source: Caselaw Access Project

author: Aktjndebl:

license: Public Domain

text:
    Lykes Bros. Steamship Co., Inc. (Formerly Lykes Bros.-Ripley Steamship Co., Inc.), Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96637.
    Promulgated November 29, 1940.

      Robert N. Miller, Esq., and Ward Lomless, Esq., for the petitioner.

      J. L. Backstrom, Esq., for the respondent.
   OPINION.

Aktjndebl:

The question for decision is whether the respondent erred in including in petitioner’s income for 1934 and 1935 the amounts of $100,000 and $150,000, respectively, that were deposited by the petitioner in a special account as described in the findings of fact. The petitioner’s views are that the amounts deposited were either parts of a government subsidy useable only for capital purposes, hence not income under Edwards v. Cuba Railroad Co., 268 U. S. 628, or that they wrere not received for the petitioner’s separate use, benefit, and disposal and so are not income within the definition in Eisner v. Macomber, 252 U. S. 189. The respondent takes the position that the full amounts paid to the petitioner by the Post Office Department were taxable income, in that they were received by it without restriction and solely as compensation for carrying mail and other services; that no part of the sums received was required to be placed in escrow; and that the amounts placed in escrow were not solely for capital purposes.

At the outset it is to be noted that the petitioner, while contending that the full sums received from the Post Office Department were subsidies, does not contend that such classification of them removes the full sums from the category of taxable income. It does not claim that the doctrine of the Cuba Railroad Co. case goes so far as to exempt all of the mail payments, but limits the application of that case to the sums set aside in the special bank account.

There is little room for doubt that the entire sums paid to the petitioner in the taxable years were subsidies in the sense that they were governmental aids or grants designed to encourage the expansion of the American Merchant Marine. The huge sums paid in excess of normal postal rates were clearly for that purpose. But, applying the broad term of subsidy to the amounts paid to the petitioner does not solve the question in issue here, because of the different purposes for which such governmental grants are made. From the Supreme Court cases a few general rules may be drawn. Govenmental grants made in order to induce construction and operation of railroads are not mere gifts. Burke v. Southern Pacific R. R. Co., 234 U. S. 669, 679. Such a grant made to a railroad company proportionate to mileage of railway completed is treated as a reimbursement for capital expenditures and is not income. Edwards v. Cuba Railroad Co., supra. A grant to a railroad to make up a deficiency in operating income is income for Federal tax purposes. Texas & Pacific Railway Co. v. United States, 286 U. S. 285.

The real point at issue in this case .is whether the payments by the Government, to the extent of the sums set aside by the petitioner, were made for capital purposes within the principle of the Cuba Railroad Co. case. This must be determined on the basis of the agreement between the United States and the petitioner. The agreement relating specifically to the payments to be made to the petitioner is that of February 21,1933, executed by the petitioner and the Postmaster General. The only requirement in that contract calling for any expenditure by the petitioner was that the petitioner should construct or reconstruct vessels at a cost of $20,000,000 within the 10-year period of the contract, subject to reduction in amount by the Postmaster General. The provisions relating to that requirement do not in any way require that any part of the revenues from carrying the mads be set aside or that the cost of construction be paid from such revenues. There is no tie-up in the contract between the mail revenues and the construction to be performed by the petitioner. The revenues were purely on a mileage basis, without any reference to the amount or cost of construction of vessels by the petitioner. Therefore, under this contract it can not be said, as in the Cuba Bailroad Co. case, that there is any indication of a purpose that the mail revenues were to be in reimbursement to the petitioner for capital expenditures.

The petitioner says that the contracts for the purchase of vessels and for the transportation of ocean mail pay were interdependent, and that it was understood by all parties to both contracts that deposits required under the purchase contract would be made from the ocean mail pay. There is partial interdependence of contracts in that the purchase contract of February 17, 1933, was to become effective only if and when a mail contract with the Postmaster General was executed, and further in that the purchase contract provided that the deposits were not to be required if the mail contract was terminated or modified without fault of the petitioner, or if Congress did not make a timely appropriation to pay for the mail services to be rendered by the petitioner. These provisions are all -in the negative, providing what shall not be done under the named circumstances. There is nothing in them requiring the affirmative act of setting aside any of the ocean mail pay. And so, even finding a partial interdependence of contracts, we are unable to find therein what is essential to the petitioner’s case, namely, that the deposits were required by the contract to be made out of the income received under the ocean mail contract. See Monroe Abstract Corporation, 41 B. T. A. 5, and cases there cited. It must be remembered that in each of the taxable years the petitioner had revenues from other sources of over $6,000,000, and on the record in the case there is no reason to suppose that the deposits required were intended to be made from postal revenues rather than from the other revenues. Moreover, there is no relation by amounts or percentages between the sums to be deposited and those to be received under the ocean mail contracts; the deposits were to be made without regard to how much or little was realized under the mail contracts.

The chief reliance of the petitioner to show intended appropriation of mail pay to the deposit requirements is the letter of the Postmaster General which is set out in the findings of fact. In that letter article 12 of the sales contract is spoken of as “providing for the placing of a certain amount of mail pay in escrow.” If this statement in the letter can be taken to mean that the parties understood that a part of the mail pay was to be set aside, it still does not establish the petitioner’s case. A reading of the whole letter shows that it was thought that the setting aside was to be for the purpose of providing security “in lieu of bond on the mail contract.” Quite obviously the Postmaster General had no thought that the escrow provision was intended to require an appropriation to capital purposes, and in this view the principle of Cuba Railroad Co. does not apply. When, following the Postmaster General’s letter, an amenda-tory agreement was executed by the Shipping Board and the petitioner eliminating that part of the ship purchase contract which required the approval of the Postmaster General for the modification or postponement of deposits, the principal connecting link between the two contracts was broken. Accepting the Postmaster General’s construction of the contracts that the deposit arrangement was to secure performance, it would seem that after the amendment of March 20 the deposits were required by the Shipping Board as security for performance of the purchase contract rather than to assure the making of any capital expenditures. That securing performance was the principal purpose is indicated by the fact that none of the deposits were disbursed for any purpose during the life of the contract.

One of the provisions of the Shipping Board contract is that the petitioner might spend directly for new construction, reconditioning, remodeling, or improvement of vessels any amounts it saw fit, and any sums so spent should reduce the amounts required to be deposited. This seems to us to indicate that the parties did not intend to require a part of the mail payments to be set aside. Under this provision, if the petitioner had expended for any of the several purposes listed, the amount of $100,000 in the first year and $150,000 in the second year, regardless of the source of the funds expended, it would not have been required to deposit any sums with the Whitney bank. This demonstrates that the parties to the contracts did not intend that the deposits were to be required to be made out of the, mail payments. Either a deposit from any source, or construction, remodeling, etc., to the extent provided, would leave the entire mail payments free to be used by the petitioner for any purpose, hence income within the rule of Eisner v. Macomber, supra.

An important fact in this case is that the mail payment income was directly dependent upon operations. If petitioner operated its vessels and carried ocean mails it was to be compensated therefor, based upon mileage and the class of vessel operated. The income was not, as in Cuba Railroad Co., dependent on construction, and, after the Postmaster General’s waiver of the deposit provisions in February 1933, it was in no way contingent on the making of deposits. On the facts, then, the case becomes very like that of Texas & Pacific Railway Co. v. United States, supra, which involved the taxability of sums paid to railroads to make up deficiencies in operating income. The Supreme Court pointed out in that case that the railroads “were bound to operate their properties in order to avail themselves of the government’s proffer. Under the terms of the statute, no sum could be received save as a result of operation.” Concluding on that point, the Court said:

• Clearly, then, the amount paid to bring the yield from operation up to the required minimum was as much income from operation as were the railroad's receipts from fares and charges.

In this case, as in the one quoted, the entire receipts were from the operation of the petitioner’s property and equally are income.

Decision will be entered for the respondent.


author: TuRnee:

text:
    W. D. Ambrose, Petitioner, v. Commissioner of Internal Revenue, Respondent. Elizabeth Anne Ambrose, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 95744, 95745.
    Promulgated November 29, 1940.

      George 8. Atkinson, Esq., and Douglas M. Brooks, G. P. A., for the petitioners.

