author: Meblott :

text:
    Cyrus S. Eaton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 86942.
    Promulgated April 15, 1938.

      Richard Inglis, Esq., I. W. Sharp, Esq., H. A. Mihills, G. P. A., and L. O. Weiss, G. P. A., for the petitioner.

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

Meblott :

The Commissioner made several additions to the net income shown by petitioner’s return for the year 1929 and determined a deficiency in his income tax for said year in the amount of $157,-882.69. Some of the additions are conceded to have been made properly. The petition alleges that the respondent (Commissioner] erred: (1) in increasing petitioner’s taxable income by the addition of $427,343.75 representing the market value on December 3, 1929, of 12,500 shares of Central Alloy Steel Corporation common stock acquired by petitioner under the circumstances hereinafter related; (2) in disallowing the deduction from gross income, as a loss, of $1,287,536.15 claimed to have been sustained by the petitioner on the sale of certain securities on December 30, 1929; and (3) in disallowing $279,338.80 of a loss of $456,923.56 sustained by a partnership of which petitioner was a member, as a result of which he was prevented from taking his proportionate amount of the loss, or $117,322.30, as a deduction from his gross income.

All of the facts were stipulated. A resume of them will be sufficient for present purposes.

Issue I.

Petitioner was a member of the partnership of Otis & Co., which was a dealer in securities with its principal office in Cleveland, Ohio. The partnership kept its books and made its returns of income on a calendar year basis.

During the latter part of the year 1929 the Central Alloy Steel Corporation, hereinafter called Alloy, acquired the property and assets of the Interstate Iron & Steel Co., hereinafter called Interstate, in exchange for shares of stock of Alloy, which Interstate then distributed among its stockholders. Alloy had entered into an agreement with Interstate on October 2, 1929, that it would “procure some firm or individual to enter into a binding agreement” with Interstate to purchase any shares of Alloy which the stockholders of Interstate should receive. Pursuant thereto Alloy entered into an agreement with Otis & Co. under which Otis & Co. agreed to purchase the Alloy stock, at $60 per share, if offered within two weeks after the ratification of the agreement by the stockholders of Interstate.

The contract between Otis & Co. and Alloy provided that Alloy, “as full compensation to the Dealer for undertaking and carrying out the purchase * * * and when the Dealer shall have fully performed its obligations to purchase stock offered to it” as* provided by the agreement, should “issue to the Dealer Twelve Thousand Five Hundred (12,500) shares” of Alloy stock, fully paid and nonassessable.

Otis & Co. had been unwilling to assume on its own behalf and at its own risk the obligations involved in the above agreement and had executed it only at the request of petitioner and upon his written agreement, contained in a letter dated October 2,1929, reading as follows:

You will agree to purchase at 60 Central Alloy stock from the Interstate stockholders offered you during the two weeks subsequent to the ratification of the merger, and scrip (if issued) at market until Jan. 1 next, all for my account, I to receive the compensation for this indemnity from Central Alloy.

The market value of Alloy stock at the time the agreement was made was approximately $54 per share. Pursuant to the agreement petitioner, through Otis & Co., purchased 79,687 shares of Alloy at $60 per share which, together with the 12,500 shares, made a total of 92,187 shares acquired by petitioner under the agreement.

The respondent treated the receipt of the 12,500 shares as a fee to petitioner for purchasing the 79,687 shares, the fee being computed upon the basis that the shares received had a fair market value of $34.1875 per share, or a total value of $427,343.75. Petitioner maintains that the sum paid out in acquiring the 79,687 shares — $4,781,220 —should be treated as the cost of the entire 92,187 shares.

Eespondent argues that “in view of the plain and unambiguous terms of the agreement * * * that the stock was full compensation * * * for undertaking and carrying out the purchase” the fair market value of such stock must be held to be “compensation for personal service” and hence income to petitioner under section 22 (a) of the Eevenue Act of 1928. Petitioner contends that the 12,500 shares “average down” his cost per share to an amount about equal to the actual value of the shares and that it is obvious that the agreement to purchase the shares at 60 would not have been made but for the fact that the contemporaneous agreement had been made under which he would receive more shares than those actually purchased. He contends that there is no difference in principle between the transaction before us and one in which a purchaser of preferred stock receives a “bonus” of common stock, in which case the total purchase price is, in the language of article 58 of Eegulations 74, “* * * fairiy apportioned between such common stock and the securities purchased for the purpose of determining the portion of the cost attributable to each class of stock or securities * * Cf. C. H. Mead Coal Co., 28 B. T. A. 599.

It is, of course, well settled that compensation for personal service, though paid in the form of stock or securities, must be included in gross income to the extent of the fair market value of such property when received. Marshall Field, Glore, Ward & Co., 16 B. T. A. 1299; affd., 47 Fed. (2d) 541; Benedict Crowell, 21 B. T. A. 849; affd., 62 Fed. (2d) 51; Old Colony Trust Co. et al., Administrators, 22 B. T. A. 1062; affd., 59 Fed. (2d) 168; J. Kemp Bartlett, 28 B. T. A. 285; affd., 71 Fed. (2d) 598; and Adam H. Davidson, 34 B. T. A. 479 affd., 91 Fed. (2d) 516. But is this rule applicable here ?

In James Brown, 10 B. T. A. 1036, 1054, the petitioner was paid certain amounts to induce him to purchase some stock which the majority stockholder desired should be purchased by one friendly to the company. The Board held that the amount paid to the petitioner did not constitute income, but was a reduction of the cost of the stock. It was said that the two contracts — the agreement under which the additional amounts were paid and the purchase by him of the stock at a price which he considered too high — were to be “considered together upon the basis of the intent of the parties when made and in the light of the results reached in their final consummation”, and that the amount so paid could not be “considered as taxable income.”

The rule applied in the above case is not unlike the rule frequently applied in cases somewhat analogous. Thus, where different classes of securities are acquired in consideration of a lump sum, the profit is computed by allocating the cost between, or among, the securities purchased in the proportion that the fair market value of each class bears to the total fair market value of all classes. Cf. Cliford Hemphill, 25 B. T. A. 1351. In the case of stock dividends the cost of the original shares is allocated to the stock received and the original shares. Silas H. Burnham, 29 B. T. A. 605. In the sale of rights to subscribe to new issues of stock, such rights being “essentially analogous to a stock dividend”, and in the case of the sale of stock acquired through the exercise of such rights, the gain or loss is to be computed by, or after, an allocation of cost. Miles v. Safe Deposit & Trust Co., 259 U. S. 247. While the facts in the cited cases are not entirely analogous to the facts in the instant proceeding, there is in our opinion sufficient similarity to justify the application of the same rule. It is therefore held that the respondent erred in treating the fair market value of the 12,500 shares of Alloy stock as income to the petitioner when they were received. Upon this issue petitioner is sustained.

Issue II.

Industrial Shares, Inc., is a corporation organized under the laws of the State of Delaware by a certificate of incorporation filed December 23, 1929, with an authorized capital stock of 1,000 shares of preferred stock of the par value of $100 each, with no voting rights, and 10,000 shares of common stock of the par value of $10 each, with full voting rights. One hundred shares of the common stock of said corporation were subscribed for by the incorporators. At a meeting of the incorporators held December 23, 1929, a board of directors consisting of three persons was elected. At a meeting of the board of directors held December 26, 1929, officers were elected and the treasurer of the corporation was authorized to accept subscriptions for, and to sell, the preferred shares of the corporation at their par value of $100 per share. The treasurer of the corporation, on December 28, 1929, in accordance with the authority previously given to him by the board of directors, received subscriptions from seven individuals for an aggregate of 250 shares of the preferred stock of the corporation at $100 per share' and the cash received, or $25,000, was deposited to the credit of the corporation.

At a meeting of the board of directors of Industrial Shares, Inc., held December 30, 1929, the treasurer reported the sales of the preferred stock and the deposit of the sum of $25,000. Immediately following the report of the treasurer there was presented to the board of directors an offer from petitioner, contained in a letter dated December 30, 1929, addressed to the corporation and signed by petitioner, reading as follows:

