author: Disney :

text:
    The Atlantic Land Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100410.
    Promulgated December 11, 1940.
    /. Garfield Houston, Esq., for the petitioner.

      J. Harrison Miller, Esq., for the respondent.

       Originally entered as a memorandum opinion of the same date.

   OPINION.

Disney :

This proceeding involves income tax for the calendar year 1936 in the amount of $3,129.65, in which amount deficiency was determined by the Commissioner. All facts were stipulated and we find the facts as so stipulated. They may, so far as necessary to the examination of the question involved, be summarized as follows:

The petitioner is a corporation organized under the law of Pennsylvania, has its principal office in Pennsylvania, and filed its income tax return for 1936 with the collector of the twenty-third district of Pennsylvania.

The deficiency of $3,129.65 resulted from the Commissioner’s determination that a dividend of $18,350, declared by petitioner’s board of directors on December 30, 1936, payable on that day and credited on petitioner’s books, without restrictions as to withdrawals, on December 31, 1936, in the proper amounts to each of petitioner’s stockholders as an account payable was not “paid” during 1936 within the meaning of section 27 (a) of the Revenue Act of 1936.

The dividend was declared to stockholders of record December 20, 1936, and charged to earned surplus. The purpose in declaring the dividend was to establish credit for undistributed profits taxes. Petitioner throughout 1936 had an earned surplus accumulated after February 28, 1913, in excess of the dividend declared. Petitioner had five directors, all of whom were present at the meeting on December 30, 1936, and three of whom were also stockholders of petitioner entitled to share in the dividend. Only two other stockholders were entitled to share therein. On December 30 and 31,1936, petitioner had $7,709.23 cash on hand available for payment of dividends, and unencumbered investments available for payment of dividends, consisting of stocks and bonds, in the amount of $185,298.76, cost as entered on petitioner’s books, but of a market value of $291,155.12.

At the directors’ meeting on December 30, 1936, petitioner’s president informed the three stockholders present that the dividend was available to any stockholder who desired to receive it forthwith, and that the amounts respectively payable would be credited to each on the company’s books without restrictions as to withdrawals; also that this constituted payment of the dividend for income tax purposes, requiring them to report the dividend in their income tax returns for the year 1936. All did so, and paid income taxes accordingly. One of the stockholders present at the meeting held a power of attorney for the other two stockholders who were not present, authorizing her to act for them in matters relating to their stock in petitioner, and for some years she had acted as their representative at meetings of stockholders and directors of the petitioner and in other business matters in which they were concerned. During December 1936 the bank account of the petitioner was subject to vsdthdrawal by checks signed by any two of its officers.

The accounts payable representing the dividends credited to the stockholders on petitioner’s books on December 31, 1936, were actually paid to them in cash on January 29,1937, February 5,1937, and March 11, 1937.

Was this dividend “paid” within 1936, within the meaning of section 27 (a) of the Eevenue Act of 1936? The Treasury regulation with reference to that section, Regulations 94, article 27 (b), reads in part as follows:

(b) When dividends are considered, paid. — A dividend will be considered as paid when it is received by tbe shareholder. A dividends paid credit can not be allowed unless the shareholder receives the dividend during the taxable year for which the credit is claimed.
* * * * * * *
If a corporation, instead of paying the dividend directly to the shareholder, credits the account of the shareholder on the boohs of the corporation with the amount of the dividend, the credit for a dividend paid will not be allowed unless it be shown to the satisfaction of the Commissioner that such crediting constituted payment of the dividend to the shareholder within the taxable year.

We think this case is governed by Valley Tractor & Equipment Co., 42 B. T. A. 311. The only difference between the situation in the two cases is the fact that no checks were issued in the instant proceeding. The credits were, however, without restriction as to withdrawal, so that no check by the corporation was necessary, the only thing necessary being withdrawal by the stockholders. That there was not sufficient cash to pay all dividends is immaterial under Saenger, Inc. v. Commissioner, 84 Fed. (2d) 23; certiorari denied, 299 U. S. 578, and Baker v. United States, 17 Fed. Supp. 976, as we said in the Valley Tractor & Equipment Co. case, supra. The stockholders had due notice. They reported the amounts credited to them in their income tax returns for 1986 and paid the tax thereon. The object of the statute has been satisfied. We hold that the dividends were paid within the purview of section 27 (a) of the Revenue Act of 1936.

Decision will be entered for the petitioner.

       SEC. 27. CORPORATION CREDIT FOR DIVIDENDS PAID.
      (a) Dividends Paid Credit in General. — For the purposes of this title, the dividends paid credit shall be the amount of dividends paid during the taxable year.


source: Caselaw Access Project

license: Public Domain

text:
    American Liberty Oil Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 98487, 98488.
    Promulgated December 13, 1940.

      J ofotiB. King, Esq., for the petitioner.

      Jwmss E. Teatman, Esq., for the respondent.
   OPINION.

Disney :

These proceedings were consolidated for hearing and report and involve the redetermination of deficiencies of $54,778.42, $723.55, and $97,929.97 in income tax for the respective years 1932, 1933, and 1934, and a deficiency of $13,735.90 in excess profits tax for the year 1934. All of the facts, except those relating to the deductibility of an item of $120,000, were stipulated. The stipulated facts are incorporated herein by reference as our findings of fact on the issues to which they apply. Separate findings of fact will be made on the issue involving the item of $120,000.

The petitioner, a Delaware corporation, was organized on May 28, 1932. In August 1932 and in 1933 it organized under the laws of Delaware the Wofford Production Co. (hereinafter referred to as the Wofford Co.) and the Southern Liberty Oil Co. (hereinafter referred to as the Southern Co.), respectively, both of which are wholly owned subsidiaries of petitioner.

The petitioner and the Wofford Co. filed a consolidated return for 1932. In 1933 the petitioner, the Wofford Co., the Southern Co., and other corporations filed a like return.

Issue 1. — Income from Oil and Gas Lease.

In January 1931 E. L. Pinkston and his wife executed an oil and gas lease in favor of the Warner-Quinlan Co. (hereinafter referred to as the Warner Co.) on a tract of land in Eusk County, Texas. The lessors reserved a royalty of one-eighth of the oil and gas produced and saved from the premises. As further consideration the lessors were to receive from the lessee a maximum of $31,000 payable only out of and from one-eighth of the seven-eighths of the oil produced, saved, and sold from the leased premises.

In October 1931 the Warner Co. assigned the lease to the Mills Bennett Production Co. (hereinafter referred to as the Mills Co.), in consideration for which the assignee assumed the obligations of the lease and agreed to' pay to the assignor the sum of $2,000 for each acre covered by the lease “solely out of one-fourth of the proceeds received by Buyer [Mills Co.] from the sale of its seven-eighths of the oil and/or gas produced, saved and marketed from said leased premises, if, as and when produced.”

On August 9, 1932, the Mills Co. assigned the lease, together with seven completed wells, equipment, and personal property in and on the land, to W. M. Wofford in consideration for two notes for $35,000 each, payable in three and six months, Tespectively, and the assumption of the oil payments to the Pinkstons and the Warner Co. To secure the payment of the notes and the amounts assumed by Woffoi-d, the assignor reserved a vendor’s lien against “each and all the leasehold and property hereby conveyed and assigned.” There were expressly excluded from the assignment all drilling rigs, drilling rig equipment on the leaseshold, and surplus casing and line pipe.

On August 12, 1932, Wofford assigned his interest in the lease and all property thereon to the Wofford Co. subject to the assignment contract of August 9,1932, between himself and the Mills Co.

In 1932 and 1933 the Wofford Co. made the following oil payments under the lease: In 1932, to E. L. Pinkston and wife, $25,727.65, and to the Warner-Quinlan Co., $27,421.09; in 1933, to the Warner-Quinlan Co., $40,445.27. These amounts were not included in the consolidated returns of the petitioner. In his determination of the deficiencies the respondent included the amounts in gross income of the Wofford Co. and allowed as a deduction for depletion 27% percent of the amount of the payments. The petitioner alleges that the amounts do not constitute income of the Wofford Co.

