author: Sternhagen:

text:
    North American Railway Construction Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3167.
    Promulgated January 28, 1927.
    Personal service classification denied to a railroad construction and maintenance corporation.

      Harry Eugene Kelly, Esq., for the petitioner.

      L. O. Mitchell, Esq., for the respondent.
    This proceeding involves a deficiency of $40,127.62 income and profits taxes for the calendar year 1918, arising from the refusal of the respondent to grant the petitioner classification as a personal service corporation within the meaning of section 200 of the Revenue Act of 1918.
    FINDINGS OF FACT.
    The petitioner is an Illinois corporation with its principal place of business in Chicago. It was organized in 1898.
    The capital stock of the petitioner at the beginning of the year 1918 was $60,000. It was increased to $100,000 by means of a stock dividend, and in April, 1918, its authorized capital stock was increased from $100,000 to $250,000 but only $100,000 of the increase was issued. In 1920 the capital stock was decreased to $100,000 and since then it has remained at that figure. Throughout 1918 the following persons were stockholders and held the percentages of the outstanding capital stock listed after their respective names:
    Per cent
    Andrew S. Littlefield_50%
    Samuel P. McGough_16%
    Emmett M. Pry_16%
    Daniel Ooolidge- 8⅛
    Artliur S. Littlefield_ 4⅝
    Calvin G-. Littlefield_ 3½
    H, H. McDonald_ ⅜
    Andrew S. Littlefield was the president of the company. He died in 1923. During 1918 he had full charge of the executive administration of the petitioner and was actively and regularly engaged therein at an annual salary of $20,000. He was very active in the pursuit of his duties and at all times kept acquainted with all matters pertaining to the company and its work. He traveled about looking over the company’s work and noting its progress from time to time. While absent from the office he was at all times kept advised as to conditions, and always kept in touch with all the work so that he could take proper steps for its best performance. All of the time he was in Chicago he spent in the petitioner’s office. He was among the first arrivals in the morning and among the last to leave at night. During 1918.he was absent from Chicago one-third to one-half the time on petitioner’s business. He was a practical engineer of long experience in railroad construction and his duties extended actively and constantly to work under the Baltimore & Ohio Railroad contract hereinafter set forth.
    Samuel P. McGough during 1918 was vice president -and general manager of the petitioner. Previous to 1900 he had* been employed in the maintenance department of the Baltimore & Ohio Railroad Co. at Pittsburgh, and when he left that company in 1900 he had been with it for nine years. Later he was employed in the construction of'a canal in Ñew York. Still later he was superintendent and engineer of a construction company engaged in building tunnels, retaining walls and abutments. Afterwards he became an inspection engineer for a company selling rail joints to railroad companies and in this capacity it was his duty to inspect the joints to ascertain whether they were properly installed. In 1904 he became associated with the petitioner and remained with it until Andrew S. Littlefield’s death in 1923.
    During the progress of the work under the petitioner’s contract with.the Baltimore & Ohio Railroad Co., McGough spent the whole of his time at Pittsburgh in its field of operations under the contract and was actively and regularly engaged in the work under that contract. He was in immediate charge of the petitioner’s organization.
    Emmett M. Fry was vice president during the year 1918. He devoted all his time to the business. His work was of substantially the same character as Andrew S. Littlefield’s, except that he had less to do with the financial matters of the company. His annual salary was $6,000. He was a practical engineer and his work consisted of practical engineering, especially in the construction of steam and interurban railroads. His experience was substantially the same as Andrew S. Littlefield’s. He and Littlefield went together in about 1892 and continued together until Littlefield’s death.
    Arthur S. Littlefield, a son of Andrew S. Littlefield, became an officer of the petitioner during 1911, and during all of 1918 was secretary and treasurer thereof at an annual salary of $5,100. He had charge of the office, was responsible for the petitioner’s books of account, and had charge of the correspondence of the petitioner with its branch offices as to the different jobs. He checked each report and pay roll which came from the branch offices to see that it was correct for book entries. He handled the office work pertaining to labor gangs recruited for the work that was being done by the petitioner under its contract with the Baltimore & Ohio Railroad. He was responsible for all of the petitioner’s .office details, and had to attend to most of the clerical work. He gave all of his time to this employment.
    Andrew S. Littlefield, Fry, McGough, and Arthur S. Littlefield each devoted his time to the petitioner as .much as any ordinary man could devote his time to a company of which he was an officer.
    Calvin G. Littlefield was cashier and timekeeper of the petitioner until 1917, when he went into the United States Army. He was not actively engaged in the petitioner’s affairs during 1918. H. H. McDonald was employed in the petitioner’s office until 1917, but at that time went into the Government service and was not actively engaged in the petitioner’s affairs during 1918. Daniel Coolidge was not actively engaged in the petitioner’s affairs during 1918. These three stockholders held a total of 11% per cent of the petitioner’s capital stock.
    The petitioner was engaged principally during the year 1918 in carrying out the following contract with the Baltimore & Ohio Railroad Co.
    This agreement, Made this 18th day of July, 1917, between The Baltimore and Ohio Raileoae Company, hereinafter called Railroad, and the North American Railway Construction Company, hereinafter called Company.
    WITNESSETH :
    In consideration of the payments to be made and the work to be performed as hereinafter mentioned, the parties hereto do agree between themselves as follows:
    1. The Railroad hereby employs the Company to perform the work in maintenance and renewals of existing main tracks and side tracks of the Railroad on the Pittsburg Division between Pittsburg and Connellsville, including Pittsburg Terminals, and on the New Castle Division between New Castle Junction, Pa., and Akron Junction, O., including the New Castle Junction Terminals. The work to be done by the Company shall include the construction of additional yard tracks and industrial tracks in connection with those parts of the line of the Railroad as above set forth if called upon so to do by the Railroad. The work to be done by the Company in the maintenance and renewal shall include tie, rail and ballast renewal, aligning and surfacing tracks, ditching, mowing right of way, weeding and cleaning roadbed and other similar work as may be required by the Division Engineer in charge.
    2. The Railroad agrees that it will provide all tools, materials, work train equipment and service and the Company will provide all the labor with necessary superintendents, foreman and timekeepers.
    3. It is agreed that all work to be done under this contract shall be done under the direction and supervision of the Division Engineer of the Railroad, who shall direct the Company as to the work to be done, designating the locations and specifying the number of men to be employed at the designated locations, and. the Company agrees to do no work except such as may be directed by the said Engineer and at all times to do all work under the supervision of said Engineer and to his approval.

      '■4. It is agreed that the Division Engineer of the Railroad shall have the right, from time to time, to request the dismissal of employes of the Company, and the Company agrees, on receipt of direction to dismiss any employe,' that such employe shall be promptly discharged.
    5. The Company agrees that it will at all times during the life of this contract keep proper books showing the cost of the work at the site of the work. It shall give to the Division Engineer a daily report and account of all labor performed for the day, signed in duplicate, one copy whereof shall be executed by the Division Engineer or his authorized representative, if the same shall be found correct, and returned to the Company. The Company will also deliver to the Division Engineer at the end of each month a complete and accurate statement showing all labor, materials and renewals of plant chargeable during the month. All bills of the Company entering into the cost of work done shall be filed with the Division Engineer on or before the 5th day of the month subsequent to the month in which the work shall have been done.
    It is agreed that all books of the Company and all its daily labor and material reports and records of cost, or other records in connection with the work, shall be open to inspection at all times by the Division Engineer or other representative of the Railroad.
    6. The Railroad agrees that during the progress of any work to be done by the Company it will station at the work and keep during its progress a representative who will be authorized to check and approve payrolls or material-invoices and who will cooperate with the Superintendent of the Company in the direction of the work.
    7. The Railroad agrees that it will furnish transportation free to the representative of the Company in general charge of the work and to his superintendents and local timekeepers over that portion of the line of the Railroad within which the Company agrees to perform work under this contract.
    The Railroad shall not be required to give free transportation for any laborers, but the Company shall pay full tariff rates, taking receipt for same and submitting such receipts attached to its bill at the end of the month, but no percentage or profit will be paid to the Company on the cost of such transportation.
    The Company shall procure accident insurance policies acceptable to the Railroad protecting the Railroad and the Company against all liability for injury or death of employes, the cost of such policies and any legal expense to which the Company shall be put for the same will be treated as a part of the cost of the work upon which the percentage of the Company is to be calculated.
    8. The Company agrees that no charge will be made on account of general office expense in connection with any work done by it and that percentages will only be paid on superintendents, foremen, timekeepers, local cashier and laborers actually employed on -the work and whose labors are confined strictly thereto.
    9. The Railroad agrees to pay the Company for all labor performed at actual cost plus twelve (12%) per cent.
    10. In the event that the Railroad shall request the Company to furnish any materials, tools or supplies, the Railroad shall pay for the same at actual cost plus twelve per cent. All materials, tools and supplies furnished by the Company at the request of the Railroad shall become the property of the Railroad upon arrival on work and the Company shall have no claim thereto upon completion of the work.
    11. This contract shall remain in force for the period of one (1) year from the date hereof, it being expressly agreed, however, that the Railroad shall Rave the right at any time to cancel this contract upon giving thirty (30) days notice in writing to the Company.
    This contract was made about July 1, and its execution entered upon about July 15, 1917. The work of execution was continued under this contract and under a renewal contract thereof until the first part of July, 1918. The renewal contract provided" for a cost-plus fee of 10 per cent instead of 12 per cent as in the 'original contract.
    The negotiations leading to the execution of this contract began in June, 1917, when Fry conferred with Stimson, one of the officers of the railroad company, at Pittsburgh, discussing the character and methods of the work that the railroad company had in view for the petitioner. A plan of remuneration upon the basis of a certain price per unit could not be reached and it was finally agreed that the only equitable way to do the work was to pay the petitioner a percentage of the total cost as a fee. When asked who would be in charge of the work Fry stated that McGough would be, because he was well acquainted with the right of way on which the work was to be performed. Arrangements were made for McGough to meet Stimson the following week so that instructions could be given him as to where the work would be done and what the railroad desired accomplished.
    The work was carried out on 650 miles of railroad out of a total Baltimore & Ohio trackage of 4,500 miles. It covered a part of the road from Cumberland west, where the industrial activities were greatest and where the railroad company’s organization had broken down because of the losses of employees of all classes to the Government’s work and service in the Army and Navy.
    Not since the railroad company had been in existence, something over eighty years, had it met the conditions that confronted it during 1917 and 1918. Because of losses of the railroad’s men its supervisory organization was considerably affected. That was the principal trouble and it was not altogether a matter of the scarcity of common labor which the contract was intended to remedy.
    The officers of the Baltimore & Ohio Railroad Co. in deciding to avail themselves of some existing organization to undertake this work decided to entrust it to the petitioner because it had in it men they knew, particularly McGough, who had formerly been a maintenance of construction engineer for the railroad company and who was familiar with the particular division of the railroad involved in the contract. They regarded McGough as the best fitted man. to undertake the work. Knowing him, they placed major reliance upon him, but they also knew Fry and Andrew S. Littlefield, were acquainted with their ability, and had equal confidence in them. They had previously had dealings with the petitioner for a number of years and regarded its reputation as being of the best.