      D. D. Smith, Esq., for the respondent.
   OPINION.

TuRnee:

The petitioners contend that under Regulations 86, article 23 (m) — 16, they are entitled to deduct from gross income the intangible drilling and development costs of the four wells drilled in 1934. The respondent contends that the contracts under which the wells were drilled were “turnkey” contracts and that such costs should be capitalized. On brief, the parties seem to center their argument around the question of whether the four contracts are or are not “turnkey” contracts.

A “turnkey” contract is generally understood as one which requires the drilling contractor to furnish all the material and equipment and to turn over a completed well for a stipulated price. The contracts in question do not conform with that definition in any respect. Here the contracts were entered into by the parties on what is commonly known as a “cost-plus” basis. The petitioners agreed to pay the cost of drilling the wells, including materials and labor, plus a bonus to the drilling company. The amount of the bonus was to be determined on the basis of the cost of materials and labor and neither the cost nor the amount of the bonus could be ascertained until the wells were completed. Obviously these contracts are not “turnkey” contracts.

The above disposition of that question is only preliminary, however, and it does not necessarily follow that the petitioners are entitled to the deduction. In Retsal Drilling Co., 42 B. T. A. 1057, we said that “If any part of the amount expended for drilling, equipping, and completing an oil well is to be deducted, it must meet the test of the statute and regulation, and it is not enough to say that such expenditures are deductible because the contract under which they were made is not, strictly speaking, a turnkey contract.” In that case the taxpayer did not hire labor or buy materials and supplies, but agreed to pay an independent contractor a stated sum for a finished job, leaving it to the contractor to make his own deal for the material, equipment, and labor. In disallowing the deduction, we pointed out that the relationship between the parties was not that of employer and employee but that of independent contractor.

On this point in the present case the respondent argues that the petitioners are not entitled to the deductions because they “made no expenditures” for intangible drilling and development costs. He contends that these expenditures were made by the Eoss Drilling Co. While it is true that the contracts provided that the Eoss Drilling Co. would “furnish” all machinery, tools, pipe, tubing, materials, and labor of every kind necessary for the drilling of the well, the remaining provisions of the contracts clearly show that the real arrangement was that the materials and labor, which included the intangible drilling costs, were to be procured by the Eoss Drilling Co. for the petitioners, subject to their approval, and were to be paid for by them. According to the contracts, the company agreed to use casing, tubing, and connections “approved by and acceptable” to the petitioners; that if the “materials” brought to the location should “not be satisfactory” to the petitioners, the company would replace same with materials which would meet the approval of the petitioners; that the contracts were entered into on a “cost-plus” basis; and that when the wells were completed, the petitioners would “be indebted” to the company for the “cost of drilling” the wells and its profit, said cost to be the amount shown by a statement furnished by the company, accompanied by supporting invoices showing all charges appearing in said statement. The company, acting as agent for the petitioners, kept their books and records and when any expenditures were made for materials and labor such items were charged to petitioners’ account. From time to time the petitioners inspected these records, also the materials, invoices, payrolls, etc., and when the wells were completed they paid the cost of each and every such item, plus a bonus to the drilling company.

We think these contracts are more in the nature of contracts of employment rather than that of an independent contractor. It seems unnecessary to point out all the differences between a contract entered into on a “cost-plus” basis and one on an independent contractor basis. It will suffice here to point out that the petitioners, in effect, employed the partnership to supervise the drilling of wells for them on their oil properties, agreeing to pay the costs thereof plus a bonus to the partnership for services rendered. We think those facts meet the test of the respondent’s regulation and we hold that petitioners are entitled to the deductions claimed.

Decisions will he entered under Rule 50.

       Am'. 23 (m) — 16. Charges to capital and to expense in the case of oil and gas wells.— (a) Items chargeable to capital or to expense at taxpayer’s option:
      (1) Option with respect to intangible drilling and development costs in general: All expenditures for wages, fuel, repairs, hauling, supplies, etc., incident to and necessary for the drilling of wells and the preparation of wells for the production of oil or gas, may, at the option of the taxpayer, be deducted from gross income as an expense or charged to capital account. Such expenditures have for convenience been termed intangible drilling and development costs. * * * Drilling and development costs shall not be excepted from the option merely because they are incurred under a contract providing for the drilling of a well to an agreed depth, or depths, at an agreed price per foot or other unit of measurement.


author: Murdock:

text:
    Elmore Milling Co., Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96520.
    Promulgated November 29, 1940.

      William Cogger, Esq., for the petitioner.

      W. Frank Gibbs, Esq., for the respondent.
   OPINION.

Murdock:

The sole question for decision is whether the dividend distribution of $50,000 made on December 15, 1936, was preferential within the meaning of section 27 (g) so as not to entitle the petitioner to a dividends paid credit under section 27 (a) of the Revenue Act of 1936. The argument of the respondent is that Earle and Mabel, by reason of the contributions of capital which resulted from their contribution of bonds to the petitioner, became the owners of interests in the corporation in addition to those represented by their shares and, consequently, they received less than their pro rata share of the $50,000 dividend. The facts show, however, that they donated the bonds to the corporation without any intention of increasing their proportionate interest in the corporation. The donation of those bonds, of course, added to the value of the interests of all of the stockholders, including those who had made no contribution whatsoever. The stockholdings remained the same, and every share received its pro rata equal share of the dividend distribution without any preference. There was no connection whatsoever between the capital contribution made by Earle and Mabel and the dividend of December 15, 1936. The capital contribution was made on May 20, 1935, over a year and a half before the dividend was declared. The respondent makes no point of the fact that Goldsmith returned the $50 which he received as a dividend. The evidence clearly shows that he did that from personal choice and not because of any agreement or understanding either expressed or implied. Neither does the Commissioner make any point of the fact that a portion of Mabel’s dividend was used to cancel a loan which she had obtained from the petitioner. The Commissioner erred in disallowing the dividends paid credit claimed by the petitioner for 1936.

Decision will be entered for the ‘petitioner.


author: Disney:

text:
    Sun Pipe Line Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98764.
    Promulgated November 29, 1940.

      O. J. McGuire, Esq., and W. G. Magathan, Esq., for the petitioner.

      Brooks Fullerton, Esq., for the respondent.
   OPINION.

Disney:

Stated tersely, the problem for solution here is whether section 351 (b) (2) (B) of the Revenue Act of 1936, as amended by section 355 (b) of the Revenue Act of 1937, by the phrase “indebtedness incurred prior to January 1, 1934”, was intended to cover indebtedness which existed prior to that date in the form of debentures and was retired after the crucial date, new bonds being issued for cash and the proceeds being used to retire the old debentures. In a word, the facts before us are that 5 percent bonds were issued in 1930 to certain parties and were retired in 1934 with the proceeds of a 3½ percent bond issue sold to parties other than those holding the issue of 1930, though the trustee was the same for both issues. In 1937 it redeemed the 3½ percent bonds and deducted the amount of such redemption from its undistributed adjusted net income, acting under the provisions of section 351 (b) (2) (B) of the Revenue Act of 1936, as amended by section 355 (b) of the Revenue Act of 1937. The Commissioner denied such deduction.

The question is one of first impression. The petitioner cites no case specifically considering the point here raised, and the respondent agrees that there is no authority exactly in point, though he adduces and relies upon certain cases as embodying the principle properly to be applied here.

After much study of this vexing problem, we have concluded that Congress did not intend to deny credit for payments upon indebtedness which represents an actual, though not a technical, continuance of indebtedness existing prior to January 1, 1934. The statute originated in section 351 of the Revenue Act of 1934, where the language used was identical with that in the 193G Act. Of this statute, the Senate Finance Committee report said:

* * * Considerable hardship has been avoided by permitting the deduction from the adjusted net income of a reasonable amount used or set aside to retire indebtedness incurred prior to January 1, 1934. This will substantially and properly relieve personally owned corporations which have outstanding bonds or other indebtedness that must be met from current earnings before distributions can be made.

