitioner is liable as a transferee.

Reviewed by the Board.

Judgment will he entered wider Rule 50.

Murdock, Goodrich, and Leech concur in the result.


author: Lansdon:

text:
    Boos Brothers Cafeteria Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 39200.
    Promulgated February 26, 1932.

      John B. Milliken, Esq., and George H. Roster, Esq., for the petitioner.

      P. M. Glarh, Esq., for the respondent.
   OPINION.

Lansdon:

The petitioner’s claim of good will value for its cafeteria at 1059 Market Street, San Francisco, is not established by the evidence. At that date no substantial profits had been realized and the income had been no more than a reasonable return on the capital invested in tangible assets. It is true that there was an expectation of profitable business during the exposition period, which was realized later. Neither the hope of good business nor the realization of that hope in subsequent years is good will. On this issue the determination of the respondent is approved. Dwight & Lloyd Sintering Co., B. T. A. 119; Rock Springs Distilling Co., 2 B. T. A. 207; Victor J. McQuade, 4 B. T. A. 837; Joseph Z. Muir et al., 4 B. T. A. 893.

The respondent has disallowed the deductions claimed on account of the annual payments under the terms of the agreement through which petitioner obtained a lease on premises located at 522-534 Hill Street, Los Angeles, on the theory that such amounts represented the purchase price of good will and, therefore, were capital investments. Upon the record we are convinced that no good will was acquired in that transaction. Petitioner’s sole object was to secure a suitable location for a branch of its own business. It razed the buildings and erected a more suitable structure. It never made any use of the trade name of the B. and M. Company. The payments in question must be regarded either as capital cost of the lease or as rentals for the premises.

The agreement through which the petitioner became a sublessee provides for three kinds of payments, viz., (1) a lump sum of $56,760 for the tangible property; assumption of the obligation to pay the rental of $2,100 per month reserved to the fee oivner in the original lease; and (2) the payment of $2,200 per month to the lessees. We think it perfectly clear that the latter payments must be regarded either as rentals deductible as ordinary and necessary expenses under section 234(a) (1) of the Eevenue Acts of 1924 and 1926 as and when paid, or as a bonus ratably distributed over the term of. the sublease and recoverable tax free. J. Alland & Bro., Inc., 1 B. T. A. 681; Columbia Theatre Co., 3 B. T. A. 622. On this issue the determination of the respondent is reversed.

Decision will be entered under Rule 50.


author: Matthews :

text:
    Western Indiana Gravel Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.

      Docket No. 23855.
    Promulgated February 29, 1932.

      C. G. Maxwell, Esq., for the petitioner.

      L. A. Luce, Esq., for the respondent.
   opinion.*-

Matthews :

This proceeding involves, three principal questions: (1) whether the value of the four .contracts executed on March 1, 1916, between the petitioner and the Railroad Company is includable in petitioner’s invested capital; (2) whether a deduction may be allowed petitioner in respect of exhaustion of the same contracts; and (3) whether the petitioner’s condition in 1920 and 1921 was such as to entitle it to special assessment under section 327. Certain secondary questions arise which can be disposed of .in the consideration of the major issues.

As to the first question, invested capital, the controlling provisions of the ,1918 and 1921 Revenue Acts. (which in these respects are Identical) are set out by footnote.

The statute requires that the property be “ bona fide paid in for stock or shares,” in order to be included in invested capital. The petitioner contends that this requirement is met by the transfer of the rights under the contracts by Neville and his associates in exchange for stock of the corporation under the corporate resolution of March 3, 1916; and that the rights had a value at that time equal to the par value of the stock issued therefor, or $100,000. On the evidence we are of the opinion that the associates held in their individual capacities no rights in these contracts which they could have transferred to the petitioner corporation on March 3, 1916. It is necessary here to call attention to but a few facts to sustain this conclusion.

The letter of January 10, 1916, in which Neville and his associates made the offer to the Railroad, is signed “ Western Indiana Gravel Company, by M. A. Neville.” The Railroad’s letter of February 17, 1916, submitting the contracts to Neville and his associates, is addressed to the Western Indiana Gravel Company; and in all four contracts the second party is designated as “The Western Indiana Gravel Co., a corporation organized under the laws of the State of Indiana.” That letter requested that the contracts be executed and returned to the Railroad, “ for execution on the part of this company.” It appears as a settled policy of the Railroad that it would sign a contract only after an agreement had been reached and the other party had already signed.

Neville, having seen the completed drafts of the contracts in the chief engineer’s office, proceeded on February 18 to incorporate himself and his associates as the Western Indiana Gravel Company. The certificate of incorporation was issued by the State of Indiana on February 26. The execution of the contracts by the petitioner took place a few days later, on March 1.

We are unable to perceive, on this evidence, that any valid, legally binding contract between the five associates and the Railroad Company existed prior to the formal execution of the four contracts on March 1 by the petitioner corporation.

Summarized, the facts clearly show that the five associates, through Neville and Coppock, had reached a general understanding with officials of the Eailroad Company, in particular Worcester and Paquette, with respect to the two gravel beds; that this understanding finally crystallized into a definite written offer by Neville in the name of the Western Indiana Gravel Company; that this offer was considered and modified in some respects by the Eailroad Company; that the Eailroad Company submitted formal contracts to the associates, which may be considered in view of the modifications a counteroffer; and that these contracts were accepted and executed by the Western Indiana Gravel Company, a corporation, acting through its agent and president, M. A. Neville, and at the same time, but not until then, accepted and executed by the Eailroad.

On these facts we find no prior contract between the Eailroad and the associates which the latter could assign to the new corporation, as they attempted to do by the resolution of March 3; and there was, of course, no such assignment. The only contracts were those executed by the petitioner corporation on March 1.

The present case is very similar on its facts to Kaufmann & Baer Co. v. Heiner, 34 Fed. (2d) 698, decided by the United States District Court for the Western District; of Pennsylvania, the principal differences being that in the Eaufmann case, the taxpayers had concluded before incorporation an agreement for a lease and the terms of that agreement provided for. the creation of a corporation, with a certain paid-in capital, etc., and which should, and did, become the lessee. The contentions of the taxpayer, that the value of the lease should be included in its paid-in surplus and that a deduction should be allowed for the lease’s exhaustion, are substantially the same as here. The court in that case said:

The facts in this case do not disclose that anything of value was paid in to the corporation in connection with this alleged lease. The incorporators themselves bargained for this lease to be made to the corporation. They did not assign the lease to the corporation; in the promotion and organization of the corporation the lease was provided for. * *- * There was nothing paid in td this corporation by anybody, so far as this lease was concerned. The parties themselves negotiating for the lease had in contemplation that it could be performed only by the corporation; and the corporation acquired the lease not by assignment but by direct grant from the Oliver Estate. The shareholders in the corporation really contributed nothing of value to the corporation so far as this lease is concerned.
The position we have taken is supported by the Circuit Court of Appeals, 4th Circuit, in Kleeson vs. Blair, 28 Fed. (2d) 557. The views we have taken here, and those expressed by the 4th Circuit are in entire accord with the Supreme Court in the case of LaBelle Iron Works vs. U. S., 256 U. S. 377 (388) * * *.