      The railroad company in taking over the petitioner’s service considered most the fact that it had the man power and the brains to do the work. Reliance for the service was placed not only on McGough, Littlefield, and Fry, but on the petitioner’s organization as a whole.
    The petitioner brought to the work six superintendents who had not come from the service of the railroad company.
    The principal object that the railroad sought in making its contract with the petitioner was an effective organization so that it could maintain its right of way to meet the very extraordinary demands that the war conditions had placed upon it.
    In maintaining a railroad it is not so essential that there be a large number of laborers as it is that there be an adequate number of well directed laborers. It is necessary to have a certain amount of common labor to do the work in an economical manner, but in order to do that it is necessary to have adequate and competent supervision. Organization is thé desired object in work of this character.
    The maintenance force was composed largely of common laborers, and it was built up during the summer time, as the work is seasonal. Such work is done during the spring and summer months and requires the recruiting of large forces each spring. In 1911 and 1918 the better class of common labor had been drawn into the Government service and into more lucrative employment in munitions plants. The poorer classes of common labor were left for railroad service. Consequently, the supervisory and directory organization had to be so much the better in order to get results. With the force that the petitioner was handling, about 3,500 men, it required a very good organization to direct their force and obtain economical results. By poor direction in such matters results are decreased to such an extent that a railroad company can afford to pay almost any price for good organization. The petitioner supplied that sort of organization and service, and it was very effective — much more so than the railroad company’s own efforts at the time the contract was made.
    The petitioner’s organization was under the general control of the railroad company’s engineers, who supervised the work and saw that it was done according to the proper methods. The railroad company furnished plans and specifications but the details of the work were left to the petitioner’s independent judgment and its men exercised such judgment in carrying them out. The railroad company’s engineers gave directions and orders when they found the work was not being carried out according to their plans and they indicated at what points the force should be applied.
    The petitioner in performing the work provided for under the contract employed one general superintendent, six superintendents, a chief clerk, two stenographers, five time posters and approximately fifty timekeepers. It also had charge of twelve general foremen, over two hundred and thirty-seven foremen, twenty-five carpenters, some bricklayers and hodcarriers, and over thirty-three hundred track laborers. The salaries and wages of all these men were fixed by the railroad company. It also had twenty camps, ten or twelve commissaries, and two labor agents, one at Pittsburgh and one at Chicago. The above figures are representative of the petitioner’s organization at its highest efficiency. The actual number of men employed varied from time to time.
    The petitioner’s main office was four ordinary rooms in the Monad-nock Building in Chicago. It maintained no other general office. Its employees there were one stenographer, one full-time bookkeeper, one part-time bookkeeper, and an office boy. At this office were received and kept all of its books and records.
    The petitioner rented an office in the Conestoga Building in Pittsburgh which it made its local headquarters under the Baltimore & Ohio contract. The petitioner in discharging the contract had superintendents located at Cleveland, Newton Falls, Holloway and Youngstown, Ohio, and at Pittsburgh and West Newton, Pa. The offices at these places reported directly to the office in the Conestoga Building in Pittsburgh, and the business at the Conestoga Building was reported directly-to the petitioner’s general office in the Monad-nock Building, Chicago, Ill.
    The petitioner’s work for the Baltimore & Ohio Railroad Co. was a construction and maintenance job. It consisted of taking up and loading old rails, unloading and laying new rails, retieing and re-ballasting the "track, maintaining the platforms, sweeping snow, repairing switches and keeping them clean, putting in new switches, building industrial tracks, inspecting camps, building commissaries, refitting camp cars to take care of the men, building and filling in trestles and consulting Baltimore & Ohio division engineers, supervisors and other assistants as to the handling of the work that was to be done. The petitioner did the work where it was directed to do it by the railroad company’s officers, and when it was directed where to do the work it had charge of the job and its immediate supervision.
    In all of this work McGough as the local man at the scene of operations was constantly in communication with the petitioner’s office at Chicago and was carrying out the instructions of the home office at Chicago. He was in constant communication with Littlefield and Fry of the home office. Littlefield and Fry also visited the work at Pittsburgh at different times to inspect it. There was not a day that letters were not exchanged about the work.

      McGough made an official daily report of the men and the time they were employed and of other matters in order that it might be known how much money was being spent. A copy of this report was sent to the railroad company. These reports showed not only the number of men employed but the type of work that was being done, the number of ties put in, the number of rails laid and the kegs of spikes and bolts used.
    Most of the material was supplied by the railroad company but the petitioner was occasionally called upon to furnish material in emergency for making repairs in camps and to build camps, such as lumber, mattresses and cots. The item of material was very small.
    McGough and the other officers of the petitioner were constantly traveling over the Baltimore & Ohio Bailroad on the rear ends of trains and on gasoline motor cars, and sometimes for miles on foot, inspecting the work that was being done and ascertaining if the foremen were doing their work in accordance with instructions that had been given them.
    While the work was being conducted, the tracks on which the work was being done were being used by the railroad company and had to be kept open and constantly in condition for the heaviest transportation, including fast passenger and freight trains. This was while the war was at its height.
    The engineering work involved building curves in relaying the rails, making the proper curvature, the elevation of curves, raising the track to the proper grade, surfacing the tracks and looking after alignment, all of which were things the petitioner had been doing for years and which were matters requiring skilled men. The selection of these skilled men was made by McGough and the superintendents. The men would not have been worth anything if they had not been familiar with that kind of work. It was important that the petitioner have a knowledge of the work in order to pick out men who could be entrusted with it, and a sufficient knowledge to see from inspection that there was done that which the petitioner was required to do, and that it was being done properly.
    There was a necessity for cooperation among the men and in the work of the different divisions. The officers of the petitioner had to meet the general superintendents, the superintendents, the engineers and the road masters, and work out with all of them the problems that confronted them.
    The company would not have entrusted the maintenance of its property to anyone not familiar with the physical characteristics of the railroad, the nature of the maintenance work, the conditions under which it had to be done, and the operation of the trains. The company required of the petitioner that its men have knowledge of maintenance methods — how the work should be done — from actual experience. ■ The maintenance work required executive ability, the organizing of forces, and the planning of arrangements to take care of them at the particular time.
    The petitioner had to provide quarters for the men to sleep in, and had to provide cooking and dining-room accommodations for feeding them, and the problem was a heavy one at that particular time. The petitioner carried all of the employees on its pay rolls, kept and audited the accounting and time records, and made a report each month to the railroad company.
    The bills for the cost of the work were prepared in the petitioner’s Pittsburgh office under McGough’s supervision, and were sent out in duplicate, one to the Chicago office of the petitioner and the other to the railroad company. The pay rolls for the men were made up every two weeks by the Pittsburgh and Chicago offices. The petitioner’s bills for its services and for all expenses and disbursements for purchases and wages were made up and presented to the railroad company twice a month, and the company mailed checks to the petitioner for the amounts of them. All costs in connection with the work were first paid by the petitioner, which was reimbursed by the railroad company.
    When the petitioner started work and took over such existing organization as the railroad company had, many of the men did not want to go over to the petitioner, being afraid that they would lose the benefits in connection with the relief department of the railroad company, on the assumption that they would be leaving the service of the railroad company. They were assured, however, that they would not endanger their standing and that they would be considered as still working for the railroad company.
    The petitioner’s rate of pay per day was greater than the railroad company had paid for similar work but the disparity did not run throughout the period of operation. Before the work was closed the railroad company instructed and required the petitioner to increase the wages in order to hold the men that the petitioner had on the force, as other railroad companies were paying more than the men in the petitioner’s organization were receiving.
    In 1918 the Baltimore & Ohio Eailroad Co. paid to the petitioner a total of $1,234,797, of which $145,513 was compensation to the petitioner, $1,006,346 for the labor pay roll, $3,800 office expense at Pittsburgh, $18,381 transportation expense, $5,475 material and labor in fitting up camps, $4,844 labor fees and advertising, $1,062 loss on meals, and $49,366 for miscellaneous expenses.
    During 1918 the petitioner had other contracts with the Baltimore & Ohio Eailroad, the Cincinnati, Hamilton & Dayton Eailway Co., and the Interurban Railway Company of Des Moines, on both the cost plus basis and the straight-contract-price basis. These contracts provided in substance, but in varying terms, for the laying and grading of tracks, the making of excavations, the erection and construction of various kinds of buildings and railroad appurtenances, the furnishing of labor, and similar items.
    The net income from all contracts was $136,822.43, of which $116,455.86 was derived from cost-plus contracts and $20,366.57 from straight-contract-price agreements.
    The petitioner also received $120 as rentals.
    In 1917 and 1918 the approximate average invested capital of the corporation was $75,000. This invested capital consisted of between $6,000 and $10,000 in tools, machinery and equipment, $20,000 in cash, and $44,850 in the following stocks and bonds: Chicago <⅞ West Town Railway Co. bonds, $15,000; Union Loop bonds, $11,250; Chicago Elevated Railway Syndicate stocks and bonds, $18,600.
    The stocks and bonds, amounting to $44,850, were the petitioner’s investment in stocks and bonds as of December 31, 1917. December 81, 1918, the corporation owned investments in stocks and bonds as follows: Union Loop bonds, $11,250; Chicago & West Town Railway Co. stock, $15,000; Chicago, Burlington & Quincy Railway Co. bonds, $14,061.25; Armour & Co. bonds, $23,843.75; Oregon Short Line bonds, $8,200; or a total of stocks and bonds of $72,375.
    During 1918 the corporation bought United States Liberty Loan bonds as follows: April 30 to August 31, $61,052; September and November, $16,500; and in August it bought United States anticipation certificates in the sum of $50,000, and therefore owned, during 1918, $127,552 worth of United States securities.
    In June, 1918, the Chicago Elevated Railway Syndicate stocks and bonds were disposed of at a selling price of $3,907.
    It was then and has regularly been the custom of the corporation to invest its surplus cash in securities, so that the corporation would receive a return on its surplus in excess of the interest paid by banks ¡during periods when the corporation’s funds were not needed. The Union Loop bonds were kept by the company for several years, because they constituted a conservative investment and produced a fair return. The Chicago Elevated Railway Syndicate stocks and bonds were taken by the petitioner in lieu of cash for stock long owned by the petitioner in the Northwestern Elevated Railway Co. The par value of the old stock was $18,600, for which the petitioner received $18,600 par value of stock and $6,700 in bonds. The bonds were carried on the books at a nominal value of $1. This investment was kept for its speculative possibilities. Because the petitioner had done considerable work for the Chicago & West Town Railway Co. and for the Chicago Elevated Railway Co., it became a matter of business enterprise on the part of the petitioner to subscribe for the bonds of those companies.
    The United States anticipation certificates were purchased by the corporation with the view of holding them to meet any necessity for paying subsequent Federal taxes.
    The stocks and bonds owned by the petitioner comprised the cash capital of the corporation maintained for such use as might develop. During 1918 the income from investments was $3,872.14, including $900 in dividends.
    A warehouse built in 1903 at a cost of $2,860.88 was carried among the assets of the corporation from 1912 to 1919 at a value of $500.
    The corporation had a stock of tools, machinery and equipment on December 31,1917, of the value of $8,452.75, and the stock of tools, machinery and equipment on December 31, 1918, was $9,298.72'.
    The opening and closing balance sheets as shown by the petitioner’s return for 1918 are as follows:

    During 1918 the petitioner from time to time borrowed sums of money and paid interest thereon in the total amount of $3,200.41. These sums of money were borrowed to pay the wages of employees working.on the petitioner’s cost-plus contracts with the Baltimore <⅞ Ohio Railroad Co. and from time to time during January, March, April, May, June, and July the petitioner advanced therefrom, without demand by the railroad company, sums for wages. During 1917 advancements for wages were made by the petitioner during five months and the average amount of such advancements was $19,-315.85. During 1918 such advancements were made for seven months, the average amount being $37,345.04. The interest paid by the petitioner was not one of the elements of cost reimbursed by. the railroad, nor on which it paid a percentage. Other than the Contract set forth above the petitioner had no agreement with the Baltimore & Ohio Railroad with respect to the payment or advancement of money for carrying on the work. These loans were necessitated, at least in part, by the fact that for a portion of . the time the railroad company failed to make payments promptly. After complaint by petitioner this condition was remedied and prompt payment was resumed.
    The loans were made on the personal credit of Andrew S. Little^ field, and none of the stocks and bonds of the petitioner were pledged as collateral.
   OPINION.

Sternhagen:

The special method of treating certain corporations as partnerships and imposing the tax, not upon the corporation but upon the individual stockholders, prescribed by section 218 (e), Revenue Act of 1918, is confined to those corporations which are within the statutory definition of section 200. The attributes set forth in the definition must all exist, and the failure of any one defeats the claim for such classification and requires. that the corporation be taxed under the remaining provisions of the statute applicable .to corporations generally. Scheffler Hair Colorine Co., 1 B. T. A. 61. It is therefore only necessary to look for one of these attributes at a time, and if it be not found from the evidence, the claim fails and it is unnecessary to consider whether the remaining statutory attributes are present.

In considering a case where the corporation seeks to be entirely free from tax imposed upon itself, as distinguished from a claim under section 303, it is necessary to test the claim by applying the statutory requirements to all of the petitioner’s business and circumstances. For it is only by considering these in their entirety that it can be determined whether any one of the claimed attributes measures up to the terms of the statute. The relation of each to the whole is essential to the consideration of the primary source of income and the materiality of capital as an income-producing factor. Thus it is necessary to consider the Baltimore <& Ohio contract not as presenting the sole data for the year in question but .as one with the other facts.

.That, all evidence considered, this petitioner is not within the definition is in our opinion very clear. This was not a personal business. It was organized and carried on as a construction business backed by financial credit and responsibility, ready to furnish the labor and equipment necessary to fulfill its ppntracts, indemnifying the owner against loss or failure to perform, and in the first instance undertaking to finance the cost of the project. To this end it owned equipment upon which it deducted depreciation on its return. It borrowed substantial sums of money on its own and its officers’ credit, it invested its reserve capital in liquid securities which yielded it income — relatively little but not immaterial.

Reading the several contracts the performance of which constituted most of its business for the year in question, it is inconceivable that they could be undertaken without capital or that capital is not a material income-producing factor. They appear to contemplate that the petitioner should in the first instance bear the cost and thereafter be periodically reimbursed plus a percentage. Whether in fact it bore such cost in all cases does not appear. To some extent it did and borrowed the money to do so. The contracts themselves would indicate that the petitioner first paid the cost of labor and equipment, financing it as best it could, and then received periodic repayment from the railroad company.

The situation is quite different from that considered in Bryant & Stratton Commercial School, Inc., 1 B. T. A. 32, relied upon by petitioner. There the Board found that the activities of the principal' stockholders in the personal business of education were the primary source of income and that their capital was not material. Here capital is material and we doubt that the stockholders are the primary factors of income production. The statute must surely mean something more than that the business should be capably managed by its executive officers. All corporate income is to some extent ascribed to this.

Judgment will be entered for the Commissioner.


source: Caselaw Access Project

author: Love:

license: Public Domain

text:
    Union Trust Co. of Cleveland, Ohio, Executor, Estate of Ellen C. Herenden, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6983.
    Promulgated January 28, 1927.

      T. C. Thompson, Esg., and S. A. Bailey, Esq., for the petitioner.
    /. F. Greaney, Esq., for the respondent.
   Love:

This is a proceeding to redetermine a deficiency in estate tax of the estate of Ellen C. Herenden. The amount of the deficiency asserted by the Commissioner is $303.98.

The sole question at issue is whether or not Ellen C. Herenden was. at the date of her death, a nonresident of the United States.

FINDINGS OF FACT.

The petitioner is an Ohio corporation, with its principal office in Cleveland, and is the executor and trustee of the estate of Ellen C. Herenden, deceased.

The decendent was born at Newport, N. Y., in 1864. Her father was a. native of Massachusetts, and her mother a native of New York. The decendent had one brother who resided in New York, who died two years prior to her death. After the death of her brother she had no near relative in the United States.

Some time prior to April 26, 1912, she went to France, and from that time until 1918 she remained abroad most of the time. In 1918 she was in the United States and on or about January 5, 1918, returned to France. On the passport which she obtained at that time for her trip to France, in a statement as to “ Object of Visit,” there is written the word “ Residence.” She never thereafter returned to the United States.

On April 26, 1912, she executed a will, dating the same in Paris, France, which was witnessed by persons then in Paris. On the 7th day of November, 1922, she executed a codicil to that will which was dated at Le Bouscat, France, and witnessed by persons then in Le Bouscat. In both those instruments she described herself as “ Ellen O. Herenden, of Cleveland, Ohio, residing temporarily in France.”

The major portion of her property, during her stay in France, was held and managed for her by the Citizens Savings & Trust Co., the predecessor of the Union Trust Co.

The decedent died in France on December 3, 1922, and her will was duly probated in Cuyahoga County, Ohio. The value of the trust estate on September 22, 1911, was $74,790.06, and on December 3, 1922, was $103,231.98. John C. Armstrong, assistant secretary of the Union Trust Co., from 1917 to date of her death, prepared her income-tax returns and filed same with the collector at Cleveland, Ohio, and paid the taxes there. Those returns were made on the basis that decedent was a resident of Cleveland, Ohio. The Union Trust Co., as executor of her will, obtained an inventory of the personal effects of the decedent at date of her death and that inventory did not contain any item of household furniture.

While in France, her correspondence, was addressed to her,, care of Morgan, Harjes & Co., Paris, France, with some letters addressed to various hotels and sanitariums.

The terms of her will as modified by the codicil, bequeathed her estate—

One hundred dollars, each, to three friends in France.

Two hundred dollars to a friend in England.

One hundred dollars to another friend in England.

A life estate in the net income of her estate to Miss Francis S. Dickerman, residing in Chicago, Ill., and the corpus of the estate, together with the income after the death of Miss Dickerman to the Citizens Savings & Trust Co., of Cleveland, in trust to be held for the benefit of the Cleveland Day Nursery and Free Kindergarten Association, under direction that that association should found, in a suitable location in Cleveland, in a quarter where such work is most needed among the working classes, a day nursery and kindergarten to be named “ Charlotte Herenden Day Nursery and Kindergarten ” in memory of decedent’s mother.

The decedent was a citizen and a resident of the United States at the time of her death.

Judgment will be entered after 15 days’ notice, under Rule 50.


author: Arundell:

text:
    Dixie Groves & Cattle Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6311.
    Promulgated January 28, 1927.