The petitioner contends that the question is controlled by Thomas v. Perkins, 301 U. S. 655, and the respondent relies upon the more recent case of Anderson v. Helvering, 310 U. S. 404. In the Perhms case the oil lease was assigned for cash and $395,000 payable only out of one-fourth of the oil produced and saved from the leased premises. The payment was not a personal obligation of the assignee and the instrument assigning the lease did not purport to reserve a lien. The Court held that the assignment withheld “from the operation of the grant one-fourth of the oil to be produced and saved up to an amount sufficient when sold to yield $395,000.” So holding, the assignors of the assignee were held to be taxable on the income from the interest in oil which they reserved in the assignment. In the Anderson case there was a conveyance of certain royalty interests, fee interests, and deferred oil payments for cash and $110,000 payable “from one-half of the proceeds received by him [assignee] which might be derived from oil and gas produced from the properties and from the sale of fee title to any or all of the land conveyed.” The assignor retained a first lien against “ ‘that one-half of all oil and gas production and fee interest * * * from which the $110,000 is payable,’ the lien and claim ‘not in any way [to] affect the one-half interest in all oil and gas production and fee interest or the revenue therefrom which * * * [it] is to have and receive undei this agreement.’” In holding that Anderson, as assignee, was taxable upon the gross proceeds of oil produced from the premises, the Court pointed out that the assignor was not dependent upon oil production alone for its deferred payment of $110,000, that payments made from other than oil and gas production would not be entitled to depletion, and that “the reservation of this additional type of security for the deferred payments serves to distinguish this case from Thomas v. Perkins." As to the force of its decision in the PerMns case, it said:

* * * In the interests of a workable rule, Thomas v. Perkins must not be extended beyond the situation in which, as a matter of substance, without regard to formalities of conveyancing, the reserved payments are to be derived solely from the production of oil and gas. * * *

It is clear from a reading of these cases that, in situations where the lessor’s reserved interest is payable only out of production of oil and gas, the amount attributable to that interest is not income of the lessee, but where the amount may be paid from another source, as, in the Anderson case, from the proceeds of sales of the fee title to land conveyed, the gross income from production is taxable to the lessee. The payments in question here were made to the original lessors and their' lessee. Were their oil payments to be derived solely from the production of oil and gas ? If so, the Perkins case governs the issue.

In addition to the usual owner’s royalty interest of one-eighth, the Pinkstons, the original lessors, were entitled to receive a maximum of $31,000 “with and from %th of the %ths of the first oil that may be produced, saved and sold by lessee from the leased premises, * * * the obligation to pay said additional consideration, * * * to arise only if, when and as the oil from which, same can be made is produced, saved and sold as hereinbefore provided.” The assignment contract between the Warner Co., the original lessee, and the Mills Co. contains terms equally as clear that the payment reserved by it, being $2,000 per acre, was to be derived solely out of oil and gas produced. It not only provides that the consideration was payable only out of one-fourth of the assignee’s seven-eighths interest in oil and gas produced from the lease, but, to eliminate any doubt as to intent, expressly provides “that the obligation of the Buyer [Mills Co.] to pay the said sum of money is conditioned that the same can be liquidated by the application of one-fourth of the proceeds received by the Buyer from the sale of its seven-eighths of the oil and/or gas produced, saved and marketed from said leasehold.” These provisions, without more, bring the case within the Perkins case, as clarified by the Anderson decision.

But respondent insists that the payments were not payable solely out of oil and gas because the “assignors” had a lien on the equipment on the* leasehold for the amount of their payments. In its acquisition of the lease, the Mills Co. agreed to pay the Warner Co., its assignor, $2,000 per acre out of oil and gas production, and assumed the obligations of the lease. Wofford, as the assignee of the Mills Co., gave the latter notes aggregating $70,000, without designating any source of payment, and assumed the oil payments to the Pinkstons and the Warner Co., the assignor reserving a vendor’s lien against the leasehold and property assigned by the instrument, as security for the obligations of Wofford. The Wofford Co. acquired the lease subject to the assignment contract between the Mills Co. and Wofford.

We fail to see how the lien reserved by the Mills Co. affects the question in any material way. The payments here involved were made to the original lessor and lessee, neither of which had security for the payments reserved by them or could derive amounts from any source other than oil and gas production. Amounts payable to them were wholly contingent upon the production of oil and gas. Such benefits as the lien conferred were in favor of the Mills Co., which had no interest in oil and gas production on the lease except to see that its liability to the owners of the land and their lessee was discharged. We are of the opinion that the Perkins case governs. Accordingly, it was error for the respondent to include the payments in question in gross income of the Wofford Co. In view of this holding and in accordance with the stipulation of the parties, there should be eliminated as a deduction from gross income of the Wofford Co. the amounts allowed by the respondent as deductions for depletion on the amounts paid on the reserved oil payments.

Issue 2. — Deductibility of Taxes.

Upon the incorporation of petitioner on May 28, 1932, it acquired in a nontaxable reorganization all of the assets and assumed all of the liabilities of the Golding-Murchison Oil Co. Petitioner’s books were kept and its income tax returns filed on the accrual basis. The petitioner accrued on its books in 1932 and subsequently paid state, county, and independent school district taxes of the State of Texas for 1932 on the property acquired in the reorganization.

The question is whether the taxes are deductible from gross income of the petitioner for 1932. In Texas Coca-Cola Bottling Co., 30 B. T. A. 736, we held that like taxes of the State of Texas accrue and become a lien on the property on January 1 each year and that a purchaser of the property thereafter within the tax year may not deduct the amount thereof as taxes paid or accrued within the year, but must add the amount to the cost of the property acquired. The petitioner relies upon Corondelet Building Co. v. Fontenot, 111 Fed. (2d) 267, in contending that only five-twelfths of the taxes should be capitalized as part of the cost of the property, and that the remainder is deductible from gross income. The case relied upon by petitioner involved taxes of Louisiana and does not control the question here. Taxes on real property in Louisiana are not a personal liability of the owner and do not become a lien until November 27 of the tax year. In the State of Texas, as we pointed out in the Texas Coca-Cola Bottling Co. case, supra, taxes are a lien on the property on January 1, and the owner of the property on that date is personally liable for the amount of the taxes. Cranfill Brothers Oil Co. v. State, 54 S. W. (2d) 813; Humble Oil & Refining Co. v. State, 3 S. W. (2d) 559. The respondent’s action in disallowing a deduction for the amount of the taxes was proper.

Issue 3. — Profit on Sale of Leases and Equipment.

On April 18, 1934, the petitioner sold to the Atlantic Oil Producing Co. (hereinafter referred to as the Atlantic Co.), for $1,600,000 cash, certain leasehold interests and equipment used on the leased premises for the production of oil and gas therefrom, excepting from-the sale, however, 4,400,000 barrels of oil when, as, and . if produced. The contract was carried out in accordance with its terms, except that petitioner received a cash consideration of $1,500,-000 in the sale. On April 18, 1934, third parties held contracts entitling them to receive a total of $1,206,391.17 from the proceeds of the sale of oil if, as, and when produced from the leases. This amount was to be deducted or paid from the 4,400,000 barrels of oil reserved by the petitioner.

The petitioner’s interest in the oil reserves in the land covered by the leases was estimated by the respondent to be 19,295,522 barrels as of January 1, 1934. From that date to April 18, 1934, 205,919 barrels of oil were produced from the leases. The fair market value on April 18,1934, of the 4,400,000 barrels of oil reserved by petitioner, less the sums payable to third parties, was not less than $1,596,804.41.

On April 18, 1934, the depreciated cost of the lease and well equipment thereon was $648,134.05 and the cost of the leaseholds, less depreciation allowed or allowable, was $946,828.01. Legal expenses on titles, commissions, and cost of abstracts incurred by petitioner in connection with the sale were $19,149.96.

The issue is the correct method of computing gain or loss on the sale. All of the factors necessary to make the computation are embodied in the stipulation. Petitioner reported no gain from the transaction, for reasons not apparent from the record. In his determination of the deficiency for 1934, the respondent determined a taxable gain of $706,780.16, by deducting from the cash consideration of $1,500,000, a base of $781,827.13 for the interest sold, plus $11,392.41 for allowable depletion. The base arrived at is the same percentage of the total cost of the leases and lease equipment ($1,614,122.02) as the value of the interest sold ($1,500,000) bears to the total value ($3,098,804.41) of the interest sold and interest retained.

We had a similar question in Columbia Oil & Gas Co., 41 B. T. A. 38, now before the Circuit Court of Appeals for the Fifth Circuit, on petitions filed by both parties. The respondent assumes that we will follow that case here and makes no new contentions. Petitioner is satisfied with the result we reached in that case to the extent that the adjusted basis for the lease equipment is deductible in full from the cash received. It contends that no part of the base of the property sold should be allocated to the oil reserved in the sale and that, if the cost of the leases is allocated between the oil sold and the oil reserved, it should be made in the ratio that the number of barrels of oil reserved bears to the number of barrels of oil sold.