I am the owner of the following shares of stock held by Otis & Oo. of Cleveland, for me, which I am willing to sell at the respective prices set opposite the different items:
1,000 shares of Central Alloy Steel Corporation common at $35.00_ $35, 000.00
7,250 shares of Commonwealth Securities Incorporated common
at $50.00_ 362,500.00
1,000 shares of Inland Steel Corporation common at $75.00- 75, 000. 00
200 shares of Mesta Machine Company common at $200.00- 40, 000. 00
Total_$512, 500.00
I am also the owner of 92,187 shares of Central Alloy Steel Corporation Common which is deposited with the Cleveland Trust Company of Cleveland, Ohio, under a certain Collateral Trust Agreement by and between Cyrus S. Eaton and Otis & Co., First Parties, the Cliffs Corporation, Second Party, Continental Shares, Inc., Third Party, Commonwealth Securities, Incorporated, Fourth Party, and The Cleveland Trust Company, Fifth Party, to secure the payment of three notes of Cyrus S. Baton guaranteed by Otis & Co., all dated December 3,1929, and payable on or before one year after date, with interest at the rate of six per cent. (6%) per annum, to-wit:
Note to the order of Commonwealth Securities, Incorporated— $500, 000. 00
Note to the order of Continental Shares, Inc- 2,087,480. 00
Note to the order of Cliffs Corporation- 1,100,000. 00
Total_$3,687,480.00
I am willing to sell said 92,187 shares' of Central Alloy Steel Corporation so deposited with The Cleveland Trust Company at $35 per share or for an aggregate price of $3,226,545.00.
I hereby offer to sell, assign, transfer and set over to you all of the above mentioned shares of stock held by Otis & Co. and The Cleveland Trust Company for me at the prices above indicated, aggregating $3,739,045., to be paid by you in the following manner:
1 — $3,687,480. by your assumption of the three notes to Commonwealth Securities, Incorporated, Continental Shares, Inc., and The Cliffs Corporation, aggregating that amount above referred to and your agreement to pay and perform all of my obligations and the obligations of Otis & Co. under said three notes and under the Collateral Trust Agreement securing the same above referred to.
2 — The balance of $51,565. by crediting said amount on a subscription for 5,200 shares of your Common Stock of the par value of $10. each, which I hereby agree to make.
The balance of $435.00 necessary to make up the subscription price of $52,000. for 5200 shares of your Common Stock I will pay in cash.
You will assume the accrued interest on the notes above referred to and will be entitled to the full dividends on the stocks sold without accounting to me for any portion of the same.
I attach copies of the three notes dated December 3, 1929, and the Collateral Trust Agreement dated December 2, 1929 above referred to, for your information.
If you desire to accept this offer please indicate your acceptance on one of the duplicate copies hereof and return the same to me.

Petitioner’s offer, as set forth in the above letter, was accepted by Industrial Shares, Inc., on December 30, 1929, and pursuant thereto he, on said date, assigned the securities to Industrial Shares, Inc., and acquired 5,200 shares of its common stock. This was the only common stock of Industrial Shares, Inc., ever issued or outstanding, except the 100 shares subscribed for by the incorporators, which 100 shares were assigned to the petitioner on January 3,1930. Petitioner did not own any of the shares of preferred stock of Industrial Shares, Inc., at any time.

The securities which petitioner transferred to Industrial Shares* Inc., had, at the time of transfer, an aggregate market value of $3,342,832.06. Of that amount $2,906,269.56 was attributable to the stock of Alloy (92,187 shares at $31.1875) and the balance to the stocks of Commonwealth, Inland, and Mesta. The liabilities of petitioner, which were assumed by Industrial Shares, Inc., amounted to $3,687,480.

The petitioner claimed a loss as the result of the above transaction in the amount of $1,287,536.15, computed as follows:

The claimed loss was disallowed by the respondent. He determined that it occurred in connection with the transfer by petitioner of his property (securities) to the corporation in exchange for its stock; that immediately after the exchange the persons transferring property to the corporation (including the original incorporators and the purchasers of its preferred stock) were in control of the corporation ; and that the stock and securities in the corporation received by each was substantially in proportion to his interest in the corporation prior to the exchange. Thus, says the respondent, the transfer is one falling exactly within the provisions of section 112 (b) (5) of the Revenue Act of 1928, with the possible exception that the exchange by petitioner may not have been solely for stock or securities in the corporation since he also received, as part of the consideration for the transfer, the assumption of his indebtedness; but if this view be accepted, then no loss is to be recognized because of section 112 (e) of the Revenue Act of 1928. The applicable provisions are shown in the margin.

Petitioner contends that there was no exchange of property for stock, but that what occurred was a purchase of stock by the original incorporators and the holders of the preferred, after which the corporation purchased his property; that, even if it be held that there was an exchange of property so far as he is concerned, still no such holding can be made relative to the acquisition of the stock by the original incorporators and the preferred stockholders; that in any event the control of the corporation, as required by the statute and as such term has been interpreted by court and Board decisions, has not been shown to exist; that the rule enunciated and applied by the court in Halliburton v. Commissioner, 78 Fed. (2d) 265, and relied upon by the respondent in making his determination, is unsound and should not be followed; that even if there were an exchange, the persons did not receive stock substantially in proportion to their interest in the property prior to the exchange as required by section 112 (b) (5), supra; and that in any event the respondent erred in construing the assumption by the corporation of petitioner’s indebtedness to be “other property” within the purview of section 112 (e).

The first question is whether the transaction was a sale or an exchange. Petitioner on brief argues that inasmuch as his offer was “in terms an offer to sell the securities and not an offer to exchange them for stock in Industrial Shares, Inc.”, it must necessarily be found that he made an outright sale rather than an exchange as determined by the respondent. His argument, however, is not persuasive. “The terminology used by the parties * * * is not conclusive.” National Grange Mutual Liability Co., 31 B. T. A. 666, 670; affd., 80 Fed. (2d) 316. Petitioner transferred to the corporation certain securities and $435 in cash and received from the corporation 5,200 shares of its common stock and the right to be relieved of an indebtedness. The word “property” as used in section 112 (b) (5), sufra, includes money paid for stock. Halliburton v. Commissioner, 78 Fed. (2d) 265. There was therefore a transfer of property for property. Such a reciprocal transfer is an exchange.

It must next be determined whether this exchange falls within the provisions of section 112 (b) (5), supra. If it does, petitioner is not entitled to the deduction of the claimed loss, and if it does not, the claimed loss is an allowable deduction unless the exchange is within the provisions of section 112 (e), supra, also relied upon by the respondent. In order for the transaction to come within the provisions of subdivision (b) (5) there must be (1) a transfer of property to a corporation by one or more persons solely in exchange for stock or securities in such corporation; (2) immediately after the exchange such person or persons must be in control of the corporation; and (3) in the case of an exchange by two or more persons the stock or securities received by each must be substantially in proportion to his interest in the property prior to the exchange.

If the transfer made by petitioner is to be considered alone, it is clear that it is not within the provisions of section 112 (b) (5); for immediately after the exchange he was not in control of the corporation. “Control” means the ownership of at least 80 percent of the voting stock and at least 80 percent of the total number of shares of all other classes of stock. Sec. 112 (j), supra. Immediately after the exchange the corporation had outstanding 5,300 shares of common and 250 shares of preferred stock. Petitioner, not being the owner of any preferred stock, did not have the control required by the statute.

Kespondent’s disallowance of the claimed loss is not bottomed, however, solely on the transfer made by petitioner. It is his position that two or more persons, namely, the petitioner and those who acquired the preferred stock, transferred property to the corporation, consisting of securities and cash, and received in exchange stock and other property, the latter being the indebtedness of petitioner assumed by the corporation. It would serve no useful purpose to discuss or decide whether the stipulated facts warrant his conclusion that the transfers were all a part of one transaction or plan. Certainly, the short period of time elapsing between the organization of the corporation and the completion of the transfers tends to support this conclusion. We prefer, however, to rest our decision on another ground, and it may be assumed that the transfers were made pursuant to a plan devised by petitioner and the others. Inasmuch as the transferors immediately after the transfers owned all of the stock of the corporation, they had the necessary control required by the statute. But this holding does not justify the dis-allowance of the claimed loss.

Under the provisions of section 112 (b) (5), supra, the loss must be allowed as a deduction unless “the amount of the stock * * * received by each [of the transferors] is substantially in proportion to his interest in the property prior to the exchange.” This clause requires a comparison “between the value of the share of each trans-feror in the total assets before the exchange and the value of its shares of stock or interest in the corporation after the exchange.” United Carbon Co. v. Commissioner, 90 Fed. (2d) 43. See also Edwin L. Dana, 36 B. T. A. 231; Samuel E. Diescher, 36 B. T. A. 732. If, therefore, there was a substantial difference between the value of the asset possessed by each transferor prior to the exchange and the value of the stock received by him through the exchange, the transaction does not fall within the provisions of subdivision (5).

Immediately prior to the exchange petitioner had securities the market value of which at the time of the transfer has been stipulated to be $3,842,832.06. This amount, and not the sum of $3,739,045, which Industrial Shares, Inc., agreed to pay for them, represents the value of the securities transferred to the corporation by petitioner. These securities were subject to an indebtedness of $3,687,480. Petitioner transferred the securities and $435 in cash to Industrial Shares and received 5,200 shares of its common stock, and the corporation assumed the indebtedness of $3,687,480. Other persons transferred to the corporation $25,000 in cash and received 250 shares of preferred stock. It is apparent from the foregoing that petitioner and the preferred stockholders did not receive stock substantially in proportion to their interests in the aggregate of property prior to the exchange. The value of the share of the preferred stockholders in such aggregate of property transferred was $25,000, while the value of the shares of petitioner was nothing at all. After the transfers the value of the shares or interest in the corporation of both petitioner and the preferred stockholders was nothing, inasmuch as the indebtedness of the corporation was approximately $300,000 in excess of the value of all of its assets. Under these circumstances it must be held that the trans-ferors did not receive stock which was substantially in proportion to their interests in the property prior to the exchange, and recognition of the loss sustained is not barred by the provisions of section 112 (b) (5), supra. Moreover, such recognition is not barred by the provisions of section 112 (e), supra, also relied upon by the respondent, as this section has no application unless the amount of the stock received by each transferor is substantially in proportion to his. interest in the property prior to the exchange.

The respondent erred in disallowing the claimed loss.

Issue III.

