author: Mellott :

text:
    The Raritan Company of Delaware, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent. The Middlesex Company of Delaware, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 106869, 106870, 108554, 108555.
    Promulgated October 8, 1942.

      Paul F. Myers, Esq., and Martin W. Meyer, Esq., for the petitioners.

      Charles Oliphant, Esq., for the respondent.
   OPINION.

Mellott :

These proceedings, duly consolidated for hearing, involve deficiencies in personal holding company surtax as follows:

The entire amount of each deficiency is in controversy.

Docket Nos. 106870 and 108555 (Earitan Co.) arise out of the same basic facts. Docket Nos. 106869 and 108554 (Middlesex Co.) arise out of a partly separate but wholly parallel set of facts which, except for details as to names, dates, amounts, etc., are substantially identical with those in Docket Nos. 106870 and 108555. The facts are found to be as stipulated.

The sole issue in each proceeding is whether payments made in 1937, 1938, and 1939 under the circumstances hereinafter related are deductible under the provisions of section 355 of the Eevenue Act of 1936, as amended, section 405 of the Eevenue Act of 1938, and section 504 of the Internal Eevenue Code, which were in effect for the years 1937, 1938, and 1939, respectively, and provided in identical terms for the following additional deduction in computing the net income subject to the personal holding company surtax:

“ (b) Amounts used or irrevocably set aside to pay or to retire indebtedness of any kind incurred prior to J anuaryl, 1934 * *

The facts hereinafter set out are taken principally from the stipulation filed in the first mentioned proceeding, involving the Raritan Co.

Petitioners are corporations organized under the laws of Delaware. Lach has its principal office in New Brunswick, New Jersey, and each filed personal holding company returns, for the three taxable years in issue, with the collector of internal revenue at Newark, New Jersey. The notices of deficiency were mailed in Docket Nos. 106869 and 106870 on January 17,1941, and in the other proceedings on June 18,1941.

Johnson & Johnson, a corporation organized under the laws of New Jersey, is a large and internationally known manufacturer of medical, surgical, and hospital supplies which for many years has directly Or through subsidiaries operated plants in New Hampshire, Massachusetts, New Jersey, Illinois, and Georgia, in England, Australia, Canada, South Africa, Northern Ireland, and other parts of the British Empire. Since 1927 it has been actively controlled and managed by Robert Wood Johnson and J. Seward Johnson, who are now chairman of the board and vice president, respectively, and who acquired their control in the manner hereinafter described.

Johnson & Johnson was founded as a partnership in 1886 and incorporated in 1887 by the father of Robert Wood and J. Seward and his brother, James W. Johnson. The father of the two boys died in 1910. In 1927, when the two sons of the deceased co-founder together held slightly less than one-half of the common stock (which is the only stock which has ever had voting power), certain differences with respect to management policies arose between them and James W. Johnson, the surviving co-founder. The latter thereupon agreed to sell part of his common stock to each of his nephews so that they would then jointly own substantial control of the business.

Under the above agreement J. Seward Johnson in 1927 purchased from his uncle 1,667 shares of common stock of Johnson & Johnson, paying therefor in cash $541,710, which amount he in turn borrowed from the Chase National Bank of New York City. Through a stock dividend in 1931 this block of stock was increased to 4,167 shares'.

Five years having passed with no reduction in the loan, a plan was formulated in 1932 whereby all, or most, of the substantial dividends regularly paid on Johnson & Johnson stock could be made available, and they were in fact used, to curtail the bank loan, with the result that by 1939 the loan had been entirely liquidated by funds thus derived from Johnson <& Johnson dividends.

The plan called for the organization of a series of two corporations on the theory that if one held the stock of the other the latter would not be subject to any tax under section 104 of the Revenue Act of 1928 or corresponding provisions of subsequent acts. Thus on or about March 31, 1932, the petitioner “The Raritan Company of Delaware, Inc.” (hereinafter referred to as Delaware) was organized under the laws of that state and its entire capital stock of 500 shares was issued to J. Seward Johnson in exchange for 30,000 shares of the common stock of Johnson & Johnson. Shortly thereafter there was organized under the laws of Newfoundland “The Earitan Company, Limited” (hereinafter referred to as Newfoundland), and it acquired from Delaware the aforesaid 30,000 shares of common stock of Johnson & Johnson in exchange for all but three shares of its own common stock. The reasons which led to the selection of Newfoundland for the incorporation of the second corporation were the large interests of Johnson & Johnson throughout the British Empire and confidence in the economic stability of that Empire as well as the tax saving.

At about the same túne Newfoundland purchased from J. Seward Johnson an additional 4,167 shares of common stock of Johnson & Johnson, paying therefor in cash $541,710, with which he in turn paid off the entire amount of his loan at the Chase National Bank. This was the same block of stock which he had bought in 1927 from his uncle at the same price. In order to make this purchase Newfoundland borrowed from the Chase National Bank $541,710. This indebtedness was evidenced by Newfoundland’s interest-bearing demand note for that amount dated May 19,1932, which was at all times amply secured by collateral. A true copy of this note is incorporated in the stipula- ’ tion of the parties. It was retained by the bank as evidence of the indebtedness until the final payment in 1939 of the balance then due thereon in the amount of $203,500, at which time it was surrendered to Delaware.

The following notations were made on the note from time to time by the bank in due course of business to record the intervening payments on account of reduction of principal:

The payments from 7/26/32 to 12/10/36, inclusive, were made by Newfoundland, but the payments on 3/2/37 and 12/31/38 and the above mentioned final payment in 1939 were made by Delaware under the circumstances hereinafter set out.

In December of 1936 Newfoundland was completely liquidated and dissolved in accordance with the provisions of section 112 (b) (6) of the Eevenue Act of 1936 and with the prior consent of the Commissioner of Internal Eevenue, formally granted under section 112 (i) of the Eevenue Act of 1936, that the exchange thereby effected was not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income taxes.

The liquidator of Newfoundland transferred to Delaware as sole stockholder (outside of the three qualifying shares which were liquidated by the payment of $20 each, being the same amount which had been paid in for such shares) all of the assets of Newfoundland, subject to the indebtedness on the note at the Chase National Bank, which at that time had been reduced to $230,000. The assets so transferred consisted solely of Johnson & Johnson common stock and a small amount of cash, which assets thereupon became the sole assets of Delaware.

It has been stipulated that the final decision on the above facts in Docket No. 106870 shall be controlling with respect to thé corresponding issues in Docket Nos. 106869,108554, and 108555. The petitioner corporation in Docket Nos. 106869 and 108554 was the counterpart of Delaware with respect to a similar sequence of facts arising out of a similar purchase of Johnson & Johnson stock in 1927 by Robert Wood Johnson.

Respondent determined that no credit could be allowed to the Delaware corporations since the payments made by them were on indebtedness assumed upon the liquidation of the Newfoundland companies on or about December 31, 1936; in other words, that the amounts were not “set aside to pay or to retire indebtedness * * ⅜ incurred prior to January 1,1934 * ⅛

Petitioner contends (and hereinafter reference will be made only to Raritan, the Delaware corporation) that Sim Pipe Line Co. v. Commissioner, 126 Fed. (2d) 888, affirming Sun Pipe Line Co., 42 B. T. A. 1413, and Piermont Corporation, 43 B. T. A. 770, are controlling and require that the claimed deduction be allowed. It argues that the same conclusion is also justified upon other grounds, which will be stated more fully by us later in connection with the consideration of them.

In the Sum, Pipe Line Co. case the taxpayer had issued, in 1930, bonds aggregating three and a half million dollars. Subsequent to January 1, 1934, it retired these bonds with the proceeds of a larger issue, the new bonds being sold to parties other than the holders of the first mentioned bonds. In the taxable year it redeemed the bonds last issued and deducted the amount under the statute applicable here. In the Piermont Corporation case the taxpayer, being indebted prior to January 1,1934, to a bank, thereafter replaced the obligation with twenty-year debentures. At the end of the year 1934 and again at the end of the year 1935, $50,000 was set aside in a sinking fund for the retirement of the bonds and these amounts were deducted under the same statute. The Board concluded in each case that the taxpayer was entitled to the claimed deduction and the court affirmed. The essence of the Commissioner’s theory under which the claimed deductions had been disallowed was that the personalities of the obligees had changed. We deemed that to be immaterial. The court agreed that this was so, pointing out that “* * * it is the contract, not the parties who are bound by it, that matters. The term [indebtedness] has been defined as an obligation to pay or perform * * * and is synonymous with owing. * * * Nowhere do the cases stress to whom.” Petitioner construes the first portion of the quotation as implying that it is equally unimportant by whom the indebtedness is owing; but manifestly such construction is erroneous. The cited cases are therefore not determinative of the present controversy.