The first point raised by petitioner was considered and rejected by us in the Columbia Oil & Gas Co. case, supra, and is the same as that advanced by the member dissenting from the decision. We are of the opinion that the conclusion reached by the majority in that case is correct and, accordingly, will follow it here.

The method proposed by petitioner for the allocation of the adjusted basis of the leaseholds between the portion sold and the portion retained on the basis of the oil reserved and oil sold was also considered in the Columbia Oil & Gas Co. case and rejected in favor of a method having as its foundation the values of the interests in the leases sold and retained. The plan adopted was regarded as producing more equitable results on the facts of the case than the “barrel” method proposed by the taxpayer.

The ratio of oil reserved to the oil sold is greater here than it was in the Columbia Oil & Gas Co. case and the value of the interest in the oil sold in comparison with the value of all of the property sold, less equipment, is about half of the ratio found in that case. While the facts here do not result in as wide a difference between the so-called “barrel” and “value” methods of apportionment as there was in the Columbia Oil & Gas Co. case, we think the method applied there should be followed here. Accordingly, the method used for determining gain in that case will be followed here in the recomputation of gain or loss on the transaction under Rule 50.

Issue 4- — Expense of Sale.

FINDINGS OF FACT.

On June 1, 1931, the Golding-Murehison Oil Co. agreed in writing to sell and deliver to the pipe lines of the Tyler Pipe Line Co. (hereinafter referred to as the Tyler Co.) such amounts of oil produced from its properties as the latter might desire to purchase. The contract was not recorded. The agreement was assumed by the petitioner in connection with the acquisition of the assets of the Golding-Murchison Oil Co. in May 1932. Petitioner was not in a position to perform its part of the contract after the sale of its property to the Atlantic Co. on April 18,1934.

A controversy arose between the officers of petitioner and the Tyler Co. as to what should be done about the contract of June 1, 1931, in view of the sale to the Atlantic Co. Negotiations with the Tyler Co. to determine the amount of the liability of petitioner on account of breach of the contract were commenced prior to the sale and continued until April 1936. On April 1, 1936, the Tyler Co. discharged the petitioner from its obligation under the contract of June 1, 1931, for a consideration of $120,000. On June 30, 1936, the amount of the consideration was entered on the books of petitioner in an account entitled “Sale of Leases — Atlantic.” On December 31, 1936, the item was transferred to an account styled “.Earned Surplus— Unappropriated 1934.”

OPINION.

The petitioner contends that the amount of $120,000 which it agreed on April 1,1936, to pay to the Tyler Co. constitutes an expense incurred in making the sale to the Atlantic Co. and should be reflected in computing the profit realized therefrom. It insists that liability for damages for default under the contract was incurred in 1934 and was accruable in that year, even though the amount of the liability was not agreed upon until 1936. The argument is based, in part, upon an assumed showing that an agreement was reached prior to the sale that the Tyler Co. would release petitioner from its obligations under the contract; that the Tyler Co. would sustain damages on account of the breach; and that the amount of the damages would be ascertained later. The proof does not go so far. It was realized that a sale of the leases giving the purchaser the right to receive the oil would be a breach of the contract. Negotiations were commenced prior to the sale to' settle the matter, including the amount of damages sustained, but no agreement was reached thereon until April 1936, about two years later.

Questions of this sort have been before us in numerous proceedings. Each case must be decided on its peculiar facts. In Thorne, Neale & Co., 13 B. T. A. 490, we said:

* * * The sound rule established is that where the taxpayer acting in good faith disputes the liability and does not enter the item as a liability as of the year in which the transaction occurred out of which the liability arose the taxpayer can not taire the deduction in that year but must take the deduction when the liability is finally determined or admitted. * * *

In Lucas v. American Code Co., 280 U. S. 445, the taxpayer sought to deduct in its 1919 return the amount of a judgment recovered against it in 1922 on a contested breach of a contract of employment in 1919. The Court said: “Obviously, the mere refusal to perform a contract does not justify the deduction, as a loss, of the anticipated damages. For, even an unquestionable breach does not result in loss, if the injured party forgives or refrains from prosecuting his claim. And, when liability is contested, the institution of a suit does not, of itself, create certainty of loss.”

The petitioner relies upon Automobile Insurance Co. v. Commissioner, 72 Fed. (2d) 265. In that case claims of the taxpayer against the German Government were allowed by the Mixed Claims Commission in 1928 and the question was whether the amount of the award was accruable as taxable income in 1928, the insurance company being on the accrual basis, or whether taxation should be in subsequent years, when partial payments were made on the award. The court held that the amount of the award was accruable as income in 1928,. upon the ground that there was reasonable expectation in that year that payment would be made. No such expectation was shown in Commissioner v. Speyer, 77 Fed. (2d) 824, affirming 30 B. T. A. 517, under another award by the Mixed Claims Commission, and a different conclusion was reached. The facts here do not justify a finding that in 1934 the Tyler Co. had reasonable expectation of receiving any amount.

The sale of the oil to the Atlantic Co. was a breach of the contract with. the Tyler Co. giving rise to a claim for damages. The loss did not, however, occur at that time for the amount of the damages sustained had not been determined until 1936, and at all times prior thereto was in dispute, if not actively contested.

No error was committed by the respondent in refusing to allow the item of $120,000 as a cost or expense in computing the gain realized on the sale of the property.

Issue 5. — The Question as to Liquidation of the 'Wofford Production Co.

The Pinkston lease produced oil and gas from the time of its acquisition in August 1932 by the Wofford Co. Upon the transfer of the lease to petitioner on April 1,1934, for $150,000, the petitioner credited the amount in an intercompany account upon its books to cover transactions with the Wofford Co. The credit left a balance due the Wof-ford Co. of $146,825.90. The lease had a fair market value of $260,000 on April 1,1934.

The Pinkston lease was the only operating asset owned by the Wofford Co., and after it was transferred to petitioner there remained as assets of the Wofford Co. cash in the amount of $139.21 and an account receivable of $146,825.90 due from petitioner, and liabilities consisting of a small amount for taxes, which was paid in 1934.

The Wofford Co. has not acquired any assets or conducted any business operations since April 1, 1934. Neither has petitioner paid anything to it on account of the indebtedness of $146,825.90. The franchise taxes of the Wofford Co. since 1934 have been paid by petitioner. The Wofford Co. has not been formally dissolved and its stock has not been canceled.

Since December 31, 1934, the petitioner has paid $4,641.98 in franchise, income and other taxes for the account of the Wofford Co., all of which was charged to the Wofford Co. on petitioner’s books. The amount paid included Federal income and excess profits taxes of $3,460.56 for 1934, resulting from the sale of the Pinkston lease to petitioner.

The respondent determined in his computation of petitioner’s tax liability for 1934 that when the Wofford Co. transferred its sole operating asset to petitioner and discontinued business, the trans-feror, in substance, “became liquidated.” He found that petitioner actually received, in distribution, the sum of $110,000, representing the difference between the fair market value and the recited selling price for the Pinkston lease, and that it constructively received, also as a liquidating dividend, the sum of $146,825.90 owing by it to the liquidating corporation. Article 22 (a)~l of Regulations 86 was cited by the Commissioner in connection with his action as to the item of $110,000, and petitioner raised no issue respecting the matter. Upon brief it concedes that a profit in that amount was realized by reason of receipt from a wholly owned corporation for $150,000 of property having a fair market value of $260,000. The question for decision is whether the item of $146,825.90 is taxable to petitioner as gain resulting from distributions in liquidation of the Wofford Co.

Upon brief respondent contends that the Wofford Co. was “in substance and in fact liquidated” as effectively as though it had been formally dissolved, notwithstanding the fact that the corporation continued in existence by payment of its franchise taxes. The fact that petitioner held all of its stock and hence had absolute control over the account receivable is stressed by respondent.