Cf. Amalgamated Products Co., 12 B. T. A. 659.

We hold, therefore, that there was here no such paying in of property for shares as to bring that jnoperty within the purview of the statute for purposes of inclusion in the petitioner’s invested capital.

The petitioner’s second contention is that a deduction of $10,000 a year for ten years should have been allowed by way of exhaustion of the value of the contracts upon acquisition. As the contracts cost the petitioner nothing, there is no basis for an exhaustion allowance.

We come now to the third issue, whether the petitioner is entitled to special assessment under section 328 of the Revenue Acts of 1918 and 1921, by reason of its coming within one of the categories of section 327. The relevant portion of the last named section (identical in the two acts) is set out by footnote.

The petitioner rests its claim to special assessment on two grounds: (1) borrowed capital; (2) the exclusion of the value of the contracts in question. We shall consider them in this order.

The invested capital of petitioner, not including any value the gravel contracts might have had, was for 1920, $67,062.43; and 1921, $122,201.22. The peak of the petitioner’s borrowings was always reached in midsummer and the peak of its accounts receivable for both years was also reached in the same months, the rise and fall of both accounts being explained by the fact that petitioner’s productive season lay between May and November.

But mere proof of borrowings does not prove an abnormality. We are not told by the petitioner that the relation of borrowed money to invested capital here shown is unusual in the gravel business, and, in the absence of such evidence, there is nothing upon which we may base an opinion that the use of borrowed money in these amounts created an abnormality. Higginbotham-Bailey-Logan Co., 8 B. T. A. 566; Camden Woolen Co., 12 B. T. A. 1277; W. E. Beckmann Bakers’ & Confectioners’ Supply Co., 13 B. T. A. 860; Mutual Oil Co. of Arizona, 14 B. T. A. 538; and Peck Coal Corporation, 15 B. T. A. 189.

It remains to decide whether the exclusion from invested capital of the value of the four contracts in itself creates an abnormality. It is perfectly clear, at the outset, that the mere statutory exclusion of an asset from invested capital does not of itself justify special assessment. Morris & Co., 1 B. T. A. 704; W. E. Beckmann Bakers’ & Confectioners’ Supply Co., supra; Sanford Cotton Mills, 14 B. T. A. 1210; Enameled Metals Co., 14 B. T. A. 1392; J. D. Williams, Inc., 22 B. T. A. 21.

Engrafted on this rule, however, is the exception adopted in J. M. and M. S. Browning Co., 6 B. T. A. 914, where the asset excluded for statutory reasons is a substantial part of its capital and productive of a very substantial part of the taxpayer’s income. Clarence Whitman & Sons, Inc., 11 B. T. A. 1192; Detroit Opera House, 13 B. T. A. 587; Rothschild Colortype Co., 14 B. T. A. 718.

But the petitioner can not avail itself of this exception, for in the above cases the asset excluded for statutory reasons was paid in for stock, and while the asset was not part of the invested capital, as defined by the statute, it was nevertheless an unrecognized capital asset largely productive of the petitioner’s income, so that its exclusion would result in abnormality. Such is not the case here. The contracts were not paid in for stock, so that the petitioner has not met the first condition of its claim. Electric Appliance Co., 19 B. T. A. 707; Washington Electric Supply Co., 9 B. T. A. 1399. Moreover, the petitioner did not have a patent right or even a leasehold. The most that it had was a mere contract right which the Railroad might terminate on ninety days’ notice, “ upon equitable terms, considering at such time the investment in and value of the second party’s plant for such operations, but excluding any consideration of future profits.” The value of that right has not been established. The petitioner here is attempting to attribute to the contract the value of future profits which might or might not be realized, and which, even if realized, would result not wholly from the contract itself, but also from the petitioner’s labor and its capital invested in physical equipment. We can not find in this situation any abnormality. As we said in Coca-Cola Bottling Works of Pittsburgh, 19 B. T. A. 267, with respect to a contract (excluded for invested capital purposes) for bottling and selling Coca-Cola in a given territory:

* * * The profits they realize in a given year are the result of the existence of these contracts, but whether they do realize profits is dependent upon factors outside of the contracts, such as management of the concern, business method pursued, zeal with which they push the business, capital investment necessary for carrying on the business, etc. And where the full capital which is invested in the business and which is necessary for its operation is recognized for invested capital purposes, we do not think an abnormality exists because there has not been taken Into consideration a value which may attach to the contract under which the profits were realized, but which represents no investment on the part of the petitioner. Cf. Hub Furniture Co., 11 B. T. A. 303; Mutual Oil Co. of Arizona, 14 B. T. A. 538; Troy Motor Sales Co., 14 B. T. A. 546; and Moses-Rosenthal Co., 17 B. T. A. 622.

Cf. Keystone Wood Products Co., 19 B. T. A. 1116; Standard Slag Co., 20 B. T. A. 503.

We find no reason, therefore, to allow petitioner the benefit of assessment under sections 327 and 328 of the revenue acts.

Judgment will he entered for the respondent.

       Sec. 325. (a) That as used in this title—
      The term “ intangible property ” means patent?, copyrights, secret processes and formulae, good will, trade-marks, trade-brands, franchises, and other like property;
      The term “ tangible property ” means stocks, bonds, notes, and other evidences of indebtedness, bills and accounts receivable, leaseholds, and other property other than intangible property;

      SBC. 326. (a) That as used in this title the term “ invested capital ” for any year means (except as provided in subdivisions (b) and (c) of this section) :
      *******
      (2) Actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, at the time of such payment, but in no ease to exceed the par value of the original stock or shares specifically issued therefor, unless the actual cash value of such tangible property at the time paid in is shown to the satisfaction of the Commissioner to have been clearly and substantially in excess of such par value, in which case such excess shall be treated as paid-in surplus: ♦ * *
      *******
      (5) Intangible property bona fide paid in for stock or shares on or after March 3, 1917, in an amount not exceeding (a) the actual cash value of such property at the time paid in, (b) the par value of the stock or shares issued therefor, or (c) in the aggregate 25 per centum of the par value of the total s.tock or shares of the .corporation outstanding at the beginning of the taxable year, whichever is lowest: Provided,, That in no case shall the total amount included under paragraphs (4) and (5) exceed in the aggregate 25 per centum of the par value of the total stock or shares of the corporation outstanding at the beginning of the taxable year; * * *

         Sec. 327. That in the following cases the tax shall be determined as provided in section 328 :
      *******
      (d) Where upon application by the corporation the Commissioner finds and so declares of record that the tax if determined without benefit of this section would, owing to abnormal conditions affecting the capital or income of the corporation, worlc upon the corporation an exceptional hardship evidenced by gross disproportion between the tax computed without benefit of this section and the tax computed by reference to the representative corporations specified in section 328. * * *


author: Matthews:

text:
    Hotel Dempsey Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 16430, 26171, 27084.
    Promulgated February 29, 1932.