Petitioner argues that in the instant proceeding there was a mere “technical” change whereby it, on dissolution of its wholly owned subsidiary, “was found to be standing in the shoes of the subsidiary”; that the equity in the subsidiary’s assets to which it succeeded was not substantially different from the equity which it had before the dissolution; that a substantial part of the subsidiary’s assets was posted as collateral for, and thus doubly subject to, the indebtedness; that through its control of the subsidiary petitioner could have redeemed or obtained possession of the collateral just as easily before as after the dissolution; and that there was no actual change of any sort, after January 1,1934, “other than in the technical respect just noted.”

At the threshold petitioner is confronted with an extant opinion of this Board holding directly contrary to its present contention. In Samuel Goldwyn, Inc., Ltd., 43 B. T. A. 1086, 1089, it was said:

* * * The concept of indebtedness is inextricably associated with a particular obligor — an obligor that here must occupy such legal status prior to a certain date. * * * We think the conclusion inescapable from the statutory language that the indebtedness must have been incurred prior to January 1, 1934, by the taxpayer, i. e., the personal holding company. The statutory language and the use of a critical date would otherwise be devoid of meaning. * * *

Petitioner, pointing out that under the facts in the cited case the taxpayer was not in existence at the time the indebtedness was created and that the notes upon which the payments were made had not even been issued prior to the taxpayer’s incorporation on May 18, 1934, argues that the above language is mere dicta and should not be considered controlling in the instant proceeding. It also requests that the paragraph be reconsidered “because the thoughts there expressed are much too broadly stated even as dicta.” In that connection it points out that a secured debt, e. g., might continue for years if the interest is paid and that one who pays the debt for the purpose of relieving his property of the lien against it is not necessarily a debtor. The question has been reconsidered and, whether it was necessary or not that all of the quoted language be used in the cited case, the Board is of the opinion that it correctly enunciates the principle which must be applied in the instant proceeding. Therefore, unless the indebtedness in issue was “incurred” by petitioner prior to January 1, 1934, it is not entitled to the claimed deduction. This brings us, then, to the other contentions made by petitioner.

It is true that under the reorganization provisions of the revenue act petitioner, owning all of the stock of its subsidiary, could at any time take to itself as a distribution in complete liquidation, all of its subsidiary’s property without making itself liable for tax. It is also true that the basis for determining gain or loss upon a subsequent sale would be the basis in the hands of the subsidiary. (Sec. 113 (a) (15), Revenue Act of 1936.) It does not follow, however, as petitioner contends, that, from the standpoint of the revenue acts, petitioner is to be considered as owning at all times an “equity in the collateral [owned by the subsidiary] which secured the indebtedness here in question.” Petitioner refrains from suggesting that the corporate entity of the Newfoundland corporation should be ignored; and it is obvious that as much reason exists for ignoring both corporate entities as for ignoring one. “A taxpayer is free to adopt such organization of his affairs as he may choose and having elected to do some business as a corporation, he must accept the tax disadvantages.” Higgins v. Smith, 308 U. S. 473. Nor is it particularly important whether the corporation was set up for the purpose of avoiding tax or that respondent, in earlier years, may have endeavored to apply section 102 or 104 on the theory that a corporation had been “formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders.” Cf. Mead Corporotion v. Commissioner, 116 Fed. (2d) 187. The fact remains that petitioner and its sole stockholder selected the method of doing business and apparently deliberately chose to have petitioner’s subsidiary, rather than it, incur the indebtedness. Having done so, the burdens as well as the benefits must be accepted.

Petitioner, citing Bank of Indian Territory v. Eckles, 19 Okla. 159; 91 Pac. 695, in which the words “contracted” and “incurred” are distinguished, contends that the latter, as used in the statute now under consideration, merely means that the indebtedness must have been “brought on,” “occasioned,” or “caused” prior to January 1, 1934. It argues, therefore, that the clause “indebtedness incurred prior to January 1,1934,” should not be limited by construction so as to “apply only where it was a particular corporation or taxpayer that technically entered into a certain contractual obligation prior to that date.” We do not agree. The word “incurred,” as the court points out in the cited case, “is defined as to become liable or subject to; to render liable or subject to.” Petitioner, under the presently stipulated facts, did not “become liable or subject to” the indebtedness until December, 1936. It apparently recognized that this was so; for in the resolution which it adopted for the liquidation of its subsidiary it was stated:

That all of the other property [except the $60 paid in cash in redemption of the 3 shares of stock] * * * be set over in kind to * * * [petitioner] subject to the payment of all indebtedness due and owing by * * * [Newfoundland] which * * * [petitioner] assumes and agrees to pay, in complete cancellation and redemption of the said 497 shares held by it.

The liquidator assigned the Johnson & Johnson shares to petitioner, referring to the fact that they were deposited “with the Chase National Bank ⅜ * * as collateral security for the payment of a promissory note dated May 19, 1932 — on which there is now due the sum of * * * $230,000 and accrued interest which * * * [petitioner] hereby assumes and agrees to pay * * *.” When this occurred, and not before, the indebtedness was “incurred” by petitioner.

Other suggestions urged upon us by petitioner are not wholly unsound, but seem to be more or less immaterial. It is no doubt true that the selection of Newfoundland for the incorporation of one of the links in the corporate chain was dictated by business reasons and, as the parties have stipulated, because of “confidence in the economic stability of the [British] Empire.” There is also no reason to apply the rationale of Gregory v. Helvering, 293 U. S. 465, or to hold that there was a complete novation. Whether petitioner had, or had not, entered into a contract with the bank, specifically assuming and agreeing to pay the note, is likewise without significance here.

As stated at the outset, our question is whether the indebtedness was incurred by Raritan, the Delaware corporation, prior to January 1, 1934. It is apparent we have concluded this question must be answered in the negative. This disposes of the only issue and requires a holding, which is now made, that the respondent committed no error in determining the deficiency in Docket No. 106870. It follows that the deficiencies in the other proceedings must also be sustained.

Decision will be entered for the respondent in each of the fowr proceedings.

       Art. 351-4. Regulations 94, as amended by T. D. 4777, 1937-2 C. B. 197; art. 405-2, Regulations 101, and sec. 19.504 — 2, Regulations 103, provide that “The indebtedness must have been incurred (or, if incurred by assumption, assumed) by the taxpayer prior to January 1,1934, * * *.


source: Caselaw Access Project

author: SteeNhageN : TuRNER,

license: Public Domain

text:
    Edith Evelyn Clark, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103989.
    Promulgated October 9, 1942.

      Cornelius C. Moore, Esq., foi the petitioner.

      Davis HasMn, Esq., for the respondent.
   OPINION.

SteeNhageN :

The Commissioner determined a deficiency of $21,-230.25 in gift tax for 1932. The facts are not in dispute.

Petitioner, now a resident of New York City, is the widow of James F. A. Clark. She and her husband formerly resided at Newport, Rhode Island, and her tax return for 1932 was filed there.

On June 13, 1931, petitioner’s husband transferred securities to a trustee by an instrument directing the trustee to collect the income, pay expenses, and distribute net income to petitioner for life; and upon her death to divide the principal into equal shares for the benefit of their three children, and to pay all or part of the income of a share to each child for life, and upon the child’s death to distribute the share among the child’s issue. The trust was expressly made irrevocable by the grantor.

Thibd : Tbe Grantor grants to the Wife the right from time to time, by written instrument executed with the formalities required by law in respect to a deed of real estate, and delivered to the Trustee, to revoke, terminate or amend this deed of trust and/or any provision thereof, to any extent and in any manner that the Wife may determine.

On June 22,1932, petitioner amended the deed of trust by striking out this part of article third. On that date the value qf trust corpus was $754,012.84. The Commissioner determined that by the amendment petitioner made a gift of the remainder interest in the trust, and computed a gift tax on a value of $338,815.67, the undisputed present worth of the trust corpus payable at the death of a person aged 47 years. This was explained in the notice of deficiency, as follows:

Since the provisions of the deed of trust dated June 13, 1931, provided you with full power to revoke, terminate or amend the same, or any provisions thereof to any extent and in any manner that you shall determine, you were vested with complete control and disposition of the property and your relinquishing such right on June 22, 1932, constituted a gift within the meaning of the gift tax act of 1932.

The argument to support this view is that, since the petitioner had an unqualified power to amend the trust, even to the extent of directing that the property be transferred to her, she was in substance the owner of the property, and that when she amended the trust by relinquishing this power, she in effect transferred the property, subject to her continuing right to receive the income, to the successor beneficiaries named in the trust. The argument involves the idea that the relinquishment of the power is the same as its exercise. Whether the donee of the power should appoint to the successor beneficiaries or should expressly relinquish the power to appoint, the effect is to assure to the successor beneficiaries the acquisition of the property upon her death, and thus give them a present vested interest in lieu of the contingent expectancy they had under the original trust. The question is whether this change may be regarded as a ^transfer of property within the meaning of those words in the gift tax statute!