During 1929 petitioner was a member of a partnership called Otis & Co., a dealer in securities. As of September 1, 1929, F. E. Eberstadt became a member of the firm, with an interest of 10 percent in its profits and losses. He contributed $1,600,000, which included securities for which he had paid $1,130,482.08 but were accepted by the partnership on that date at their fair market value of $1,555,362.50. On the records of the partnership an amount of $14,428.09 representing inter-office interest (contra credit on which was included as interest income in computing taxable income of the partnership) was added to market value of the securities contributed by Eberstadt, making a total of $1,569,790.59.

Some of the securities contributed by Eberstadt were disposed of prior to December 31, 1929, for $780,810. The remaining securities were included in the closing inventory of Otis & Co., of December 31, 1929, at a value of $332,157.03 and a loss of $456,923.56 was thus computed by the partnership. The petitioner’s distributive share of the profits of the partnership was 42 percent and his aliquot part of the loss sustained was $191,907.90.

The respondent disallowed $279,338.80 of the loss claimed by the partnership and hence in effect disallowed $117,332.80 of the deduction of $191,907.90 claimed by petitioner in his return of income for said year. The respondent computed the loss to the partnership as follows:

Inventory value of securities on hand 13-31-29_$332, 057.03
Eberstadt cost of securities contributed_$1,130, 482. 08
“ “ “ “ sold_ 620,840.29
“ “ “ “ on hand 13-31-29_ 509,641.79
Allowable loss_$177,584. 76
Loss per boohs- 456,923.56
Loss disallowed-$279,338.80
The above basis of $509,641.79 was computed as follows:
Eberstadt’s cost of securities_,_$1,130, 482.08
“ “ “ “ sold__ 620,840.29
“ “ “ “ on hand Dec. 31, 1929_ $509,641.79

Upon this issue, therefore, the question is whether the loss of $456,923.56 claimed by the partnership should be allowed, or whether only $279,338.80 should be allowed.

The petitioner contends that the fair market value of the securities contributed to the partnership at the date of contribution, at which value they were accepted by the partnership, is the proper basis to be used in the determination of gain or loss. This question has heretofore been considered by this Board and by the courts, and if the decisions in those cases are followed judgment must be for the petitioner on this issue. See Edward B. Archbald, 27 B. T. A. 837; affd., 70 Fed. (2d) 720; certiorari denied, 293 U. S. 594; Carroll E. Doner, 32 B. T. A. 364; Helvering v. Walbridge, 70 Fed. (2d) 683; certiorari denied, 293 U. S. 594; Chisholm v. Commissioner, 79 Fed. (2d) 14; certiorari denied, 296 U. S. 641.

Upon brief respondent states that he is cognizant of the above decisions and of the fact that they are contrary to his present contention. He, though citing no authorities in support of his view, states simply that he does not agree with the decisions and, as stated by him in XIY-1 C. B. 208, he declines to follow them “pending the outcome of further litigation of the question involved.” The Board is of the opinion, however, that the above decisions are correct and should be followed.

It is unnecessary to discuss this question at length or to repeat what was said in the above cases. An amendment was made to the revenue act in 1934 under which, in effect, the rule contended for by the respondent in the instant proceeding is applicable to later years. Section 113 (a) (13) of the Revenue Act of 1934- provides that if property is acquired by a partnership, its basis shall be the same as it would be in the hands of the transferor. If, therefore, the present controversy were under the Revenue Act of 1934 or a later year, the cost or other basis to the partnership would be the same as the cost or basis in the hands of the contributing partner. But Congress did not attempt to make the above legislation retroactive. On the contrary, it stated (sec. 1, Revenue Act of 1934) that the provisions of the title, which included section 113 (a) (13), supra, should “apply only to taxable years beginning after December 31,1933.” A law will not be given retroactive effect unless the intention that such effect should be given is made clear by the act itself. Cf. Brewster v. Gage, 280 U. S. 327; United States v. Magnolia Petroleum Co., 276 U. S. 160; Schwab v. Doyle, 258 U. S. 529.

On this issue the action of the respondent is disapproved.

Reviewed by the Board.

Judgment will be entered under Rule BO.

       SEC. 112. RECOGNITION OF GAIN OR LOSS.
      (a) General rule. — Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.
      (b) Exchanges solely m hind.—
      * ******
      (5) Transfer to corporation controlled by transferor. — No gain or loss shall he recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; hut in the case of an exchange hy two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.
      • ******
      (e) Loss from exchanges not solely in hind. — If an exchange would he within the provisions of subsection (b) (1) to (5), inclusive, of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain or loss, but also of other property or money, then no loss from the exchange shall be recognized.
      * ******
      (3) Definition of control. — As used in this section the term “control” means the ownership of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.


source: Caselaw Access Project

author: Hill :

license: Public Domain

text:
    Cyrus W. Scott Manufacturing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 83451.
    Promulgated April 15, 1938.

      Walter E. Barton, Esq., for the petitioner.

      James H. Yeatman, Esq., for Che respondent.
   OPINION.

Hill :

The questions presented for determination are:

(1) Was the petitioner entitled to use the reserve method of handling bad debts in its income tax return for the year 1933?

(2) Was petitioner entitled to deduct either the addition to its reserve for bad debts for the taxable year, or the following items as bad debts specifically ascertained and charged off during the taxable year:

Note of Gyrus W. Scott_$4,114. 94
Interest on above note_ 641. 53
Cyrus W. Scott advances_ 4,500.00
Due from stockholders_ 564.78
Total- 9,821.25

Relative to the first question presented, petitioner concedes that prior to 1932 it used the specific ascertainment method of charging-off bad debts and that it changed to the reserve method on its books of account and in its income tax return for 1932, without having first requested or secured permission from the Commissioner to do so. Petitioner contends, however, that the Commissioner acquiesced in such change and gave implied permission therefor by accepting and closing its 1932 return without adjustment and that it is therefore entitled to use the reserve method in its accounts and in its income tax return for 1933. Respondent, on the other hand, contends that under the circumstances here his acceptance and closing of the return for 1932 without adjustment did not amount to permission to change to the reserve method.

The pertinent parts of the applicable statute and regulations are set forth in the margin:

Petitioner relies on an implied rather than direct permission of the Commissioner to change from the method of specific ascertainment of bad debts to reserve for bad debts and bases such implication upon the fact that the Commissioner accepted and closed without adjustment its 1932 return in which it used the reserve method and deducted the additions to reserve for bad debts in that year from gross income. Petitioner cites the following cases as supporting the claim that the Board and the courts have held that such action on the part of the Commissioner constitutes the granting of the permission required by the cited statute and regulations: Clark Brown Grain Co., 18 B. T. A. 937; Ganahl Lumber Co., 21 B. T. A. 118; Gardner Governor Co., 5 B. T. A. 70; Greylook Mills v. Blair, 293 Fed. 846; Home Ice Cream & Ice Co., 19 B. T. A. 762; Jonas Cadillac Co., 16 B. T. A. 932; Norwich Woolen Mills Corporation, 18 B. T. A. 303.

The facts in the instant case distinguish it from the cases cited above in that in all of those cases a tax liability was shown, either on the return or in the adjustments made therein by the Commissioner, while in the instant case there was no tax liability shown by the return, no field examination of petitioner’s accounts was made, and the Commissioner made no adjustment of the accounts as stated in the return. Furthermore, in the present case, it was apparent from the return that no adjustment which the Commissioner might make would result in a tax liability.

Petitioner’s income tax return for 1932 showed a total of deductible losses of $116,683.69 in excess of income. The addition to reserves for that year shown as a deduction in such return was $39,993.02 and the net amount of such reserve at the end of that year was $19,574.10. Had the Commissioner disallowed in toto the deduction of $39,993.02 as reserve for bad debts in petitioner’s tax return for 1932, there would have still remained deductible losses of $76,640.67 in excess of income for that year. If the Commissioner had disallowed the deduction of only that part of the reserve represented by the net amount of such reserve at the end of the year 1932, there would have remained deductible losses of $97,057.59 in excess of income for that year. In neither event would the return have shown a tax liability of petitioner for 1932. It being apparent from the return as filed that no action which the Commissioner might take with reference to the deduction of reserve for bad debts would result in a tax liability against petitioner for that year, no field investigation was made of petitioner’s accounts and the audit of the return consisted solely of proving the computation thereof. Since the return showed conclusively that petitioner had no income tax liability in 1932, regardless of whether it followed the specific ascertainment method of charging off bad debts or used the reserve method in that respect, it would have been a futile act for the Commissioner to disallow the deduction of the reserve for bad debts and his failure to disallow such deduction is without negligence. There was no affirmative action by the Commissioner in this case, such as characterized the cases cited above, upon which to base an implication of consent to a change in the accounting methods. Under such circumstances we think it was not incumbent upon the Commissioner, in order to avoid a waiver of compliance with the regulations, to deny the deduction in question and that his failure to do so did not amount to implied permission to change from the one method of accounting to the other. Cf. Ross B. Hammond, Inc., 36 B. T. A. 497, 506, wherein we said: “We are unable to see, in the circumstances in this case, that mere inaction by the Commissioner is evidence of the voluntary relinquishment of right which is essential to waiver, and plainly estoppel does not lie, there being no showing of detriment to petitioner.”