The requirement spoken of by the committee, “that must be met from current earnings before distributions can be made”, seems to apply alike to “bonds or other indebtedness” already issued on the effective date, and those with which the original issue is supplanted, but where the economic position of the taxpayer is not altered. We think that no distinction was intended between a corporation which after the date set, changes the form of its obligation, even changes the obligee, but remains equally obligated, and one which merely remains bound by the original obligation. True, the statutory date must be given meaning and effect, but we think this is reasonably done and Congressional intent accomplished by denying credit to indebtedness which is new in an economic sense to the taxpayer, i. e., does not merely take the place of indebtedness existing prior to the effective date. This seems to be the thought behind the language of the Ways and Means Committee Report on the Revenue Act of 1937 when, denying a recommendation that the credit for retirement of indebtedness provision be repealed, it said:

* * * -while recognizing the reasons which impelled the joint committee to make this recommendation, your committee feels, from- further study of .the question, that the denial of this deduction would cause hardship in numerous eases where, due to the particular circumstances of the corporation, a dividend distribution can not be made because of a necessity for legal reasons of using the earnings and profits to discharge the debts. Moreover, any loss of revenue caused by the continued allowance of this deduction can not increase, since indebtedness incurred after 1933 can not be used as a basis for the deduction. No corporation cm, be formed for the purpose of taking advantage of this deduction. Furthermore, it is inevitable that the revenue loss must decrease as pre-1934 debts are retired. * * * [Italics supplied.]

The Committee seemed to think that if “pre-1934 debts are retired” and new corporations for taking advantage of the deduction prevented, justice will be subserved. The intent in our opinion was to prevent further incorporating of the pocketbook, but not to affect those incorporations already existing. Here the incorporation of pocketbook was done when the corporation was formed and the original bonds were issued, not when the state of indebtedness was continued in a slightly different form. In Commissioner v. Tennessee Co., 111 Fed. (2d) 678, the court considered the question whether “indebtedness” included indebtedness contingent at the effective date set by the act. After pointing out that the word “indebtedness” has both a strict and a broad meaning, the court came to the conclusion that a broad implication was required by the act and stated that “the operation of the statute is ‘cushioned’ so as to make it prospective in case of debt retirement payments”, and though the court was of the opinion that the kind of debt in the case considered was one “most calculated to accomplish avoidance”, nevertheless upheld the deduction, saying: “So we must await the happy day when pre-1934 indebt-ednesses are finally extinguished.”

The Revenue Act of 1936 provides, hi section 351 (b) (3) (B), that credit shall be allowed for certain contributions or gifts:

* * * including, in tlie case of a corporation organized prior to January 1,1936, to take over the assets and liabilities of the estate of a decedent, amounts paid in liquidation of any liability of the corporation based on the liability of the decedent to make any such contribution or gift, to the extent such liability of the decedent existed prior to January 1, 1934; * * *

The case of such corporation was new in the act. Commenting on the inclusion thereof, the Report of the Conference Committee says:

Contributions or gifts to charitable organizations pledged by an individual who died prior to January 1, 193'6, and assumed by a corporation organized to take over the assets and liabilities of the estate of such decedent after that date are allowed as a deduction in computing the adjusted net income for the purposes of this tax. This deduction seems meritorious, for the liabilities assumed by the corporation are with respect to gifts going to charitable organizations and were actually incurred prior to January 1, 1936, but due to the delay in the organization of the corporation were not actually incurred by the corporation as such until after that date.

It would seem from such language that there was Congressional intent not to exclude from credit, where the debt was not “actually incurred” after the effective date, but represented indebtedness existing prior thereto; and that such thought applies equally in case of new bonds to take up those prior to the date involved.

The question as to what constitutes the incurrence of indebtedness has received the attention of the courts in connection with municipal bond issues in excess of constitutional or statutory limits. Though there are decisions to the contrary, the weight of authority is that a bond issue which of itself would be void, as contravening such constitutional limit beyond which the municipality might not become indebted, is not void if the bonds are exchanged for, or their proceeds are used to take up, a previous valid issue. Here that is true to the extent of $3,500,000 and not true as to $500,000. Obviously any claim for deduction from adjusted net income must be and is denied to the extent of $500,000, since that amount may, so far as the record herein shows, represent the retirement of bonds the proceeds of which went to the new purpose of laying a pipe line. However, petitioner, though it set up a claim in its return and petition for credit of $3,400,000, is in effect asking only for a credit of $67,045.49, since only that amount is necessary to eliminate the deficiency set up. Petitioner’s adjusted net income was returned as, and by the respondent found to be, $1,307,845.49. Dividends paid credit allowed in the amount of $1,240,-000 leaves undistributed adjusted net income of $67,045.49. Therefore that amount of deduction out of the $3,400,000 claimed would eliminate any deficiency. The debentures discharged in 1937 were to the extent of $67,045.49 retired from petitioner’s income of that year, and were not paid with borrowed money or replaced by substituted indebtedness.

In Aetna Life Insurance Co. v. Lyon County, Iowa, 82 Fed. 929, the issuance and sale of bonds by a county for the purpose of discharging outstanding indebtedness, executed pursuant to statute, was held not to create a debt within the meaning of a constitutional debt limitation. The controlling thought was that the actual indebtedness was not increased.

In City of Huron v. Second Ward Savings Bank, 86 Fed. 272, it was held, considering bonds in the territory of Dakota, that “Bonds which are issued to fund a valid indebtedness neither create any debt nor increase the debt of the municipality which issues them. They merely change the form of an existing indebtedness.” The organic law of the territory of Dakota provided that “no municipal corporation should ever become indebted exceeding 4 per centum on the value of the taxable property within such corporation.” The bonds were sold and the proceeds applied to pay warrants.

In City of Los Angeles v. Teed, 44 Pac. 580, this question was considered. The California Constitution, article 11, § 18, forbids any city to “incur any indebtedness or liability in any manner, or for any purpose, exceeding in any year the income and revenue provided for it for such year, without the assent of two-thirds of the qualified electors * * The court said: “* * * merely to fund or refund an existing debt is not to ‘incur an indebtedness or liability.’ A bond is not an indebtedness or liability; it is only the evidence or representative of an indebtedness. And a mere change in the form of the evidence of indebtedness is not the creation of a new indebtedness within the meaning of the constitution [citing cases]

In City of Poughkeepsie v. Quintard, 32 N. E. 764, the Court of Appeals of New York interpreted a statute providing that a city council shall not “create” any obligation not payable in the current year. Bonds were sold and the proceeds used to pay prior bonds. It was said: “There is a new creditor, and a reduced rate of interest, but the same old debt. The municipal liability is not increased, but merely suffered to remain; and not a dollar of new or added debt results.”

The respondent cites Helvering v. California Oregon Power Co., 75 Fed. (2d) 644, and cases to the same effect, that is, that where one bond issue is issued at a discount and expense incurred, the amount of expense and discount amortized and new bonds later issued to a different creditor, in retirement of the earlier issue, the portion of the discount and expense of the old bond issue unamortized at the date of the new issue was properly deducted in the year of the new issue, and not amortized over the life of the later bond issue. It was there held that “the two bond issues were not interrelated in any legal sense, but were in fact substantially separate transactions and should be so treated.” We think, however, that from such treatment, for the purpose of that ease, it does not follow that the treatment must be the same here and that the new bonds represented “indebtedness incurred” after the crucial date. Though there the bond issues were separate for purposes of considering expense and discount, and such expense of the first issue logically was deductible only when it was closed, upon the question herein presented the indebtedness involved in the second was that involved in the first, under the above cases.

Being unable to distinguish the instant situation in principle from the cases above reviewed to the effect that indebtedness is not incurred by new bonds with the proceeds of which an old issue is retired, we conclude and hold that there was error in the denial of the deduction under section 351 (b) (2) (B) of the Revenue Act of 1936, to the extent of $67,045.49. This is obviously “reasonable with reference to the size and terms” of the indebtedness of $3,500,000-, and the requirement of paying $400,000 in 1937, within the requirement of section 351 (b) (2) (B) of the Revenue Act of 1936, as amended, and we so hold.

Reviewed by the Board.

Decision will be entered umder Rule 50.

Sternhagen dissents.