If this were a testamentary power of appointment, the petitioner’s express relinquishment of it in her will would have the legal effect of a transfer of the property to the children from the donor of the power; and this would also be true, if, despite the exercise of the power by appointing them, they, nevertheless, chose to take by virtue of the original trust. Under such circumstances, their acquisition of the property at the death of the donee ofThNpower would~nbt be regarded as by transfer at her death to support an estate tax upon her estate. Helvering v. Grinnell, 294 U. S. 153 (disapproving Wear v. Commissioner, 65 Fed. (2d) 665, and Lee v. Commissioner, 57 Fed. (2d) 399); Helvering v. Safe Deposit & Trust Co. of Baltimore, 316 U. S. 56. See also Legg's Estate v. Commissioner, 114 Fed. (2d) 760. It seems equally true that her relinquishment during her life is not a transfer by her. It is a final and irrevocable extinguishment of the power, Merrill v. Lynch, 13 N. Y. Supp. (2d) 514. The property interests which the beneficiaries have after the relinquishment are already contingently theirs by virtue of the original trust, and the relinquishment removes a power of defeasance and gives them greater assurance of their future expectancy. To regard this as a present transfer of property is, we think, to distort the language of the statute too far to be acceptable. Cf. Commissioner v. Solomon, 124 Fed. (2d) 86.

Reviewed by the Board.

Decision will be entered for the petitioner.

TuRNER,

dissenting: In my opinion, the Board has confused the question here involved and decided another. The reasoning applied is that applicable to cases where the power or right involved is a general power of appointment. Here the interest in and right to the property were much broader. Under a power of appointment the holder of the power not only has no interest of his own in the remainder estate nor any right whereby he may bring the corpus unto himself for his own unfettered use, consumption, or enjoyment, but merely has the power to designate for the donor a different donee. In the instant case petitioner not only had the power to amend the trust instrument so as to shift the remainder interest to parties other than those named by the grantor but had the further power to revoke the trust at any time she saw fit, to designate herself as the distributee and thereby bring the corpus of the trust to herself for her own unfettered use, enjoyment, and consumption and deprive anyone other than herself of any and all rights whatsoever in the property.

In Richardson v. Commissioner, 121 Fed. (2d) 1, under substantially similar facts, the question was whether the income of the trust was taxable to the holder of powers substantially similar to those held by the petitioner here, the said holder of the power not being the grantor. While recognizing that under the laws of Connecticut the power of revocation, which was never exercised, was not an asset of the holder’s estate and gave him no interest in the corpus of the trust, the court stated the question there as being “whether an unfettered control over the corpus of a trust either in the grantor or in the donee of a power of revocation, who may appropriate it to his personal use, is not the equivalent of ownership of property for tax purposes.” The court answered that question in the affirmative and affirmed the decision of the Board. It is true that the tax there dealt with was income tax and the section of the statute applicable was section 22 (a) of the Bevenue Act of 1932, which is very broad in its scope, while the tax here dealt with is the gift tax, which was imposed by section 501 of that act. Section 501 is also very broad in scope, however, and applies to gifts, direct or indirect, and to property, tangible or intangible. It.very ob-_ viously_ applies also to gifts of value even though of a character not subject to classification as property. Sec. 506, Revenue Act of 1932.

"while it maybe, and probably is, true that under real property law the petitioner’s act of relinquishing her power to revoke and to take the corpus did not effect the vesting of remainders in the successor beneficiaries but the elimination or removal of the power or danger of defeasance, the powers, rights, and interests of the petitioner were in my opinion such as to make their relinquishment a taxable gift within the meaning of the above cited statute. Cf. Richardson v. Commissioner, supra. By the original grant the grantor parted with any and all rights in and to the property, whether legal or beneficial in character. After the grant those rights reposed somewhere and with someone. Legal title was in the trustee and the successor beneficiaries had what probably should be referred to as a remainder subject to divestment, but what has more practically been described by the majority as a “contingent expectancy.” All other rights — those of real substance — were for all practical purposes in the petitioner. Her rights, which included the right to take the corpus as her own and to consume it for her own purposes, were far greater than anything received and held by the so-called successor beneficiaries, and, regardless of any theories that may be evolved from real property law, her relinquishment of those powers and rights effected a passage or transfer of her rights and interests in the property from her to the successor beneficiaries. Such transfers are taxable gifts within the meaning of the statute. Cf. Burnet v. Guggenheim, 288 U. S. 280, and Lehman v. Commissioner, 109 Fed. (2d) 99.

We do not have here a case comparable to that of A. P. Giannini, 42 B. T. A. 546, for there the petitioner at all times refused to accept or take the compensation voted to him by the bank of which he was president. The same may not be said of Edith Evelyn Clark with respect to the interests in and rights to the property here involved. She accepted the grant of all such interests and rights and held them for more than a year before passing them by her own act to the holders of the “contingent expectancy.” The rights considered in Helvering v. Grinnell, 294 U. S. 153, and Merrill v. Lynch, 13 N. Y. Supp. (2d) 514, were of an entirely different character.

Smith, Disney and Ofper agree with this dissent.


author: Disnet :

text:
    William H. Cree, Petitioner, v. Commissioner of Internal Revenue, Respondent. Ruth A. Cree, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 105667, 105835.
    Promulgated October 13, 1942.

      Maurice Levy, Jr., Esq., for the petitioners.

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

Disnet :

The petitioners acquired by assignment two separate oil and gas leases. Both before and after and with such acquisition they also acquired certain fractional interests which the previous lessee had sold. These provided for participation in the working interest, that is, the lessee’s interest, after payment of royalties, but each was limited to a particular well. 1'n filing Federal income tax returns, the petitioners reported the income from the participating interests as “royalties” and separately reported the income from leases as income from business or profession. Depletion was claimed as to both classes of interest. The Commissioner in determining deficiencies allowed depletion upon the income from the leases to the petitioners as lessees, and does -not now deny such depletion, taking issue only upon the method of computation thereof, i. e., he argues that depletion allowable to petitioners as lessees should be computed upon each lease as a “property” within the meaning of section 114 (b) (3), Revenue Act of 1938, while the petitioners urge that each well is a property. With reference to the position of the petitioners as holders of rights to participation, the Commissioner allowed depletion, but only upon the amounts remaining after deduction of certain expenses, this view being based upon the language of the assignments of the rights to participate, which the Commissioner regarded as reducing the petitioners’ gross income for depletion purposes to the amounts received by the participant after payment of the expenses provided for. Upon brief, and without any pleadings asking for increased deficiency, the respondent urges that the participants had, under their assignments, only a right to net amounts, not constituting depletable interests.

After careful examination of these interesting questions, we are of the opinion that the petitioners are entitled to compute depletion upon the gross amounts received by them from the properties, and that under the circumstances here presented each lease constitutes a property, so that depletion is limited to 50 percent of the net income therefrom, under section 114 (b) (3), Revenue Act of 1938, requiring therefore consideration of those wells the operation of which resulted in loss. Though no case is suggested, or found by us, which presents a parallel to the situation here presented, we think it clear from J. T. Sneed, Jr., 40 B. T. A. 1136; affd., 119 Fed. (2d) 767; certiorari denied, 314 U. S. 686, and Allie M. Turbeville, 31 B. T. A. 283 (292); affd., 84 Fed. (2d) 307, that in general the land covered by an oil and gas lease constitutes a “property” within the statute. The latter case says: “The term ‘the property’ applies to the particular acreage covered by each of the several leases.” In Vinton Petroleum Co. of Texas, 28 B. T. A. 549; affd., 71 Fed. (2d) 420; certiorari denied, 293 U. S. 601, the same is held, where eight different but neighboring tracts were involved, and taxpayer sought to consider all as one “property.” Though in Helvering v. Jewel Mining Co., 126 Fed. (2d) 1011, the court held that there were two properties where a lessee of coal land subleased a part of the land, this only emphasizes the idea that there was a separation of acreage, and that such is the sound test of what constitutes a property. The court points out that the taxpayer retained its lease on one part of the land, but subleased “another part of the land,” and that each party operated separately. Herein, the owner of certain rights under the lease purchases the same lease- In Mascot Oil Co., 29 B. T. A. 652, we held that a lessee of oil-producing land did not create a new “property” by granting an exclusive sublease to drill to depths below 1,600 feet. The petitioner cites G.C.M. 22106, C.B. 1941-1, p. 245, wherein it is stated, inter alia, that a single tract or parcel of land may be divided into two or more separate tracts or parcels by means of conveyances or leases “carving up the original ‘tract’ or ‘parcel’,” and that a taxpayer with several interests in a tract has several properties therein. But we do not think the idea soundly applied here, where the whole leasehold is acquired by one formerly owning only certain limited rights with respect thereto.