Accordingly, we hold that petitioner was not entitled to the deduction of $33,014.86, claimed as additions to reserve for bad debts. Our holding on this point disposes of the assigned error based upon the disallowance by respondent of a deduction of $5,697.72 representing that part of the above claimed additions to reserve which is in excess of $27,317.14, the amount of bad debts charged to such reserve by petitioner.

The next question for consideration is whether petitioner is entitled to deduct as debts ascertained to be worthless and charged off in the taxable year the items totaling $9,821.25 set forth in our findings of fact. Petitioner charged those items to the reserve for bad debts. The first of those items is $4,114.94 representing a charge-off for partial worthlessness of the principal of a note by Cyrus W. Scott to petitioner and the second of such items is $041.53, representing a charge-off for worthlessness of the total amount of accrued interest on such note. This note was for the principal sum of $15,094.94, with interest at 6 percent per annum, dated April 11, 1930, and due April 11, 1931. It was secured by 109.8 shares of stock of petitioner corporation, having a book value at the time of such charge-off of $150 to $175 per share, according to the testimony of L. E. Bryan, Jr., vice president of the Second National Bank of Houston, and a stockholder and director of petitioner. In view of this testimony, we can find no justification for the charge-off for partial worthlessness either as to the principal of the note or accrued interest thereon, and the deduction therefor is disallowed.

The third item included in the claimed deduction of $9,821.25 is $4,500, representing the total of moneys advanced monthly to Cyrus W. Scott in 1932 and 1933 after he had resigned as president and manager of petitioner, which petitioner claims was to be repaid to it. After his resignation as indicated Scott was elected chairman of the board of directors of petitioner in order that his name might continue to be connected with the corporation. The evidence is clear that this advance was made to Scott for the use of his name in connection with petitioner’s business. The Cyrus W. Scott Manufacturing Co. was organized by Cyrus W. Scott and he had many personal friends and friends in trade circles, which fact was thought to be commercially valuable to petitioner. We are convinced that it was never intended that Scott should repay these advances, but that they were paid to him as salary for the use of his name and for acting in a nominal official capacity. This conclusion is further fortified by the fact that no time was fixed for the repayment of these advances and no interest thereon was charged or provided for. Also, petitioner continued to advance Scott $150 a month through January and February 1934, after charging off in December 1933 as a bad debt the $4,500 advanced to him in 1932 and 1933. The deduction of this item of $4,500 is disallowed for the reason that no part of it represented a debt owing by Scott to petitioner. However, $2,000 of the $4,500 was paid by petitioner to Scott in the taxable year as salary and petitioner is entitled to deduct that amount as a business expense. Respondent concedes petitioner’s right to this deduction.

The fourth and last item included in the claimed deduction of $9,821.25 is $564.78 owed to petitioner by two of its stockholders, R. B. Mundine and D. E. Ouzts. Beyond the fact that this item was charged as a bad debt to the reserve for bad debts in the taxable year, no evidence was offered as to its worthlessness or when, if at all, it became worthless. Petitioner is, therefore, not entitled to a deduction for this item.

Judgment will be entered under Bule SO.

       Revenue Act of 1932.—
      SEC. 23. DEDUCTIONS FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:

        * * * * * * *
      (3) Bad Debts. — Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts) ; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction.

       Regulations 77.—
      Art. 191. Bad debts. — Bad debts may be treated in either of two ways—
      (1) By a deduction from income in respect of debts ascertained to be worthless in whole or in part, or
      (2) By a deduction from income of an addition to a reserve for bad debts.
      Taxpayers were given an option for 1921 to select either of the methods mentioned for treating such debts. (See article 151, Regulations 62.) The method used in the return for 1921 must be used in returns for subsequent years and in returns under the Revenue Act of 1932 unless permission is granted by the Commissioner to change to the other method. A taxpayer filing a first return of income may select either of the two methods subject to approval by the Commissioner upon examination of the return. If the method selected is approved, it must be followed in returns for subsequent years, except as permission may be granted by the Commissioner to change to another method. Application for permission to change the method of treating bad debts shall be made at least 30 days prior to the close of the taxable year for which the change is to be effective. (See also article 195.)
      Where all the surrounding and attending circumstances indicate that a debt is worthless, either wholly or in part, the amount which is worthless and charged off or written down to a nominal amount on the boohs of the taxpayer shall be allowed as a deduction in computing net income. * * * In determining whether a debt is worthless in whole or in part the Commissioner will consider all pertinent evidence, including the value of the collateral, if any, securing the debt and the financial condition of the debtor. Partial deductions will be allowed with respect to specific debts only.


author: Smith :

text:
    E. D. Perry, as Executor of the Estate of Frank O. Green, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88343.
    Promulgated April 19, 1938.

      E. D. Perry, Esq., and C. B. Knobbe, G. P. A., for the petitioner.

      James G. Maddox, Esq., for the respondent.
   OPINION.

Smith :

The applicable provision of the taxing statute to the question presented by this proceeding is section 303 of the Revenue Act of 1926, which, in so far as material, reads as follows:

Seo. 303. For the purpose of the tax the value of the net estate shall he determined—
(:a) In the case of a resident, by deducting from the value of the gross estate—
(1) Such amounts for funeral expenses, administration expenses, claims against the estate, unpaid mortgages upon, or any indebtedness in respect to. property (except, in the case of a resident decedent, where such property is not situated in the United States)., to the extent that such claims, mortgages, or indebtedness were incurred or contracted bona fide and for an adequate and full consideration in money or money’s worth, losses incurred during the settlement of the estate arising from fires, storms, shipwreck, or other casualty, or from theft, when such losses are not compensated for by insurance or otherwise, and such amounts reasonably required and actually expended for the support during the settlement of the estate of those dependent upon the decedent, as are allowed by the laws of the jurisdiction, whether within or without the United States, under which the estate is being administered, but not including any income taxes upon income received after the .death of the decedent, or any estate, succession, legacy, or inheritance taxes.

On brief the respondent contends that the evidence of record in this proceeding does not show that the $12,000 claimed as a deduction for the support of the widow was “reasonably required” for the support of the widow during the settlement of the estate; that there is no evidence that the estate is still in process of settlement as contended by the petitioner; and that the full amount of $12,000 was not “actually expended” within the meaning of the statute.

We are of the opinion that the contentions of the respondent do not derive support from the fact that the evidence of record does not show that the full amount of $12,000 was reasonably required for the widow’s support or that the evidence does not show that the estate is still in process of settlement. The disallowance of $10,000 of the claimed deduction was not based upon any such grounds. We therefore confine our consideration only to the third contention made by the respondent, namely, that the full amount of the $12,000 claimed as a deduction for the widow’s support has not actually been expended by the estate.

The petitioner contends that under the law and decisions of the State of Iowa an amount allowed for the support of decedent’s dependents during the administration of the estate is considered to be an administration expense. The argument made is that the $12,000 allowed by the court is a deduction from the gross estate either as an administration expense or as.a claim against the estate, both of which are allowed as deductions from the gross estate under section 303 (a) (1) of the Revenue Act of 1926.

Tlie petitioner’s contention that the Iowa law and the decisions of the courts of Iowa are controlling in determining whether the allowance of $12,000 is a legal deduction from the gross estate is without legal support. Congress has authority to tax the transfer of the net estate. Congress, likewise, has authority to determine the manner in which the amount of the net estate shall be determined. The taxing statute carries its own criteria for the determination of the net estate. Where Congress has specifically determined what amounts shall be allowed as deductions from the gross estate in the determination of the net estate the laws of the state in which the estate is being administered have no binding force. See Burnet v. Harmel, 287 U. S. 103, and cases therein cited.

From an inspection of section 303 (a) (1) of the Revenue Act of 1926 it is seen that Congress has permitted the deduction from gross estate of numerous classifications of expenses. It has provided an entirely separate classification for the deduction of allowances for the support of dependents during the period of administration. The language of the statute is “such amounts reasonably required and actually expended for the support during the settlement of the estate of those dependent upon the decedent.” The respondent has disallowed the deduction of $10,000 of the amount claimed for the widow’s allowance upon the ground that the money has not been actually expended by the estate. When relating to financial transactions the word “expended” ordinarily has the meaning of paid out or disbursed. See Adams v. Prather, 176 Cal. 33; 167 Pac. 534, 538. We have no doubt that this is the meaning in which Congress used the term. Furthermore, the word “expended” in the statute is qualified by the word “actually.” The meaning of Congress in this provision is not ambiguous. If the amount claimed as the widow’s allowance has not actually been paid out, we think it follows, as night the day, that the amount has not been actually expended.

But the petitioner contends that the amount was actually expended by reason of the fact that the executor gave a note to the widow evidencing the obligation of the estate to make the payment. This contention of the petitioner must be denied. The giving of a promissory note is not the equivalent of the payment of a debt. See Eckert v. Burnet, 283 U. S. 140; Edmond A. Hughes, 27 B. T. A. 1022; S. E. Thomason, 33 B. T. A. 576. The execution by the petitioner and the delivery of the note to the widow changed the form of the obligation to pay the widow’s allowance, but it did not pay it. The assets of the estate in the executor’s hands were not reduced thereby. Where an allowance to the widow is not “actually expended”, that is “paid out”, it is not a legal deduction from the gross estate. See Commissioner v. Strauss, 11 Fed. (2d) 401.