       SEC. 355. UNDISTRIBUTED ADJUSTED NET INCOME.
      For the purposes of this title the term “undistributed adjusted net income” means the adjusted net income (as defined in section 356) minus—
      *******
      (b) Amounts used or irrevocably set aside to pay or to retire indebtedness of any kind incurred prior to January 1, 1934, if such amounts are reasonable with reference to size and terms of such indebtedness.


author: HaüRon:

text:
    R. Douglas Stuart, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97501.
    Promulgated November 29, 1940.

      Herbert Pope, Esq., Preston B. Kavanagh, Esq., and Benjamin M. Price, Esq., for the petitioner.

      D. A. Taylor, Esq., for the respondent.
   OPINION.

HaüRon:

The basic question is whether petitioner was taxable in 1934 and in the first seven months of 1935 on the entire net income of the four trusts which he created for the benefit of his four minor children.

In computing the deficiencies in petitioner’s income tax for 1934 and 1935, respondent included in petitioner’s taxable income the entire net income of the four trusts during 1934 and during the period from January 1 to August 2,1935, on which date the trust indentures were amended to provide that they were “irrevocable and not subject to alteration, change or amendment.” In the deficiency notice respondent grounded his determination on section 166 (2) of the Revenue Act of 1934. In an amended answer and in his brief respondent supports his determination under sections 167 (a) and 22 (a) of the Revenue Act of 1934, as well as under section 166 (2).

The pertinent provisions of section 166 (2) of the Revenue Act of 1934 are as follows:

Where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested—
*******
(2) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, then the income of such part of the trust shall be included in computing the net income of the grantor.

Respondent contends that section 166 (2) is applicable because under paragraph ninth of the trust indentures power was vested in petitioner’s wife and his brother to revest title to the corpora of the trusts in petitioner and because petitioner’s wife and his brother did not have substantial adverse interests in the disposition of the corpora of the trusts or the income therefrom. Petitioner asserts that no power to revest title to the corpora of the trusts in petitioner was vested in petitioner’s wife and his brother under paragraph ninth, and that even if such power were vested in petitioner’s wife and brother, they Rad substantial adverse interests in the disposition of the corpora of the trusts and the income therefrom.

In support of his assertion that no power to revest title to the corpora of the trusts in petitioner was vested in petitioner’s wife and his brother under paragraph ninth, petitioner argues that the powers given to petitioner’s wife and his brother under that paragraph could be exercised only in the interests of the beneficiaries named in the trust indentures. Petitioner points to the fact that under the trust indenture no power is given expressly to his wife and his brother to revest title to the corpora of the trusts in him, that he is not named as a beneficiary in the trust indentures, and that under paragraph eighth of the trust indentures he is given a power to withdraw the whole or any part of the corpora of the trusts only upon first delivering to the trustees other property satisfactory to the trustees “of a market value at least equal to that of the property withdrawn.” Petitioner relies on Higgins v. White, 93 Fed. (2d) 357; Knapp v. Hoey, 24 Fed. Supp. 39; affd., 104 Fed. (2d) 99; Phebe Warren McKean Downs, 36 B. T. A. 1129; and Ellsworth B. Buck, 41 B. T. A. 99.

To determine whether under paragraph ninth power was vested in petitioner’s wife and his brother to revest title to the corpora of the trusts in petitioner, that paragraph must be interpreted in accordance with the intent of the petitioner as gathered from the trust indentures in their entireties. Ellsworth B. Buck, supra. It is sufficient if the powers given to petitioner’s wife and his brother under paragraph ninth amounted in fact to a power to revest title to the corpora of the trusts in petitioner. Ralph Pulitzer, 36 B. T. A. 964; cf. Bowler v. Helvering, 80 Fed. (2d) 103.

An examination of paragraph ninth in the light of the principles set forth above compels the conclusion that petitioner’s wife and his brother had the power to revest title to the corpora of the trusts in petitioner within the meaning of section 166 (2). Under paragraph ninth of each trust indenture, petitioner’s wife and his brother were given “full power * * * to alter, change or amend this indenture at any time and from time to time by changing the beneficiary hereunder, or by changing the time when the Trust Fund, or any part thereof, or the income, is to be distributed, * * * or in any other respect.” Under the provisions of paragraph ninth the powers given to petitioner’s wife and his brother were absolute, and these absolute powers were not limited by any other provisions of the trust indentures. Cf. Fulham v. Commissioner, 110 Fed. (2d) 916. The provisions of paragraph eighth limited only the right which petitioner reserved in that paragraph to withdraw the corpora of the trusts and did not limit the absolute powers granted to petitioner’s wife and his brother in paragraph ninth. As donees of absolute powers, petitioner’s wife and his brother could exercise the powers in favor of petitioner. See Frank v. Frank, 305 Ill. 181; 137 N. E. 151; Perry, Trusts and Trustees, 7th ed., vol. I, p. 453; Farwell, Powers, 2d ed., p. 8. Since under paragraph ninth petitioner’s wife and his brother had the power at any time to amend the trust indentures to make petitioner the sole beneficiary of the trusts and to provide for immediate distribution of the corpora to him, they had, in fact, the power to revest in petitioner title to the corpora of the trusts within the meaning of section 166 (2). Cf. Ralph Pulitzer, supra.

The cases relied on by petitioner in support of his argument that the powers given to petitioner’s wife and his brother under paragraph ninth were limited are distinguishable. In Higgins v. White, supra, the power to revest the corpus in the grantor, which was vested in the grantor and his cotrustees, was to be exercised only if “the trustees shall deem it wise so to do” and was thus a fiduciary power as distinguished from an absolute power. See Fulham v. Commissioner, supra. In Knapp v. Hoey, supra; Phebe Warren McKean Downs, supra; and Ellsworth B. Buck, supra, the grantor included in the trust indenture an express provision to the effect that the trust was irrevocable.

Petitioner argues next that, if the powers given to his wife and his brother under paragraph ninth were so broad that they had the power to revest in petitioner title to the corpora of the trusts, they also had the power to amend the trust indentures to make themselves the beneficiaries of the trusts, and thus had substantial adverse interests in the disposition of the corpora of the trusts and the income therefrom within the meaning of section 166 (2). In support of this argument petitioner relies on Laura E. Huffman, 39 B. T. A. 880.

On March 25,1932, the date on which the trusts were created, section 166 of the Revenue Act of 1928 had not yet been amended by the Revenue Act of 1932 and provided that the grantor of a trust was taxable on the trust income where he had “at any time during the. taxable year, either alone or in conjunction with any person not a beneficiary of the trust, the power to revest in himself title to any part of the corpus of the trust.” In the trust indentures petitioner reserved no power to revest in himself title to any part of the corpora of the trusts either alone or in conjunction with his wife and brother. Shortly after the trusts were created section 166 was amended by the Revenue Act of 1932. For present purposes section 166 was substantially the same under the 1934 Act as under the 1932 Act. The legislative purpose for the amendment of section 166 in the 1932 Act was “to block a possible means of tax avoidance by the device of vesting the power to revoke the trust in some person other than a beneficiary, whereby in fact the grantor may i*etain ‘substantially the same control as if he alone had power to revoke the trust’.” Fulham v. Commissioner, supra; see Report of the Senate Committee on Finance, S. Rept. No. 665, 72d Cong., 1st sess., p. 34.

In Fulham v. Commissioner, supra, the taxpayer conveyed certain property in trust to himself and another as cotrustees. The trustees were to accumulate the income of the trust until the death of the taxpayer’s wife. During the life of the taxpayer’s wife the trustees were empowered to pay her “at any time or from time to time any part or parts or the whole of the principal and/or accumulated income” of the trust. After the death of the taxpayer’s wife the trustees were to pay the income, and eventually the principal, to the children of the taxpayer and their issue. Power to revoke the trust and revest the corpus in the taxpayer was vested in a committee subject to the consent of the taxpayer’s wife. Petitioner conceded that the committee did not have a substantial adverse interest in the disposition of the corpus or the income therefrom, but maintained that the taxpayer’s wife did have such a substantial adverse interest. In holding that the taxpayer’s wife did not have a substantial adverse interest in the disposition of the corpus or the income therefrom within the meaning of section 166 (2) of the Revenue Act of 1934, the Circuit Court stated in part as follows:

The evident policy of the Revenue Act is to tax the income to the grantor of a trust when he retains the substantial mastery over the corpus. Even though in form he lodges the power of revocation in someone other than himself, Section 166 is founded on the reasonable premise- that the grantor still retains practical mastery, when this power is given to someone having no stake in the trust, or a stake so insubstantial that the holder of the power would not improbably be amenable to the grantor’s wishes. This calls for a realistic appraisal.
*******
Upon appraisal of the trust instrument against a background of realities, we are convinced that this is a typical arrangement, falling within Section 166, where the grantor retains the controlling hand over something he has seemed to give away.