This Board has said that the word “liquidation” as applied to a corporation is recognized by textwriters and courts as meaning “the operation of winding up its affairs by realizing its assets, paying its debts and appropriating the amount of profit or loss”, and that liquidation of a corporation is “an existing condition brought about by affirmative action, the normal and necessary result of which is the winding up of the corporate business.” W. E. Guild,, 19 B. T. A. 1186. In Fred T. Wood, 27 B. T. A. 162, we said with respect to the meaning of the term “liquidation”:

* * * There must be a manifest intention to liquidate, a continuing purpose to terminate its affairs and dissolve the corporation, and its activities must be directed and confined thereto. It contemplates an impairment of capital or a retirement of outstanding stock, though a distribution, if one of a-series of distributions in liquidation, may be a liquidating dividend even if it, of itself, does not impair capital. Liquidation can not be brought about by mere declaration, and the question of whether a corporation is in liquidation is therefore one of fact. * * *

It has been said that the decisive factor is “whether the distribution was made with the intent to maintain the corporation as a going con-eem or "with tlie intent to liquidate the business.” Horn, & Hardart Baking Co. v. United States, 84 Fed. Supp. 89.

Although respondent’s contention here is based upon the theory that the Wofford Co. was liquidated in 1934, his determination of tax liability of petitioner is not strictly in accordance with such argument. As we have already pointed out, instead of treating the Pink-ston lease as a distribution in liquidation, he regarded it as a sale by a corporation to a shareholder at a price substantially less than its fair market value, which, therefore, resulted in taxable income to the purchaser under section 22 (a) in an amount measured by the difference between the price paid for the property and its fair market value. Notwithstanding such treatment of the transaction, the alleged gain was included in petitioner’s gross income as a liquidating dividend. In determining the tax liability of the Wofford Co. he regarded the transaction as a sale resulting in taxable income to it. The computation of tax liability attached to the deficiency notice contains no indication that he made any deduction for the basis petitioner had in stock of the Wofford Co. or for the outstanding liabilities of the corporation. Neither did he regard the cash of the Wofford Co. as having been distributed, although, as an asset capable of being distributed, its status did not differ from the account receivable.

It is apparent from these observations that the respondent’s action in determining the deficiency was at least inconsistent with a finding of complete liquidation, if not arbitrary. Determinations of that sort are not entitled to the same weight before this Board as determinations having a proper foundation. Helvering v. Taylor, 293 U. S. 507. The question was presented to us upon an agreed statement of facts and our decision must be made upon such facts. Weaver v. Commissioner, 58 Fed. (2d) 755; Iowa Bridge Co. v. Commissioner, 89 Fed. (2d) 777; Norfolk National Bank of Commerce & Trusts v. Commissioner, 66 Fed. (2d) 48.

A somewhat similar situation prevailed in Walker Products Corporation, 30 B. T. A. 636. In that case all of the stock of the Charles B. Luker Co. was owned by the Pittsburgh Melting Co., the stock of which and other corporations was owned by a holding company dominated by the same interests. The Charles B. Luker Co. sold its principal asset in June 1924 and took back a purchase money mortgage maturing three years later. During that period the corporation’s assets consisted entirely of the mortgage and an account receivable against its stockholder. It did no business in 1925, 1926, and 1927, but was kept alive with the view of acquiring another plant to operate. In 1927 the Pittsburgh Melting Co. gave up the idea of acquiring the plant for its subsidiary and disposed of the mortgage and closed out the account receivable. From these and other facts we held that liquidation occurred in 192Y.

A case more in point is C. M. Menzies, Inc., 34 B. T. A. 163, in which there was a disposition in 1931 of all of the corporation’s assets to an individual owning 90 percent of the stock for an amount, evidenced by the transferee’s note, equal to the net worth of the corporation and an assumption of the corporation’s indebtedness. Payments were made on the note at various times thereafter and the note was paid in full in 1935. No steps were ever taken to dissolve the corporation and at the time of the hearing it was still in existence. Such activities as the corporation engaged in after 1931 related to collection of the note and management of the property conveyed to it in part payment thereof. The question was whether the disposition of all the corporation’s assets was a sale or a distribution in liquidation. This fact and the fact that the return of the corporation for 1931 stated that it was abandoned after the disposal of its assets was held not to be decisive. In holding that no liquidation occurred in 1931 we emphasized the fact that the corporation had not been dissolved, that no steps had ever been taken to dissolve it, that it had not been abandoned, and that it was still in existence.

Here petitioner owned all of the stock in the Wofford Co., but the point is no more decisive in these proceedings than it was in C. M. Menzies, Inc., supra, where the transferee of the corporation’s assets owned 90 percent of its stock. O. Moorshead, 28 B. T. A. 253. Power to cause the liquidation of a corporation is far removed from an intent to liquidate and liquidation in fact.

Aside from the transfer of the lease, in connection with which petitioner concedes tax liability upon a theory other than partial or complete liquidation, no asset of the Wofford Co. was actually distributed to petitioner. The account receivable was not charged off or otherwise disposed of during the taxable year, and it still constitutes an asset of the Wofford Co. Respondent’s determination that the account receivable was received by petitioner in liquidation proceedings rests entirely upon the theory that it was constructively received. The doctrine of constructive receipt must be sparingly applied. John A. Brander, 3 B. T. A. 231. No justification appears for its application here.

We conclude that the Wofford Co. was not in liquidation in 1934 and that it was error for respondent to include the item of $146,825.90 in petitioner’s gross income as a liquidating dividend.

Issue 6. — The Question as to Liquidation of the Southern Liberty Oil Co.

The properties of the Southern Co. consisted of various oil and gas leases in the Conroe Field in South Texas. On November 30, 1934, it conveyed all of its producing properties to petitioner for a recited consideration of $177,011.93. Prior thereto petitioner made advances to the Southern Co., which were carried on petitioner’s books as an account receivable from the Southern Co. On December 31, 1934, the balance due petitioner in the account was $71,194.15.

The respondent treated the sale as a liquidation of the Southern Co. and computed taxable gain thereon of $172,958.88 by valuing the property transferred at $374,970.81 and holding that the excess of the figure over the recited consideration, plus $25,000 as basis for capital stock, was taxable gain. In making the computation respondent did not allow as a deduction the indebtedness of the Southern Co. to petitioner, aggregating $71,194.15.

In computing the consolidated net income of petitioner for 1933, the respondent allowed as a deduction a net loss of the Southern Co. in the amount of $82,740.32.

The Southern Co. was not dissolved in 1934. It is still in existence. For the year 1934 and subsequent years it has paid its franchise taxes and has filed income and capital stock tax returns.

In its petition and amended petition filed herein, petitioner alleged as error the respondent’s failure to allow as a deduction in his computation of the liquidating dividend received from the Southern Co. the amount of $71,194.15 for unpaid advances. The prayers, however, ask that the “profit, if any” realized in the transaction be reduced by the balance in the account for advances. The amended answer filed by the respondent admits the allegation of error and requests that there be reflected in the computation of gain the net loss of $82,740.32 sustained by the Southern Co. in 1933, thereby increasing the liquidating profit by $11,546.17 or to $184,505.05 and giving rise to an increased deficiency. Petitioner’s reply to the amended answer admits, in effect, that the value of the equipment transferred was $374,970.81, as determined by respondent in his computation of the deficiency. It then alleges that the gain realized was $126,764.43, computed as follows:

Value of property transferred-$374, 970. 81
Less:
Advances_$71,194.15
Consideration paid for property-177, Oil. 93
- 248,206. 08
$126,764. 73

Upon brief respondent makes an unconditional statement that the Southern Co. was liquidated and that liquidation was accomplished in the form of a sale of its assets to its sole stockholder. He then proceeds to argue the point raised by his amended answer under the assumption that there is no issue whether a liquidation, in fact, occurred. Petitioner’s argument upon brief is merely that except for the corporation to which the indebtedness was owing, the Southern Co. had the same status as the Wofford Co. at the close of 1934; that if the transfer of operating assets of the Wofford Co. was equivalent to' a liquidation,- then liquidation occurred here; and that if the indebtedness of petitioner to the Wofford Co. constitutes income to petitioner, the indebtedness of the Southern Co. to petitioner should be allowed as a deduction under this issue. Neither party filed a reply brief.

The computations of the respondent are based upon a determination that the Southern Co. was liquidated. The petitioner’s present theory is consistent with the one advanced in the issue involving the Wofford Co. except for the deduction of the item for advances, and is within the prayers of the petition and amended petition. It has been said that “The relief demanded is gauged by the prayer.” Moise v. Burnet, 52 Fed. (2d) 1071. Under that rule, the prayer here would present the general question of whether a profit was realized, and, if so, the amount thereof.