The stipulated facts in this case show that the amount of the widow’s allowance actually expended by the estate during the period of settlement was not exactly $2,000. Total payments on the note to September 30, 1987, inclusive, amounted to $4,850. These payments included interest and, in some cases, a part of the principal. The portion that represents interest is not a legal deduction from gross* income as the widow’s allowance actually expended by the estate. The portion that represents principal is a legal deduction. The adjustment will be made in the Eule 50 computation.

Judgment will be entered u/nder Rule 50.


author: Hill:

text:
    Hal Price Headley and Genevieve M. Headley (Husband and Wife), Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88174.
    Promulgated April 20, 1938.

      James Park, Esq., and Wallace Muir, Esq., for the petitioners.

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

Hill:

This proceeding is for the redetermination of a deficiency in income tax for.the year 1934 in the amount of $215.88. The sole issue raised by the pleadings is whether respondent erred in disallowing a deduction of $4,700 for attorneys’ fees in the circumstances referred to below. The facts, while not stipulated, are not in dispute.

Petitioners are husband and wife, residing in Fayette County, Kentucky, and for the taxable year filed a joint income tax return. The husband, Hal Price Headley, will for convenience hereinafter be referred to as petitioner.

Petitioner for many years has been engaged in the business of farming, and the breeding, rearing, and raising of thoroughbred horses. The major portion of petitioner’s income was derived from his horse business. In the taxable year, out of a total gross income of $123,651.65, the amount of $88,940.75 was realized from the horse business, and for the years 1928 to 1936, the gross income from the horse business constituted 74.3 percent of petitioner’s total gross income.

On August 18, 1933, in the District Court of the United States for the Northern District of Illinois, Eastern Division, an indictment was returned against petitioner and one Marvin Hardin, a colored employee working as a groom in petitioner’s stables. The indictment alleged violation of the Harrison Narcotics Act and the Narcotic Drugs Import and Export Act, as amended, and contained three counts. The first count charged that the defendants on July 28,1933, at Arlington Park Race Track, Arlington Heights, Illinois, unlawfully purchased heroin, a derivative of opium; the second count charged that the defendants, at the same place and on the same date, fraudulently and knowingly received, concealed, bought, and facilitated the transportation and concealment of heroin, unlawfully imported into the United States; and the third count charged that the defendants, on March 6, 1933, and thereafter, at Miami and Hialeah Park, Florida, and elsewhere, conspired to commit the offenses alleged in the first two counts. The indictment further charged that it was a part of the alleged conspiracy that the defendants were to receive, conceal, buy, sell, and facilitate the transportation and concealment of heroin “for the purpose of administering same to race horses.”

The following overt acts were alleged in the indictment: That the defendants, at approximately 45 minutes before the post time in each case, administered heroin as follows: (1) at Hialeah Park, Florida, on March 6, 1933, to a race horse named Liquer; (2) at Arlington Park Race Track, on July 12, 1933, to a race horse named Cabouse; (3) at Arlington Park Race Track on July 17, 1933, to a race horse named Technique; (4) at Arlington Park Race Track on July 18, 1933, to a race horse named Big Beau. It was further alleged that on July 28, 1933, at Arlington Park -Race Track, Arlington Heights, Illinois, the defendants had in their possession and under their control, in Barn P, a large quantity of heroin.

Under the rules of racing in Kentucky, if petitioner had been convicted of the offenses charged in the indictment above referred to, he and his horses would have been ruled off the tracks not only in Kentucky but in all other states of the United States and in England; his business would have been ruined, and he would not have been permitted to attend races even as a spectator on any race track in the United States. In the event of conviction, petitioner could have sold his stallions and brood mares, but could not have sold his race horses, without the consent of the racing association of Illinois.

Petitioner employed counsel to defend him against the above mentioned indictment, and during the taxable year 1934 paid the sum of $4,700 for attorneys’ fees and expenses.

Petitioner’s trial was continued from time to time on motion of the Government until December 2,1936, when petitioner filed a motion to suppress certain evidence. The motion was granted, and thereafter the case was dismissed for want of prosecution.

The question presented here is whether or not, under the circumstances above set forth, the amount of $4,700 is deductible from petitioner’s gross income as “ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” Sec. 23 (a), Revenue Act of 1934. Respondent admits that $4,700 was paid by petitioner in 1934, but contends that the amount was not an expense of carrying on his trade or business.

Similar questions have been considered by the Board and the courts in numerous cases. In Welch v. Helvering, 290 U. S. 111, the Court pointéd out that:

Many cases in the federal courts deal with phases of the problem presented in the case at bar. To attempt to harmonize them would be a futile task. They involve the appreciation of particular situations, at times with border-line conclusions.

We shall make no attempt here to discuss generally the numerous decisions bearing on the question at issue. Instead we shall refer briefly only to cases which on the facts and by analogy approach nearest to the instant proceeding.

Kornhauser v. United States, 276 U. S. 145, lays down the rule that where a suit or action against a taxpayer is directly connected with or, as otherwise stated, proximately resulted from his business, the expense incurred is a deductible business expense, citing with approval Sarah Backer et al., Executors, 1 B. T. A. 214.

In Commissioner v. People's Pittsburgh Trust Co., (C. C. A., 3d Cir.), 60 Fed. (2d) 187, affirming 21 B. T. A. 588, it was held that expense incurred by a corporation executive in successfully defending himself against a criminal charge involving fraud in making the corporation’s income tax return was deductible in his personal return as an ordinary and necessary business expense. The court said:

While the expense for which claim was made might be deemed personal, in the sense that the outlay was made by the taxpayer in defending himself from a charge which, if proved, would have subjected him to imprisonment or fine or both, yet it was an expense made necessary by the nature of the taxpayer’s business. * * * The expenses incurred and paid out by him were, in our view, made necessary because a criminal quality was attributed to acts which were performed by the taxpayer in carrying on his trade or business.

In Commissioner v. Continental Screen Co. (C. C. A., 6th Cir.), 58 Fed. (2d) 625, affirming 19 B. T. A. 1095, attorneys were employed to represent the corporation before the Federal Trade Commission on a charge of operating in violation of the Sherman Anti-Trust Act, with the result that an order was entered dismissing the complaint. The fees paid to the attorneys were held deductible. The court said:

Tbe proceeding before tbe Trade Commission was undoubtedly an “action” against respondent [taxpayer] which was “directly connected with” or which “proximately resulted” from its business. * * * The life of the business was endangered. Under such circumstances respondent followed the very natural and ordinary procedure suggested by the vital necessity of the situation. It employed counsel to protect its interest and agreed to pay for their services. Any other course upon the part of its board of directors would have been unusual and would, no doubt, have subjected them to well founded criticism by its stockholders.

See also National Outdoor Advertising Bureau v. Helvering (C. C. A., 2d Cir.), 89 Fed. (2d) 878, where the court cited with approval the decision in the Continental Screen Co. case, supra, on the ground that “the taxpayer’s resistance was there justified, and was ‘necessary’ to the protection of his business.”

In Louisiana Jockey Club, Inc., 13 B. T. A. 752, the petitioner paid a note which had been assumed by the city of New Orleans as a part of the purchase price of land. Petitioner paid the note in order to obtain immunity from interference by city authorities with the conduct of its business. The Board held that the amount so paid was a legal deduction from gross income as a necessary expense, saying at page 757:

We can not doubt from the evidence that the petitioner paid the money under a threat that it would not be permitted to operate its race track unless the payment was made. It was essential that it make it in order to continue in business.

In Citron-Byer Co., 21 B. T. A. 308, the petitioner was engaged in the junk business, and purchased certain coils of wire from the Government. The Government agents delivered what the Government contended and petitioner apparently admitted was another and more expensive kind. The Government demanded additional pay and received it. Thereafter, petitioner and its two officers were indicted for conspiracy to defraud the Government in the transaction. This indictment was dismissed for want of prosecution. A second indictment was found, and upon hearing was quashed for lack of proof. The Board held that the alleged offenses arose directly out of taxpayer’s business, and, the court having determined that no such offenses had been committed, the fees paid by the petitioner to its counsel to defend against the indictments were deductible as ordinary and necessary expenses of its business.

Of course it is well settled that attorneys’ fees paid in successfully defending either a civil action or a criminal charge of a purely personal nature not directly connected with the taxpayer’s business, or proximately resulting therefrom, are not deductible. Pantages Theater Co. v. Welch (C. C. A., 9th Cir.), 71 Fed. (2d) 68; George L. Richard, 12 B. T. A. 886; Frank G. Robins, 8 B. T. A. 523.

We think the present case comes sqnarely within the decisions first above cited. Petitioner was charged with having committed criminal acts in the process of carrying on his business. The offenses alleged arose directly out of the conduct of his business; they were “directly connected with” or “proximately resulted from” his business. If he had been found guilty as charged, his business would have been ruined. At an expense of $4,700 he successfully defended himself against the accusations; the indictment was dismissed for want of prosecution. That he was innocent of the offenses charged is a legal presumption. In our opinion, the deduction claimed is properly allowable.

Respondent relies upon Welch v. Helvering, supra. There a grain commission agent made payments to the creditors of a bankrupt corporation of which the taxpayer was secretary. The payments were made for the purpose of strengthening his individual standing and credit, and reestablishing business relations with the corporation’s former customers. The court held that such expenditures were not deductible for the reason that they did not constitute ordinary and necessary expenses of operating a business. The decision was based upon facts which, we think, are clearly distinguishable from the present proceeding.