In considering wbetber the taxpayer’s wife had a substantial adverse interest within the meaning of section 166 (2), the Circuit Court in the Fulham case stated that the observations of the Supreme Court in Helvering v. Clifford, 309 U. S. 331, were pertinent, though made in respect to section 22 (a). In the Clifford case the taxpayer declared himself trustee of certain property. The trust was to terminate at the end of five years or on the earlier death of the taxpayer or his wife. During the continuance of the trust the taxpayer was to pay over to his wife the whole or such part of the net income as he in his “absolute discretion” might determine. On termination of the trust the entire corpus was to go to the taxpayer and all undistributed net income was to go to his wife. During the continuance of the trust the taxpayer retained broad powers of control over the corpus. During the year 1934 all the trust income was distributed to the taxpayer’s wife. The parties stipulated that the taxpayer’s wife had substantial income of her own from other sources; that there was no restriction on her use of the trust income,’ that the trust was not designed to relieve the taxpayer from liability for family or household expenses; and that after the creation of the trust the taxpayer paid large sums from his personal funds for family and household expenses. The Supreme Court held that the taxpayer was taxable on the income of the trust under section 22 (a) of the Revenue Act of 1934. The Supreme Court stated in part that “the short duration of the trust, the fact that the wife was the beneficiary, and the retention of control over the corpus by respondent all lead irresistibly to the conclusion that respondent continued to be the owner for purposes of section 22 (a)”, and made the following observation:

* * * To hold otherwise would be to treat the wife as a complete stranger; to let mere formalism obscure the normal consequences of family solidarity; and to force concepts of ownership to be fashioned out of legal niceties which may have little or no significance in such household arrangements.

To determine whether petitioner’s wife and his brother had substantial adverse interests within the meaning of section 166 (2), the trust indentures must be appraised “against a background of realities,” Fulham v. Commissioner, supra. The record in this proceeding does not furnish by itself a complete background of “realities.” Although this proceeding and the proceeding brought by petitioner’s brother, John Stuart, Docket No. 97500, were not consolidated for hearing, this proceeding was heard immediately after the proceeding brought by petitioner’s brother and the two proceedings admittedly involve substantially similar questions and facts. Therefore, in order to appraise the trust indentures against a complete background of “realities” the Board may notice the record in the proceeding brought by petitioner’s brother. O'Donnell v. United States, 91 Fed. (2d) 14; Wigmore, Evidence, Sd ed., 1940, sec. 2579. The record in the proceeding brought by petitioner’s brother shows, inter alia, that in 1930 petitioner’s brother executed three trust indentures by which he created three separate trusts, one for the benefit of each of his three children; that petitioner’s brother named himself, hi$ wife, and petitioner as the trustees of each trust; that petitioner’s brother was the president of the Quaker Oats Co.; that petitioner’s brother transferred 700 shares of the common stock of the Quaker Oats Co. to the trustees of each trust; that the provisions of each of the three trust indentures executed by petitioner’s brother were substantially the same as the provisions of the four trust indentures executed by petitioner; that under paragraph ninth of the three trust indentures executed by petitioner’s brother the very same powers were given to his wife and to petitioner as were given to petitioner’s wife and his brother under paragraph ninth of the four trust indentures executed by petitioner; and that on August 3, 1935, the wife of petitioner’s brother and petitioner executed an amendment to the three trust indentures executed by petitioner’s brother changing paragraph ninth to provide that the trusts were “irrevocable and not subject to alteration, change or amendment.”

An appraisal of the trust indentures against a background of “realities” thus completed by the record in the proceeding brought by petitioner’s brother leads to the conclusion that petitioner’s wife and his brother did not have substantial adverse interests in the disposition of the corpora of the trusts or the income therefrom within the meaning of section 166 (2). Petitioner’s wife and his brother had no actual stakes in the trusts as beneficiaries. Cf. Corning v. Commissioner, 104 Fed. (2d) 329; Laura E. Huffman, supra; and Daniel P. Woolley, 39 B. T. A. 802. At best they had only potential stakes in the trusts by reason of the powers given them under paragraph ninth. However, the powers under paragraph ninth were given them only for the duration of petitioner’s life, cf. Laura E. Huffman, supra; and during their joint lives the powers under paragraph ninth could be exercised only by their joint action. See Bowler v. Helvering, supra.

In the light of the “realities”, the potential stakes which petitioner’s wife and his brother had in the trusts were so insubstantial that they “would not improbably be amenable to the grantor’s wishes.” Fulham v. Commissioner, supra. The interests of petitioner’s wife and his brother appear to be identical with those of petitioner. Cf. Laura E. Huffman, supra. With respect to the interests of petitioner’s wife, the observations made by the Supreme Court in Helvering v. Clifford, supra, are as pertinent here as they were in Fulham v. Commissioner, supra. There is no more ground here for treating petitioner’s wife as a complete stranger than there was in the Clifford or Fulham cases. The stake of petitioner’s wife in the trusts here was no more substantial than was the stake of the taxpayer’s wife in the trust in the Fulham case. To hold that the interests of petitioner’s wife were adverse to those of petitioner would be “to let mere formalism obscure the normal consequences of family solidarity.” Helvering v. Clifford, supra. Furthermore, the interests of petitioner’s brother were not only linked to those of petitioner by a close family relationship, but by a close business relationship as well. Petitioner and his brother were, respectively, the first vice president and the president of the Quaker Oats Co. The original corpora of the four trusts created by petitioner and of the three trusts created by his brother consisted of common stock of the Quaker Oats Co. Petitioner was one of the trustees of the three trusts created by his brother, and his brother was one of the trustees of the four trusts created by petitioner. In the four trusts created by petitioner the donees of the power to revest title in him were his wife and his brother, and in the three trusts created by petitioner’s brother the donees of the power to revest title in him were his wife and petitioner. The natural result of this cross-relationship was that petitioner’s brother would be amenable to the wishes of petitioner in the conduct of the four trusts created by petitioner and that petitioner, in turn, would be amenable to the wishes of his brother in the conduct of the three trusts created by his brother. That the interests of petitioner’s wife and his brother were identical with those of petitioner is borne out by the fact that on August 2, 1935, petitioner’s wife and his brother executed an amendment to each of the trust indentures which provided that each of the trust indentures was “irrevocable and not subject to alteration, change or amendment”, and thus destroyed whatever potential stakes in the trusts they had prior thereto, and also by the fact that on August 3, 1935, petitioner and the wife of his brother executed a similar amendment to each of the trust indentures executed by his brother. Against such a background of “realities” it cannot be held that the potential stakes which petitioner’s wife and his brother had in the trusts clothed them with substantial adverse interests within the meaning of section 166 (2). Fulham v. Commissioner, supra.

Since under paragraph ninth of the trust indentures power to revest in petitioner title to the corpora of the trusts was vested in his wife and his brother, and since his wife and his brother did not have substantial adverse interests in the disposition of the corpora of the trusts or the income therefrom, it is held that petitioner was taxable on the entire net income of the trusts during 1934 and during the period from January 1 to August 2,1935, under section 166 (2) of the Revenue Act of 1934. Fulham v. Commissioner, supra. In view of this conclusion it is not necessary to consider the further contentions made by respondent that petitioner was also taxable on the entire net income of the trusts during the period in question under sections 167 (a) and 22 (a) of the Revenue Act of 1934.

Decision will he entered under Buie 60.


author: Tyson:

text:
    John Armistead, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98816.
    Promulgated November 29, 1940.