We think we are not here faced with the question of depletion by a mere holder of a participating interest in the working interest or leasehold, nor required to base our conclusion upon the form of his instrument of participation, for here the petitioners, in addition to acquiring rights to such participations in the working interests limited to certain wells, have acquired the leaseholds, on each lease. The participating interests were carved out of each leasehold, that is, the lessee (in order to obtain funds for drilling operations) assigned small fractional interests in his working interests, designating them as applying to particular wells. Though so designated and limited, they were obviously interests in the lease, in that they conferred rights growing out of the lease and granted by the holder thereof, even though not applying to all of the production upon the lease. The lease indeed constitutes a mere right to participate in, that is receive, the production from all wells, except in so far as that right is assigned, with the duty of paying expenses. Thus no essential difference is seen between lease and participating interest, and when the petitioners acquired the leaseholds, as well as the fractional interests in rights thereunder sold by the lessee, there was effected a merger of interests, so far as the petitioners were concerned. 21 C. J. 1037. Higgins v. California Petroleum Asphalt Co., 41 Pac. 1087. The rights to participation were merged with the leasehold in which they participated. We see nothing to prevent such merger, and no reason to view the petitioners in two different stati, that of lessees, and, separately, that of participants in leasehold rights, i. e., in the right coi production under the lease (though only from a single well). Nol intervening estate in law or equity appears to prohibit the merger] of the lesser participating right in the larger leasehold estate. It isl as if tbe limited right to participate had been canceled. The leasehold is no longer burdened with it; and the lessee can not logically present a participating right or charge against himself as giving him a different status for purposes of computation of depletion.

We need not here decide whether a single tract of land may be the subject of more than one “property” by division of estates or interests therein among different owners, as argued between the parties; for here such different estates or interests, growing out of the same lease, rest in the same person, and áre not seen as calling for viewing such party in more than one category. He owns a lease, save only so far as rights have been conveyed to, and remain in, others.

We conclude and hold that the petitioners have only one property right in each lease, and that it can not be divided by considering as a unit each well as to which participating rights had been sold, where such rights had returned to the lessee. It follows from this that depletion must be limited to 50 percent of the net income from each of the two leases, each of which we hold to be a “property” of the petitioners; it also follows that depletion should, subject to such limitation, be computed upon the gross income from each lease, received by petitioners both as lessees and as participants, for as lessees the petitioners are entitled to the entire income therefrom, subject only to interests held by the participants-assignees; and that the expenses of operating, maintaining, and repairing the wells may not be deducted before computation of depletion, under section 114 (b) (3), Revenue Act of 1938, except of course, as above stated, in calculating the limitation of depletion to 50 percent of net income from each lease. This view renders it unnecessary to consider other issues.

Decision will be entered under Rule 50.


author: Sternhagen:

text:
    C. D. Johnson Lumber Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104938.
    Promulgated October 13, 1942.

      Everett A. Johnson, Esq., for the petitioner.

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

Sternhagen:

1. (a) The petitioner assails the partial disallowance of depletion and depreciation deductions for 1936 and 1937. It claims that the computation should be made upon the same basis as that of its predecessor, the Pacific Spruce Corporation, because, it contends, it acquired the properties in a reorganization, as defined in Eevenue Act of 1934, section 112 (g) (l). The essential controversy is whether the statutory definition of the term “reorganization” has been met. The case was tried and submitted before the decisions of the Supreme Court of February 2, 1942, in Helvering v. Alabama Asphaltic Limestone Co., 315 U. S. 179; Palm Springs Holding Corporation v. Commissioner, 315 U. S. 185; Marlborough House, Inc. v. Commissioner, 315 U. S. 189; and Helvering v. Southwest Consolidated Corporation, 315 U. S. 194, and the briefs were largely devoted to the consideration of the cases which had been decided in the several Circuit Courts of Appeals and in the Board. These considerations must now be adjusted to the reasoning of the Supreme Court.

Of paramount importance is the fact that this case arises under the 1934 Act, for the difference between that statute and the earlier Act of 1928 is an important factor of the decision in the Southwest Corv-solidated case, which involved the later statute. The generalizations which have affected the reorganization decisions under the earlier acts, such as the importance of continuity of interest, are subordinate, in considering reorganizations of later years, to the express legislation which has laid down specific conditions to be literally complied with if the definition is to be applied. It is not enough, under subdivision (B) in the 1934 Act, that, underlying a transfer of property from the old corporation to the new, there is a continuing interest of the same persons — the transfer must be “in exchange solely for all or a part of [the new corporation’s] voting stock.” “Solely leaves no leeway.” “Voting stock plus some other consideration does not meet the statutory requirement.” Helvering v. Southwest Consolidated Corporation, supra. And it is not enough, under subdivision (C), that the bondholders or other creditors of an insolvent corporation should eon-tinue in control of tbe new — the continuing control must be, as prescribed in subdivision (h), by ownership of shares, Helvering v. Southwest Consolidated Corporation, supra; and this is not satisfied by regarding the bondholders or other creditors of an insolvent corporation as if they were the shareholders. Helvering v. Southwest Consolidated Corporation, supra.

In the present case, to treat the transfer to, and acquisition by, petitioner as in reorganization would be directly contrary to the 1934 statute as expounded in the Southwest Consolidated case. Even though the petitioner acquired the assets of the Pacific Co. (ignoring the mesne transfer to the Timber Co.), the acquisition was not solely in exchange for petitioner’s shares, as subdivision (B) requires; to a large extent, it was in exchange for petitioner’s promise to pay $1,669,-100, a large part of the stated price of the assets sold on foreclosure of the bonds, the remaining part being preferred and common shares of petitioner. The acquisition of the other three groups of assets was not in exchange for any shares.

Subdivision (C) is not met, because the control of the petitioner immediately after the transfer did not rest in the Pacific corporation or its stockholders or both, but rested (again ignoring the intervention of the Timber Co.) in the bondholders and preferred shareholders of the Pacific Co. Furthermore, since the petitioner’s proposed future payments of $1,669,100 were to be made to the Timber Co. (which, argu-endo,, may be identified with the former bondholders who held its shares), Le Tulle v. Scofield, 308 U. S. 415, prevents recognition of a statutory reorganization; for, instead of the former bondholders becoming shareholders through the foreclosure, they continued to a large extent to be creditors. This is not, even under the earlier statute, a proprietary interest or similar to the continuing interest of actual or constructive shareholders.

It is held, therefore, that the Commissioner correctly held that the assets were not acquired by petitioner in a statutory reorganization and disallowed the deductions taken by petitioner for depreciation and depletion upon the same basis as had been applicable to the deductions of the Pacific Co.

(b) The Commissioner, after determining that petitioner had not acquired the depreciable and depletable properties in a statutory reorganization, held that the petitioner’s basis for such deductions was its cost. In its petition, petitioner did not (except as affected by the reorganization issue) assail the figures which the respondent had used as bases, nor did it at the hearing propose to show by evidence what figures should be taken as cost bases .in lieu of those used by the Commissioner if it were held that no statutory reorganization had occurred. This was expressly referred to by respondent’s attorney in his opening statement, and no attempt was made by petitioner, either by amended pleading or otherwise, to establish bases other than those used by respondent. It was contended only that the refusal to recognize a reorganization and to use the predecessor’s basis in computing the deductions was error, thus leaving it inferable that, if it were held that no statutory reorganization had occurred, no attack would be made upon the figures used. At that time the reorganization cases in the Supreme Court had not yet been decided and the subject of reorganization was in conflict in the lower courts; so the petitioner had no reason for assurance as to the proper basis, and if the Commissioner’s computation was believed to be in error, it should have been assailed in the petition and the correct basis established by evidence. The case was tried in September 1941, and petitioner’s attorney died in November 1941. The decisions of the Supreme Court in the four reorganization cases came down in February 1942. On March 9, 1942, petitioner, by new attorneys, moved for leave to file an amended petition and to reopen the proceeding at Portland, Oregon, for further testimony upon the question of fair market value of the properties. Respondent vigorously opposed these motions, showing, among other things, that the subject had been expressly mentioned at the hearing and that petitioner had failed to cover it as it might have attempted to do. After consideration of the arguments upon the motion, it was denied.

The basis and method of the Commissioner’s determination do not appear clearly in the deficiency notice, and the evidence indicates that as to some of the properties book values were used, as they had also been used by petitioner in the returns. There is evidence to indicate that the books reflected figures other than cost and to some extent were made up from appraisals and contained appreciation adopted from opinions. It can not be said from the' evidence that the Commissioner’s determination of the deductions was in error, nor can any other figures be found as the correct figures established by the evidence. The Commissioner’s determination as to the deduction applicable to each of the several units and groups of assets must, therefore, be sustained. Indeed, it is hard to conceive of any better, in view of the composite assets of various kinds and the difficulties of finding actual, or devising constructive, costs to be attributed to the separate units or groups to which depreciation or depletion is to be applied. Under the circumstances, it is easy to believe that petitioner, by its former attorney, acted upon a considered judgment in omitting to assail the determination except upon the ground of a statutory reorganization.

The Commissioner’s determination of deductions for depreciation and depletion is sustained.

2. The Commissioner, in determining the deficiency, made no change in the inventory figures used by the petitioner on its returns. Petitioner now claims that its inventory figures for lumber were in error and should be corrected; that for the beginning and end of each of the two years in question the figure should be based on the lower of cost or market because this was the basis which it elected to use for the inventory of its first return, and, in the absence of a permitted change in the basis, the lower of cost or market must be used in each subsequent inventory. The respondent urges that the inventory has not in fact been valued by petitioner at cost or market, whichever is lower; that no permission of the Commissioner has been asked, as a change would require, and none has been given, and that petitioner may not use the lower of cost or market.