      S. B. Pack, Esq., J. G. Murphy, Esq., and A. P. Dawson, G. P. A., for the petitioner.

      T. M. Mather, Esq., for the respondent.
   OPINION.

Matthews:

The petitioner in the instant proceeding is claiming that it was affiliated with the Midland City for the tax years in controversy. Section 240 (b) of the Revenue Act of 1918 provides:

(b) For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns directly or controls through closely affiliated interests or by a nominee or nominees substantially all the stock of the other or others, or (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests.

Section 240 (c) of the Revenue Act of 1921 is similar to this provision and section 1331 (a) (b) of that same act provides:

(a) That Title II of the Revenue Act of 1917 shall be construed to impose the taxes therein mentioned upon the basis of consolidated returns of net income and invested capital in the case of domestic corporations and domestic partnerships that were affiliated during the calendar year 1917.
(b) For the purpose of this section a corporation or partnership was affiliated with one or more corporations or partnerships (1) when such corporation or partnership owned directly or controlled through closely affiliated interests or by a nominee or nominees all or substantially all the stock of the other or others, or (2) when substantially all the stock of two or more corporations or the business of two or more partnerships was owned by the same interests * * *.

Counsel for the petitioner contends that an affiliation existed because the business of the petitioner and the Midland City constituted an economic unit and the same interests who owned over 99 per cent of the stock of the petitioner and owned approximately 54 to 80 per cent of the stock of Midland City controlled the balance of the stock of the latter corporation.

As far as the Act of 1917 is concerned, since it is clear that these interests did not own the minority stock, affiliation for so much of the fiscal year ending March 31, 1918, as falls within the calendar year 1917 must be denied.

As to the remaining years, there is no doubt that the corporations were operated as an economic unit and that Block and the other stockholders of the petitioner constituted the same interests. We must, therefore, determine whether these interests “ controlled ” the minority stock of the Midland City. Counsel for petitioner does not contend that Block and his associates had any legal control over the stock of the minority stockholders, but that Block had actual and practical control and sets forth in his brief a number of factors to establish that control. It is true that a number of the Circuit Courts have held that actual or practical control is sufficient to entitle the corporations to affiliation under the 1918 Revenue Act. However, since the hearing of this proceeding the Supreme Court of the United States, in the case of Handy & Harman v. Burnet, 284 U. S. 136 has held that the word “ control ” as used in section 240 of the Revenue Act of 1918 means legally enforceable control of the stock, saying:

Tbe purpose of §240 was, by means of consolidated returns, to require taxes to be levied according to tbe true net income and invested capital resulting from and employed in a single business enterprise even though it was conducted by means of more than one corporation. Subsection (b) clearly reflects the intention, by means of such returns, to secure substantial equality as between shareholders who ultimately bear the burden. That intention is shown by the legislative history and was given effect by the regulations contemporaneously promulgated. It requires no discussion to show that such returns will not make against inequality or evasion unless the same interests are the beneficial owners in like proportions of substantially all of the stock of each of such corporations. Alameda Investment Co. v. McLaughlin, 28 F. (2d) 81; Montana Mercantile Co. v. Rasmussen, 28 F. (2d) 916. Commissioner v. Adolph Hirsch & Co., 30 F. (2d) 645, 646. Commissioner of Internal Revenue v. City Button Works, 49 F. (2d) 705. Affiliation on any other basis would not make against inequality or evasion. It would require very plain language to show that Congress intended to permit consolidated returns to depend on a basis so indefinite and uncertain as control of stock without title, beneficial ownership or legal means to enforce it. Control resting solely on acquiescence, the exigencies of business or other considerations having no binding force is not sufficient to satisfy the statute.

Since it is clear that Block and the other stockholders of the petitioner did not have any legal control over the stock of the minority stockholders in Midland City, and that the same interests were not the beneficial owners in like proportions of substantially all of the stock of both corporations, the petitioner and the Midland City are not entitled to file affiliated returns.

Judgment will be entered under Rule 50.


text:
    John H. Wourms, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 23780.
    Promulgated February 29, 1932.

      John E. Wourms, Esq., pro se.

      Eugene Meaoham, Esq., for the respondent.
   OPINION.

Matthews :

The petitioner in this proceeding is claiming the right to deduct as a bad debt an amount of $50,410, being the difference between $56,660, which he claims was the value of the stock of the Callahan Mining Company, to which he was entitled as compensation, and the amount of $6,250 received by him in 1922 in full settlement of his claim for such services. If the petitioner had received the full amount of the stock to which he was entitled as compensation, the fair market value thereof would have constituted income to him when received. There is no evidence as to what was the fair market value thereof. The statement in the stipulation that “ the petitioner alleges that in 1916 responsible parties offered him $56,660 in cash ” for the stock is not evidence of its fair market value. The petitioner did. receive $6,250 in cash, which he correctly included in his income.

But even if the petitioner had established the value of the stock, he is not entitled to a bad debt deduction. The petitioner was on the cash receipts and disbursements basis and never received the stock, never reported it in income or accrued it in any way. There is no basis for a bad debt deduction. See Charles A. Collin, 1 B. T. A. 305, and Charles K. Beekman, 17 B. T. A. 643.

Judgment will be entered for the respondent.


text:
    Garrison Bros. State Bank, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 43175.
    Promulgated February 29, 1932.

      R. G. Wright, Esq., and C. L. Stone, C. P. A., for the petitioner.

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

Matthews:

Petitioner operated a bank at Sumas, Washington. Its banking business ivas taken over and continued by a new corporation known as the Bank of Sumas. The record indicates that enough assets of petitioner were transferred to the Bank of Sumas to equal the deposit liabilities which it assumed, but we do not know the terms of the agreement whereby these assets were acquired by the Bank of Sumas.

The memorandum of agreement between certain individuals interested in organizing the new corporation, which is quoted in part in our findings of fact, refers to a $10,000 surplus to be paid to the petitioner for good will. Petitioner contends that the agreement was not carried out in accordance with this memorandum in that the $10,000 which grew out of the sale of the capital stock of the Bank of Sumas at $160 per share was paid over to Loomis and Brygger, who owned all the stock of the petitioner, and was not received by the petitioner. It has been shown that Loomis was instrumental in organizing the Bank of Sumas and that Brygger, as an officer of the Marine National Bank, rendered financial assistance. Petitioner’s position is that the profit arising from the transaction was a promotion profit earned by Loomis, the active promotor, and the Marine National Bank, which aided in the financing thereof, and that the $10,000 in question did not represent income to the petitioner corporation. We do not find in the record facts sufficient to support this position. The Bank of Sumas continued, without interruption, the operation of the business which had been conducted by the petitioner. The only evidence contained in the record with respect to the consideration for the sale of the petitioner’s banking business to the Bank of Sumas is the statement in the revenue agent’s report that the consideration was $40,000. The respondent has determined that the petitioner derived a profit of $10,000 less $1,386, which latter amount represents the loss to the petitioner resulting from the sale of its banking house and furniture and fixtures at a price lower than the depreciated costs of these properties.

. The determination of the respondent is prima fade correct. The burden is upon the petitioner to prove that the respondent erred in determining the deficiency involved herein. The petitioner has failed to show error and the determination of the respondent is sustained.