On the issue submitted, respondent’s action is reversed.

Judgment will be entered wider Rule 50.


author: TURNER:

text:
    Lillian M. Jeffries, Administratrix, Estate of James B. Jeffries, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81968.
    Promulgated April 22, 1938.

      Paul E. Shorb, Esq., for the petitioner.

      S. L. You/ng, Esq., for the respondent.
   OPINION.

TURNER:

The question presented for determination is whether the decedent’s salary is exempt from Federal income tax by reason of the constitutional limitation on the powers of the Federal Government to levy taxes on the salaries of the officers of state agencies or instrumentalities which are engaged in the performance of essential governmental functions. The controversy between the parties is whether the South Florida Conservancy District was engaged in the performance of an essential governmental function. The respondent makes no point that the district was not an instrumentality of the State of Florida, nor that the petitioner was not an official of the district.

Petitioner alleges that the State of Florida, in accepting from the United States the grant of swamp and overflowed lands, accepted them in trust and under a duty to drain and reclaim them, with the Federal Government recognizing that in so doing the state would be performing an essential governmental function. We find nothing in the act under which the lands were granted to indicate that they were given in trust to the state. The grant was outright and effective from the date of the act of Congress by which made, and the only proviso was that the proceeds received by the state from the lands he used exclusively, so far as necessary, for the purpose of reclaiming the lands by means of drains and levees. See Wright v. Roseberry, 121 U. S. 488. In speaking of the purposes and requirements of the act, the Court there said:

The object of the grant, as stated in the act, was to enable tbe several states to which it was made, to construct the necessary levees and drains to reclaim the land; and the act required the proceeds from them, whether from their sale or other disposition, to be used, so far as necessary, exclusively for that purpose. The early reclamation of the lands' was of great importance to the states, not only on account of their extraordinary fertility when once reclaimed, but for the reason that until then they were the cause of malarial fevers and diseases in the neighborhood.

In Leovy v. United States, 177 U. S. 621, 623, the Court said respecting the act:

* * * This legislation declares a public policy on the part of the government to aid the States in reclaiming swamp and overflowed lands, unfit for cultivation in their natural state, and is a recognition of the right and duty of the respective States, in consideration of such grants, to mate and maintain the necessary improvements.

From the foregoing statements of the Supreme Court it appears that the state in accepting the grant assumed the duty of using the proceeds received therefrom by it, so far as necessary, for reclaiming the lands. Whether this could be said to be an acceptance in trust, or whether the state was under any further duty to the Federal Government, we do not deem it necessary to decide.

In furtherance of the object for which the lands had been granted to it, the State of Florida created the district, which, during the taxable year and for several years theretofore, was engaged in attempting to make the swamp and overflowed lands situated within its boundaries habitable and available for settlement by rendering them sanitary and suitable for agricultural purposes. For the use of the district in performing this work the state provided funds by means of charges or assessments imposed by it on lands situated in the district. A drainage district created by a state as a political subdivision thereof for the purpose of draining and reclaiming swamp and overflowed lands by rendering them habitable and cultivatable is an instrumentality of the state created for the purpose of performing prescribed functions of government. Houck v. Little River Drainage District, 239 U. S. 254.

It is a proper matter for judicial notice that the reclamation of swamp and overflowed lands is a most legitimate exercise of the police power. See Leovy v. United States, supra, page 636, where the Supreme Court said:

We think that the trial court might well take judicial notice that the public health is deeply concerned in the reclamation of swamp and overflowed lands. If there is any fact which may be supposed to be known by everybody, and, therefore, by courts, it is that swamps and stagnant waters are the cause of malarial and malignant fevers, and that the police power is never more legitimately exercised than in removing such nuisances. The defendant was not deprived of the defense that the act which he was charged with was performed in order to promote the health of the community, by the fact, if fact it was, that the order under which he acted did not say anything about the subject of health, but simply authorized the erection of the dam, so as to exclude the overflow from the river.

Here tlie state created an agency of its own for the exercise in a particular area of its police power as related to drainage. The police power, however, is and remains a governmental power and its exercise does not extend to the performance of activities that are nongovernmental and proprietary in nature. Ohio v. Helvering, 292 U. S. 360. Accordingly we hold that the drainage and reclamation work carried on by the district was the exercise of functions essentially governmental in character and not private or proprietary.

This conclusion, we think, is consistent with recent decisions. In Brush v. Commissioner, 300 U. S. 352, the Supreme Court, in holding that the acquisition and distribution by the city of New York of a supply of water for its inhabitants was the exercise of an essential governmental function, stated among other reasons that the health and comfort of the people are dependent upon an adequate water supply. If the furnishing of a supply of water needed for health purposes constituted a governmental function, the removal of excess water from a swamp area also necessary for health purposes would appear to constitute a governmental function. In Hoskins v. Commissioner, 84 Fed. (2d) 627, the court, in holding that the operation of school cafeterias by a public school system was a governmental function, among other reasons relied on the fact that such operation tended to improve the health of the pupils. See Gregg v. United States, 22 Fed. Supp. 802 (U. S. Dist. Ct., W. Dist. Pa., Feb. 23, 1938), to the same effect. In Ernest H. Hale, 33 B. T. A. 504, the conclusion that the maintenance of municipal play grounds was an essential governmental function was based on the duty of the municipality to preserve the public health.

The district also built some roads and bridges in connection with its principal activity of drainage and reclamation. These, being incidental to its principal work, partook of its nature. Brush v. Commissioner, supra. However, standing alone, they would also be governmental functions. Commissioner v. Harlan, 80 Fed. (2d) 660, affirming 30 B. T. A. 804; Boomer v. Glenn, 21 Fed. Supp. 766.

Respondent, in support of his contention that the district was not engaged in performing governmental functions, relies on our decision in T. P. Wittschen, 25 B. T. A. 46, which was followed in D. G. Wood, 29 B. T. A. 919. In the Wiltschen case we held that a utility district organized by the vote of the people, with power to own and operate works for supplying the inhabitants of the distri'ct with light, water, power, heat, transportation, telephone service and other means of communication, and the means for the disposal of garbage, sewage, and other refuse matter was not organized as a political subdivision of the State of California primarily for governmental purposes and was not engaged in performing essential governmental functions. Clearly the objects and powers of that district are so varied and different from those of the district involved here that our decision there may not be said to be controlling in the instant case. In the Wood case it was held that the water control and improvement district organized under the laws of Texas as a political subdivision thereof and engaged in furnishing water to the arid and semi-arid area comprised in it was not engaged in the performance of an essential governmental function. In Ashton v. Cameron County District, 298 U. S. 513; petition for rehearing denied, 299 U. S. 619, there was in issue the question of whether a similar improvement district organized under the laws of Texas to furnish water for irrigation and domestic uses was created for the exercise of governmental or mere corporate functions. Relying upon its former decisions with respect to the immunity of states and municipalities from Federal taxation as being applicable, the Supreme Court concluded that the district was created to exercise governmental functions. Our decision in the Wood case, therefore, is not in harmony with the conclusion reached by the Court. Nor is it in harmony with the later decision of the Court in Brush v. Commissioner, supra, where the Ashton case was considered at length. In view of the foregoing, the decision in the Wood case can not be applied here.

More in the nature of a suggestion than a contention, the respondent states on brief that petitioner has failed to show affirmatively the manner and to what extent the imposition of the tax here involved would be a burden on the district in the conduct of its activities. In such cases the officers and employees are the means through which a state agency must necessarily exercise its powers and, as such, are not subject to tax by the Federal Government. Collector v. Day. 11 Wall. 113; Brush v. Commissioner, supra; Commissioner v. Sherman, 69 Fed. (2d) 755; and Commissioner v. Harlan, supra. Cf. Joseph B. Strauss, 35 B. T. A. 673. In Indian Motocycle Co. v. United States, 283 U. S. 570, the Supreme Court said: “Where the principle applies it is not affected by the amount of the particular tax or the extent of the resulting interference, but is absolute.” Recently, in Helvering v. Mountain Producers Corporation, 303 U. S. 376, the Supreme Court overruled its prior decisions in Gillespie v. Oklahoma, 257 U. S. 501, and Burnet v. Coronado Oil da Gas Co., 285 U. S. 393, and held that income derived by private agencies or individuals from state owned lands was subject to Federal income tax, but there is nothing in that decision which in any way indicates that the Court modified or in any way intended to modify or change its position as taken in Brush v. Commissioner, supra, and other cases cited to the effect that the salary of an officer of an instrumentality of a state, which instrumentality is engaged in activities essentially governmental in character, is not subject to Federal income tax.

Reviewed by the Board.

£ Decision will be entered for petitioner.


author: Tyson:

text:
    The Allentown National Bank and Ethel Harrison Kift, Executors of the Estate of Robert L. Kift, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 86150.
    Promulgated April 22, 1938.

      Thomas M. 'Wilkins, Esq., and C. L. Turner, C. P. A., for the petitioners.

      Lewis S. Pendleton, Esq., and Frank T. Horner, Esq., for the respondent.
   OPINION.