      J. O. Murphy, Esq., for the petitioner.

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

Tyson:

The petitioner contends that his income here in controversy is exempt from tax under the provisions of the Public Salary Tax Act of 1939 on the theory that his' contracts with the State of Georgia, the county of Fulton, and the city of Atlanta either (1) constituted him an officer of the state and of each of its named political subdivisions, or (2) under those contracts he became an employee, as distinguished from an independent contractor, of that state and of each of such subdivisions; and that in either of such events the income here involved would be free from tax.

The first question for consideration is whether the petitioner was an officer of the State of Georgia, the county of Fulton, and the city of Atlanta, or any of them.

There has been no statute or ordinance cited as operative during the taxable years, and we know of none, creating an office prescribing the duties or fixing the compensation for services of the character of those undertaken to be performed, and performed, by petitioner for either of the above mentioned state, county, or city. Petitioner in each case took no oath of office and made no bond for the faithful performance of his services. The period of his employment in each case was not definite and fixed, but was terminable at the will of his employer. His compensation in each case was on a commission and not on a fixed salary basis, the commissions being dependent entirely upon the results of work he performed as finally translated into taxes collected by the state and its subdivisions. His services were not continuously rendered for either the state, county, or city, alone, since, being employed by all three and rendering services to all three during the taxable years, his entire time was not devoted to the performance of services for any one exclusively, and neither the state, county, nor city contract prohibited petitioner from accepting other employment. Under these facts we think it unnecessary to discuss authorities in deciding, as we do, that petitioner was not during the taxable years an officer of the State of Georgia, the county of Fulton, or the city of Atlanta. The following authorities are pertinent in support of our conclusion: J. F. Roberts, 13 B. T. A. 438; affirmed per curiam, Roberts v. Commissioner, 44 Fed. (2d) 168; Ewart v. Commissioner, 98 Fed. (2d) 649, affirming Howard Ewart, 35 B. T. A. 692; Commissioner v. Emerson, 98 Fed. (2d) 650, reversing Sigurd A. Emerson, 35 B. T. A. 901; certiorari denied, 305 U. S. 642; J. E. Huckabay, 40 B. T. A. 9; and John T. Rowland, 40 B. T. A. 11 (on appeal to Third Circuit).

The next question for consideration is whether the petitioner was an employee, as distinguished from an independent contractor, of the above mentioned state, county, and city, or any one of them. He was engaged for an indefinite time to perform the special services of collecting and furnishing the taxing authorities with data and information relative to property which had been escaping taxation. He did not devote all his time to services rendered separately to the state, the county, or the city, nor was he required to do so. He used his own methods and judgment in achieving the desired results, except that “from time to time”, but not generally, the board of tax assessors and receivers of the city of Atlanta directed him in regard to making investigations for them. He paid his own office rent and his office employees, as well as all other expenses connected with the performance of his services for the state, the county, and the city.

From all these facts and the whole record, it is our opinion, and we so hold, that petitioner was not an employee of the State of Georgia, or Fulton County, or the city of Atlanta, but that the relation sustained by him during the taxable years with that state and those subdivisions of the state was that of an independent contractor. Roberts v. Commissioner, supra; Harry D. Kremer, 31 B. T. A. 566; J. E. Huckabay, supra; and John T. Rowland, supra, and cases cited therein.

We do not think that the soundness of this conclusion is adversely affected with respect to Fulton County and the city of Atlanta because of the provision in petitioner’s contract with Fulton County to the effect that he was to work under the direction of the board of tax assessors of that county, or because of the provision in petitioner’s contract with the city of Atlanta to the effect that petitioner’s “approach or contact with tax payers [was] to be only with the consent and direction of the Tax Assessors” of that city. The degree of control retained by the city of Atlanta and the county of Fulton, over the rendition of services by petitioner, in these provisions of the respective contracts, i. e., whether the right to instruct petitioner was limited to instructing him what to do, only, or extended also to instructing him how to do it, is not clearly indicated; and it can not be determined from these provisions that such a right of control over the rendition of services by petitioner was retained by the city of Atlanta and Fulton County, or either of them, as was inconsistent with the relationship of petitioner as an independent contractor. Cf. Kreipke v. Commissioner, 32 Fed. (2d) 594; Harry D. Kremer, supra; and Mesce v. United States, 64 Ct. Cls. 481; certiorari denied, 276 U. S. 612. A reasonable construction of these ambiguous provisions in the two contracts would seem to be that it was not intended thereby that petitioner was to be instructed by either the county or city as to the way he should “ferret out” or “seek out” property escaping taxation, since use of their own methods had failed to discover such property, and they apparently employed petitioner for the primary purpose of effectuating the desired end through use by the petitioner of his own methods of doing the work, thus placing the petitioner in the role of an independent contractor rather than in that of an employee. Railroad Co. v. Hanning, 15 Wall. 649, 657; Singer Manufacturing Co. v. Rahn, 132 U. S. 518; Casement v. Brown, 148 U. S. 615; and Chicago, Rock Island & Pacific Railway Co. v. Bond, 240 U. S. 449.

Moreover, the apparent construction placed by the parties upon the provisions of the two contracts in performing the contracts shows clearly that over the services actually rendered by petitioner for the city of Atlanta and Fulton County, for which petitioner received part of the compensation here involved, no control by the county was exercised and but little, if any, by the city, since petitioner was always permitted to, and did, use his own methods in rendering his services to the city and county, with possibly a few exceptions as to the city, “from time to time”; and whether or not he discovered any taxable property was dependent upon his own ingenuity.

We hold that the respondent did not err in determining that the commissions here involved are to be included in petitioner’s income for the taxable years 1934, 1935, and 1936. We further hold that petitioner, having failed to file a return as required by law for each of the years 1934, 1935, and 1936, is further liable for a 25 percent penalty on the deficiencies for those respective years as redetermined pursuant to this opinion.

Decision will be entered v/ndetr Rude 50.

       Sec. 201. Any amount of Income tax (including interest, additions to tax, and additional amounts) for any taxable year beginning prior to January 1, 1938, to the extent attributable to compensation for personal service as an officer or employee of a State, or any political subdivision thereof, or any agency or instrumentality of any one or more of the foregoing;
      (a) shall not be assessed, and no proceeding in court for the collection thereof shall be begun or prosecuted (unless pursuant to an assessment made prior to January 1, 1939) :


author: Leech :

text:
    Vahram Chimchirian, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97510.
    Promulgated November 29, 1940.

      Henry ~Ward Beer, Esq., for the petitioner.

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

Leech :

Respondent has conceded that petitioner is not taxable in respect of income for the years 1936 and 1937 and for the period January 1 to October 24, 1938. The only issue submitted is, then, whether petitioner, a nonresident alien individual, is taxable upon income received during 1933, 1934, and 1936 from the sale of rugs on consignment through a commission merchant located within the United States, where such rugs were purchased by buyers here.

The reason for respondent’s concession as to 1936 and 1937 and part of 1938 is that, in section 211 of the Revenue Act of 1936, Congress, convinced of the impracticability of the system for taxing nonresident aliens, created a new taxing scheme for such persons. Eeport of Committee on Finance (S. Eept. No. 2156, 74th Cong., 2d sess.). The essence of the new scheme was that nonresident alien individuals having no office or place of business in this country should be taxed at a rate of 10 percent on their income from United States sources in so far as that income consisted of interest, dividends, salaries, rents, etc., “or other fixed or determinable annual or periodical gains, profit and income”; and that nonresident aliens engaged in trade or business or having a place of business here should be taxed like everyone else, “Engaged in trade or business within the United States” was defined, however* so as not to “include the effecting of transactions within the United States in stocks, securities or commodities through a resident broker, commission agent or custodian,”

In other words, from 1936 onward, persons in the situation of petitioner were exempt from Federal income tax.

Petitioner, arguing from respondent’s concession and relying wholly on Union Internationale De Placements v. Hoey, 96 Fed. (2d) 591, takes the position that section 211, especially section 211 (b) of the Revenue Act of 1936, is a mere clarification of existing law and that he is to be similarly exempted as to 1933, 1934, and 1935.