For its opening inventory — that of December 1, 1935 — petitioner used a figure of $199,695.03, based upon the unit figure of $12.40, as shown on its first return. This had been used by the predecessor receiver during the preceding five years. The figure had been constant throughout the receivership period, and had been fixed by the receiver when he took over the property in February 1931. When petitioner acquired the manufactured lumber as part of the composite group of assets for a lump sum of $700,000, it entered on its own books the same figure as had been on the receiver’s books. No attempt was made at that time to ascertain the fair market value of the lumber in the inventory, nor was any effort made to relate the lumber in the inventory to the entire group of assets acquired as a means of finding the proportionate cost of the lumber. The inventory figure was merely carried over from the receiver’s books, the only explanation being that the president of the new corporation, the petitioner, wanted a good showing for the first year’s operations. So far as the evidence shows, there was no knowledge at that time as to whether the figure being placed on the books was in fact the lower of cost or market.

To support its contention that the figure was the lower of cost or market, petitioner caused its accountant to make a study in 1940 for the purpose of this proceeding. This, however, is not probative that an election had been made in 1936. The only probative evidence on that point is that in its return for 1936, filed in 1937, appears the following statement: “Lower of cost or market at Nov. 30, 1936, at Dec. 1, 1935, value as stated on books of receiver of predecessor company,” although, as has been stated, it was entirely unknown then whether it was in fact the lower figure. Indeed, the one who prepared the return testified that it was an incorrect statement. Apparently the first effort to ascertain market value was December 1937, when the petitioner’s accountant was -working on the 1937 return. He made a computation which indicated to him that the net realizable proceeds on November 30, 1937, would be about $15.22 per M, and lie then sought the approval of the president to use the lower of cost or market, asked for a computation of market values, and this indicated realizable net proceeds of $15.10. The president refused to permit the change of the inventory from cost to market, because the books already showed a loss and he did not want to increase it. In the return for 1937 it was stated that the inventory was based on cost.

The petitioner’s primary ground for demanding that its inventories for both years be computed at the lower of cost or market is that in its first return it stated that its inventories were valued on that basis; that this statement is the expression of an election; and that, having made the election, it is bound to and entitled to have that basis used and continued. It can not, however, be found that the petitioner in its first return elected to have its inventories valued at the lower of cost or market. It is clear from the evidence that it did not in fact make such an election, even though it stated in its 1936 return that the closing inventory was on that basis. At that time it did not know the market value on either the opening or closing date. The use of the figure of $12.40 in the opening inventory was not because it was the lower of cost or market, but because it was imported from the receiver’s books, where in turn it was not a figure either of cost or market. Certainly, as to the opening figure, it can not, upon the evidence, be found that its use was an election between cost and the lower of cost or market. As to the closing inventory of 1936, said in the return to have been valued at the lower of cost or market, the evidence shows that the statement was incorrect. The figure used was an accountant’s computation of average cost of production, without regard for the fact that the lumber was to a large extent acquired among the assets purchased at auction for a lump sum price of $700,000. It was purely a mathematical figure, the relation of which to cost is not shown. The same figure was used as the value of opening inventory of the following year, and in that return it is expressly stated that the inventory was valued at cost, without reference to market.

Under these circumstances, it can not be said from the evidence that market value was ever in these two years a factor in the valuation of the inventory or that petitioner elected to value its inventory at the lower of cost or market. Cf. Rogers, Brown & Crocker Bros., Inc., 32 B. T. A. 307. Market value, even if it had been satisfactorily proven, is irrelevant.

Petitioner contends, however, that the opening figure of $12.40 is, in any event, not the correct cost figure applicable to it, and demands instead a figure of $15.22, which would have the effect of reducing its income for 1936 by $45,414.52. While the evidence shows that the figure of $12.40, upon which the opening inventory is valued, may not be petitioner’s cost because it was simply brought onto its books from tbe books of tlie receiver, where it had been a static inventory-figure for five years, this only reaches the point where petitioner must affirmatively prove the correct cost. This, we think, it has not successfully done.

The figure of $15.22 was derived by petitioner’s accountant from a larger figure of cost postulated as the cost to the receiver, irrespective of the use by the receiver of the $12.40. It is not necessary to consider whether this figure of $15.22 does fairly or accurately reflect the receiver’s cost; for it is the petitioner’s cost with which we are concerned in this proceeding and not that of its predecessor. As has been noted, the lumber in the inventory was acquired by petitioner among the assets which as a whole cost it $700,000. Since the acquisition was not in a reorganization and the predecessor’s cost does not carry over into the succeeding owner’s basis, the petitioner is bound to use its own cost, which is found in its purchase price of all the assets. The portion of that price which is properly to be regarded as the cost of any particular part of the assets may conceivably be \ determined in various ways upon evidence directed to that fact; but it seems clear that it is not established by a retrospective determination of an adjusted cost of production of the preceding owner in the preceding year.

As to the proper part of the petitioner’s cost of $700,000 to be allocated to the lumber inventory, the evidence affords no answer different from or better than the $199,695.08. No other finding could be made which would be supported by the evidence, and we therefore sustain the use of that figure as the opening inventory for the 1936 determination.

Since the inventory is not properly determinable with reference to market values and such values are not a factor, the petitioner’s claim that its closing inventory for 1937 should be reduced from the book value of $17.69, which it used and which the Commissioner adopted without change, to $15.10, a constructed market value, must be denied, irrespective of the method by which such market value figure was determined.

On the entire lumber inventory question, we hold that the evidence supports no ground for using figures different from those used on the returns and the deficiency determination.

Decision will be entered wnder Rule 50.

       SEC. 112. RECOGNITION OF GAIN OR LOSS.
      * * ⅜ v • * *
      (g) Definition of Reorganization. — As used in this section and section 113—
      (1) The term “reorganization” means (A) a statutory merger or consolidation, or (B) the acquisition by one corporation in exchange solely for all or a part of its voting stock; 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 another corporation; or of substantially all the properties of another corporation, or (C) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (D) a recapitalization, or (E) a mere change in identity, form, or place of organization, however effected.


author: Abttndell: Disney,

text:
    Pioneer Real Estate Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105267.
    Promulgated October 13, 1942.

      Cedric A. Major, Esq., for the petitioner.

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

Abttndell:

The principal issue is whether the entire award of $340,-572.50, received by petitioner as compensation for the land taken and as consequential damages to the remaining land and building, is taxable gain to the extent that it exceeds the cost of the land taken ($21,-674.42) plus the expenses of the condemnation proceeding ($11,646.03). Respondent, in accordance with G. C. M. 20322, 1938-2 C. B. 167, determined the issue in the affirmative and held that a profit of $307,-252.05 was realized upon the condemnation award.

Petitioner, however, contends that the award was in substance two distinct awards for separate purposes. The first was the sum of $28,254.57 paid as compensation for the land actually taken, and petitioner concedes that it realized a taxable gain to the extent that this amount exceeded the basis of the property so taken. The second was the amount of $812,317.93 paid to compensate petitioner for the damage to the remaining land and building which was occasioned by the condemnation. Petitioner maintains that the latter amount was paid not for the property taken but to reimburse it for damage to the remaining assets.

It concludes, therefore, that this sum should not be included in the profit resulting from disposition of the strip ■ of land, but should be applied against and reduce the bases of the remaining property.

We agree with petitioner. There is no issue here as to the allocation of the award between compensation for the land taken and severance damages to the remaining property. See Seaside Improvement Co. v. Commissioner, 105 Fed. (2d) 990; certiorari denied, 308 U. S. 618; Langley Collyer, 38 B. T. A. 106. The facts show that damages were actually sustained and that the court, in making the award, stated separately the amount that was to serve each purpose. While the compensation payable to petitioner was included as a unit with that payable to Lehigh, the parties here have stipulated the amount of petitioner’s share and the extent to which that figure represented a recovery for the land taken, on one hand, and for severance damages to the remaining property, on the other. Besponclent does not contend, nor indeed could he under the facts as stipulated, that severance damages were not specially awarded or that petitioner did not sustain such damages. Under these circumstances to hold, as does respondent, that petitioner received $340,000 as payment for a strip of land costing only $21,000, is contrary to the facts. Petitioner’s computation seems to us sound and logical, and should be adopted here unless there are persuasive considerations in the decided cases requiring a different conclusion.

Bespondent’s method of computing gain or loss under similar circumstances was formerly in accord with that urged upon us here by petitioner. He argues, however, that he was led to abandon this position and to assume the one he now maintains because of three adverse decisions of the Ninth Circuit Court of Appeals, this Board having subsequently adopted the view expressed by that court. The decisions upon which this argument rests are Wolf v. Commissioner, 77 Fed. (2d) 455, reversing 29 B. T. A. 702; Christian Ganahl Co. v. Commissioner, 91 Fed. (2d) 343; certiorari denied, 302 U. S. 748, reversing 34 B. T. A. 126; Central & Pacific Improvement Corporation v. Commissioner, 92 Fed. (2d) 88, reversing 34 B. T. A. 208; Calvin C. Green, 37 B. T. A. 25; Jamieson Associates, Inc., 37 B. T. A. 92; affirmed in part and reversed in part sub nom Seaside Improvement Co. v. Commissioner, supra; Palladium Amusement Co., 37 B. T. A. 149; Income Syndicate, Inc., 37 B. T. A. 926; and Langley Collyer, supra.