In any event, we think that under the prevailing circumstances our duty is to determine whether petitioner realized taxable gain in the transaction in the amount alleged by the respondent. See Charles L. Coughlin, 15 B. T. A. 515; John I. Chipley, 25 B. T. A. 1103; Houston Lighting & Power Co., 34 B. T. A. 745.

If the petitioner realized income in the form of taxable gain, it was only by reason of a partial or complete liquidation of the Southern Co. As to that point, the facts are in all material respects the same as those involved in the preceding issue, and our decision is that petitioner realized no taxable gain in 1934 from distributions of liquidating dividends by the Southern Co. Under that issue petitioner conceded the receipt of taxable income from the Wofford Co. to the extent that the fair market value of the property transferred exceeded the recited consideration in the transaction. The petitioner’s argument here embodies a like concession by admitting taxable gain equal to the difference between the value of the property and advances and the amount of the consideration. The lease was transferred on November 30, 1934, and at the close of the year the amount due petitioner from the Southern Co. for advances was being carried as an account receivable, and, therefore, an asset, of the former. No contention is made, and the stipulated facts do not establish, that the account constituted part of the consideration for the transfer of the lease. Neither does it appear that the account has at any time since the close of 1934 been written off or otherwise eliminated from petitioner’s books. Under the circumstances, the item of $71,194.15 may not be used to reduce gain realized by petitioner in the transaction. Accordingly, we hold that the taxable income realized by petitioner in this transaction was $197,958.88, representing the difference between the fair market value of the assets transferred and the recited consideration therefor, of which $184,505.05 may be included in petitioner’s income under Eule 50.

The parties have stipulated that depreciation allowable on the Pinkston lease for 1932 and 1933 should be recomputed on the basis of 1,600,000 net barrels of recoverable oil. This agreement will be reflected in the recomputation of the deficiencies to be made under Eule 50.

Decision will be entered wnder Bide SO.


author: Stbrnhagen :

text:
    Marjorie Lipe Stacy, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99420.
    Promulgated December 13, 1940.

      Benjamin E. Shove, Esq., for the petitioner.

      Loren P. Oahes, Esq., for the respondent.
   OPINION.

Stbrnhagen :

The petitioner is proceeding entirely in her individual capacity, and assails the Commissioner’s determination of the deficiencies in her individual income tax. Neither her receipts nor her deductions as guardian for the Lipe children are in issue. The children are separately taxable upon their income, even though it is received for them by the petitioner as guardian; they have included the amounts in question in their returns, and their taxes are not now in controversy. The petitioner’s dual position as an individual and as a guardian must be kept clear, Van Wart v. Commissioner, 295 U. S. 112.

In determining a deficiency for each of the taxable years in question, the Commissioner has included in petitioner’s individual income the amounts of $56,099.88 for 1933, $50,806.56 for 1934, $44,900.85 for 1935, and apparently $61,233.93 for 1936, although this last amount can not be clearly identified in the copy of the deficiency notice appended to the petition. Recognizing that they were received by the petitioner from the property guardians pursuant to a surrogate’s order directing that they be applied to the care, support, and maintenance of the children, he nevertheless held that the amounts were received by petitioner “as an individual in payment of services in furnishing board and lodgings, care and supervision with respect to the three minor children.” This determination by the-Commissioner is contrary to the evidence. Nothing in either the applications of the guardians of the property or the surrogate’s order-pursuant thereto recognizes a demand of the petitioner or an obligation to her for payment for her services. On the contrary, the petitioner testified, and there is other evidence to show, that she made no such demand and had no intention at any time of charging the-children for any services which she might perform. Clearly she had a right to renounce any such claim which she might have, and it is not for the Government to characterize the allowance made to her as a payment for services.

During the year 1938, as in the years prior thereto, Marjorie Lipe Stacy, 37 B. T. A. 786, petitioner treated $20,000 of the amount which she received from the property guardians as rent, and included it as such in her income on her individual tax return. She now stands by that inclusion and makes no contest of such treatment of the $20,000 by the Commissioner. She shows, however, that in-1933 or 1934 she announced her intention to make no such rent charge,, and after 1933 she omitted any such item from her individual income. This she was entitled to do. There is no obligation upon petitioner to charge rent for the occupancy of any part of the house,, and if, as an individual, she chose to permit the Lipe children to-occupy the house free of rent, no one had any power to require her to do otherwise, and the Commissioner could not properly treat her as receiving the rent which she thus disclaimed.

She did have the right, with the approval of the surrogate, to recover from the children any advance which she had made for their share of the cost of the house, provided their proportionate ownership-of the house was recognized. It has been recognized in the petitions to the surrogate and his order of March 1931 and in her letter of October 23, 1936. Apparently in the early years the petitioner was-permitted to allocate $11,111 to amortization of her outlay of the-children’s share of the cost of the house. But this was not income-to the petitioner; it was a recovery of her advance, as was any other amount which she might properly apply to such amortization.

It is still true, as the Board said in the earlier proceeding covering; 1931 and 1932, that the Commissioner’s concept of the petitioner’s-relation to the income and expenses of her wards is incorrect. The-entire amounts which she received by order of the surrogate were received by her as guardian, and as such she was accountable therefor. The only amount shown by this evidence which petitioner may be regarded as having received individually as income from the allowances made to her as guardian, was the $20,000 treated by her as-rent received. This she has included in her 1933 income, and the inclusion of more than this in 1933 or any part of the allowance in 1934, 1935, and 1936 is in error. The Commissioner’s determination is reversed. There are apparently other items covered by the deficiency determinations which the petitioner does not contest.

Decision will be entered under Bule 50.


author: Muedock :

text:
    Margaret White Marshall (Formerly Margaret White Wood), Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96948.
    Promulgated December 17, 1940.

      Harrison Lillibridge, Esq., for the petitioner.

      L. A. Spaulding, Jr., Esq., for the respondent.
   OPINION.

Muedock :

The Commissioner determined a deficiency of $467.38 in gift tax for the calendar year 1937. The only issue for decision by the Board is whether or not the petitioner made a taxable gift to her children of remainder interests in the corpus of two trusts. The facts have been stipulated and the Board adopts the stipulation as its findings of fact.

The petitioner established two trusts on June 3, 1937, and transferred $10,000 to each. The trusts were irrevocable. The income of one was to be paid to Kathleen Bowen for life and the income¡ of the other was to be paid to Mary Eells for life. The principal of each trust fund was to be distributed to the petitioner upon the death of the life beneficiary, if the petitioner were then living, but in case the petitioner were not then living, the principal was to be distributed among the children of the petitioner and their issue per stirpes.

The petitioner concedes that there was a gift of the life estate in each trust. The parties have stipulated the values of those life estates. The petitioner contends that there was no gift other than the life estate in each trust. The Commissioner concedes that the petitioner reserved to herself a reversionary interest, the value of which must be excluded in computing the taxable gift. He contends, however, that the provisions transferring the property to the children of the petitioner and their issue, in case the petitioner does not survive the life tenants, effected a present gift of contingent remainders and those gifts were subject to tax in 1937. It is upon this latter point only that the parties are in disagreement.

The remainder interest after the death of the life beneficiaries in each trust will either go to the children of the petitioner or revert to the petitioner. But it can not do both. Actuaries are able to compute, by means of tables of experience, the probabilities of whether the petitioner will survive the life tenants and thus enjoy the remainders herself or whether the children will receive the remainders because their mother will fail to survive the life tenants. The parties have stipulated the values which an actuary attributes to the re-versionary interests of the mother and to the remainder interests of the children. The question here, however, is not one of the probabilities as to which way the remainder will go and values based thereon, but it is whether the petitioner made any gift in 1937 of the remainder interests to her children.

The trust agreements clearly evidence the petitioner’s intention to transfer by gift only the life estates and to retain in herself a remainder interest in the entire corpus. The trust instruments accomplished her purpose. The remainder interests in the children are wholly contingent upon her death prior to the termination of the life estates and upon the ascertainment at that time of the particular remaindermen who will take. The death of the petitioner is the indispensable event which may bring one or another of these contingent interests into being. If the petitioner should survive the life tenants, then the children will get nothing. The transfers of the remainder interests to the children are to take effect only in case the petitioner fails to survive the life tenants. Thus, those transfers are to take effect in possession or enjoyment, if at all, after the death of the petitioner. Should the property thus pass at her death, its value will be included in her gross estate for estate tax purposes even though she retained for herself only a possibility of reverter. Sec. 302 (c) of the Eevenue Act of 1926, as amended; Klein v. United States, 283 U. S. 231; Helvering v. Hallock, 309 U. S. 106. The Supreme Court has said that the gift tax and the estate tax are in pari materia and must be construed together; Congress had no purpose to tax gifts before the donor had parted fully with his interest in the property given; and the test of completeness of a transfer for gift tax purposes is the same as that applied in determining whether the donor had retained an interest subject to the estate tax upon its extinguishment at death. Sanford v. Comonissioner, 308 U. S. 39.