Judgment will he entered for the respondent.


author: Aettndell :

text:
    Prophylactic Brush Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Florence Manufacturing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 15383, 26079, 32996, 47845, 47846.
    Promulgated February 29, 1932.

      Ferdinand Tannenbawn, Esq., and George E. Cleary, Esq., for the petitioners.

      Elden MeFarla/nd, Esq., for the respondent.
   OPINION.

Aettndell :

Petitioners claim that the patent issued in 1909 and the patent applications pending on March 1, 1913, had a value on that date of $1,750,000, and that deductions for exhaustion should be allowed on that value. The value claimed is the amount fixed by petitioners’ witness, Boyle, who was the only witness called upon to testify as to value. Boyle had been connected with petitioners in various capacities since 1897. In 1913 he was sales manager, later treasurer, and for several years prior to 1930 he was president. He reached his valuation on the basis of estimates that in five years after 1913 sales would be doubled and that savings effected through the use of machines would increase to 50 cents per dozen of tooth brushes. Sales for 1913 amounted to approximately 221,000 dozens. Doubling this figure and applying the 50 cent estimated saving gives $221,000, which the witness capitalized at 10 per cent thus, reaching a figure of $2,210,000. This he reduced by 20 per cent to take care of contingencies, and gave the resulting figure of $1,750,000 as his opinion of the value of the patent and pending applications.

Petitioners cite Boggs & Buhl v. Commissioner, 34 Fed. (2d) 859, and Bonwit Teller & Co. v. Commissioner, 53 Fed. (2d) 381, as requiring our acceptance of the opinion of value expressed by witness Boyle, “ unless there are facts in the record clearly to show that the valuation was in error.” The Boggs & Buhl decision is based upon the supposition that the Board “ disregarded the only positive and direct evidence as to the value ” of good will,- but it recognizes the rule that the Board may “ reject expert testimony and reach a conclusion in accordance with its own knowledge, experience and judgment.” We do not understand this decision to mean that where we are unable to accept the conclusion of a witness we must have knowledge of the subject matter acquired outside the record. Obviously it would be error for us to base a conclusion on facts outside the record, save perhaps such as come within the rule of judicial notice. As we read the decision, it means to state the same rule as in the Bonwit Teller case, namely, that we may adopt a value other than that fixed by a witness “ provided that there were sufficient basis in the record for the value adopted.” In Pfleghar Hardware Specialty Co. v. Blair, 30 Fed. (2d) 614, which involved the valuation of good will, the court said:

It is urged that no witness testified as to the value of good will in 1913. In the absence of an actual sale, such testimony of value can be but an opinion, and can only be formed by taking into account the same financial history as the Board had before it, and applying some such formula as that approved by the Tax Bureau. The absence of opinion testimony, is not, therefore, important.

See also Am-plus Storage Battery Co. v. Commissioner, 35 Fed. (2d) 167; Anchor Co. v. Commissioner, 42 Fed. (2d) 99; Tracy v. Commissioner, 53 Fed. (2d) 575.

In our opinion the valuation claimed can not be justified *on the facts existing and known at March 1, 1913. While it is true that petitioners have been tremendously successful, it does not appear that the full measure of their success was visible on March 1, 1913. Moreover, it appears that a substantial part of petitioners’ income is properly attributable to intangibles other than patents. There are in evidence briefs and memoranda filed with the respondent in support of petitioners’ claims for special assessment in which petitioners represented that they had extremely valuable good will and trade names, trade-marks, and secret processes. The present record does not contradict those assertions.

The conclusion expressed by the witness is based in part on his estimate that production would be doubled in five years after 1913. At the same time he had planned and had in mind an extensive advertising campaign, which was put into effect and was successful. Between 1909 and 1916 the sum of $471,088.10 was spent in advertising petitioners’ products. It thus appears that the estimate of production on which the valuation was based was to depend on the success of advertising rather than on the capacity of the patented machines. From 1909, when the first patented machine was put into operation, to 1912 the production had increased from 170,498 dozens to 207,374 dozens, an increase of 21 per cent, or at an average rate of a little over 5 per cent a year. Contrasted with this past history, petitioners’ witness testified that he expected production to increase 100 per cent in the next five years, or at an average rate of 20 per cent a year. While there is evidence that improvements in the machines were expected to result in increased speed of operation, the facts known at March 1, 1913, do not warrant any such step-up in production as estimated by the witness.

Likewise, it appears that the estimated saving of 50 cents per dozen was an overoptimistic estimate and not warranted by the known facts. Prior to 1913 the saving effected had averaged only about 23 cents per dozen, and in 1913 it was 22 cents, including the estimated 4 cents saved in the cost of bristles. According to one computation of petitioners, savings in 1917 and 1918 amounted to only 16 cents per dozen, and on the calculation prepared in connection with the present proceedings the total savings were 22.9 cents for 1917 and 26.7 cents for 1918. We think it not unreasonable to assume that an increase in savings would follow from improving the brush-making machines and increasing production, but the evidence does not establish any reasonable ground for believing that the saving would be more than doubled at the end of five years.

We are also unable to agree with the witness’ method of capitalizing earnings to reach a value. In the few cases in which earnings in excess of a reasonable return on tangibles have been capitalized for the purpose of valuing intangibles, it has been customary to use a rate of not less than 15 per cent.

The evidence does, however, satisfy us that at March 1, 1913, the patents and pending applications had a substantial value. The machine patented in 1909 was the only automatic brush-making machine in this country. The monopoly obtained by the possession of that patent gave petitioners a distinct advantage over manufacturers using the hand method of making brushes. At March 1, 1913, it had been demonstrated that the use of the machine would materially lower costs and enable petitioners to meet the competition of foreign-made brushes. It had also been demonstrated at that date that machine production could be increased. It was reasonably evident that, with the improvements being made, some of which had been completed in 1912, the hand method would in time be entirely displaced by the machines. At March 1, 1913, the machines patented first had been in use about four years and the improved machine for about a year. The average annual production of those machines was something over 10,000 dozens of brushes per machine. According to the testimony of the former president, petitioner was able to build and put into operation an average of about two additional machines per year. As petitioners’ product was a staple commodity for which there was an established market, and it was a fair assumption that its field would expand as costs were lowered, it was justified in anticipating that it would have need for the installation of additional machines. On the basis of the performance of the machines in operation at March 1, 1913, and allowing for increased production as the result of further improvements, and taking into consideration the rate at which additional machines could be built, it was possible to predict with reasonable certainty the production that could be expected in the future. It was also known at March 1, 1913, that savings in the cost of manufacture amounting to about 22 cents per dozen had been effected through the use of machines, and, assuming a reasonable increase through the lowering of overhead as a consequence of improving the machines, it was not unreasonable to expect that there would be some increase in the amount of the savings to be effected. While anticipated savings and increased production are proper elements to be taken into consideration, a prospective purchaser of patents would not look at them alone in fixing his price. The value of a patent lies in the amount of profits it will bring to its owner. In determining in the present case what a willing buyer might be expected to offer for the patents, the anticipated savings must be translated into terms of profits, which requires that they be reduced by such factors as the cost of manufacturing the patented machines, and the costs of their operation and maintenance. A prospective purchaser would also take into consideration the period over which profits might be expected to be realized and discount those of future years to their present worth. The profits realized prior to March 1, 1913, were susceptible of calculation, and on the basis of past performance it was possible to forecast what production and profits might be expected in the future.