In each of' these cases the principal issue presented was -what effect should be given to a special benefit assessment levied in a condemnation proceeding against the remaining property of the condemnee. In most instances the assessment had been deducted from the amount of the award, so that the taxpayer had in fact received only the net award. The Commissioner took the position, G. C. M. 12632, C. B. XIII-1, p. 104, and the Board upheld him, that gain or loss on the property actually taken was to be computed separately, and equaled the difference between the award for and the cost of the property taken; and that the basis of the remaining property was either reduced or increased by deducting therefrom the severance damages awarded and adding thereto the special assessment levied. There was thought to be justification for this view in that the assessment was levied only upon the property remaining after the condemnation and therefore should have no bearing upon the computation of gain or loss in connection with the property taken.

The first case to be presented to the Ninth Circuit, Wolf v. Commissioner, supra, was unusual in that the amount of the assessment was approximately $900 in excess of the awards both for the property taken and for severance damages. The court was unwilling to tax the con-demnee on the difference between the cost of the property taken and the award which he had only constructively received by having it set off against his liability on the assessment. To reach this conclusion the court held that the entire proceeding to open a street is one proceeding and the result should be treated as an entirety. It stated that “the petitioner was paid nothing whatever for the land taken, and in addition he was required to pay $891.60, which was the net result of the entire transaction so far as he was concerned. The gain, if any, derived by the taxpayer from the transaction was in the increased value of the property already owned by him. This increase is not a taxable gain.” The separate question of how to treat the severance damages was not considered in this case, for the assessment exceeded the total award.

The same issue was before the court in the Christian. Ganahl Co. case, where, although the benefit assessment did not exceed the total award, it did exceed the amount of severance damages allowed. The court thought, however, that the case was indistinguishable in principle from the Wolf case. In Central & Pacific Improvement Corpora tion v. Commissioner, supra, so far as appears no severance damages were awarded, but since the basis of the property taken plus the benefit assessment exceeded the amount of the award, the court held that the taxpayer had derived no taxable gain from the condemnation. In Calvin C. Green, supra, a case in which no briefs were filed •inasmuch as the parties^ .agreed that the rulings of the Ninth Circuit were governing, the Board stated that the proper method of computing the tax was “to include all of the amounts received and to deduct from the total, the assessments paid plus the basis of the property condemned. The basis for the remaining property remains the same and is neither reduced by the amount of the severance damages nor increased by the amount of the assessments.” In subsequent Board decisions, Jamieson Associates, Inc., Palladium Amusement Co., Income Syndicate, Inc., and Langley Collyer, all supra, there was no showing that severance damages had been awarded, and the Board decided in each instance, as the only issue before it, that in computing gain on the condemnation the award should first be reduced by the assessment deducted from it, on the theory that the condemnation proceedings must be regarded as an entirety.

Thus it appears that the cases cited by respondent dealt primarily with a problem that is not involved here, namely, the tax treatment to be given benefit assessments in connection with condemnations. The rule there stated, that condemnation proceedings are to be regarded as an entirety, resulted from a refusal to tax the property owner upon an amount which he had not received but which, by reason of the simultaneous assessment, merely represented an increase in the value of the remaining property. Bespondent places particular emphasis upon the language quoted above from the Board’s opinion in the ■ Green case, but that statement is not to be divorced from the facts which were then before the Board. In that case, while severance damages had been awarded, an assessment greater in amount had been levied, and under the controlling rule the assessment was to be deducted from the aw'ard. Consistency, perhaps, requires that, if the assessment is to be deducted from the award, it should be deducted from the total award, including that for severance damages.

In the instant case petitioner actually received the amount awarded for the land taken and concedes that it is to be taxed upon the gain therefrom. We can perceive no valid reason for treating the additional award for severance damages as something other than what it actually was. In any case in which there is no assessment, or perhaps even where an assessment is made if it is less in amount than the severance damages awarded, the problem dealt with in the cited cases does not arise. Under such circumstances the condemnee receives in cash the full amount of the award.for the property taken .and .gain or loss thereon may properly be computed by applying against it the basis of the property condemned; and the severance .or consequential damages or so much thereof as remain after deducting the special assessment if one is made, may fairly and logically .be applied against and reduce the basis of the remaining property, which, in the final analysis, is the property affected both by the assessment and by the. severance damages.

Respondent further contends that in any event the consequential damages should be taxed on the ground that they were paid to reimburse petitioner for future loss-of rentals from its warehouse. The cases of Hort v. Commissioner, 313 U. S. 28, and Acme Land & Fur Co., 31 B. T. A. 582; affd., 84 Fed. (2d) 441, are cited in this connection. We think there is no merit in the contention and that there is no analogy between this case and those cited. The Hort case held that the amount received for cancellation of a lease was a substitute for the future rent reserved therein, and, since the rent would have been included in gross income when received, the substitute payment was to be similarly treated. In the Acme case it was held that an amount received to compensate the taxpayer for damage caused by a flood to its wild animal life was not exempt from tax as a gift or constitutionally immune because received from a state or its political subdivision. The Board took pains to point out that there was no impairment of the taxpayer’s capital, since its lands were still . worth more than their cost. In the present case the severance damages were paid in recognition of the injury sustained by petitioner’s remaining properties. These were capital assets in which petitioner had a capital investment. “Recovery for injury to capital ‘is never income, no matter when collected’. U. S. v. Safety Car Heating '<& Lighting Co., 291 U. S. 88, 98, * ⅝ H. Liebes ét Co. v. Commissioner, 90 Fed. (2d) 932, 935. The fact that the extent of the capital injury is measured in part by an anticipated decrease in future rentals makes the recovery no less a return of capital. Farmers’ & Merchants'1 Bank of Catlettsburg, Kentucky ,v. Commissioner, 59 Fed. (2d) 912. We conclude, therefore, that petitioner is entitled to apply the severance damages against the bases of its remaining land and building.

The second question is whether the portion of the award denominated interest is taxable as ordinary income or constitutes part of the award. Respondent recognizes that the Second Circuit Court of Appeals has adopted the latter view and has been followed in this respect by the Board. Seaside Improvement Co. v. Commissioner, supra; Commissioner v. Estate of Appleby, 123 Fed. (2d) 700, affirming 41 B. T. A. 18; Edith Henry Barbour, 44 B. T. A. 1117 (appeal pending, C. C. A., 6th Cir.). Notwithstanding the decision to the contrary by the Third Circuit in Commissioner v. Kieselbach, 127 Fed. (2d) 359, we adhered to our former position in David S. Brown, 47 B. T. A. 139, and we continue to do so. Petitioner is therefore sustained on this issue.

It is stipulated that the amount of the so-called interest is to be allocated among the awards for the land taken, the land retained, and the warehouse, in accordance with figures set forth in the stipulation. Petitioner concedes on brief that a similar allocation should be made with respect to the expenses of the condemnation proceedings. These adjustments, together with those required by petitioner’s abandonment of two issues raised by the pleadings, may be given effect in the recomputation under Pule 50.

Reviewed by the Board.

Decision will be entered umder Bule 50.

Disney,

dissenting: I can not agree with the conclusion reached by the majority opinion on the second point, that is, holding that interest upon a condemnation award is not ordinary income. In my opinion, since in the condemnation proceeding the property is taken and valued as of a certain date, the amount ultimately paid above the aAvard proper, that is, the value of the land taken or other damages, is compensation for the delay in the payment of the award, that is, compensation for the use of money, which is the essential definition of interest. Had the award been paid at the same time as the taking of the property, or the ascertainment of the amount of damages, no additional sums would have been required to pay the obligation of the government or municipality condemning the property. The effect is that the taxpayer’s money is being detained and used by the con-demnor and, although in a very general sense the whole amount paid is “just compensation” to the condemnee, in a more accurate and particular sense only the amount of the award, for property or damages, is compensation for- such property or damages, and, in my opinion, in the matter of income taxes we should view the situation in the more particular meaning of the term “compensation.” The “interest” is paid for delay in payment only. As I view the question, Commissioner v. Kieselbach, 127 Fed. (2d) 359, states the better rule on this question, when it holds that interest is ordinary income. I therefore respectfully dissent.

       “After careful consideration, this office is of the opinion that the various steps incident to a street opening or similar improvement project, including the condemnation award for property taken, the award for severance damages to and a special benefit assessment levied against the remaining portion of the plot or parcel of real estate affected, constitute a single proceeding, the results of which are to be calculated as an entirety for Federal income tax purposes.’’