The Board in the case of Lorraine Manville Gould Dresselhuys, 40 B. T. A. 30, held that there was no gift subject to tax where property placed in trust was to return to the donor unless a certain event took place, but was to go to others if the event took place. The Board said that a gift must be complete and there is no gift where the tíansfer is subject to a condition precedent, such as 'the one there involved. The reasoning oí the Board there applies with equal force here. The corpus of each of these .trusts will return to the donor unless a certain event takes place, her. death before the death of the life tenants. Thus, there will be no complete transfer of the remainder interest to her children until and unless she dies prior to the death of one or both of the life tenants. The remainders to the children were not taxable gifts in 1937. Emily Trevor, 40 B. T. A. 1241; William T. Walker, 40 B. T. A. 762; Marrs McLean, 41 B. T. A. 1266; Lorraine Manville Gould Dresselhuys, supra; Sanford v. Commissioner, supra.

Section 510 makes the donee of any gift personally liable for the tax to the extent of the value of the gift to such donee. Suppose that the children in this case had been required to pay a tax on the value of their remainder interest in 1937, and suppose, further, that the life tenants had thereafter died while the petitioner was still alive, íhe children would thus have paid a gift tax on something which they never received. It has been pointed out heretofore that Congress probably did not intend to impose a tax under such circumstances. Sanford v. Commissioner, supra; Lorraine Manville Gould Dresselhuys, supra; Hesslein v. Hoey, 91 Fed. (2d) 954. This serves to corroborate our conclusion that there was no completed gift of these remainder interests in 1937 within the meaning of section 501 (a) of the Revenue Act of 1932.

Decision will he entered under Bule 50.


author: Tyson:

text:
    Floyd, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 99562.
    Promulgated December 18, 1940.

      Sidney J,. Hayles, C. P. A., for the petitioner.

      J. Marvin Kelley, Esq., for the respondent.
   OPINION.

Tyson:

This proceeding involves a deficiency of $3,228.78 in personal holding company surtax for the year ended December 31, 1934.

The only question presented is whether in determining petitioner’s undistributed adjusted net income, under section 351 of the Revenue Act of 1934, the respondent erred in disallowing a claimed deduction of $13,445.25 representing an amount set aside from its income for 1934 to retire an indebtedness alleged to have been incurred prior to January 1, 1934.

The proceeding has been submitted upon a stipulation of facts, which is adopted and incorporated herein as our findings of fact. There will be set forth herein only those facts which are deemed necessary to a determination of the issue.

The petitioner is a Georgia corporation, with its place of business in Atlanta.

On November 19, 1932, the internal revenue agent in charge at Atlanta, Georgia, recommended an additional assessment of income tax against the petitioner of $39,114.68 for 1930 and of $15,317.05 for 1931, resulting from the application of section 104 of the Revenue Act of 1928. On May 2, 1933, the Acting Deputy Commissioner approved such recommendation to the extent of $39,114.68 for 1930 and $13,080.11 for 1931. The petitioner filed several protests in Atlanta and Washington, D. C., and at the several conferences held in those cities the petitioner contended that section 104 of the 1928 Act should not be applied to it.

The petitioner made an offer in compromise of the proposed deficiencies for 1930 and 1931, but on May 17, 1934, such offer was rejected as being inadequate.

Under date of June 8, 1934, the Commissioner mailed a formal deficiency notice setting forth his final determination of a proposed deficiency of $52,194.79 in petitioner’s income tax for the years 1930 and 1931. That notice advised the petitioner of its right of appeal to this Board, under section 272 of the Revenue Act of 1928, for a redetermination of the proposed deficiency and, further, if petitioner did not desire to petition the Board, the notice requested petitioner to execute a certain form “permitting an early assessment” of the deficiency. The petitioner duly appealed to this Board, which, on October 9,1935, entered its decision thereon “that there is a deficiency in income taxes for the year 1930 in the amount of $18,775.05 and that there is no deficiency or overpayment in income taxes for the year 1931.” The petitioner did not appeal that decision and, in due course, during 1935, petitioner settled that tax liability, plus interest thereon, by payment of $23,756.70.

On December 31, 1934, the petitioner set aside all of its 1934 net income, in the amount of $13,445.25, in a specially designated reserve fund to apply on the payment of the proposed deficiencies for 1930 and 1931. Such action was taken pursuant to a resolution adopted at a meeting held on the same date by petitioner’s board of directors, which resolution set forth that such action was expedient although the company had denied liability and had employed counsel to contest the asserted deficiencies.

The amount of $13,445.25 so set aside was claimed by petitioner as a deduction for the taxable year 1934, under the provisions of section 351 (b) (2) (B) of the Revenue Act of 1934, which, for the purpose of computing undistributed adjusted net income of personal holding companies, allows a deduction of “amounts used or set aside to retire indebtedness incurred prior to January 1, 1934, if such amounts are reasonable with reference to the size and terms of such indebtedness.” In denying such claimed deduction, the respondent determined that the proposed deficiencies for 1930 and 1931 constituted merely a contingent liability up to and including 1934, and not an absolute “indebtedness” as that word is used in the above quoted statute and as it is defined by article 351-4 of Regulations 86, as amended by T. D. 4777, C. B. 1937-2, p. 196, as “an obligation, absolute and not contingent, to pay, on demand or within a given time, in cash or other medium, a fixed amount * *

The respondent contends that the proposed additional income tax liability for 1930 and 1931 was in controversy during those years and did not ripen into a fixed or absolute indebtedness until finally determined by the Board’s decision entered on October 9, 1935.

The petitioner contends that the claimed deduction has been disallowed, not under the provisions of the applicable statute, but only under a restricted construction thereof by the above quoted regulation.

We are of the opinion that the Board’s decision of October 9, 1935, did not as of that date create a liability or indebtedness of petitioner for income tax for the years 1930 and 1931; for the factual circumstances existing in 1930 and 1931 and the then applicable statute had already fixed petitioner’s tax liability for those years. The deficiency notice proposed the assessment of additional taxes in a certain amount and the Board’s decision redetermined the amount by applying the law to the facts as established by events which had occurred in each of the years 1930 and 1931. The petitioner’s correct tax liability, as imposed by law, was ascertainable at the close of each of the years 1930 and 1931 and the controversy between the petitioner and the Commissioner as to the amount thereof did not serve to postpone the time when the liability, if any, became fixed, or to cause the liability to remain contingent upon a future settlement of the controversy. It is 17611 settled that the liability for Federal income tax is incurred in the year for which the tax is imposed, irrespective of the time the tax may be assessed or may become due and payable, for, all of the events upon which the tax is predicated having occurred in that year, the amount of the tax liability is then fixed by law and ascertainable. United States v. Anderson, 269 U. S. 422; Hygienic Products Co., 37 B. T. A. 202 (and cases therein cited); affd., 111 Fed. (2d) 330; certiorari denied, 311 U. S. 655; Central National Bank of Cleveland, Administrator, 35 B. T. A. 489; Central United National Bank, 33 B. T. A. 588; affd., 99 Fed. (2d) 568; Continental Baking Corporation, 30 B. T. A. 354; affd., 77 Fed. (2d) 119; Brooklyn Union Gas Co., 22 B. T. A. 507, 517, 527; affd., 62 Fed. (2d) 505; and Haverty Furniture Co., 20 B. T. A. 644.

It is also settled that a liability incurred for Federal taxes constitutes a debt to the United States. Billings v. United States, 232 U. S. 261. See also Price v. United States, 269 U. S. 492; and United States v. Proctor, 286 Fed. 272.

Under the cited authorities the petitioner’s income tax liability for the years 1930 and 1931 constituted a debt incurred prior to January 1, 1934, and in our opinion such liability constituted an “indebtedness” as that word is used in section 351 (b) (2) (B), supra.

Since the petitioner’s tax liability for the years 1930 and 1931 constituted an “indebtedness incurred prior to January 1, 1934” and since the amount of $13,445.25 was set aside to retire such indebtedness, which amount was, in the light of facts in the instant case, a reasonable amount, we hold that the respondent erred in disallowing the claimed deduction of $13,445.25 in computing petitioner’s undistributed adjusted net income and its personal holding company surtax for the taxable year 1934.