But even if it be conceded that savings alone are a proper measure of value, as contended by petitioner, the facts known at March 1, 1913, would not support the value claimed. On the basis of established production and savings, with a reasonable allowance for increased production through improvements, the total savings to be expected, discounted to present worth, would be between $500,000 and $600,000. On the same basis, but allowing for an increase in savings to the amount upon which the valuation witness based his calculations, gives a figure slightly in excess of $1,000,000.

Considering all the evidence in the light of known facts at March 1, 1918, and giving effect to the profits and the increases in production and savings that the evidence indicates might reasonably be expected over the life of the patents, it is our opinion that $865,000 represents the fair market value at March 1, 1913, of the 1909 patent and patent applications pending on that date.

Petitioners contend that the period over which exhaustion deductions are allowable is seventeen years from January 19, 1915, when patents were granted on improvements to the brush-making machine and for which applications were pending at March 1, 1913. In view of the fact that the claim is for exhaustion deductions on the value of the original patent, granted June 6, 1909, as well as the applications pending on March 1, 1913, and that the evidence was directed to both and not limited to the patents issued in 1915, we are of opinion that the deductions should be spread over the average life of the patents, which will be seventeen years from March 23, 1912. See Syracuse Food Products Corporation, 21 B. T. A. 865, 890, and cases there cited.

Decision will be entered under Rule 50 in each of the 'proceedings except Docket No. 15383, which will be restored to the general calendar for further hearing under Rule 62.


author: Lansdon :

text:
    Samuel Kraemer, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 37822.
    Promulgated February 29, 1932.

      A. Oalder Mackay, Esq., for the petitioner.

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

Lansdon :

There is no controversy over the facts. The only question raised is whether the bonus of $37,500 received by petitioner during the taxable year is part of the net income from the property within the meaning of section 214 (a) (10) of the Revenue Act of 1921, which provides in part as follows:

(a) That in computing net income there shall be allowed as deductions:
* * * * * * *
(10) * * * And provided further, That such depletion allowance based on discovery value shall not exceed the net income, computed without allowance for depletion, from the property upon which the discovery is made, except where such net income so computed is less than the depletion allowance based on cost or fair market value as of March 1, 1913; * * *

Pursuant to such section the respondent promulgated the following regulation, which is article 201 (e) of Regulations 62:

* * * Net income is the gross income from the sale of all mineral products and any other income incidental to the operation of the property for the pro-ducticm of the mineral products, less operating expenses, including depreciation on equipment, and taxes, but excluding any allowance for depletion. * * *

The petitioner is not here contending for depletion in respect of the bonus, but asks that he be allowed to deduct the amount of depletion sustained in the taxable year up to the full net income from the property, which, he contends, includes the bonus received. The respondent contends that the bonus is no part of the net income from the property.

The nature of a bonus paid for an oil and gas lease is discussed at some length in Work v. Mosier, 261 U. S. 352, where the question was whether a bonus received from auctioning leases on Osage Indian land was part of the income to be distributed to the tribe. In holding that the bonus was part of the income, the Supreme Court said:

The bonus which was the result of bidding for desirable and profitable oil and gas leases secured for the members of the Osage Tribe the just value of the use of their property which the fixing of royalties in advance by the President was not adapted to give them. It was in effect a supplement to the royalties already determined. It was really part of the royalty or rental in a lump sum or down payment. We do not see how it can be classified as anything else. It was income from the use of the mineral resources of the land. Of course, it involved a consumption and reduction of the mineral value of the land, but so does a royalty. This is an inevitable characteristic of income from the product of the mine. What was intended to be distributed to the members of the tribe was the income from the mineral deposits in their lands, and the bonus was part of that * * *.

As we read section 214 (a) (10) above, it seems clear that Congress intended to limit the deduction for depletion based on discovery value so that it could not be used to offset income from other sources. We do not read such section as limiting the deduction to the net income from the sale of oil and gas. The statute says “ net income * * * from the property upon which the discovery is made.” The plain meaning of such language, we think, supports the petitioner’s contention that the depletion allowance is limited only to the total net income from the oil and gas property, which includes the bonus received. Cf. Murphy Oil Co. v. Burnet, 55 Fed. (2d) 17.

The facts of Darby-Lynde Co. v. Alexander, 51 Fed. (2d) 56, cited by the respondent in support of his position, are distinguished from those of the instant proceeding. The question there involved was whether profit from the sale of leases was part of the income from the property within the meaning of section 204 (a) (2) of the Revenue Act of 1926.

Decision will be entered under Rule 50.


author: Love :

text:
    Smart Farm Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 42845.
    Promulgated February 29, 1932.

      J. Marvin Haynes, Esq., and G. J. McGuire, Esq., for the petitioner.

      Stanley B. Anderson, Esq., for the respondent.
   OPINION.

Love :

Petitioner contends that the question involved in this proceeding is controlled by our decision in Virginia Beach Golf Course Annex Corporation, 23 B. T. A. 1169. We agree with that contention.

The respondent contends that the facts in the instant proceeding differ from those in the case relied upon by petitioner in that the dividend in the Virginia Beach case was stipulated to have been an unliquidated dividend in hind, whereas the dividend in the instant proceeding was for a definite amount, namely, $80 per share; that by the declaration of such dividend the petitioner created an indebtedness of $400,000 in favor of its stockholders; and that when it liquidated such indebtedness with $2,729.23 of cash and $397,270.77 of land contracts, it realized the profit of $254,631.62 contained in such contracts, on the ground that what it did was just the same as if it had sold the land contracts for $397,270.77 and taken the proceeds therefrom to pay its indebtedness to its stockholders.

We think the dividend in the instant proceeding is as much a dividend in kind as was the dividend in the Virginia Beach case, supra. The resolution of the stock holders specifically authorized the directors “ to distribute cash and assets of the Company to the stockholders ” and in accordance with such resolution the directors resolved That a dividend in the amount of Eighty ($80.00) Dollars per share be and the same hereby is declared in partial liquidation of the capital stock * * * payable in cash and in land contracts receivable taken at the book value thereof.” At that time petitioner had only $9,357.32 of cash in its treasury, whereas it had land contracts on its books in the amount of $575,059.98. We think this fact, together with the action taken by the stockholders and directors, clearly shows that the dividend to the extent of $397,270.77 was one in kind, namely, “in land contracts receivable taken at the book value thereof.”

It follows that our decision here must be the same as it was in Virginia Beach Golf Course Annex Corporation, supra, and that the respondent erred in including the amount of $254,631.62 in petitioner’s net income. See particularly point 1 of our opinion in the Virginia Beach case, at page 1112.

Reviewed by the board.