Tyson:

As shown in our findings of fact, Prudential Insurance Co. policy No. 827,018 contained the following provision: “The Insured may at any time * * * change the Beneficiary or Beneficiaries under this Policy, * * *” On November 21, 1912, the insured exercised the right given in this provision by substituting his wife as beneficiary in lieu of the original beneficiary named in the policy. In neither the endorsement effectuating this change nor in the original policy was there any provision as to the right to change the beneficiary other than that quoted above. We are of the opinion that, under the quoted provision, the right of the insured to change the beneficiary was not exhausted by its exercise in the instance mentioned and that the right to make such a change remained in him until his death. Consequently the designation of decedent’s wife in the change made was not irrevocable and the value of this policy is includable in the gross estate. Helena Liebes, Executrix, 20 B. T. A. 731; affd., 63 Fed. (2d) 870; Hintz v. Hintz, 78 Fed. (2d) 432.

The facts in the instant case distinguish it from the cases of David A. Reed et al., Executors, 24 B. T. A. 166, and Caroline W. Edwards et al., Executors, 31 B. T. A. 879, and the cases cited therein in support of the holdings that no right existed to a change in beneficiary after such right had once been exercised. In those two cases the policies provided for the “right of revocation” by the insured, but also further provided that “When the right of revocation has been reserved, * * * the insured, * * * may designate a new beneficiary, with or without reserving right of revocation, * * There were no such, provisions with reference to the designation of a new beneficiary-in the policy here involved. The right to change the beneficiary in this policy is given in broad, comprehensive terms, without the limitations specifically imposed in the policies, as shown by the quotations therefrom considered in the cited cases.

There is a further provision in this policy which leads to the same conclusion as that reached with regard to the effect of the provision in the policy for a change of beneficiary. The policy provided, inter alia, that the insured could borrow from the insurance company certain specified amounts while the policy was in force. Under this right of the insured to borrow on the policy he reserved an interest therein which was extinguished only by his death and, therefore, for this reason also the value of the policy is includable in the gross estate. Louise C. Moore, Executrix, 33 B. T. A. 108, 111; Caroline W. Edwards et al., Executors, supra.

For the reason that the Prudential policy was taken out in 1907 and the beneficiary therein changed in 1912, both events occurring prior to the passage of the 1918 Revenue Act, petitioners contend that the value of this policy is in no event includable in the gross estate of the decedent, under the decision in Lewellyn v. Frick, 268 U. S. 238. This contention is untenable. In the Erich case, supra, the Court had under consideration section 402 (f) of the Revenue Act of 1918, the counterpart of which appears as 302 (g) of the Revenue Act of 1926. The 1918 Act did not contain any provision similar to subsection (h) of section 302 of the 1926 Act, which is controlling here. Subsection (h) has been considered by the courts and this Board since the decision in the Frich case, supra, and it has been held that under its provisions the value of an insurance policy payable to a beneficiary other than the insured’s estate, if otherwise includable in the gross estate of the insured, should be therein included irrespective of the date on which the policy was taken out or of the date on which a change in the beneficiary therein was made. Levy’s Estate v. Commissioner, 65 Fed. (2d) 412; Cook v. Commissioner, 66 Fed. (2d) 995; certiorari denied, 291 U. S. 660; Scott v. Commissioner, 69 Fed. (2d) 444; Newman v. Commissioner, 76 Fed. (2d) 449; certiorari denied, 296 U. S. 600; Louise C. Moore, Executrix, supra; Guaranty Trust Co. of New York et al., Executors, 33 B. T. A. 1226.

As shown in our findings of fact, a general provision of Northwestern Mutual Life Insurance Co. policy No. 1,794,035 was “with_reservation to the Insured of the right of revocation and change of Beneficiary.” A later clause provided that “the Insured (1) may designate one or more Beneficiaries if none be named herein, either with or without reservation of the right to revoke such designation * * This later clause was, as to this policy, inoperative, since it applied only when there was no beneficiary named in the policy, and there was a beneficiary, Ethel II. Kift, named in this policy. Under the general provision the insured reserved the right to change the beneficiary and therefore the value of this policy is includable in decedent’s gross estate. Helena Liebes, Executrix, supra; Hintz v. Hintz, supra.

It might also further be said that no change of the original beneficiary in this policy was ever made. Ethel H. Kift was the original beneficiary named therein and remained the primary beneficiary after the endorsements adding contingent beneficiaries to the policy. The only change made by these endorsements with reference to the status of the original beneficiary was a change as to the method by which she was to receive the proceeds under the policy; that is to say, under the original policy she was to receive the proceeds in one lump sum after the death of the insured, while under the change made by the endorsements she was to receive the proceeds (1) under option A of the policy, or (2) in the event of her surviving the contingent beneficiaries and their lawful surviving children, if any, she was to have the privilege of receiving the proceeds of the policy under option C, which provided for the payment of the proceeds in a number of stipulated monthly installments. There never having been a change made in the original beneficiary, the express right given in the policy to change the. beneficiary had never been exercised by the insured prior to his death and the right remained in him at the time of that event. Consequently, for this reason also the designation of decedent’s wife as the original and primary beneficiary in the policy was not irrevocable.

In Mutual Benefit Life Insurance Co. policy No. 1,355,369 the right to change the beneficiary was reserved and never exercised by the decedent. Also in New England policy No. 552,581, where the original beneficiary was changed, the endorsement effecting the change reserved the right in the decedent to make a further change of beneficiary, and no further change was ever made. Consequently, the right to change the beneficiary in both these policies remained in the decedent at the time of his death and the designations of the beneficiaries therein were not irrevocable. The values of these two policies are includable in decedent’s gross estate. This seems to be tacitly conceded by petitioners, since their main contention on brief as to them is to the effect that, if includable in the gross estate, the value of the policies should be the “commuted value of the periodic payments of principal and/or interest provided for in the policies.”

The same contention, in the alternative, is also made by petitioners with regard to Northwestern Mutual policy No. 1,794,035. We do not agree with this contention. The proof shows no proper basis upon which a commuted value of either of these three policies could be determined. To the contrary, in each policy it was directed that the insurance company should retain the amount which would otherwise have been payable as a lump sum to the beneficiary, and pay the beneficiary interest on such amount at certain percentage rates. These facts bring the method of proper ascertainment of the value of the amounts receivable by the beneficiaries under these policies squarely within the rule announced in Estate of A. Murat Willis, 28 B. T. A. 152, which rule is to the effect that such amounts under similar facts are not to be properly arrived at by commutation, as contended here by petitioners.

There is no proof as to the method used by respondent in determining the values of the two of these policies which were not included in the gross estate by the executors in their return; nor is it shown in the record that such values were erroneous. Neither is there any error shown in the value of New England policy No. 552,581 as set out in the return of the executors and considered in respondent’s determination as being correct. Consequently, the determination of respondent as to all three of these policies is approved.

Petitioners claim as a deduction $500 paid the widow of decedent under the provisions of section 12 (a) of the Pennsylvania Fiduciaries Act of 1917. The deduction was disallowed by the respondent. The applicable Revenue Act of 1926, section 303 (a) (1), provides for the deduction of “* * * amounts reasonably required and actually expended for the support during the settlement of the estate of those dependent upon the decedent, as are allowed by the laws of the jurisdiction, * * * under which the estate is being administered, * * *” There is no evidence that the $500 was either “reasonably required” or “actually expended” for the support of the widow and child of decedent, and, notwithstanding that under the order of the Pennsylvania court in pursuance of the Pennsylvania statute the $500 was paid the widow for her use, we approve its disallowance as a deduction by the respondent. Mary A. Powers, Executrix, 6 B. T. A. 633; Mary M. Buck et al., Executors, 25 B. T. A. 780; affd., 73 Fed. (2d) 760.

Decision will be entered under Rule SO.

       Sec. 302. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
      * * * * * * *
      (g) To the extent of the amount receivable by the executor as insurance under policies taken out by the decedent upon his own life; and to the extent of the excess over $40,000 of the amount receivable by all other beneficiaries as insurance under policies taken out by the decedent upon his own life.
      (h) Except as otherwise specifically provided therein subdivisions (b), (c), (d), (e), (f), and (g) of this section shall apply to the transfers, trusts, estates, interests, rights, powers, and relinquishment of powers, as severally enumerated and described therein, whether made, created, arising, existing, exercised, or relinquished before or after the enactment of this Act.

       Sec. 471. Appraisers; exemption to widow and children.

      The widow, if any, or if there be no widow, or if she has forfeited her rights, then the children forming part of the family of any decedent dying, testate or intestate, within this commonwealth, or dying outside of this commonwealth, but whose estate is settled in this commonwealth, may retain or claim either real or personal property, or the proceeds of either real or personal property, belonging to said estate, to the value of five hundred dollars; and the property so retained or claimed shall not be sold, but suffered to remain for the use of the widow or children. It shall be the duty of the executor or administrator of such decedent to have the said property, if personal, appraised and set apart to said widow or children by the appraisers appointed to appraise the other personal estate of the decedent; or, if real, then by two appraisers to be appointed by the orphans’ court, who may be the same persons appointed to appraise the personal estate.


author: Murdock:

text:
    Lansing McVickar, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 77993.
    Promulgated April 22, 1938.

      Thomas M. Wilkins, Esq., for the petitioner.

      Harold F. Noneman, Esq., for the respondent.
   OPINION.