Reviewed by the Board.

Decision will be entered for the petitioner.


author: Smith :

text:
    Columbia River Paper Mills, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97938.
    Promulgated December 18, 1940.

      Clarence D. Phillips, Esq., for the petitioner.

      B. H. Neblett, Esq., for the respondent.
   OPINION.

Smith :

This is a proceeding for the redetermination of a deficiency in income tax for 1937 in the amount of $2,089.34, of which amount only $1,774.29 is in controversy. The question in issue is whether the petitioner is entitled to deduct from gross income the full amount of interest which accrued upon its bonds outstanding during the year, or only such portion thereof as the number of days that they were outstanding bears to the total interest accrual period.

The proceeding was submitted to the Board upon the pleadings, a signed stipulation of facts, incorporated herein by reference, and certain exhibits received in evidence.

The petitioner is a corporation organized and existing under the laws of the State of Washington, with its principal business office in Portland, Oregon. It was incorporated in 1923. It lias had outstanding from the date of organization both common and preferred shares of capital stock, the preferred shares providing for the payment of accumulative dividends at the rate of 8 percent per annum. For a number of years prior to the taxable year no dividends were paid upon the preferred shares.

Under date of August 1, 1937, the petitioner offered to éxchange for shares of its preferred stock income 5 percent bonds maturing August 1,1967, bearing interest from July 1,1937, payable if earned, at the rate of $140 par value of bonds for each $100 par value of preferred stock. The owners of approximately one-half of the preferred stock outstanding accepted the proposition and sent in preferred stock certificates in exchange for the bonds. Up to December 81, 1937, the petitioner had issued $455,000 of the bonds in exchange for shares of preferred stock.

The petitioner, keeping its books of account and making its income tax returns upon the accrual basis, accrued as interest payable upon its income bonds for 1937 $11,375 (interest from July 1 to December 31, 1937), and claimed the amount as a legal deduction from gross income in its tax return. In his audit of the return the respondent disallowed the deduction from gross income of $5,754.22 of the $11,375 on the ground that this represents the interest which accrued prior to the date the bonds were outstanding.

In his deficiency notice the respondent states in part:

(b) Deduction claimed on account of interest accrued on income bonds, in tbe amount of $11,375.00, is disallowed to tlie extent of $5,754.22 it being held that to such extent the claimed deduction does not represent interest on indebtedness within contemplation of section 23 (b) of the Revenue Act of 1936.

The section referred to above permits the deduction from gross income of “All interest paid or accrued within the taxable year on indebtedness.”

The Commissioner’s regulations do not cover the precise point herein presented. Counsel have not cited any published ruling by the respondent or any Board or court decision that is strictly in point. In Boston Elevated Railway Co., 37 B. T. A. 494, however, one of the questions in issue was whether the company was entitled to deduct as interest from the gross income of 1931 $156,206.11 representing an accrual of interest from July 1 to August 18, 1931. Under a statute dividends on preferred stock were to cease as of July 1 and the preferred stockholders were thereafter recognized as creditors. The trustees for the company fixed August 18 as the date for the surrender and cancellation of the preferred stock. The respondent had disallowed the deduction of the $156,206.11 upon the ground that it had not accrued on outstanding indebtedness. We held (p. 508) that it was deductible as interest. In Hummel-Ross Fibre Corporation, 40 B. T. A. 821, the Board held that a corporation on the accrual basis which issued preferred stock in exchange for its outstanding bonds and accrued interest was entitled to deduct from gross income the amount of the interest which had accrued upon the bonds to the date of exchange.

In this proceeding the respondent does not question the liability of the petitioner to pay the full amount of $11,375 of interest accrued upon its books. He simply says that a portion of that amount is not deductible from gross income because it accrued upon obligations before they were issued and outstanding. He argues that the $5,754.22 disallowed as a deduction represents a dividend paid by the petitioner upon its preferred stock. This is upon the theory that the interest payable on the preferred stock starts to accrue at the 5 percent rate only from the date the income bond was exchanged for shares of preferred stock, and that the interest accrued by the petitioner on the bonds from July 1 to the date of exchange was a dividend payable by the petitioner and not interest upon indebtedness.

We think that this contention of the respondent can not be sustained. Dividends paid by a corporation must generally be paid pro rata to the stockholders. The interest upon the bonds was not so paid. There was clearly no intention on the part of the corporation to pay a dividend in 1937.

Section 23 (b) of the statute permits the deduction of interest “paid or accrued within the taxable year on indebtedness.” It does not say that the indebtedness upon which interest has accrued and become a liability of the taxpayer must be outstanding during the entire interest accrual period. Thus, if a debtor keeping his books of account on the accrual basis is entitled to pay for a bill of goods without interest within sixty days from date of purchase, fails to make such payment within the sixty-day period, thereafter gives an interest-bearing note bearing tbe date of purchase and payable within six months, we think that such debtor would be entitled to deduct the accrual of interest computed from the date that the note bears. The requirement of the statute is, in our opinion, clearly met if the interest accrual period falls within the taxable year, and the payment of the interest becomes a fixed liability of such year, as is the situation here.

The action of the respondent in disallowing the deduction of any part of the interest accrual of $11,375 claimed by the petitioner as a deduction from the gross income of 1937 is reversed.

Decision will be entered, under Rule 50.


author: Tyson :

text:
    Industrial Cotton Mills Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92186.
    Promulgated December 19, 1940.

      Joseph B. Brennan, Esq., and Hilary H. Gardner, G. P. A., for the petitioner.

      F. L. Van Haaften, Esq., for the respondent.
   OPINION.

Tyson :

The respondent has determined an income tax deficiency f or the year 1934, in the amount of $2,251.99, resulting from his dis-allowance of a deduction of $16,378.09 based upon his determination that such amount represented the excess over $2,000 of a capital loss sustained upon petitioner’s disposition of certain machinery and equipment in 1934.

The petitioner assigns error in such determination and alleges that instead of limiting the deduction to $2,000 the respondent should have allowed a deduction of the full amount of $18,378.09 as a loss sustained through the loss of useful value of the capital assets alleged to have been discarded and disposed of at salvage value during that year.

For the purposes of this proceeding, the parties have stipulated the facts as to the items of machinery and equipment involved herein, the time of acquisition and cost thereof, the depreciation sustained theieon, the amount received upon the disposition thereof in 1934 and that a loss was sustained by petitioner on such assets m the amount of $18,378.09 during the taxable year 1934. Such stipulated facts are incorporated herein by reference and need not be set out in full.

The petitioner is a Virginia corporation, having its principal office in Rock Hill, South Carolina. Since its organization in 1921, and including the taxable year 1934, petitioner has been engaged in the business of manufacturing denim, a heavy dyed cotton fabric used for overalls and work garments of various kinds. The manufacture of denim is the most competitive branch of the textile industry and there were only eight concerns, including petitioner, in the United States engaged in its manufacture.

In 1925, at a cost of $15,690.61, petitioner installed a steam plant, consisting of three Lombard vertical boilers with the necessary foundations, pumps, pipes, and fittings, for the purpose of furnishing steam required in the sizing department, the dye house, the finishing room, and in heating the mill. That steam plant had a normal useful life of 20 years when .installed.

By 1932 a number of petitioner’s competitors were producing preshrunk denim by the use of a newly patented Sanforizing process controlled by Cluett, Peabody & Co., which, through advertising, had created a nation-wide demand for preshrunk cotton cloth. In order to meet the competition of other textile mills, the petitioner installed Sanforizing machinery in 1932. Cluett, Peabody & Co. made periodic checks on all users of the Sanforizing process and it was found that petitioner’s low pressure steam plant could not produce the amount of steam pressure required to secure the proper shrinkage. That circumstance required the installation of a new high pressure steam plant, which was completed and put into service during 1934. Thereupon the machinery and equipment of the old steam plant was of no further use to petitioner, or any other textile mill using the Sanforizing process and was permanently discarded from use in 1934, at which time the depreciated and unrecovered cost of such machinery and equipment amounted to $9,629.92. Thereafter, and during 1934, the steam plant machinery and equipment was dismantled. The three boilers were salvaged and sold at a net price of $1,620 and the purchasers thereof removed them from petitioner’s plant at their own risk and for use in connection with certain print cloth but not denim, cotton mills. The balance of the steam plant machinery and equipment, consisting of boiler foundations, pipes, fittings, and pumps, had no sale value and was junked during that year.