Judgment will l>e entered for the petitioner.


text:
    Clara Burdette, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 37321.
    Promulgated February 29, 1932.

      A. Calder Machay, Esq., for the petitioner.

      B. M. Coon, Esq., for the respondent.
   OPINION.

Lansdon:

The Revenue Act of 1921 provides in section 234 (a) (5) that the class of deductions contended for by the petitioner in this appeal, shall be allowed in cases where the bad debts are ascertained to be worthless and charged off within the taxable year. It is conceded that these debts were charged off by petitioner in 1924; also that they were worthless at the time. The respondent contends, however, that they were worthless and uncollectible in prior years, and, that in the situation which obtained in 1923, we must, as a matter of law, regard the petitioner as having ascertained their true condition not later than that year.

Conceding that forcible collection of the notes was barred by the statute of limitations at the time she presented them to the executor for payment, the petitioner now makes a special plea of fact, which, she claims, entitles her to the deductions in the taxable year. She asserts, that in good faith and in virtue of the memorandum given to her by the son prior to his death, which she believed was a sufficient acknowledgment under the California laws to revive the statute and extend their enforceable life, she considered the notes good until their repudiation. The record convinces us as to the good faith of the petitioner. Her claim is based upon actual worthlessness for which the law intended she could apply in reduction of her taxes. As against her contention that the proper year for such deduction was 1924, when she first learned that nothing would be paid on her notes, the respondent asks us to indulge in an irrebuttable legal presumption that the notes, in fact, lost all value at the death of their maker in October, 1923, because no one thereafter could waive the statute of limitations which barred their forcible collection. He argues, also, that since all persons are presumed to know the law, the petitioner was chargeable with knowledge of worthlessness at the time and that it must be presumed that she ascertained her loss in that year and not in 1924.

We think the respondent’s position in respect to both points stated is unsound in law. In the first place, although the statute of limitations had run on these notes and their maker’s executor was without power to waive that bar, such fact did not per se destroy their value, since they were still bona fide debts in favor of the petitioner. Booth v. Hoskins, 75 Cal. 271; 17 Pac. 225; De Cazara v. Orina, 88 Cal. 437; 22 Pac. 74; Spect v. Spect, 88 Cal. 437; 26 Pac. 203. Outlawed notes, in suits by an administrator against their holder, have been successfully pleaded in matters of defense (see Puckhaber v. Henry, 152 Cal. 419; 93 Pac. 114), and we are unable to say in this case what the value of these notes may have been in the hands of the petitioner. A statute of limitations takes away no right of property (Cooley on Const. Law, p. 340) and, being merely a statute of repose, determines no issues of merit between debtor and creditor. Terry v. Anderson, 95 U. S. 623. The debtor has no vested right in such a defense. A legislature may repeal or extend the statute and revive the right of action at any time. A suit may be successfully maintained on them in another jurisdiction, if brought within the period there allowed, and service is obtainable on the debtor. Campbell v. Holt, 115 U. S. 620; McEldowney v. Wyett, 44 W. Va. 711; 45 L. R. A. 609; Hulbert v. Clark, 129 N. Y. 295; 14 L. R. A. 59.

If, however, we could agree with the contentions of the respondent on his first proposition as to the date when these notes became un-collectible, we are not persuaded that the petitioner is legally bound to take notice of such date. The provisions of law which allow the deduction here, claimed require the petitioner to show that she charged the amount off her books in the year of ascertainment of its worthlessness, from which we think it follows that she must have actual and not constructive knowledge of the facts in order to take advantage of its provision. Where property rights alone are affected by actual knowledge of a basic fact, there is no rule of law which conclusively presumes such knowledge. Black v. Ward, 27 Mich. 191. The maxim that everyone is presumed to know the law has no application here. Its provisions are limited to the necessities which gave rise to its adoption in order to prevent offenders against criminal laws from pleading ignorance as a defense, and, in cases of fraud, to escape responsibility for their acts. Topolewski v. Plankington Packing Co., 126 U. S. 654. In this case the court, anent the doctrine discussed, among other things, said:

There is no presumption in this country that every person knows the law; it would be contrary to common sense and reason if it were so * * *. If everybody knew the law there would be no need of courts of appeal whose existence show that judges may be ignorant of the law.

It is obvious that the statute here applicable intended that the taxpayer, and not the law, should determine when bad debts were to be considered worthless in his hands, requiring only that good faith be shown. The provision here discussed has been many times construed by the courts and this Board, and it has been always held that it is the date of ascertainment of worthlessness by the taxpayer, and not of the worthlessness as later facts might develop, which governs. Jones v. Commissioner, 38 Fed. (2d) 550; Stephenson v. Commissioner, 43 Fed. (2d) 348; Murchison National Bank, 1 B. T. A. 617; Samuel Bird, 4 B. T. A. 259; Higginbotham-Bailey-Logan Co., 8 B. T. A. 566; Mitten v. Commissioner, 11 B. T. A. 731; R. B. Lawler, Executor, 17 B. T. A. 1083; Ida C. Calloway, Executrix, 18 B. T. A. 1059; American Warehouse Co., 19 B. T. A. 8. In United States v. Frost, 25 Fed. Cas. 1221, No. 15,172, this identical provision, then a part of the income-tax law of 1864, came before the United States District Court for the Northern District of Illinois for construction; the question being whether or not the judgment of the taxpayer, in respect to a similar claim, should prevail as against facts indicating worthlessness at a different date. Respecting the language used in that law, which was identical with the recitals here considered in section 214, supra, the court, among other things, said:

The language is “ to ascertain to be worthless.” By whom or how? The law is silent on this important point, and, therefore, there must be a discretion given,to the person making his return, and if that discretion is used fairly and honestly there would seem to be no just ground for complaint.

There has been no change of opinion expressed by the courts in respect to the construction put upon this provision of the tax laws since the early decision just cited; and in American Trust Co. v. Commissioner, 31 Fed. (2d) 47, the court, in recognition of the fallibility of human judgment, held that, to entitle the taxpayer to take such a'deduction, the ascertainment need not be absolute and that a claim may be duly ascertained to be worthless though later it may prove to be in fact collectible.

It follows, from this holding, that in a reverse situation, where an over optimistic taxpayer erred in judgment, the same good faith when exercised in ascertainment of worthlessness must be the only criterion by which we can determine his rights. In support of this view, the court in Jones v. Commissioner, supra, said:

In the light of subsequent events, it is quite easy now to determine that the debt was worthless before 1921; but the real question with which we are concerned is, not when did the debt become worthless, but when did decedent ascertain it to be worthless.