       In I. T. 2590, C. B. X-2, p. 170, It was held:
      “* * * Tlie award being separable, this office is of the opinion that gain or loss will result from that portion of each award which represents the amount paid for tbe acquisition of land. No taxable gain is recognized, however, with respect to that portion of the award which represents the severance damages, but the amount thereof should be deducted from the basis to be used in determining gain or loss upon the subsequent disposition of the remaining portion of the property, unless the amount of the severance damages exceeds the cost or other basis of the remaining portion of the property, in which case such excess is taxable gain.”


author: Leech :

text:
    The Independent Life & Accident Insurance Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105769.
    Promulgated October 15, 1942.

      Walter E. Barton, Esq., and Lee Quest, Esq., for the petitioner.

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

Leech :

The principal issue is whether petitioner is taxable as a life insurance company under section 201 (a) of the Revenue Acts of 1934, 1936, and 1938, as contended by petitioner, or as an insurance company other than life or mutual, under section 204 of those acts, as determined by respondent.

The Florida statute distinguishes sick and funeral benefit companies from life insurance companies. While petitioner may have been classified by Florida as the former, it may still be true that its business is that of life insurance within the meaning of the Federal revenue acts. See Commissioner v. Luquire Burial Association Co., 102 Fed. (2d) 89; Helvering v. Oregon Mutual Life Insurance Co., 311 U. S. 267. However, this is not enough to bring petitioner within section 201 (a). It must also comply, at least, with the requirements as to reserves which, under section 201 (a), mean the same as under section 203 (a) (2). Standard Industrial Life Insurance Co. of Louisiana, Inc., 42 B. T. A. 1011. See also Regulations 94, and Regulations 101, art. 201 (a)-1.

Petitioner made additions to its reserves in each year so that the total would be not less than 3 percent of gross premiums received in that year. It contends that this was in accordance with the Florida statute, supra, and that therefore it is a “life insurance company” within the purview of section 201 (a), supra. It might well be doubted whether this reserve met the requirements of the Florida statute, which seems to require that there be set aside annually an amount not less than 3 percent of gross premiums received during that year. However, petitioner’s statements showing its reserves were accepted by the Insurance Commissioner of Florida without question and we therefore pass this point. The respondent concedes that petitioner’s reserves were held for the fulfillment of the policy contracts, but he contends that “reserve” as used in the Federal revenue acts means an actuarial reserve based upon standard mortality tables. This the Florida statute requires for life insurance companies, but not for “sick and funeral benefit” companies such as petitioner.

We agree with respondent. It is clear that, as used in sections 201 (a) and 203 (a) (2), the word “reserve”vhas a technical meaning peculiar to the law of insurance and is not anything which a state statute or officer may so designate. Helvering v. Inter-Mountain Life Insurance Co., 294 U. S. 686; Helvering v. Illinois Life Insurance Co., 299 U. S. 88; McCoach v. Insurance Co. of North America, 244 U. S. 585; United States v. Boston Insurance Co., 269 U. S. 197; Minnesota Mutual Life Insurance Co. v. United States, 66 Ct. Cls. 481. A reserve for a life insurance policy is built up so that in future years as the probabilities of death of the insured increase the premium may remain level. The amount of the reserves is actuarially computed according to recognized tables of mortality and with an assumed rate of interest. The reserve here was not computed upon the basis of any mortality table. It was fixed at a flat rate of 3 percent of gross premiums. Although this fulfilled the requirement of the Florida statute, we do not think it is within the technical meaning of “reserve” as used in the revenue acts. Mothe Burial Benefit Life Insurance Co. v. Fontenot, 46 Fed. Supp. 978. See Commissioner v. Oregon Mutual Life Insurance Co., 112 Fed. (2d) 468; affd., Helvering v. Oregon Mutual Life Insurance Co., supra; Commissioner v. Monarch Life Insurance Co., 114 Fed. (2d) 314; Continental Assurance Co. v. United States (Ct. Cls.), 8 Fed. Supp. 474; Old Lime Insurance Co., 13 B. T. A. 758; Paul and Mertens, sec. 36:13.

The reserves of petitioner in 1938 were actuarially computed upon the basis of a standard table of mortality. However, we do not think this change in method of computation converts it into a life insurance company within the meaning of section 201 (a), supra.

As stated above, the reserves contemplated by section 201 (a) are the same as under section 203 (a)(2). In the latter section they are referred to as “reserve funds required by law.” This means the law of a state in which the insurance company operates. See Standard Industrial Life Insurance Co., supra, and art. 203 (a) (2)-1, Kegulations 94 and 101.

The only requirement of the state law of Florida under which petitioner operates is a minimum one that the reserves shall not be less than 3 percent of the gross premiums. The reserves set up by petitioner in excess of this amount were therefore voluntary on its part and not required by law. A basic reason for the classification of the company as a life insurance company is therefore absent, since that excess could be withdrawn from the reserve and used for any other desired corporate purpose without violation of the state law. The statute of a state must be more specific in its requirements to satisfy the Federal revenue acts in this respect. Cf. Mothe Burial Benefit Insurance Co. v. Fontenot, supra, and National Fidelity Life Insurance Co. v. United States, 4 Fed. Supp. 421. See also Commissioner v. Pan-American Life Insurance Co., 111 Fed. (2d) 366; Commissioner v. Monarch- Life Insurance Co., supra.

Respondent is affirmed on this issue.

The petitioner relies upon Lamana-Panno-Fallo Industrial Insurance Co. v. Commissioner, 127 Fed. (2d) 56. This case reversed a memorandum decision of the Board which followed Standard Industrial Life Insurance Co., supra. In the Lamana case, the state statute required the reserves to be actuarially computed upon the basis of mortality tables. A state official there permitted the insurance company to compute its reserves at a percentage of but less than the full amount thus computed. The court said the Federal revenue acts had to do with the character and not the sufficiency of the “reserve” and held that the “reserve” in the Lamana case fulfilled that requirement. But that holding is not contrary to our conclusion here, because the reserves here, except for 1938, were not actuarially computed upon the basis of mortality tables.

We hold that petitioner, during none of the taxable years, was a “life insurance company” within- section 201 (a) of the controlling Federal revenue acts. That conclusion renders the second issue moot.

The third issue is that if petitioner is held to be an insurance company other than life or mutual and therefore taxable under section 204, should it not be taxed on the basis of premiums “earned” instead of premiums received, under section 204 (b) (5) ? Thus it argues that neither the advance premiums nor the additions to the reserves in those years to meet future risks are “earned” premiums and should, accordingly, be deducted as “unearned” premiums in computing “earned” premiums for those respective years.

Respondent concedes the correctness of petitioner’s proposed adjustments. in computing premiums earned, except for the increase of reserves for the year 1938 above the 3 percent of premiums which measured its reserve in prior years. The reserve for that year was based actuarially upon standard mortality tables. Respondent contends only that the proper reserve for that year is limited to 3 percent of gross premiums received in that year, on the ground that this was the amount of the reserve required by the Florida statute. The petitioner argues that the provisions of the state law are immaterial. Its contention is that the deductibility of the contested item under section 201- (b) (5), supra, depends upon whether, in fact, it was an unearned premium and that this item was such. See Massachusetts Protective Association v. United States, 114 Fed. (2d) 304; Travelers Equitable Insurance Co., 22 B. T. A. 784.

The reserve set up in 1938 was the amount which the petitioner would have Set up in the aggregate if it had been computing its reserves regularly on an actuarial basis. Therefore, it represents, in a large measure, additions to the reserve which should have been made in prior years on that basis. In the computation of earned premiums, the statute specifically requires that unearned premiums at the end of the preceding year be added to net premiums for the taxable year. Sec. 204 (b) (5), supra. Unearned premiums at the end of the taxable year are then to be deducted. The reserve set up during the taxable year here may properly be considered unearned premiums. But the amount of unearned premiums at the end of the preceding year is not disclosed. Certainly it was greater than the amount actually set aside in that year. Petitioner must therefore fail on this issue for lack of proof.

Decision will be entered under Bule 50.

       SEC. 201. TAX ON LIFE INSURANCE COMPANIES.
      (a) Definition. — When used in this title the term “life insurance company” means an Insurance company engaged in the business of issuing life insurance and annuity contracts (including contracts of combined life, health, and accident insurance), the reserve funds of which held for the fulfillment of such contracts comprise more than 50 per centum of its total reserve funds.