In 1927, at a cost of $20,036.61, petitioner installed 10 machines known as speeders, which were then the most modern machines used in one of the last steps of the process of drawing out, paralleling, and twisting cotton fibers preparatory to spinning. Those machines had a normal useful life of 25 years when installed and were used by petitioner up to the spring of 1934. At that time petitioner completed the installation of machinery foT the newly developed process known as long draft spinning, which eliminated the operations and usefulness of petitioner’s 10 speeders. Long draft spinning resulted in the elimination of a good deal of machinery, power, supplies, and labor theretofore used in the old process and lowered the cost of production, so that when petitioner’s competitors installed the new process of long draft spinning petitioner was compelled to do likewise to meet the competition and remain in business.

Upon installation of long draft spinning the petitioner permanently discarded from use its 10 speeders because those machines would never be of any further use to it, or any other producer of denim, or to any other kind of textile mill which hoped to remain in competition with the up-to-date mills. Those 10 speeders had a depreciated cost of $13,205.67 to petitioner when discarded in 1934 and thereafter during that year petitioner sold them to a secondhand dealer for $2,837.50.

In the instant proceeding the parties are in agreement as to the fact that petitioner’s disposition, in 1934, of the speeders, boilers, and the latter’s foundations, fittings, etc., resulted in a loss of $18,378.09 in that year. If the loss resulted from a sale of capital assets, it is allowable as a capital loss deduction under section 23 (j) of the Revenue Act of 1934 only to the extent of $2,000 thereof, pursuant to the limitations of section 117 (d) of that act. If, on the other hand, the loss resulted from a loss of the useful value of capital assets, that is, that the usefulness of those assets suddenly and prematurely terminated through some change in business conditions which caused such assets to be permanently discarded from use, then the loss is deductible in the full amount thereof as an ordinary loss represented by the depreciated basis less the salvage value of such assets. Section 23 (f) of the Revenue Act of 1934 and articles 23 (e)-3 and 23 (f)-l of Regulations 86, which regulations were operative during the taxable year and in all material respects are similar to the regulations under the prior Revenue Acts of 1918 to 1934, inclusive, ale set out in the footnote.

The issue presented herein is, therefore, whether the entire loss of $18,378.09, or any part thereof, was sustained (1) from sales of the above mentioned capital assets, or (2) from the loss of useful value of those capital assets as to which petitioner recovered the salvage value thereof during the taxable yeai.

In our opinion, the record herein clearly establishes, and we conclude as an ultimate finding of fact, that the entire loss in question was sustained from a loss of useful value of capital assets, brought about by the sudden changes in business conditions which necessitated the permanent discarding of petitioner’s old steam plant and 10 speeders upon petitioner’s installation, in 1934, of new facilities required to meet competition and remain in business. The discarded machinery and equipment was useless to petitioner and was also useless to any other up-to-date textile mill because of the demand for Sanforized fabrics and the cut in production costs effected by the introduction of long draft spinning. The necessity for and the actual discarding of the outmoded machinery and equipment prior to the termination of its normal useful life was the direct cause of petitioner’s loss, which would have been the full depreciated cost thereof if there had been no salvage value, as was true with respect to the boiler foundations, fittings, etc., of the dismantled steam plant. The sale price of $1,620 for the three boilers represented a comparatively small recovery on the dismantled steam plant, which had a depreciated cost of $9,629.92 to petitioned in 1934. Likewise, the sale of the 10 speeders to a secondhand dealer for $2,837.50 represented a comparatively small recovery on those machines, which had a' depreciated cost of $13,205.67 to petitioner in 1934. Those sales were incidental to the discarding of the steam plant and speeders and resulted in petitioner’s recovery of the salvage value thereof, which salvage value diminished the amount of the loss that would have otherwise been sustained.

We hold that petitioner’s loss, in the entire amount of $18,378.09, was sustained in 1934 from a loss of useful value of discarded capital assets and that the full amount thereof is an allowable deduction for that taxable year, under section 23 (f) of the Revenue Act of 1934 and articles 23 (e)-3 and 23 (f)-l of Regulations 86, supra. Monroe Cotton Mills, 6 B. T. A. 172, and Horn & Hardart Baking Co., 20 B. T. A. 486. Cf. U. S. Cartridge Co. v. United States, 284 U. S. 511; Illinois Pipe Line Co., 37 B. T. A. 1070; Rising Sun Brewing Co., 22 B. T. A. 826; Texas Chemical Co., 11 B. T. A. 390; Winter Harden, Inc., 10 B. T. A. 71; Peoples Ice & Gold Storage Co., 10 B. T. A. 16; Celluloid Co., 9 B. T. A. 989; and Levine Brothers Co., 5 B. T. A. 689.

The respondent erred in his determination.

Reviewed by the Board.

Decision will be entered under Rule SO.

       SEC. 23. DEDUCTIONS FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:
      * # * * * p #
      (f) Losses by Corporations. — In the case of a corporation, losses sustained during the taxable year and not compensated for by insurance or otherwise.
      Art. 23 (e)-3. Loss of useful value. — When, through some change in business conditions, the usefulness in the business of some or all of the capital assets is suddenly terminated, so that the taxpayer discontinues the business or discards such assets permanently from use in such business, he may claim as a loss for the year in which he tabes such action the difference between the basis * * * and the salvage value of the property. This exception to the rule requiring a sale or other disposition of property in order to establish a loss requires proof of some unforeseen cause by reason of which the property has been prematurely discarded, as, for example, where an increase in the cost or change in the manufacture of any product makes it necessary to abandon such manufacture, to which special machinery is exclusively devoted, or where new legislation directly or indirectly makes the continued profitable use of the property impossible. This exception does not extend to a case where the useful life of property terminates solely as a result of those gradual processes for which depreciation allowances are authorized. It does not apply to inventories or to other than capital assets. The exception applies to buildings only when they are permanently abandoned or permanently devoted to a radically different use, and to machinery only when its use as such is permanently abandoned. Any loss to be deductible under this exception must bo fully explained in the return of income. The limitations provided in section 117 with respect to the sale or exchange of capital assets have no application to losses due to the discarding of capital assets.
      * •* * * * *
      Art. 23 (£) — 1. Losses by corporations. — * * * The provisions of articles * * * 23 (e)-3. * * * are in general applicable to corporations as well as individuals.


author: SteRnhagew :

text:
    Peerless Stages, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100436.
    Promulgated December 19, 1940.

      Clyde G. Sherwood, Esg., and John V. Lewis, Esq., for the petitioner.

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

SteRnhagew :

On its return for 1936 petitioner reported a capital gain of $92,334.14, by including in its basis the $119,705.58 aggregate losses from the operation of the services from Oakland to Hayward, Castro Valley, and San Lorenzo. These amounts for each year through. 1934 had been used by petitioner as deductions in computing its taxable income, either as operating expenses or losses. - The Commissioner increased the gain from the transaction in 1936 by excluding the $119,705.58 from the basis, saying “there is no authority under the provisions of section 113 (b), Revenue Act of 1936, to capitalize as the cost of the franchise the operating losses of the years 1931 to 1935, inclusive.” Petitioner contends that the general excess of operating expenses over operating receipts from the new routes were capital expenditures not properly deductible in the year of operation.

The Commissioners determination is correct, /feo far as the evidence shows, the losses in question were entirely operating expenses and petitioner properly took deductions for them in the respective years of operation. The fact that the new operation' resulted in greater expenses than receipts is not alone reason to capitalize them. Had there been expenditures which could be identified, as. not attributable to current operation but directly and clearly to capital, .there might be some ground for permitting or even requiring a taxpayer to omit them from current deductions and charging them to “capital account” as contemplated by section 113 (b) (1) (A). This has been held in respect of the cost of solicitation of new business and of free service given to build good will. Houston Natural Gas Corporation v. Commissioner, 90 Fed. (2d) 814; cf. News Publishing Co. v. Blair, 29 Fed. (2d) 955; Successful Farming Publishing Co. v. Commissioner, 64 Fed. (2d) 890. But nothing in the evidence would have’ supported such treatment in the years of expenditure, and nothing-supports such treatment in the later year when the business’ was-discontinued. The excessive cost of current operation would not beregarded as invested capital for the purpose of measuring excess-profits under the earlier statutes.

Decision will be entered for the respondents