Murdock:

The Commissioner determined a deficiency of $6,566.09 in the petitioner’s income tax for the year 1931. One of the issues raised was waived by the petitioner and another was conceded by the respondent. The only question which the parties present for decision by the Board is whether in computing the petitioner’s gain or loss from securities sold within the year the basis to be used is the cost of those securities, or the inventory value of the securities at the beginning of the year. That issue is not raised as clearly as it might be, but the parties fully understood that it was the issue. All of the essential facts have been agreed to by the parties, either in the written stipulation filed at the hearing or otherwise. Since the facts have been thus established it is unnecessary for the Board to make any findings of fact.

The petitioner in 1930 began to devote all of his time to the trade or business of speculating in or buying and selling securities on his own account for a profit. This continued throughout 1930 and 1931. He was not a dealer in securities within the meaning of that term as defined in the Commissioner’s regulations, i. e., he was not a merchant of securities with an established place of business regularly engaged in the purchase of securities and their resale to customers. He filed his Federal income tax returns for 1930 and 1931 with the collector of internal revenue for the second district of New York. He described his occupation on his return for 1930 as “broker and dealer in securities.” He reported on that return as his profit from business or profession a loss of $65,232.84. He computed that loss as follows: He deducted $241,669, representing the inventory value of the securities which he had on hand at December 31, 1930, from the cost of all of the securities which he owned at any time during the year. He then deducted that remainder from the gross amount which he had received during the year from the sale of securities, and added two small items, one of interest paid and another of expenses. The result was a loss of $65,232.84. The return showed, under net income, a minus quantity of $64,242.32 and no tax due.

The petitioner stated on his 1931 return that his occupation was “dealer in securities.” He deducted on that return $64,242.32, representing a net loss for 1930, and reported as income from business or profession for 1931 the amount of $63,131.71, computed as follows:

Gross Sales___$3,784,244. 33
Inventory Jan. 1, 1931_ $241,669. 00
Purchases--- 3,470, 459.85
3,712,128. 85
Inventory Dec. 31, 1931_ 3,712,128. 85
Gross Gain_ 72,115.48
Less Expenses:
Interest paid_ 1,376. 72
Business Expenses including Standard Statistics, financial charts, services and information, telephone and stenographic services_ 7,607. 05
- 8,983. 77
Net Gain_ $63,131. 71

The Commissioner in determining the deficiency increased the petitioner’s income as shown by his return for 1931 by $59,172.93, described as “1930 loss overstated,” and explained that the petitioner was not a dealer and therefore had no right to write down his securities to market at the close of 1930. The effect of this adjustment was to allow $5,069.31 to be carried forward to 1931 as a net loss of the year 1930. The cost of the securities which the petitioner had on hand at the close of 1930 was $368,634.93. His income for 1930 was understated by the difference between the cost of the securities on hand at the close of the year and the inventory value of those securities. Elimination of this error would show his correct taxable net income for 1930 to have been $119,707.39, instead of a net loss.

Although on his return for 1931 he used the phrase “Inventory Dec. 31, 1931,” it appears that he had no securities on hand at that time, but had sold during the year not only all of the securities which he had purchased during that year, but all of those which he had on hand at the beginning of the year. Thus, the only inventory that the petitioner ever made use of in his income tax returns was the inventory as of December 31, 1930. He kept no books.

The petitioner first concedes that no deduction should be allowed for 1931 as a net loss of 1930, because he was not entitled to use a closing inventory and consequently had no loss. But his error did not stop there, for he was consistent in it and used the closing inventory of 1930 as the opening inventory for 1931. He had no right to use the inventory in either year. Therefore, he now contends that he erred on his return for 1931 in computing a gain from his business for that year. That gain was computed by the use of the opening inventory which he had no right to use. A correct computation of the gain or loss from his business for that year can be made only by taking the difference between the actual cost of the securities which he sold and the amount realized from the sales in 1931. That difference is a loss of $54,231.73. The loss far exceeds the other items in controversy, so that a correct computation of his income tax liability for 1931 will show, not only no tax due for the year, but a substantial net loss.

The respondent contends, however, that the petitioner’s tax liability for 1931 can not be computed in accordance with the provisions of the revenue act. That is, in the second amended answer he makes the contention that the petitioner, having used a closing inventory for 1930, must be held to the use of the same figure as the opening inventory for 1931, on the ground of estoppel. The estoppel, he says, consists of the statement on the return for 1930 that the petitioner was a dealer in securities. Hie Commissioner claims that he was misled by this statement to his disadvantage in that, as a result of that statement, he made no investigation, took no steps to assess or collect the tax until the statute of limitations had run, and so lost the tax due for 1930. Consequently, he would estop the petitioner to deny that the opening inventory for 1931 is proper. The parties have stipulated that the Commissioner made no field investigation of the petitioner’s income tax liability for 1980 until January 1934. The "Commissioner allowed the statute of limitations to run as to 1930 without ever assessing or collecting any tax for that year.

The Commissioner recognizes that he has the burden of pleading and proving the necessary elements of an estoppel. The essential elements of an estoppel include (1) the party to be estopped must have made a misrepresentation or concealment of the existence of a material fact, (2) the party claiming the benefit had a right to rely upon that fact, (3) he did rely upon it, and (4) thereby suffered loss or damage. Since the misrepresentation upon which the Commissioner says he relied was the statement in the petitioner’s return which described him as a dealer in securities, it is necessary to consider that statement to see whether or not it is the basis of an estoppel.

Section 22 (c) of the Revenue Act of 1928 provides that inventories shall be used as the Commissioner may prescribe in his regulations. He provided in his regulations that only a “dealer” could inventory his securities, and he there defined a dealer as a merchant of securities with an established place of business, regularly engaged in the purchase of securities and their resale to customers. Art. 105, Regulations 74; Schafer v. Helvering, 299 U. S. 171. The question of whether or not a particular person is a dealer within the meaning of the term as defined in the Commissioner’s regulations involves a mixed question of law and fact. Consequently, the petitioner’s statement on his return that he was a dealer in securities could have been no more than his conclusion on a matter as to which there is room for difference of opinion. Schafer v. Helvering, supra; Helvering v. Fried, 299 U. S. 175; Helvering v. Einhorn, 299 U. S. 175; Edmund S. Twining, 32 B. T. A. 600; affd., 83 Fed. (2d) 954; certiorari denied, 299 U. S. 578; Berks County Trust Co. v. Commissioner, 78 Fed. (2d) 810; Harriman National Bank v. Commissioner, 43 Fed. (2d) 950; Hammitt v. Commissioner, 79 Fed. (2d) 494; C. E. Wilson, 29 B. T. A. 1022; affd., 76 Fed. (2d) 476. The statement by the petitioner on the return that he was a dealer was not a statement of fact upon which the Commissioner could rely, but was a conclusion of the taxpayer upon a question as to which the prudent Commissioner would have to draw his own conclusion. That conclusion involved the proper interpretation of the Commissioner’s own regulations and the application of those regulations to the facts. The Commissioner well knew that he could not afford to rely upon the petitioner’s conclusion. The Commissioner can not successfully claim to be misled about such matters. Tide Water Oil Co., 29 B. T. A. 1208. Nor do we suppose that he actually relies upon such statements in returns. His failure to investigate as to 1980 may have been due to other causes. There is only an inference that it misled him in this case. A similar statement -was made on the 1931 return, yet the Commissioner made a timely investigation as to that year. The mere fact that he delayed in investigating 1930 does not prove that he was misled. If the petitioner had misstated or misrepresented any material fact bearing upon the question of whether or not he was a dealer within the meaning of that term as defined in the Commissioner’s regulations, the situation would be different. The petitioner apparently thought that he could be correctly described as a dealer. Thus, three of the essentials of an estoppel are lacking, to wit, a misrepresentation of some material fact upon which the other party had a right to rely and did rely.

Another essential of an estoppel is also lacking. The Commissioner has failed to prove damage. He has shown that he lost almost $21,000 of tax that was due for 1930, but in this case that was not enough. The closing inventory for 1930 was also the opening inventory for 1931. Although the petitioner used that closing inventory erroneously to his advantage for 1930 he used the same inventory just as erroneously in 1931 and reported for that year net income of $2,529.17 when a correct return would have shown a net loss of about $55,000. The statute permitted him to carry forward that net loss into 1932. It does not appear that he did so. He may have lost forever the benefit of that deduction for 1932, and it is possible that he overpaid taxes for 1932 in excess of the amount which he erroneously failed to pay for 1930. In other words, the final result of the error which the taxpayer made in using a closing inventory for 1930 may be that he has paid more tax than he owes. In this state of the record it can not be held that the Commissioner has proven a loss. The Commissioner had the burden of proof to establish estoppel, and a lack of proof is not to be supplied by inference. The error for 1930 may not be corrected by a deliberately erroneous computation of the tax for 1931. The loss which the petitioner sustained in 1931 so far exceeds the other items in controversy that it is apparent that there is no deficiency for that year.

The respondent relies upon the recent decision in the case of L. T. Alverson, 35 B. T. A. 482, but the two cases are somewhat different. There Alverson had kept books and had used inventories for a period of years, with the approval of the Commissioner. He sought to change to the cost basis without any adjustment for the cost recovered in prior years. A change such as that requires an adjustment at the time of the change if the use of inventories was proper in the prior years. Here the petitioner kept no books and never was permitted by the Commissioner to use inventories.

Decision will be entered for the petitioner.