      A. J. Dozier for the petitioner.

      W. F. Gibbs, Esq., for the respondent.
   Arundell:

This is a proceeding for the redetermination of a deficiency in income tax for the calendar year 1922 in the amount of $1,606.05. The error alleged by the petitioner is the refusal of the Commissioner to allow as a deduction from 1922 income losses sustained in the calendar year 1920. No proof was offered at the hearing. Aside from jurisdictional allegations, all that is admitted by the Commissioner is that he disallowed as a deduction the sum of $14,618.86, representing losses sustained in years prior to the calendar year 1921. There is no provision of law allowing losses sustained in years prior to 1921 to be deducted from 1922 income and accordingly

Judgment will be entered for the Commissioner.


text:
    Appeals of George W. Megeath et al.

    Docket Nos. 7118, 2815, 7086, 7119, 7959, 9248.
    Promulgated January 28, 1927.
    1. Seld, upon the evidence, that the cash dividend of $344,050 distributed by the Sheridan Coal Co. on April 16, 1920, was paid out of earnings accumulated after February 28, 1913, and that the entire amounts received by the petitioners who participated therein are taxable to them.

      2. Stock dividends are not distributions of corporate earnings or profits. Misner v. Macotriber, 252 U. S. 189. Where a corporation in 1917 and 1918 declares and pays stock dividends which are charged against surplus, and thereafter, in -1920, declares and pays a cash dividend, in an amount which may exceed the reduced surplus plus the earnings of the year 1920 to the dividend date,, but less than the earnings accumulated after February 28, 1913, and remaining undistributed, held, that under the provisions of section 201 (b) of the Revenue Act of 1918 the cash dividend is deemed to have been made entirely out of earnings or profits accumulated after February 28, 1913, and is to be included as a part of the gross income of the stockholders receiving such cash dividend. Appeal of Hugh R. Wilson, 3 B. T. A. 957.
    3. In the absence of evidence which will identify certain shares of corporate capital stock, sold or exchanged, with specific purchases or other acts vesting ownership thereof in the vendor, such shares, so sold or exchanged, will be deemed to be those first acquired by the vendor. Torone v. MeMligott, 274 Fed. 960, 963.
    4. March 1, 1913, value of certain shares of corporate capital stock determined for the purpose of computing the gain derived from the sale of such shares of stock. -
    6. Traveling expenses incurred by an individual, while on a business trip, incident to the transportation and .maintenance .of his wife and nurse who accompanied him, are of a personal nature and not allowable as deductions for income-tax purposes.

      Jay 0. Halls, Esq., and L. Dana Latham, Esq., for. the petitioners.

      J. W. Fisher, Esq., and George G. Witter, Esq., for the Commissioner.
    These appeals are from determinations, by the Commissioner of deficiencies in income tax for the calendar years and in the amounts as follows:
    S.A. Megeath, 1919_.,_$7, 707.17
    Alvah P. Whitmore, 1920_ 346.94
    George W. Megeath. 1920 and 1921-j._:_ 4,076.21
    Ida J. Megeath, 1920_■__ — _•-64, 618.66
    Leonard Kniffin, 1920--:- 1,408.00
    Samuel A. Megeath, 1920_ 2, Oil. 78
    By agreement of the parties the appeals are consolidated. With the exception of the appeal of S. A. Megeath, Docket. No. 2815, all of the appéáls involve the question whether dividends distributed by the Sheridan Coal Co. and received by the petitioners in 1920 are taxable as distributions made from the corporate profits accumulated after February 28, 1913. ' The appeals of S. A. Megeath, Docket No. 2815, and Ida J. Megeath, Docket No. 7119, involve the question as to the gain derived from the sale of certain shares of stock of the Sheridan Coal Co. The appeal of George W. Megeath also raises an issue as to a deduction for traveling expenses claimed iñ his return for the year 1921.

      BINDINGS OP PACT.'
    The petitioners in 1920 were stockholders of the Sheridan Coal Co. This company was organized in 1903 and has since been engaged in the business of mining coal.
    On April 16, 1920, the Sheridan Coal Co. distributed to its stockholders a cash dividend of $344,050, of which the petitioners received the following amounts:
    Alvah P. Whitmore_$5, 000. 00
    George W. Megeath_ 16, 775. 00
    Ida J. Megeath_91,125.00
    Leonard Kniffin_ 4, 900. 00
    Samuel A. Megeath_ 18,200.00
    The book surplus of the Sheridan Coal Co. at December 31, 1919, was $868,632.41; and certain adjustments made by the Commissioner in the book accounts, which adjustments are not contested by the petitioners, increased it to $931,278.14. Subsequent to December 31, 1919, additional income and profits taxes for the years 1916 to 1918, inclusive, in the amount of $227,659.78, were assessed against and paid by the Sheridan Coal Co. The income and profits tax of the Sheridan Coal Co. for the year 1919, as determined by the Commissioner in a sixty-day letter addressed to this company, under date of May 22,1925, is $3,010.92. Neither the additional assessments for the years 1916 to 1918, inclusive, nor the tax liability for the year 1919, are reflected in the adjusted surplus of $931,278.14.
    The net income of the Sheridan Coal Co. from all sources for the year 1920, as shown by the report dated December 9, 1924, of a revenue agent who examined the books of account, is $301,517.09. The net income shown by the books of account is $308,376.77. The difference of $6,859.68 is accounted for as follows:
    Additional depreciation allowed in revenue agent’s report- $2,115.32
    Additional depletion allowed in revenue agent’s report 8, 290. 04
    10,405.36
    Net increase in fire and liability insurance reserves disallowed by revenue agent as deduction from income___ 3,545.68
    Difference__ 6, 859. 68
    Cash dividends distributed by the Sheridan Coal Co. during the period January 1 to April 15, 1920, amounted to $165,144.
    At or about the time of its organization in 1903, the Sheridan Coal Co.- acquired certain coal lands in Wyoming at a cost of $680,000. The March 1, 1913, value of these lands was $1,037,780. Subsequent to March 1,1913, additional lands were acquired at a cost of $16,000. All of these lands, including the improvements thereon, were sold in 1919 for the sum of $1,250,000. The expenses in connection with the sale amounted to $42,500. At the time of the sale, the lands in question were carried on the books of account at a value of $850,-116.52 and the improvements thereon at a value of $300,290.47. The book value of the lands included appreciation in the amount of $300,000, which was written on the books during the year 1917. The total depletion charged off on the books in respect of the coal lands in question amounted to $126,233.48. The total depletion determined by the Commissioner, as shown by a sixty-day letter addressed to the company under date of May 22, 1925, is, upon the basis of cost, $26,072.89, and upon the basis of the March 1, 1913, value $42,732.17. The. total depreciation charged off by the company for the years 1917 to 1919, inclusive, on the improvements is $206,429.41. The total depreciation allowed by the Commissioner for the same years, as shown by the sixty-day letter referred to, is $128,772.41.
    The surplus of the Sheridan Coal Co. at December 31, 1912, as shown by its books of account, was $67,893.15. It included appreciation of the stock of the Roundup Coal Mining Co. in the amount of $78,000 which had been written on the books of account in June, 1910. It did not include the excess of the March 1, 1913, value of the lands over the cost thereof. The earnings of the Sheridan Coal Co. for the year 1913 amounted to $56,592.53. A cash dividend of $2,925 was paid on the preferred stock at February 1, 1913.
    In 1917 the Sheridan Coal Co. distributed a stock dividend of $200,000 and a similar distribution of like amount was made in the year 1918.
    None of the petitioners who participated in the dividend which the Sheridan Coal Co. distributed in cash on April 16, 1920, included the amounts received by them from that source in their income-tax returns. The Commissioner has held that the whole amount of the dividend was distributed out of earnings accumulated after February 28, 1913, and that those of the petitioners who participated therein are liable for tax upon the respective amounts received by them from this source.
    In the year 1908, Ida J. Megeath acquired by gift 40 shares of the capital stock of the Sheridan Coal Co. Subsequent to March 1, 1913, she acquired, either by gift or by way of stock dividends, additional shares of this stock as follows:

      In 1920 she exchanged 786 shares of the stock of the Sheridan Coal Co. for a like number of shares of the capital stock of the Megeath Coal Co., and in the same year sold the Megeath Coal Co. stock for $135-per share.
    On March 1, 1913,. S. A. Megeath owned 1,198 shares of the capital stock of the Sheridan Coal Co. which he had acquired by bequest and purchased prior to that date. In December, 1917, and again in January, 1918, he received a stock dividend of 239 shares, a total of 478 shares from this source, of the capital stock of the Sheridan Coal Co. In 1919 he sold 722 shares for the sum of $72,285.
    The net income of the Sheridan Coal Co. for the years 1904 to 1920, inclusive, as shown by its books of account, was as follows:

    The net income for the seven months ended December 31, 1910, is not shown; the net income reported in the Federal income-tax return for that period is $150,220.85. The loss of $20,818.13 for the calendar year 1911 is occasioned by an erroneous charge-off of $59,365.25. The net income reported in the Federal income-tax return for the year 1911 is $38,547.12.
    The books of the Sheridan Coal Co. show that dividends have been paid on the preferred stock as follows:

    The outstanding capital stock of the Sheridan Coal Co. for the years 1904 to 1920 was as follows:

      In 1921, George W. Megeath made a trip to Europe and later in the same year a trip to’ California. Both of these trips were made in an effort to find a market for the coke produced by the Sheridan Coal Co. He paid the expenses of the trip himself and was not reimbursed by the company. On both of the trips he was accompanied by his wife and his nurse. He had been in poor health and had been attended by a- nurse for a number of years. It was at the direction of his physician that the nurse accompanied him on his 'trips in 1921. For the steamship passage of himself, wife, and nurse to Europe and return Megeath paid the steamship company $5,000. In his return for the year 1921 Megeath claimed this item of $5,000 and the expenses of his trip to California in the amount of $6,000 as deductions from income.

       The following appeals were consolidated with the above and áre decided herewith: S. A. Megeatli, No. 2815; Alvah P. Whitmore, No. 7086; Ida J. Megeath, No. 7119; Leonard Kniffln, No. 7959; and Samuel A. Megeath, No. 9248.

   OPINION.