       Sec. 6264, Compiled Genera] Laws of Florida, 1027 :

        "Percentage for reserve. — On December 31, 1025, and annually thereafter, each association, corporation or company transacting the business of sick and funeral benefit insurance in this State, shall set aside as a reserve for the protection of all such policyholders, an amount not less than three per cent, of the gross collections from policyholders during the current year. Associations, corporations or companies organized under the laws of this State shall maintain with the Treasurer of Florida for the protection of all policyholders of this class an amount equal to said reserve * * *. The State Treasurer shall require life insurance companies to set aside such reserves on life and industrial business as shall be in accordance with any accepted and recognized standards, and shall require companies writing insurance against loss by fire and other hazards, fidelity and surety bonding and indemnity coverage, to set aside the unearned portion of premiums in force, computed according to the usual methods, for the protection of their policyholders. * * *”

       SEC. 204. INSURANCE COMPANIES OTHER THAN LIFE OR MUTUAL.
      ***** t *
      (1>) DEFINITION of Income, Etc. — In the case of an insurance company subject to the tax imposed by this section—
      *******
      (5) Premiums earned. — “Premiums earned on insurance contracts during the taxable year” means an amount computed as follows :
      From the amount oí gross premiums written on insurance contracts during the taxable year, deduct return premiums and premiums paid for reinsurance. To the result so obtained add unearned premiums on outstanding business at the end of the preceding taxable year and deduct unearned premiums on outstanding business at the end of the taxable year.


author: Hill:

text:
    Joe Degnan, Petitioner, v. Commissioner of Internal Revenue, Respondent. Toivo J. Rosander, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 108724, 108726.
    Promulgated October 15, 1942.

      Raymond, G. Wright, Esq., and F. H. Molitor, O. P. A., for the petitioners.

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

Hill:

These proceedings involve a redetermination of income tax deficiencies determined by the respondent for the year 1939 in the following amounts: Joe Degnan, $224.51, and Toivo J. Kosander, $224.51.

The proceedings were submitted under Kule 30 of the Board’s Kules of Practice and were consolidated for consideration and report. All issues have been waived by the petitioners except the question of whether or not the partnership composed of the two petitioners is entitled to compute its depletion on a percentage basis. All the facts as stipulated are adopted as our findings of fact and only those necessary to a determination of the issue are set forth.

Both petitioners filed timely income tax returns for the year 1939 with the collector of internal revenue at Tacoma, Washington.

Petitioners were equal partners in a partnership known as Degnan & Kosander. The principal office of this partnership is at Ophir, Alaska. On or about May 12, 1938, the partnership acquired a metal mine near Ophir, Alaska. This property was operated for the benefit of the partnership at all times material to this proceeding subsequent to May 12, 1938. The first items of income from the property were derived and the first items of deductible expenses were incurred by the partnership during the calendar year 1938 subsequent to May 12.

In his return for 1938 petitioner Degnan reported all items- of income derived from the property during 1938. He claimed deductions in respect of the property and a net income from the property was included in his taxable income. He did not claim any deduction for depletion in respect of the property.

Petitioner Kosander did not report any part of the income derived from the property in his return for 1938, nor did he claim any deduction in respect of the property for that year.

The net income for the year 1938 had been distributed by the partnership to petitioner Degnan in accordance with an agreement between the petitioners.

The partnership did not file a return for the year 1938 until September 18,1940, at which time a return was filed with the collector of internal revenue at Tacoma, Washington, disclosing gross income of $5,400 and total deductions of $2,511. Included among the deductions was an amount of $810 representing depletion computed on a percentage basis. The following notation was contained on the face of that return: “We elect to take depletion on the basis of 15% of gross as provided by law.” No request had been made by or on behalf of the partnership for an extension of time within which to file its return for the year 1938 and no extension was granted.

The partnership filed a timely return for the year 1939 on March 29, 1940. Included among the deductions reported on that return was the amount of $5,110.30, representing depletion claimed on the percentage basis. The following notation was contained upon that return, “Election is hereby made to take depletion on the percentage basis as provided in section 114 (B) (4) Revenue Act of ’32 and ’34.”

The ultimate question posed by this state of facts is whether or not the delinquent partnership return for 1938 or the timely return for 1939 is a “first return” within the meaning of section 114 (b) (4) of the Revenue Act of 1938. This section provides in part:

SEC. 114. BASIS FOB DEPRECIATION AND DEPLETION.
$ ⅜ ⅜ ⅜ * * ⅜
(b) Basis fob Depletion.—
* ⅜ * * # # ⅜
(4) PERCENTAGE DEPLETION FOB COAL OB METAL MINESl AND STJLPHTJR.— * * * A taxpayer making bis first return under this title in respect of a property shall state whether he elects to have the depletion allowance for such property for the taxable year for which the return is made computed with or without regard to percentage depletion, and the depletion allowance in respect of such property for such year shall be computed according to the election thus made. If the taxpayer fails to make such statement in the return, the depletion allowance for such property for such year shall be computed without reference to percentage depletion. The method, determined as above, of computing the depletion allowance shall be applied in the case of the property for all taxable years in which it is in the hands of such taxpayer, or of any other person if the basis of the property (for determining gain) in his hands is, under section 113, determined by reference to the basis in the hands of such taxpayer, either directly or through one or more substituted bases, as defined in that section. * * *

Section 187 of the Revenue Act of 1938 provides that a partnership shall make a return. By virtue of this section the partnership was required to make a return for 1938 irrespective of whether or not all of the income was distributed to one of the partners and reported by him. The question further refined is whether a return filed after the time allowed by the statute for filing the 1938 return is a proper place to elect to take percentage depletion. We think not. There appear to be no cases directly in point. Cases under other sections of the revenue act are helpful, but in the final analysis the answer to the issue of this case must be found in section 114 (b) (4).

In J. E. Riley Investment Co. v. Commissioner, 311 U. S. 55, the taxpayer filed a return without knowledge of the provisions of section 114 (b) (4) of the Revenue Act of 1934 (substantially similar to the Revenue Act of 1938 in so far as material). It took no depletion of any sort. After learning of that section the taxpayer attempted to amend its return after the time for filing its original return had expired. The Supreme Court stated in part as follows:

If petitioner’s view were adopted, taxpayers witli the benefit of hindsight could shift from one basis of depletion to another in light of developments subsequent to their original choice. It seems clear that Congress provided that the election must be made once and for ail in the first return in order to avoid any such shifts. And to require the administrative branch to extend the time for filing on a showing of cause for delay would be to vest in it discretion which- the Congress did not see fit to delegate.

If we were to hold that the partnership’s first return was either the 1938 or 1939 return, we would be giving the partnership the benefit of hindsight as much as if an amendment had been allowed in the Riley case. In that case the taxpayer took no depletion and did not know of its opportunity to elect to take percentage depletion. Certainly, the result was harsh as admitted by the Supreme Court, but that Court held the plain wording of the statute required such a result. It is to be noted that, by virtue of section 114 (b) (4), if the taxpayer does not affirmatively state that he wants the benefit of the percentage depletion, the depletion allowance will be computed without reference to percentage depletion.

Where a return was required by statute, it would be most illogical to allow the partnership to elect to take percentage depletion in a return filed long after the time allowed by statute and not to allow a taxpayer, such as the Riley Investment Co., to file an amended return upon a showing that no election was actually made because of the ignorance of the opportunity to make such. Moreover, the taxpayer in the Riley case showed cause for its ignorance of the provisions of section 114 (b) (4). See Mother Lode Coalition Mines Co. v. Commissioner, 125 Fed. (2d) 657; certiorari granted June 8, 1942; Pittston-Duryea Coal Co. v. Commissioner, 117 Fed. (2d) 436; Healy River Coal Corporation, 44 B. T. A. 613.

The election to take percentage depletion is granted to a taxpayer. The taxpayer in respect of partnership income is the partner and not the partnership. The appropriate place for the election to take percentage depletion in respect of depletable partnership assets is in the partnership return in order that such depletion allowance may be reflected in its distributable net income and thus carried into the individual income tax returns of the partners in the current taxable year. Either one of the partners is authorized to make the partnership return. The failure of the partnership to make a return of income for a given taxable year is attributable to each of the partners. The same is true if there is a failure to make the partnership return within the time limited by statute. There is no purpose in requiring a partnership return except for its relationship to items affecting the income tax liability of each of the partners. In order to subserve such purpose it must be made within the time limited by statute, so that the information required therein may be available both to the taxpayer (partner) and the Government in determining the current tax liability of the partner.

Certainly the partners who are the taxpayers in respect of the partnership income have the exclusive right if timely exercised to determine whether their tax liability on the distributable shares of partnership income shall reflect the allowance of depletion on a percentage basis. To avail themselves of such right a timely election to that end must be made so that the allowance of the percentage depletion will be reflected in the individual returns of the partners for the first taxable year in which income or deductions from the partnership property occurred. If there has been no such election the statute denies the allowance of the percentage depletion not only for such taxable year but for all subsequent taxable years. There was no such election here either by the partners for the partnership or in their individual capacities.

Applicable to the facts in this proceeding w*e construe the term “first return” as used in section 114 (b) (4) to mean the return which the partnership should have timely made for .the taxable year 1988 in compliance with the provisions of section 187, supra. Hence, neither the so-called partnership return for the taxable year 1938 made September 18, 1940, nor the partnership return timely made for the taxable year 1939 was a “first return” in which the election for percentage depletion allowance was authorized.

Since the partnership did not affirmatively elect to take depletion on a percentage basis on its “first return under this title”, we must hold that it is not entitled to compute its depletion on such basis. Cf. Louisville Property Co., 47 B. T. A. 23.

In view of our conclusion, the respondent did not err in determining the deficiencies.

, Decisions will Toe entered for respondent.