Also, in Murchison National Bank, supra, and in Samuel Bird, supra, the deductions were allowed by this Board for years subsequent to those in which the admitted facts show the debts were actually worthless. Our decisions in these two cases would seem to apply here, in view of the respondent’s contention that when, in the eyes of the law, forcible collection of an obligation is considered at an end, the taxpayer is bound to take notice of such fact and claim his deduction in that year. The claims in the cases cited were based in each case on investments made in bonds of the Imperial Bussian Government, which was overthrown in March, 1917. In January, 1918, the Soviet Government, by official decree, repudiated all of such bonds, which entirely destroyed their value as of and from that date. The petitioners deferred claiming their deduction until later years, trusting for a fortunate turn in events to restore the lost values. Of course all of these bonds were as “uncollectible” after February, 1918, as were the petitioner’s notes after October, 1923, but their holders considered them as having value notwithstanding. In the Murchison National Bank case the taxpayer ascertained worthlessness and charged off the amount thereof on part of its bonds in 1920. This Board allowed the deduction so claimed, and in its opinion said:

The Soviet Government on February 8, 1918, repudiated the bonds which taxpayer held, and from that date to the present time has not revoked, rescinded or modified its decree of repudiation. The bonds matured on June 18, 1919, but were not paid; they still remain unpaid. We know of no method or tribunal by which or before which taxpayer can enforce payment of the obligation. In short, we cannot see that at the present time the ’bonds have any value whatever, unless it be a mere speculative value, or that they had any more value in 1920 than at the present time. We are of the opinion that the bonds were worthless in 1920, and, in view of the circumstances under which they were charged off, the taxpayer should be permitted to take the full amount paid for the bonds as a deduction in determining its net income for that year.

Whatever may have been the basis of the petitioner’s belief in the value of her notes after the death of her son, her failure to claim a deduction in 1923, which she might easily have done, indicates to us her good faith in their worth up to the time she now claims she actually ascertained that they were, in fact, worthless. Her belief in the sufficiency of the written memorandum, delivered to her in May preceding her son’s death, to extend the collectible life of the notes was, under the circumstances, adequate to justify her presenting them to the executor for payment, or for bringing suit upon them in event payment was refused. Cf. Appeal of Kate I. Nixon, 2 B. T. A. 524. The year of ascertainment of the loss here involved was 1924.

Reviewed by the Board.

Decision will be entered for the petitioner.

Morris, Sternhagen, Arundell, and Van Fossan dissent.


author: Van Fossan:

text:
    Henry Doscher and John Doscher, as Executors of Claus Doscher, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 32662.
    Promulgated February 29, 1932.

      Henry F. Cochrane, Esq., for the petitioners.

      B. M. Coon, Esq., and R. H. Transue, Esq., for the respondent.
   OPINION.

Van Fossan:

The petitioners presented no evidence to support their allegations of error (1) and (2) and their counsel made no reference thereto in his brief. Therefore, we conclude that they have abandoned such issues and we approve the action of the respondent in respect thereto. The petitioners concede that the former saloon situated at Myrtle and Hamburg Avenues was assigned a proper cost of $15,000 and that a profit of $13,000 was realized upon its sale in 1923.

The only issue remaining in controversy is that respecting 72 parcels of improved real estate situated in the New Lot Section of Brooklyn,. New York.

It is unnecessary to recount the circumstances under which Claus Doscher acquired his property. In 1907 he owned 200 lots which he had difficulty in selling as unimproved real estate. Thereupon he entered into an agreement with Edward W. Lauer, a building contractor, in whom he had the utmost confidence, whereby he and Lauer would engage in the project of erecting dwellings and other buildings on all the 200 lots and selling for profit the parcels of real estate thus improved. Doscher was to furnish the land and to advance the money required to finance the operations. Lauer was to have complete charge of constructing the buildings, keep all accounts, make all sales, arrange all details of sale and collect all amounts due from the purchasers. The profits derived from the enterprise were to be divided equally and Lauer was to make a full accounting therefor after all buildings were erected and sold. As a matter of convenience and to relieve him of the unavoidable details incident to conveying title to purchasers, the possible necessity of repossession, etc., Doscher conveyed title to the entire 200 lots to Lauer’s wife. This conveyance was without consideration and no purchase money notes were given. A first mortgage covering the land was given by the Lauers to Doscher.

Pursuant to the agreement, up to July, 1910, 128 houses and other buildings had been constructed and sold. The proceeds and profits therefrom had been used as a revolving fund to aid in the building of the remaining 72 structures. Claus Doscher died in that month. Shortly thereafter the 72 buildings were completed, but Lauer made no move to account for the profits, and, on being approached, at first refused to recognize any liability to Doscher’s estate. In December, 1910, Doscher’s executors were forced to bring suit for specific performance. They were successful in the trial court and obtained a judgment. Lauer appealed. When it was discovered that a judgment against him could not be enforced, the case was compromised in November, 1912, by his agreeing to reconvey the property in controversy to the petitioners upon their releasing all claims against him, including the profits made on the 128 houses but unaccounted for by him. Due to difficulty in securing a reconveyance of one house, the formal conveyance was not made until March 28,1913.

In order to clear the property of all liens and charges against it, including the advances made by Doscher to Lauer and legal expenses and disbursements, the petitioners were compelled to pay $581,914.34 and a certain amount for back taxes. The respondent has assumed that such sum was the actual cost to petitioners of the 72 parcels of improved real estate and has computed the alleged deficiency on that basis. In this we believe him to be in error.

But, assuming the correctness of respondent’s theory, patently the sum of $581,914.34 used by the respondent in his computation in determining profit could not be the true cost. That amount represents merely the sum required to discharge obligations against the property and to settle the matters in controversy between the petitioners and Lauer. It does not include back taxes nor does it take into account the profit due to the Doscher estate from the sale of the 128 buildings previously erected and disposed of by Lauer. No accounting of the cost of construction of the 200 structures or any of them built by Lauer was ever made by him.

From the facts heretofore set forth, however, it is obvious that the transaction by which Mrs. Lauer acquired title to the lots in question was in no sense a sale to her. No consideration for the transfer was paid by either Lauer or his wife. She held the record title solely to facilitate and expedite their real estate operations. Likewise, the formal return of the record title to the petitioners under the compromise settlement with Lauer, whereby they relinquished all claims for profits due to Doscher’s estate and paid a definite sum to clear the encumbrances thereon, except taxes, was not an acquisition of property as contemplated by the statute. The real ownership of the property had never left Claus Doscher or his successors. He contributed to the project the land and funds necessary to conduct the contemplated operations, while Lauer supplied his ability and skill as a builder and contractor, superintended construction, made sales, collected balances due from purchasers and managed the undertaking generally. Though record title was transferred to Lauer’s wife, she became only a nominal owner, the transfer to her being charged with a trust in favor of Doscher, who was the real owner of the property. McGuire v. McGuire, 193 N. Y. S. 772. At most, the entire settlement proceedings, from the institution of the action by the petitioners to formal reconveyance made on March 28, 1913, served only to restore to the petitioners the record title to property of which Claus Doscher, and hence the petitioners as representatives of his estate, had at all times been the real owners. Thus, we may disregard March 28, 1913, the date of the deed from Mrs. Lauer to the petitioners, as forming the basis of calculating the gain or loss resulting from the sale of the property in 1923 and treat the transaction as one in which title existed in petitioners prior to March 1,1913.

Consequent on the above reasoning, we hold that the correct basis of calculating gain or loss on the subsequent sale of the 72 parcels is their fair market value as of March 1, 1913. This we have found to be $750,000. Since the property was sold for $697,500 there is no gain for the years 1923 and 1924.