Arundell:

The appeals of the several petitioners have been consolidated and are considered and disposed of herewith. In all, four issues are presented by these appeals for our consideration and they will be considered and disposed of in the order in which the facts pertaining, thereto are outlined in the findings of fact.

The first issue, which is common to all the appeals except that of S. A. Megeath, Docket No. 2815, is whether the distribution made by the Sheridan Coal Co. on April 16,1920, in cash in the amount of $844,050, was paid out of the corporate earnings of that company accumulated after February 28, 1913, or whether a part thereof represents a distribution of corporate earnings accumulated prior to March 1, 1913. To the extent that the distribution was made out of earnings accumulated after February 28,1913, it is, under the pro.visions of section 201(a) of the Revenue Act of 1918, a dividend, and is taxable to the recipients. Any part of the distribution which may have been made out of corporate earnings accumulated prior to March 1, 1913, is,.under subdivision (b) of the same section, exempt from the tax. There is no dispute between the parties on any question of the law applicable to the facts. The only issue is as to the source from which the earnings distributed on April 16, 1920, were derived. • ■ •

The surplus of the Sheridan Coal Co. on December 31, 1919, according to the books of account, was $868,632.41, but this was increased by the Commissioner to $931,278.14 through adjustments in the book accounts which are not contested by the petitioners. In addition to the liabilities' which appeared on the books of the Sheridan Coal Co. it was indebted to the Government for additional income and profits taxes for the years.prior to 1919 in the amount of $227,659.78, while its liability for taxes for the year 1919, as determined' by the Commissioner in a sixty-day letter addressed to the company under date of May 22, 1925, amounted to $3,010.92, a total liability for accrued taxes of $230,670.70. The correct surplus of the Sheridan Coal Co. at December 31, 1919, was, therefore, the Commissioner’s adjusted surplus less the liability for accrued taxes, or the sum of $700,607.44. The surplus at April 16, 1920, the date of the distribution, was the corrected surplus at December 31,1919, plus the earnings from January 1, 1920, less the dividends paid between January 1 and April 16, 1920. A revenue agent’s report dated December 9, 1924, which is in evidence, discloses total earnings of the Sheridan Coal Co. for the year 1920 in the sum of $301,517.09. The net income according to the books of account is $308,376.77. The difference of $6,859.68 is due to the agent’s allowance of additional depletion and depreciation and his disallowance as a deduction from income of the net increase in the fire and liability insurance reserves. The agent’s adjustments have not been contested by the petitioners. As a matter of fact, counsel for petitioners in their brief adopt the revenue agent’s figures as correct for the purposes of these appeals. Spreading the net income of $301,517.09 ratably over the year 1920, the earnings for the period January 1 to April 15, 1920, are $87,324.62. The dividends paid by the Sheridan Coal Co. between January 1 and April 15, 1920, amounted to $165,144. Adding to the corrected surplus of $700,607.44 at December 31, 1919, the earnings of $87,324.62 for the period January 1 to April 15, 1920, and deducting the dividends of $165,144, we conclude that the surplus at April 16, 1920, the date of the distribution, was the sum of $622,788.06. We pass now to the determination of the source from whence this surplus was derived.

On December 31, 1912, the surplus of the Sheridan Coal Co. according to the books of account, was $67,893.15. At that date the capital stock of the Eoundup Coal Mining Co. was carried on the books at $104,000, appreciation in the amount of $78,000 having been written on the books in June, 1910. There is no evidence before us that the March 1, 1913, value of this stock was in excess of cost, which was $26,000, Deducting this appreciation of $78,000 from the surplus, we conclude there was a deficit at December 31, 1912, of $10,106.85. The earnings of the year 1913 amounted to $56,592.53, which, when spread ratably over the year, indicate earnings of $9,432.09 for the period January 1 to February 28, 1913. Deducting the earnings of $9,342.09 from the deficit of $10,106.85 and adding the dividend paid on February 1, 1913, in the amount of $2,925, to the remainder, we conclude that the Sheridan Coal Co. had a deficit of $3,599.76 at March 1, 1913. It is apparent, therefore, that the surplus of $622,788.06 at April 16, 1920, does not include any earnings accumulated prior to March 1, 1913.

The lands which the Sheridan Coal Co. acquired at the time of organization were purchased at a cost of $680,000. The March 1, 1913, value of these same lands, it is agreed, was $1,037,780, and the excess value at that date over cost was $357,780. Since these lands were sold during the year 1919, it is apparent that any gain resulting' from the sale thereof is reflected in the surplus at April 16, 1920. If the sale resulted in a profit when the computation is made upon the basis of cost, then, to the extent that the profit represents a realization of the March 1, 1913, value in excess of cost, it is to be treated as earnings accumulated prior to March 1, 1913, and the. amount of such realization should be deducted from the surplus at April 16, 1920, in arriving at the amount of the earnings accumulated since March 1, 1913, available for distribution. In the sixty-day letter of May 22, 1925, addressed to the Sheridan Coal Co. the Commissioner determined that the profit upon the sale of the land and improvements was, when computed upon the basis of cost, $321,743.43. The Commissioner’s determination is based upon cost, less depletion, of $585,466.10 for the lands, and a cost, less depreciation of $300,290.47 for the improvements. These costs have been adopted by the petitioners for the purpose of computing the gain or loss resulting from the sale. The parties are in agreement that the March 1, 1913, value of the lands, plus the cost of subsequent additions, and less depletion based upon that value, is $1,011,047.83. The profit determined by the Commissioner represents the difference between the selling price, less expenses of selling, and the total cost of the properties sold, the computation being as follows:

Selling price_$1, 250, 000. 00
Less: Selling expense_ 42, 500.00
Net selling price_._$1,207, 500.00
Deduct:
Cost of lands_ 585, 466.10
Cost of improvements_ 300,290.47
Total cost of land and improvements- 885, 756. 57
Profit_ 321, 743.43

The petitioners contend that gain or loss should be determined by a separate computation for the lands and a separate computation for the improvements, by assigning as the selling price of the laiid so much of the net selling price as equals the March 1, 1913, value, plus additions and less depletion, of the land, and assigning the balance of the selling price to the improvements. Their computations are as follows:

Net selling price_$1,207, 500.00
Selling price of land (March 1, 1913, value plus additions and less depletion)_ 1, 011, 047. 83
Selling price of improvements_ 196,452.17
Selling price of lands_ 1, 011, 047.83
Less: Cost of lands_ 585, 466.10
Profit from sale of lands_ 425, 581.73
Cost of improvements_ 300, 290.47
Less: Selling price of improvements_ 196, 452.17
Loss from sale of improvements_ 103, 838. 30

The petitioners then reason that since the selling price of the lands does not exceed the March 1, 192.3, value thereof, plus additions and less depletion, the profit of $425,581.73 from the sale of the lands is entirely a realization of the March 1, 1913, value in excess of cost, which should be deducted from the surplus at April 16, 1920, in determining the amount of earnings accumulated after March 1, 1913, available for distribution. The petitioners also contend that the loss sustained upon the sale of the improvements should be deducted from the surplus at April 16, 1920, in arriving at the amount of the earnings accumulated after March 1, 1913, available for distribution. By deducting the profit from the sale of the lands and the loss from the sale of the improvements the petitioners arrive at a balance in the surplus account less than the amount of the dividend of April 16, 1920; hence, they contend that a portion of the dividend was paid out of earnings accumulated prior to March 1, 1913, and that a proportionate part of the dividend received by each of them is nontaxable.

It will be noted that if the loss from the sale of the improvements is deducted from the gain from the sale of the lands, as such loss and gain have been computed by the petitioners, the profit, taking the transaction as a whole, is $321,743.43, which is precisely the profit which the Commissioner has determined. However, for reasons which will hereafter appear, we believe that the profit realized by the Sheridan Coal Co. from the sale in question was an entirely different amount. The petitioners’ contention that the gain and the loss resulting from the sale of the lands and improvements, respectively, should be computed separately, is without merit. The evidence does not justify a finding that there was a sale of the lands and a sale of the improvements in the sense that there were two distinct and entirely different transactions. On the other hand, the evidence shows that the lands and the improvements were sold together for a lump sum of $1,250,000; and any arbitrary allocation of the selling price as between the lands and the improvements is unwarranted. Rather, the gain or loss resulting from the sale must be computed upon the basis of what in fact it was, a sale of the lands and improvements by one and the same transaction.

; We have previously pointed out that, upon the basis of a depleted cost for the lands of $585,466.10 and a depreciated cost for the improvements of $300,290.47, the Commissioner has determined, in the sixty-day letter to the Sheridan Coal Co., that the sale resulted in a profit of $321,743.43. The petitioners have adopted these same costs in computing the profit from the sale for the purposes of their appeals. The evidence, however, convinces us that these costs are incorrect and may not be used as the basis for the determination of the profit resulting from the’ sale. The Commissioner’s computation of the cost of the lands, as contained in the sixty-day letter to the Sheridan Coal Co., shows an addition to the cost of the sum of $35,349.58, representing the amount of depletion charged off on the books of the Sheridan Coal Co. in excess 'of the total depletion allowed by the Commissioner. The evidence shows that the total depletion charged off on the books of the Sheridan Coal Co. amounted to $126,233.48, and that the total depletion allowed by the Commissioner on the basis of cost is $26,072.89. Therefore, the excessive depletion charged off on the books is $100,160.59, which is $64,811.01 in excess of the amount restored by the Commissioner. The correct cost of the lands is the cost determined by the Commissioner in the sixty-day letter to the Sheridan Coal Co., to wit, $585,466.10 plus the sum of $64,811.01, or $650,277.11. The Commissioner adopted the book value of the improvements as the cost thereof. The evidence shows that during the years 1917 to 1919, inclusive, the total depreciation charged off on the books of the Sheridan Coal Co. on the improvements amounted to $206,429.41 and that the total depreciation allowed by the Commissioner is $128,772.41. Therefore, the excessive depreciation charged off on the books is $77,657, which, vrhen added to the book value of the improvements, to wit, $300,-290.47, results in a corrected cost for the improvements of $377,-947.47. The total corrected cost of the lands and improvements is $1,028,224.58, which, when deducted from the net selling price of $1,207,500, indicates a profit upon the entire transaction of $179,-275.42. Since the profit is less than the excess of the March 1, 1913, value over cost, the entire amount thereof is to be treated as earnings accumulated prior to March 1, 1913. Deducting the profit of $179,275.42 from the surplus of $622,788.06, leaves a balance of $443,512.64, representing earnings accumulated after March 1, 1913, which is in excess of the dividend of $344,050 distributed by the Sheridan Coal Co. in cash on April 16, 1920. Therefore, the entire amounts received by those of the petitioners who participated in the dividend were distributed out of earnings accumulated after February 28,1913, and are taxable to them.