The Report of the Committee on Finance, supra, after adverting to the unsatisfactory system for taxing nonresident aliens, does recommend “amendments to section 211 (b) of the House Bill which are intended to clarify the meaning of the phrase ‘engaged in trade or business in the United States’.” The Circuit Court of Appeals for the Second Circuit, in Union Internationale De Placements v. Hoey, supra, relies on that committee report to support its holding that a foreign corporation, situated similarly to petitioner, is not liable for capital stock tax for the years 1933 to 1935, inclusive. But, right or wrong, that conclusion is not decisive of the present issue.

Petitioner’s tax liability for the years 1933 to 1935, inclusive, is governed primarily, of course, by the Eevenue Acts of 1932 and 1934. Section 211 (a) of the Eevenue Act of 1932 reads as follows: “In the case of a nonresident alien individual who is not a resident of a contiguous country, the normal tax shall be 8 per centum of the amount of the net income in excess of the credits against net income allowed to such individual.” Section 212 (a) provides: “In the case of a nonresident alien individual gross income includes only the gross income from sources within the United States.” Section 211 (a) of the Eevenue Act of 1934 is worded identically with section 212 (a) of the Eevenue Act of 1932. The two acts define “gross income from sources within the United States” in the same terms, in section 119 (e), of which the pertinent part is as follows:

* * * Gains, profits and income derived from the purchase of personal property within and its sale without the United States or from the purchase of personal property toithout and Us sale within, the United States, shall be treated as derived entirely from sources within the country in which sold * * *. rEmphasis supplied.]

The sales of petitioner’s personal property, to wit, rugs, upon the gain from which the contested deficiencies and penalties arose, took place in this country. That is the stipulation, and the law. New York Personal Property Law, § 99 (Uniform Sales Act, § 18); 4 Williston on Contracts, §§ 1035-6. As to those transactions, petitioner is thus precisely within the terms of the statute and, in 1933, 1934, and 1935, derived income from sources within the United States, upon which he must pay the taxes and penalties claimed for those years.

There is nothing, either in Union Internationale De Placements v. Hoey, supra, or in the legislative history of the Revenue Act of 1936 to disturb this conclusion. In the case cited, the court ruled that the capital stock tax there sought to be imposed upon a nonresident corporation was an excise tax upon the privilege of doing business. The carrying on of business in the United States was hence an essential prerequisite to that taxpayer’s liability. But we know of no authority for the proposition that, prior to 1936, a nonresident alien individual had to be engaged in business here in order to be taxed. Indeed, all the implications of the authorities are to the contrary. See Askania Werke A. G., 33 B. T. A. 875; reversed on other grounds, 96 Fed. (2d) 717; Aktieselskabet Det Ostasiatiske Kompagni, 19 B. T. A. 294; Hubert de Stuers, 26 B. T. A. 201. So far as the legislative history of section 211 of the Revenue Act of 1936 is concerned, it is plain to us, and we have already held, that that section made a clean break with existing law. Zander & Cia, Ltd., 42 B. T. A. 50. That being so, even assuming the constitutionality of a retroactive statute, it would require convincing evidence of Congressional intention of retroactive application to support petitioner’s position. Lynch v. Turrish, 247 U. S. 221; Hassett v. Welch, 303 U. S. 303. Such evidence is wholly absent here.

Petitioner argues on brief that “not a shred of authority exists” for the position we take here. In making this contention he has overlooked the express, unmistakable, unambiguous language of the Revenue Acts of 1932 and 1934.

The penalty for failure to file returns, in the amount of 25 percent of the tax due, is mandatory where no return is filed by the taxpayer, and respondent’s action in imposing it for 1933, 1934, and 1935 is sustained. We also sustain his imposition of the 5 percent negligence penalty for those three years, petitioner having offered no proof to show that he was not negligent in his tax conduct or that he did not intentionally disregard rules and regulations.

As to the years 1933,1931, and 1936, decision will he entered for respondent. As to the years 1936 and 1937 and the pemod January 1 to October 1938, decision will he entered for petitioner.

       See also 1939 Cumulative Supplement to Paul & Mertens, Law of Federal Income Taxation, pars. 37.15 A to 37.15 K, inclusive.


author: Oppek,

text:
    Estate of Isaac Fish.

    Docket No. 96527.
    Promulgated June 28, 1940.

       Opinion. See p. 260.

   Oppek,

dissenting: Presumably the sole distinction from such cases as Mary Ryerson Frost, 38 B. T. A. 1402, and Everett D. Graff, 40 B. T. A. 919, is the application here of section 166 rather than 167. If these sections are to be treated as inconsistent so as to justify an opposite result from similar facts, in spite of intimations to the contrary (see e. g. Mary Ryerson Frost, supra, 1404; see also Bay “The Income Tax on Short Term and Revocable Trusts,” 53 Harvard Law Review, 1322, 1338), this seems an appropriate occasion for giving that concept expression.

Leech agrees with this dissent.


text:
    Castner Garage, Limited, Petitioner, v. Commissioner of Internal Revenue, Respondent. Universal Motor Company, Limited, Petitioner, v. Commissioner of Internal Revenue, Respondent. Island Securities, Limited, a Dissolved Corporation, J. W. A. Baird, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 98502, 98503, 99082, 99752.
    Promulgated December 4, 1940.

      Urban E. Wild, Esq., Milton Cades, C. P. A., and E. J. Greaney, C. P. A., for the petitioners.

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

Murdock:

The Commissioner determined deficiencies as follows:

The issue for decision by the Board is whether and to what extent the petitioners are taxable upon amounts received by them in 1935 and 1936 from the Prudential Insurance Co. of America as disability payments under policies of combined life, health, and accident insurance upon their president, Charles C. Pittam. .The Board adopts as its findings of fact the stipulations of the parties, together with exhibits attached thereto.

The Castner Garage, Ltd., and Universal Motor Co., Ltd., hereinafter referred to as Castner and Universal, are corporations organized under the laws of the Territory of Hawaii. Island Securities, Ltd., hereinafter referred to as Island, formerly a Hawaiian corporation, was dissolved on August 26,1936, and its remaining assets are now held by a trustee for the benefit of its creditors and stockholders. Charles C. Pittam owned a majority of the outstanding capital stock of Island, which in turn owned a majority of the stock of both Castner and Universal. Most of the remaining stock of the three companies was owned by Pittam’s brother-in-law and by officers or employees.

Four policies of combined life, health, and accident insurance in the Prudential Insurance Co. of America were taken out upon Charles C. Pittam prior to 1980. The premiums on the policies covered both the life and the health and accident features of the policies. Castner procured one of the policies and was named beneficiary therein. Universal procured one of the policies and was named beneficiary therein. Pittam procured the other two policies and the Hawaiian Trust Co., Ltd., trustee, was named beneficiary therein. The Hawaiian Trust Co., under its trusteeship, was to use the proceeds of the two policies, in the event of the death of the insured, to purchase the capital stock of Island at face value from the estate of the insured. Several changes of beneficiaries and of rights in one or more of the policies were made prior to 1935. Suffice to say that each of the petitioners, prior to the taxable years, acquired for valuable considerations certain beneficial rights in one or more of the policies and was thereby entitled to receive and did receive during the taxable years certain payments on account of the fact that Pittam became disabled from ill health. He had been regularly engaged in the business of these petitioners at salaries prior to his disability. The rights and interests in the four policies held by the petitioners during the taxable years were acquired by the petitioners for the purpose of strengthening their credit and for their use as collateral for bank loans. That purpose had been accomplished and all of the policies were assigned to the insured on May 23,1936.

The petitioners, while the policies were assigned to them, paid all of the premiums due. Also, the petitioners made certain payments when the policies were assigned to them or when certain changes in the policies were made. No deductions on account of the payments made by them in respect to the policies were ever claimed by or allowed to the petitioners.

The petitioners in their income tax returns for 1935 reported as income the excess of the amounts which they received during that year from the insurer, over the amounts which they had paid as premiums or otherwise in respect to the' policies. Universal alone received a payment in 1936, but it did not report as income any part of the amount which it received from the insurer in that year. The Commissioner, in determining the deficiencies, has included in the taxable income of the petitioners the full amounts received by them.