Reviewed by the Board.

Judgment will l>e entered under Bute 60.


text:
    John G. Hormel, Petitioner, v. Commissioner of Internal Revenue, Respondent. Benjamin F. Hormel, Petitioner, v. Commissioner of Internal Revenue, Respondent. O. W. O’Berg, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 34765-34767, 44967-44969, 55631, 55632.
    Promulgated February 29, 1932.

      R. G. Alderson, Esq., for the petitioners.

      J. M. Leinenkugel, Esq., for the respondent.
   OPINION.

Lansdon :

The respondent has asserted deficiencies in income taxes for the years and in the amounts as follows:

The deficiencies arise from the respondent’s determination that amounts received by the petitioners on “ operators’ shares ” in the Hormel Trust constitute income taxable at both the normal and surtax rates.

George A. Hormel and Jay C. Hormel, who were the principal stockholders of George A. Hormel and Company, a Minnesota corporation, hereinafter referred to as the Company, transferred 14,410 shares of common stock of the Company in trust for the purpose, as stated in the trust instrument, of providing a plan whereby the Company might continue after the death of the two principal stockholders, George A. and Jay C. Hormel, and to permit the active managers of the business to share in the earnings of the Company. Under the provisions of the trust, each holder of common stock of the Company might transfer his shares of stock to the trustee in exchange for a founders’ certificate in the trust. The trust was governed by an advisory board of seven members, but during his lifetime George A. Hormel could cast the deciding vote of such board. After him, Jay C. Hormel had the deciding vote and, thereafter, a majority vote governed. George A. or Jay C. Hormel could terminate the trust at any time by notice in writing to the trustees and to the holders of founders’ certificates, whereupon each founder would receive the proportionate share of the corpus which he contributed. From the income of the trust, which consisted of dividends from the Company, the holders of founders’ certificates were to receive 5 per cent per annum on the net book value of the stock as of November 1 each year. If no dividend was declared on the stock, or if less than 5 per cent was paid, the trustee should issue a certificate of indebtedness for the unpaid amount due on the founders’ certificates. Beyond 5 per cent, the founders’ certificates had no right to participate in the income of the trust, except as they received operators’ shares.

Under the direction of the advisory board, the trustee issued operators’ shares entitling the holder to participate in the income of the trust to the extent of the units received. Operators’ shares were distributed by the advisory board to those actively engaged in the business of the company, according to the board’s opinion of the services rendered to the Company. Operators’ shares were nontransferable and all rights thereunder ceased upon termination of the services of the holder, either voluntarily or involuntarily, except that such holder was entitled to his allotment up to the time his services ended. When an operator’s share was canceled, the trustee issued in lieu thereof a redemption certificate entitling the holder to. a sum equal to his pro rata share in the net increase in the book value of the common stock since the date of issuance of the operators’ share.

The trust instrument provided that income should be distributed each year as follows: first, the holder of each founders’ certificate should receive 5 per cent on the book value of the common stock; second, each holder of a certificate of indebtedness should have such certificate paid with interest thereon at 5 per cent per annum; third, interest at 5 per cent per annum should be paid on outstanding redemption certificates; fourth, each member of the advisory board and the trustee should be paid one-fourth of one per cent on the increase in the book value of and the amount of dividends on the common stock; fifth, the trustee should then set aside an amount, not exceeding 10 per cent of the balance of the dividends, as a reserve fund; and, sixth, the balance of the net income of the trust should be distributed pro rata among the holders of operators’ shares. Upon the termination of the trust, the corpus was to be divided rat-ably among the holders of founders’ certificates.

The petitioners are holders of founders’ certificates and operators’ shares of the Hormel trust. During the taxable years they received distributions on their operators’ shares as follows:

In 1927 the petitioner, O. W. O’Berg, severed his relation with the Company, surrendered his operators’ shares and received in lieu thereof $10,321.87 in cash and a redemption certificate. The respondent has included the cash received as taxable income for such year.

Since the trust was revocable at any time by either of the two original founders, the dividends on stock which they contributed are taxable to them individually under the following provisions of section 219 (g) of the Revenue Act of 1926:

Where the grantor of a trust has, at any time during the taxable year, either alone or in conjunction with any person not a beneficiary of the trust, the power to revest in himself title to any part of the corpus of the trust, then the income of such part of the trust for such taxable year shall be included in computing the net income of the grantor.

Others who contributed stock to the trust had no power of revocation, and the income from such property is taxable under section 219 to the trustee or to beneficiaries, depending upon the distribution of the income under the trust instrument. There can be little doubt that some portion of the income received by petitioners on their operators’ shares is nontaxable, as being income constructively donated to the trust by George A. and Jay C. Hormel, who have paid income taxes thereon (see Elnora C. Haag, 19 B. T. A. 982), but we can not determine from the record in this proceeding how much, if any, of such income was distributed to the petitioners. We do not know the relative contributions of stock by the two original trustors and by others, who later became founders. Neither do we know the dividends paid in each year, the amount set aside as surplus by the trustee, the compensation paid to the trustee and members of the advisory board, nor the relative distribution of operators’ shares, all of which, we think, are necessary to a solution of this tax problem.

It is almost certain that some part of the-income received by the petitioners was subject to tax, namely, that part which represented income received by the trustee from property contributed by those founders who had no power to revoke. Certainly such income is taxable either to the trustee or to the beneficiaries under section 219. We think the evidence is insufficient to overcome the respondent’s determination that the amounts received by petitioners should be included as a part of their gross income.

The petitioners contend that for the purpose of the normal tax they are entitled to credit as provided in section 216 (a) of the Eevenue Act of 1926 for dividends received from a domestic corporation. For the same reasons as stated in our discussion of the first point, we think petitioners have failed to show that they are entitled to the credit claimed. That part' of the trust income arising from property contributed by George A. and Jay C. Hormel, whose power to revoke made such income taxable to them, came to the trustee as a constructive donation and not as dividends of a domestic corporation. Those two individuals, who must pay the tax on such income, are entitled to the credit allowed by section 216 (a). The petitioners rely on the following provisions of section 219 (d) of the Eevenue Act of 1926:

If any part of the income of an estate, or trust, is included in computing the net income of any legatee, heir, or beneficiary, such legatee, heir, or beneficiary shall, for the purpose of the normal tax, be allowed as credits, in addition to the credits allowed to him under section 216, his proportionate share of such amounts specified in subdivisions (a) and (b) of section 216 as are, under this section, required to be included in computing his net income. Any remaining portion of such amounts specified in subdivisions (a) and (b) of section 216 shall, for the purpose of the normal tax, be allowed as credits to the estate or trust.

We can not believe that Congress intended that such credit should be allowed more than once in respect of the same income. Since we do not have the necessary facts showing stock contributions, dividends paid, the amount set up as surplus and the relative distributions on operators’ shares, we are unable to determine what part of the income distributable to petitioner was received by the trust as dividends from domestic corporations and, accordingly, the respondent’s determination must be approved.

Eeviewed by the Board.

Decision will be entered, for the respondent.