Though our conclusion is that there were sufficient earnings accumulated after February 28, 1913, out of which the Sheridan Coal Co. was enabled to make the distribution of April 16, 1920, there is the further consideration that, though it might be conceded that the petitioners’ computations are entirely correct, and that after the deduction of so much of the profit from the sale as represented a realization of March 1, 1913, appreciation there remained in the surplus earnings accumulated after February 28, 1913, in the amount of $6,043.39 only, our conclusion would be no different, since in arriving at the earnings available for distribution the petitioners have excluded from the surplus account the stock dividends paid in December, 1917, and January, 1918, in the total amount of $400,000. This it can not do, as decided by the Circuit Court of Appeals for. the Fifth Circuit, in Walker v. Hopkins, 12 Fed. (2d) 262, and by this Board in the Appeal of Hugh R. Wilson, 3 B. T. A. 957, following the reasoning in Eisner v. Macomber, 252 U. S. 189. The total amount excluded from the surplus representing the amount of the stock dividend is in excess of the distribution of April 16, 1920.

The next issue is as to the gain or loss realized by Ida J. Megeath upon the exchange in 1920 of 786 shares of the capital stock of the Sheridan Coal Co. for a like number of shares of the capital stock of the Megeath Coal Co. Of the 786 shares exchanged 40 were acquired by gift prior to March 1, 1913, 100 by gift in 1916, and 646 by gift' in 1917. (Towne v. McElligott, 274 Fed. 960, 963.) The 646 shares last mentioned were part of 2,500 shares acquired by gift in 1917. .On a total of 2,640 shares the petitioner received stock dividends in 1917 and 1918 of 1,056 shares. The 786 shares of the Megeath Coal Co. which the petitioner received upon the exchange were sold by her in the same year for a price equivalent to $135 per share; and the parties agree that for the purpose of the determination of the gain or loss upon the exchange the shares of the Megeath Coal Co. are to be valued at $135 per share.

For the purpose of determining gain or loss upon the exchange of property, the value of the property received in exchange, or selling price, is to be compared with the cost of the property exchanged, or, in the event that the property was acquired prior to March 1, 1913, with its value on that date plus the cost of subsequent additions. In no case will the gain exceed the excess of the selling price over the March 1,1913, value plus the cost of subsequent additions. It is upon this basis that the Commissioner has determined that the petitioner realized a profit of $49,967.15 upon the exchange, he having assigned to the 40 shares acquired in 1908 a value at March 1, 1913, of $100 per share, and the same value to the other shares sold, at the time they were acquired in 1916 and 1917, with proper adjustment on account of stock dividends. In other words, the Commissioner’s deter-, mination is that the petitioner realized the maximum profit upon the exchange, to wit, the excess of the selling price over the March 1, 1913, value plus the cost of subsequent additions. The petitioner contends that she sustained a loss upon the exchange, but whether that be true or not we are unable to determine, since the evidence is insufficient upon which to base a finding of the value at the date of acquisition of the 40 shares acquired by gift in 1908. Therefore, any relief which we may afford the petitioner from the Commissioner’s determination must necessarily be limited to the extent that we find the Commissioner’s determination of gain exceeds the difference between the selling price, and what we find to be the March 1, 1913, value of the 40 shares acquired in 1908 plus the cost, or fair market value at the date of acquisition, of the other shares sold which were acquired in 1916 and 1917. All of the shares sold by the petitioner were acquired by gift; hence, in addition to determining the value at March 1,1913, of the 40 shares acquired in 1908, it is necessary to determine the fair market value at the date of acquisition of the 100 shares acquired in 1916 and the 646 shares out of a total of 2,500 acquired in 1917.

So far as the record discloses there were no sales of stock of the Sheridan Coal Co. at or about the dates in question. The company is a close corporation. Its stock is not listed on any exchange and transactions involving the transfer thereof are infrequent. The common stock had a par value of $100 per share. If a valuation is to be made it must be through a consideration of book values and earnings. For the five-year period 1909 to 1913 the average earnings, after deducting dividends paid on preferred stock, were $90,567.07, which represents earnings of $9.06 per share on the common stock. The earnings for the year 1913, after deducting the dividend paid on the preferred stock, were $44,892.53, or $4.49 per share. Based on the actual surplus at March 1, 1913, as we have previously found it to have been, the book value of the stock was $135.42. Beginning with the year 1909 and continuing to 1915 there was a steady recession in the earnings of the company, the low level being reached in the year 1914, when the earnings amounted to but $14,789.38, which, after the deduction of the dividend paid on the preferred stock, represented a return of approximately 31 cents per share. In 1915 the earnings increased to $60,992.01 and in 1916 they amounted to $227,443.47. For the five-year period 1912 to 1916 the average earnings, after deducting dividends paid on the preferred stock, amounted to $73,121.59, or $7.31 per share. The earnings for the year 1916, after deducting the dividend on the preferred, were $215,743.47, or $21.57 per share. The book value of the stock in December, 1916, was $170.04 per share, after adjustments made by the Commissioner. For the five-year period 1913 to 1917 the average earnings, after deducting dividends on the preferred stock, were $165,832.50, or $16.58 per share. The earnings for the year 1917, after deducting dividends on the preferred, were $516,215.12, or $51.62 per share. In that year all of the outstanding preferred stock was retired without any increase in the bonded indebtedness or temporary obligations. The book value of the stock on August 28, 1917, was approximately $199.81 per share. The earnings for the next three years, 1918 to 1920, averaged approximately $290,000 per annum. Based on the foregoing, it is our opinion that the 40 shares owned by the petitioner on March 1, 1913, had- a fair market value at that date of $100 per share; that the 100 shares acquired by gift in December, 1916, had a fair market value at the date of acquisition of $130 per share; and that the 2,500 shares, of which 646 shares formed a part of the transaction under consideration, acquired in August, 1917, had a fair market value at the date of acquisition of $155 per share. Adopting the principles laid down in the cases of Miles v. Safe Deposit & Trust Co., 259 U. S. 247; and Towne v. McElligott, supra, and in the Appeal of D. W. Cowden, 3 B. T. A. 816, for determining the basis for computing the gain or loss upon the sale of stock upon which stock dividends have been distributed, we find that the bases for the determination of the gain resulting from the transaction under consideration are as follows: For the 40 shares held at March 1, 1913, $71.4286 per share; for the 100 shares acquired in 1916, $92.8571 per share; and for the 2,500 shares acquired in 1917, $110.7143. The maximum taxable profit resulting to the petitioner" computed on these bases is $22,445.71.

The 722 shares of stock of the Sheridan Coal Co. sold by S. A. Megeath in 1919 were acquired by that petitioner prior to March 1, 1913. Applying the basis adopted in the case of Ida J. Megeath, $71.4286 per share, the maximum taxable profit resulting to this petitioner upon the transaction in question is $20,713.55.

The additional question involved in the appeal of George W. Megeath is the deductibility of two items, one of $5,000 and one of $6,000, claimed as traveling expenses for the year 1921. The facts with respect to the trip to Europe are sufficiently set forth in our findings of fact. Upon them we find that the petitioner is entitled to deduct the sum of $1,666.67 for traveling expenses in connection with' his trip to Europe. No part of the expense incidént to the transportation of his wife or nurse to Europe may be allowed as deductions in computing taxable net income, since they are of a personal nature. The amount of $6,000 is claimed as expenses of the trip to California on business for the Sheridan Coal Co. There is no evidence upon which we can base a finding as to what part of this amount represents expenses incurred in connection with the business, and what portion thereof is in the nature of personal expenses. The Commissioner’s disallowance of this item must be approved.

Judgment will be entered on 15 days’ notice, wider Rule 50.


author: Phillips:

text:
    Appeal of Lautz Marble Corporation.
    Docket No. 6674.
    Promulgated January 31, 1927.

      ’William Cogger, Esq., for the petitioner.

      Ellis W. Manning, Esq., for the Commissioner.
   Phillips:

Petitioner appeals from the determination by the Commissioner of a deficiency of $2,058.90 in income and profits tax for the calendar year 1919, arising from the disallowance of $4,282.11 of the depreciation claimed on buildings, machinery, furniture and fixtures, and tools.

FINDINGS OP PACT.

The petitioner is a corporation existing under the laws of the State of New York, with its principal place of business in Buffalo. It was incorporated in November, 1918, with an authorized capital of $150,000.

Upon incorporation it acquired the real estate, machinery, furniture, tools and inventory of a bankrupt corporation, and issued therefor stock of the par value of $70,700, assuming a mortgage thereon of $46,800.

The Commissioner determined the fair market value of the depre-ciable tangible assets paid in to the taxpayer corporation and allowed depreciation on such values as follows:

The fair market value of the buildings when acquired was $15,000 and of the tools, $2,185.30.

Decision redetermining deficiency will be entered on 10 days' notice, under Bule 50.


author: Smith:

text:
    Nancy J. Ryman, Petitioner, v. Commissioner of Internal Revenue, Respondent. Estate of B. A. Ryman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 1705, 1706.
    Promulgated January 31, 1927.

      O. B. McAtee, Esq., for the petitioners.

      J. L. Deveney, Esq., for the respondent.
   Smith:

These are proceedings for the redetermination of deficiencies in income tax of $444.05 for the year 1919 in the case of Nancy J. Ryman, and of $257.90 and $444.05 for the years 1918 and 1919, respectively, in the case of the estate of B. A. Ryman. The proceedings were consolidated for the purpose of hearing and decision. The point in issue is whether a partnership existed between B. A. Ryman and his sons, J. Nye Ryman and G. Carroll Ryman during the years 1918 and 1919.

FINDINGS OF FACT.

1. B. A. Ryman died in the spring of 1921. His widow is Nancy J. Ryman. Their two sons were of legal age in 1918 and 1919. For these years separate individual returns for income-tax purposes were filed by husband and wife under the community property law of Texas, and the sons filed separate individual returns. Partnership returns were filed for both years for the business of the father and sons.

2. In January, 1907, the eldest son, J. Nye Ryman, was called home from college to look after the ranch and business interests of his father by reason of the father’s ill health. He became active in their, management, married, and continued in the business. The father and son entered into an agreement to the effect that the eldest son would share equally with his two younger brothers in a one-half interest in the business. At the time, the two younger sons were under twenty-one years of age. The older of the two attained his majority in March, 1912. The youngest son, Bowie, died in 1911 as the result of an accident. Upon the death of the youngest, the one-half interest in the business theretofore shared equally between the three sons was divided equally between the two sons.

The oldest brother contributed to the partnership 30 to 50 head of cattle of his own at the time he returned from college, and the three brothers together contributed about 150 head of cattle and a cattle brand. The father also contributed considerable personal property. He owned no real estate at the time. The cattle owned were grazed upon leased lands, and later upon lands which were acquired with partnership profits. Neither the brothers nor the father received from the business a salary or profits and each drew only living expenses. The bank account was carried in the names of the father and the eldest son. Checks were honored when drawn by either of them or by the younger son in the name of the father. No books of account were kept of the business, the. only record of transactions being checks on the bank account.

3. In 1918 the eldest son managed the Bay City Cattle & Pasture Co., in which the family partnership owned a one-sixth interest, and for his services received a salary of $1,100, which he paid over to the family partnership and which the partnership reported as a part of its income for that year. About 1910, B. A. Byman bought 125 shares of stock of the First State Bank of Bay City, Texas, which was paid for out of partnership proceeds and with some moneys received from the mother from sale of lands belonging to her estate. More bank stock was acquired and in 1920 each of the two brothers owned 173 shares and the father owned 258 shares. In 1919 the elder son spent some time in the bank without salary, learning something of its operation, and afterwards, in 1920, drew a salary for his services. In 1919 real estate in Bay City, Tex., was purchased with notes signed by the father and son, and title was taken in the name of the son, who, a few months later, sold the property at a profit. This lot was purchased with partnership funds and the profit reported in the 1919 partnership return. In 1918 the younger son made a contract and bond in his own name to do some grading for the Gulf, Colorado & Santa Fe Bailroad, using for this purpose teams and tools belonging to the partnership, and the profit received by him from the contracts was reported as profit of the partnership for the year 1918.

4. The partnership agreement was never reduced to writing. The father frequently stated to business associates that he and his sons were jointly interested in the cattle business and the bank accounts were understood by the bankers to be partnership accounts.

5. An ordinary common-law partnership existed between B. A. Byman and his two sons during the years 1918 and 1919.

Judgment will be entered on 15 days’ notice, under Bule 50.


text:
    Braly-Ferguson Gin Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5399.
    Promulgated January 31, 1927.

      A. 8. Walker, Esq., for the petitioner.

      8. 8. Faulkner, Esq., for the respondent.
   Phillips:

This is an appeal from the determination by the Commissioner of a deficiency of $708.48 in income tax for 1922. Petitioner alleges that the Commissioner erred in refusing to allow the deduction of a net loss of $5,267.85 alleged to have been sustained in the year 1921.

FINDINGS OF FACT.

The petitioner is a corporation having its office and place of business at Leonard, Tex. During the years 1921 and 1922 it was engaged in the business of ginning cotton for its customers, buying cotton and cottonseed from its customers, and selling such cotton and cottonseed as were purchased.

The gross income and deductions of the petitioner for the year 1921 were as follows:

Gross income.
Gross sales-$64, 681. 80
Cost of goods sold_ '68, 573.13
-$3,891.33
Rents, warehouse storage_:_:__ 993.15
Ginning fees_ 5,175.25
- 6,168.40
2,277.07
Deductions.
Compensation of officers_ $2, 500. 00
Repairs- 75. 00
Interest_'_ 853.- 60
Taxes___ 172. 70
Other expenses- 3,943.62
- 7,544.92
—5, 267.85

In computing the deficiency for 1922, the Commissioner failed to allow the deduction of $5,267.85 as a net loss sustained in 1921.

Decision for the 'petitioner will he entered on 15 days’ notice, wider Rule 60.


author: Trussell:

text:
    James T. Clark Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3660.
    Promulgated January 31, 1927.

      Fred L. Van Dolsen, Esq., for the petitioner.

      F. 0. Graves, Esq., for the respondent.
   Trussell:

The deficiency involved in this proceeding is in the amount of $1,298.91 for the fiscal year ended August 31, 1920, and arises in part from the Commissioner’s elimination from invested capital of the sum of $16,014.01, resulting from adjustments made in the capital accounts for tools and fixtures and real estate.

FINDINGS OF FACT.

The petitioner is a corporation having its principal place of business at Newark, N. J., and has been engaged in the foundry business since 1902.

On January 1, 1906, the petitioner’s ledger accounts of tools and fixtures showed a balance of $21,246.15. During the year 1906, and from January 1 to August 31, 1907, additions were charged to this account, increasing it to $22,044.90.

On September 1, 1907, the account was ruled off on the ledger and carried forward in the amount of $15,171.11, showing an arbitrary write-off of $6,873.79.

On September 1, 1908, there was a further arbitrary write-off of $1,000, and the account was carried forward as $14,171.11.

On September 1, 1909, as a result of an alleged physical inventory at cost of tools and fixtures then on hand and in use, the balance in this account was entered on the ledger in the amount of $26,696.91. The difference between this balance and the previous ledger balance is $12,525.80.

During the years 1910, 1911, and 1912, the petitioner made additions to its tools and fixtures account which were charged to expense in the first instance when purchased, and at the end of the year expense was credited and tools and fixtures charged with the amount of the additions. Such additions were—

1910_ $305.44
1911_ 290. 73
1912_1,195.46

During the year 1908 petitioner made additions and improvements to its office building at a cost of $646.88. It added to this amount a portion of a city tax assessment and charged real estate capital account with the sum of $698.58.

The amount which the Commissioner eliminated from petitioner’s invested capital is shown as follows:

$12, 523. 80 Tools and fixtures, 1908.
305.44 “ “ “ 1910.
290. 73 “ “ “ 1911.
1,195. 46 “ “ “ 1912.
- 14,315.43
698. 58 Beal estate, 1908_
1, 000.00 “ “ 1912_
- 1,698.58
16, 014. 01

The arbitrary write-off of tools and fixtures account, aggregating $7,873.79, and the additions of $305.44 in 1910, $290.73 in 1911, and $1,195.46 in 1912, are proper and lawful additions to the tools and fixtures capital account for said years. The amount of $646.88, cost of additions to office building, is a proper and lawful addition to the real estate capital account for the year 1908.

The deficiency may be redetermined m accordance with the foregoing findings of fact, pursuant to Rule 50. Judgment will be entered im, due course.


author: Littleton:

text:
    Interurban Construction Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7028.
    Promulgated January 31, 1927.
    In the taxable year the petitioner was the owner of certain stock of its subsidiary which had cost $21,929.40 and was sold to its stockholders and the stockholders of the subsidiary (affiliation continuing) for $60,000. The Commissioner computed a profit on the transaction. 3eld, that the sale did not give rise to a taxable gain.

      Claude Collard, Esq., for the petitioner.

      W. Frank Gibbs, Esq., for the respondent.
    The Commissioner determined a deficiency for the year 1920 of $26,899.81 upon the basis of a consolidated return of the petitioner with the Oklahoma Union Railway Co. and the Sapulpa Electric Interurban Construction Co. The petitioner claims that the determination of a profit upon the sale by it of the stock of its subsidiary, the Oklahoma Union Railway Co., was erroneous.

      BINDINGS OB BAOT.
    Petitioner is an Oklahoma corporation with principal office at Tulsa. Throughout the taxable year it was affiliated with the Oklahoma Union Railway Co. and the Sapulpa Electric Interurban Construction Co. At the beginning of the taxable year 1920 petitioner was the owner of 3,500 shares of the capital stock of the Oklahoma Union Railway Co. During the year 1920 petitioner sold 1,200 shares of the stock of the Oklahoma Union Railway Co., which it owned, to certain individuals who were stockholders of the petitioner and the Oklahoma Union Railway Co. for $60,000. The cost of these 1,200 shares to the petitioner was $21,929.40.
    The Commissioner computed the profit on the sale to be the difference between $60,000 and $21,929.40. The stock of the Oklahoma Union Railway Co. was acquired by petitioner in 1911.
   OPINION.

Littleton:

The issue involved in this proceeding is the same as the issue decided by the Board in the Appeal of Interurban Construction Co., 5 B. T. A. 529, upon authority of the decision of the Board in the Appeal of Farmers Deposit Bank and Affiliated Banks, 5 B. T. A. 520. Upon the authority of the decisions in those cases, it is held that petitioner derived no taxable gain from the sale of stock of the Oklahoma Union Railway Co. in 1920, and the Commissioner’s determination of a deficiency, in so far as it resulted from the inclusion of a profit upon this transaction, was erroneous.

Judgment will be entered on 15 days' notice, wader Rule 50.


text:
    Sylvan Electric Bath, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7411.
    Promulgated January 31, 1927.

      John L. McMaster, Esq., for the petitioner.

      Thomas P. Dudley, Jr., Esq., for the respondent.
   Phillips:

Petitioner appeals from the determination by the Commissioner of deficiencies in income and profits taxes as follows:

1919_ $414.82
1920_ 513.68
1921- 946.62

It alleges as error the refusal of the Commissioner to allow any value for tangible or intangible assets acquired by it for stock and his refusal to allow depreciation on such tangible property. A further error alleged in the petition was waived at the hearing.

FINDINGS OF FACT.

The petitioner, Sylvan Electric Bath, Inc., is a corporation organized under the laws of the State of New York, and owns and operates a system of baths known as hydro-electro-cataphoretic baths, intended for the relief of rheumatism and similar diseases and complaints.

The Sylvan Electric Bath was originally established about the year 1900 by one George Bueckle, now the president of the company and majority holder of the common stock. The system is based on the method developed by one Stanger in Germany. Prior to establishing the baths Bueckle made an extensive personal study of the system in Germany and acquired patent rights and special equipment. The system contemplates the use of electricity combined with certain bark extracts, and requires specialized equipment and technical supervision.

The baths were conducted as an individual business by Bueckle until the year 1915, when it was incorporated in order that additional capital might be acquired.

Sylvan Electric Bath, Inc., was organized on January 14, 1915, under a certificate of incorporation signed by Bueckle and four other incorporators.

In an agreement executed on January 30, 1915, it was provided that Bueckle should convey to the corporation the following assets:

All his rights in the Sylvan Electric Bath business, the appliances, fixtures and other articles oí personal property used in the treatment and cure of diseases for which the said Sylvan Electric Bath is established, and also the right to use the patents, methods and treatments as now used and conducted in his present establishment, said patents being described as follows:

Nos. 590171. Electric Bath.
633164. Electrotherapeutic Baths.
652446. Electromedical Baths.
653708. Hydro-Electrotherapeutic Apparatus.
692554. Chairs for Therapeutic purposes,

and any other patents he may secure after this day that may in anywise apply to or be used in this business.

And Trade Marks Nos. 35200. Medicated Bathing Liquids.
35400. Medicated Bathing Fluid.
70713. Medicated Bathing Fluid.
Also tlie good will consisting of
Its registered name,
List of prospective patrons,
List of physicians prescribing the treatment, and all other matter now in his possession in any way helpful, or likely to be helpful in conducting this business of the Sylvan Electric Bath.

The agreement further provided that the corporation should have $65,000 of 7 per cent preferred stock and $35,000 of common stock; that all of the common stock and $3,000 of the preferred stock should be issued to Bueckle for such property, and that Bueckle should assign $17,000 of the common stock to the purchasers of the balance of the preferred stock.

The agreement also provided, among other things, that Bueckle should devote his entire time and attention to the business at a salary of $3,600 per annum until the treatments averaged one hundred daily, at which time the salary was to be $5,000 per annum; and that during the completion of a new building the business was to be leased to Bueckle, who was to receive all the income and pay all the expenses.

On December 1, 1915, Bueckle, by formal bill of sale, conveyed to the corporation all of the assets of the business, both tangible and and intangible, and on the same date made a formal assignment of the patents and trade-marks which was duly registered in the office of the Commissioner of Patents.

On the transfer of the assets $3,000 par value of preferred stock and $35,000 par value of common stock was issued to Bueckle, who thereafter transferred approximately $17,000 par value of such common stock to purchasers of the preferred stock.

On March 3, 1917, the par value of the stock outstanding was $97,500, including both common and preferred.

When the books of account were opened the assets so transferred were set up on the books as “ Sundry Assets,” and in preparing income-tax returns and trial balance sheets this account carried on the books as “ Sundry Assets ” was erroneously listed and described as “ Good Will.”

In its return the petitioner included $38,000, as the cost of these assets, in invested capital. This amount was disallowed by the Commissioner.

The tangible assets transferred to the corporation on December 1, 1915, in exchange for its capital stock, had an actual cash value of $10,000 as a part of a continuing business. The intangible assets had no separate market value.

Decision redetermining deficiency will be entered on 10 days’ notice, v/nder Bule 60.


author: Phillips :

text:
    Appeal of A. Wilhelm Co.
    Docket No. 6533.
    Promulgated February 1, 1927.
    Taxpayer leased its property, the lessee agreeing to return the plant in the same condition as then existed and with assets of as great book value and actual value as then existed. During the taxable year the lessee made repairs and installed new equipment and machinery of a value in excess of depreciation. Held, that no error was committed in refusing a depreciation deduction to the taxpayer.

      II. A. Mihills, G. P. A., for the petitioner.

      Pilis W. Manning, Esq., for the Commissioner.
    This is an appeal from the determination by the Commissioner of a deficiency of $001.G-l in income and profits tax for the year 1919. The Commissioner denied the taxpayer’s contention that an additional depreciation of $37,860.78 should be allowed for the ten-month period from March 1, 1919, to December 31, 1919, during which its plant was leased, including the depreciable assets in question.
    FINDINGS OF FACT.
    The taxpayer is a Pennsylvania corporation with its principal office at Reading.
    By an instrument entitled “ lease and option,” dated February 21, 1919, the taxpayer leased its plant and all of the assets of the business as a going concern, subject to its liabilities, which were assumed by the lessee, to the Glidden Company for a term of five years, beginning March 1, 1919, and granted the lessee an option, at any time during the term of tlie lease, to purchase same, subject to its liabilities, for $1,250,000. The lease provides in part—
    1. The Lessee shall pay all expenses of the Lessor including wages, salaries and other compensation of its employes, officers and agents; all state, county, municipal, school and other taxes upon its property, taxes upon its capital stock and corporate franchises, and upon the privilege of exercising the same, excess profits taxes, war profits taxes, income taxes, (except that the Lessor shall bear the income taxes upon its income to the extent of Eighty-seven Thousand Five Hundred Dollars ($87,500) per annum,) and all other taxes of every kind and description assessed or levied by any governmental or municipal authority whatsoever; all costs of manufacture, including the costs of materials, supplies, power, light, heat and water, all expenses of transportation; all office expenses, including branch offices, all selling commissions and other expenses; all obligations and expenditures arising out of any contract, business, negligence or misfeasance or however otherwise arising, and whether the liability for the same now exists or be hereafter created in any way connected with the conduct and operation of the plant, business and assets of the said Lessor, and including damages to persons or property, legal expenses, (not including those properly chargeable to the individual stockholders of the Lessor), interest, discounts and all other expenses and losses in, or arising out of, the conducting and operating of the business of the Lessor and maintaining its organization, together with the expenses of maintaining its plant and assets according to the same standard and condition heretofore and at present existing, including the cost of new construction, new machinery, equipment, fixtures, furniture and other items of principal assets, where the same shall be necessary to replace depreciation and maintain said present existing standard and condition. The Lessee shall at its own cost keep said assets fully and properly insured against fire.
    2. The Lessee shall pay to the Lessor in addition to the foregoing a yearly rental of Eighty-seven Thousand Five Hundred Dollars ($87,500.) during each year of said term in monthly installments of Seven Thousand Two Hundred and Ninety-one Dollars, and sixty-six Cents ($7,291.66) beginning on the first day of March, 1919.
    3. The Lessee shall, at the expiration of said time, return to the Lessor its said plant, business and assets in the same condition as the same now exists, (except for such changes or replacements thereof as are necessary and usual to the normal conduct of its business) the aggregate of which assets, except the good will and trade marks, shall be of at least as great book value and actual value when so returned as the aggregate of such assets as at present existing, and the value of the aggregate of the assets described in each group thereof in the Lessor’s balance sheet, when so returned, shall be not less than ninety per cent of the value of such group of assets at the present time. The lessee shall in good faith and with due diligence make every reasonable effort, by advertising to the extent usual with the Lessor, and by other means of cultivation and development, to preserve the value of the Lessor’s good will and trade marks.
    The Glidden Company went into possession under its lease on March 1, 1919, and operated under it lor the remaining ten months of 1919.
    During the period from March 1, 1919, to December 31, 1919, the lessee erected new buildings and installed new equipment at a cost of $1†9,141.33. These expenditures were capitalized on the books of account of the lessee. None of them replaced depreciation on the lessor’s original plant. During the period in question repairs in the maintenance of the lessor’s plant were made and charged to the operations of the lessee,

      In its return for 1919, the taxpayer deducted depreciation for the two-month period ending February 28, 1919, in the amount of $4,631.64. This amount was allowed by the Commissioner. The Glidden Company claimed a deduction of $37,860.18 for depreciation for the ten-month period ending December 31, 1919, which included depreciation on additions to the plant, but that deduction was denied to it by the Commissioner. The taxpayer now contends that it is entitled to an additional deduction from gross income for 1919 of $37,860.78, representing the depreciation for the ten-month period ending December 31, 1919. This was refused by the Commissioner in determining the deficiency.
   OPINION.

Phillips :

Substantially all of the facts are stipulated. Taxpayer leased its plant under an agreement by which the lessee covenanted to bear the “ expenses of maintaining its plant and assets according to the same standard and condition heretofore and at present existing, including the cost of new construction, new machinery, equipment, fixtures, furniture and other items of principal assets, where the same shall be necessary to replace depreciation and maintain said present existing standard and condition ” and, at the expiration of the lease, to return “ said plant, business and assets in the same condition as the same now exists, (except for such changes or replacements thereof as are necessary and usual to the normal conduct of its business) the aggregate of which assets, except the good will and trade marks, shall be of at least as great book value and actual value when so returned as the aggregate of such assets as at present existing.” The lease was to continue for five years, with the right to the lessee at any time to purchase at a stated price. The lessee made repairs in the maintenance of the plant and erected new buildings and installed new equipment at a cost considerably in excess of the depreciation claimed.

The Revenue Act provides that in computing net income a deduction may be taken of a reasonable allowance for exhaustion, wear and tear. What is a reasonable allowance must be determined from all the facts and circumstances. In the peculiar circumstances hero involved, considering that the lessee was bound to make good all depreciation by replacements or additions, it is our opinion that no allowance could be justified as reasonable.

Taxpayer lays stress upon the refusal of the Commissioner to allow such deduction to the lessee, taking the position that depreciation took place and is deductible by either the lessor or the lessee. Since we are not called upon to determine the tax liability of the lessee in this proceeding, we express no opinion upon the ruling made with respect to it.

Decision will be entered for the 0ommissioner.