The petitioners contend that the amounts received by them during the taxable years by reason of the disability of the insured are exempt from taxation under the express provisions of sections 22 (b) (5) of the Eevenue Acts of 1934 and 1936, which exempt from taxation:

(5) Compensation for injuries or sickness. Amounts received, through accident or health insurance or under workmen’s compensation acts, as compensation for personal injuries or sickness, plus the amount of any damages received whether by suit or agreement on account of such injuries or sickness.

The respondent recognizes that the health features of the insurance are separable from the life insurance features and the amounts in question were received by the petitioners through health insurance on account of the sickness of Pittam. The respondent’s only reply to the contention of the petitioners is that section 22 (b) (5) does not apply in the case of a corporation. He argues at considerable length thát the exemption applies only to individuals, and goes even further, as his logic forces him, to say “Congress intended the exemption to be personal to the insured.”

Section 22, entitled “Gross Iitcome”, applies generally to both individual taxpayers and corporate taxpayers. Unlike the next section (see section 23 (e) and (f)), none of its provisions are expressly limited in their application to one or the other class of taxpayers. However, some of the provisions of section 22 (b) obviously refer only to individuals. See, for example, paragraph 6, relating to ministers, that part of paragraph 3 relating to inheritance, and the sentence in paragraph 7 relating to earned income. Other provisions of (b) are just as obviously applicable to both individuals and corporations. See, for example, paragraph 1, dealing with proceeds of life insurance, paragraph 2, on annuities, paragraph 4, on tax-free interest. Thus, it is necessary to examine the particular provision here in question to see whether, by natural implication, it might be limited in its application to the insured or, at least, to individual taxpayers.

All revenue acts beginning with that of 1928 have contained, in section 22 (b) (5), a provision identical with the one above quoted. Prior to that time and beginning with the .Eevenue Act of 1918, the same provision appeared as section 213 (b) (6). The change from section 213, which applied only to individuals, to section 22, which applies generally to both individuals and corporations, was of no consequence or significance in so far as the present issue is concerned, since those revenue acts which included the provision under section 213 (b) (6) also contained a section 233 (a) providing that the gross income of corporations means the gross income as defined in section 213, with certain exceptions not here material. Cf. United States v. Supplee-Biddle Hardware Co., 265 U. S. 189. The change elicited in legislative reports no comment relevant here. Thus, the possibility of the present question has been present under all prior acts, beginning with the Eevenue Act of 1918. Yet, apparently, it has never arisen until now.

Section 22 (b) (5) deals with amounts received as compensation for personal injury or sickness. It contains no express statement that it relates to such amounts when received by any particular limited class of taxpayers. The Commissioner contends that the provision is limited in its application to amounts received by the insured, but that argument is contrary to his own regulations and, apparently, his practice. The regulations have held consistently that the exemption was not limited to amounts received by the insured. Cf. Brewster v. Gage, 280 U. S. 327. Although Eegula-tions 86 and 94, pertaining to the Eevenue Acts of 1934 and 1936, contain no reference to section 22 (b) (5), nevertheless, all prior regulations, beginning with Eegulations 45, applying to the Eevenue Act of 1918, contain a provision substantially like that of article 72 of Eegulations 45, as follows:

Whether he be alive or dead, the amounts received by an insured or his estate or other beneficiaries through accident or health insurance or under workmen’s compensation acts as compensation for personal injuries or sickness are excluded from the gross income of the insured, his estate and other beneficiaries.

Amounts received by one member of a family as compensation for personal injuries or sickness of another member of the family would thus be exempt. We conclude that the exemption is not limited to the person who suffers the personal injuries or sickness.

Since section 22 (b) (5) would apply in the case of a father who received compensation because of the illness of his insured son, even though the son happened to be his employee, what is there to indicate that the provision would not apply to amounts received by any taxpayer who had an insurable interest in the health of an insured? It is futile to argue that a corporation can not suffer personal injury or sickness and can be compensated only for the loss of services of its employees. The same argument could be made in the case of an individual employer. In fact none but the insured actually suffers the injury or sickness. Yet we have concluded that the exemption is not limited to the insured. The only reference to the provision in the legislative reports is the following made by the Ways and Means Committee in connection with the Eevenue Act of 1918:

Under the present law it is doubtful whether amounts received through accident or health insurance, or under workmen’s compensation acts, as compensation for personal injury or sickness, and damages received on account of such injuries or sickness, are required to be included in gross income. Tire proposed bill provides that suck amounts shall not be included in gross income.

See House Report 767,65th Cong., 2d sess., pp. 29,80. l't is interesting to note the conclusion which the Supreme 'Court reached in the case of United States v. Supplee-Biddle Hardware Co., supra. The Court was there interpreting section 213 (b) (1) of the Revenue Act of 1918, which, like (b) (6) supra, exempted certain items from taxation. The exemption was in this language: “The proceeds of life insurance policies paid upon the death of the insured to individual beneficiaries or to the estate of the insured.” The Court said:

We think the Treasury Department erred in assuming that Congress intended by sections 233 and 213 to distinguish between individual beneficiaries and corporate beneficiaries in including the proceeds of life insurance policies as within gross income. We think the two sections have no such purpose. * * *
When Congress came to deal with the gross income of corporations, it made use of section 213 by reference and grafted it on to 233. It is reasonable that the purpose of section 213 to exclude entirely the proceeds of life insurance policies from taxation in the ease of individuals should be given the same effect in adapting its application to corporations, and that such proceeds should be so excluded whether by the direction of the insured they were to go to ■specially named beneficiaries or were to inure to the estate of the insured.

The language of section 22 (b) (5) is certainly no less favorable to the contention of the respondent than was the language of section 218 (b) (1). There is no sound reason for differentiating here between corporations and individuals other than the insured. We conclude that section 22 (b) (5) is general in its application and is not limited so as to exclude corporations, such as these, which have insurable interests.

Reviewed by the Board.

Decisions will be entered under Rule 50.


author: Murdoch :

text:
    Hobbs Western Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104615.
    Promulgated December 4, 1940.

      W. G. Magathan, Esq., for the petitioner.

      R. G. Whitley, Esq., for the respondent.
   OPINION.

Murdoch :

The respondent filed a motion on October 12, 1940, to dismiss this proceeding in so far as it relates to excess profits taxes because the Board is without jurisdiction. The petitioner was notified in the deficiency notice that the Commissioner had determined a deficiency of $17,427.21 in income tax and an overassessment of $7,577.92 in excess profits tax, or a net deficiency of $9,849.29, for the fiscal year ended October 81, 1937.

The Board has held heretofore that a determination in regard to income tax and a determination in regard to excess profits tax are separate in so far as jurisdiction of the Board is concerned. In Will County Title Co., 38 B. T. A. 1396, the Board assumed jurisdiction in regard to income tax for 1934, since the Commissioner had determined a deficiency therein of $529.25, but denied jurisdiction in regard to excess profits tax for that year, as to which the Commissioner had determined an overassessment of $745.04. It held in Union Telephone Co., 41 B. T. A. 152, that it had jurisdiction in regard to excess profits tax for 1936, since the Commissioner had determined a deficiency therein of $842.84, although it had no jurisdiction in regard to income tax and undistributed profits surtax for that year, since the Commissioner had determined a net overassessment as to those two taxes, represented by a deficiency in income tax of $1,128.86 and an overassessment in undistributed profits surtax of $1,148.38. It said in that opinion that although the income tax and undistributed profits surtax were related, nevertheless, excess profits taxes were imposed by a different title and, therefore, were separate for jurisdictional purposes of the Board.

We hold, following the principle of those two decisions, that the Board in the present proceeding has no jurisdiction in regard to excess profits tax, but has jurisdiction in regard to income tax for the fiscal year involved. Consequently, the proceeding is dismissed for lack of jurisdiction in so far as it relates to excess profits tax.


author: SteRnhagen :

text:
    A. R. Calvelli, Petitioner, v. Commissioner of Internal Revenue, Respondent. Irma M. Calvelli, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 101618, 101619.
    Promulgated December 4, 1940.

      PhiUp G. Sheehy, Esq., for the petitioners.

      Arthur L. Murray, Esq., for the respondent.
   OPINION.

SteRnhagen :

1. The first contention made by the petitioner is that the Commissioner erred in his determination that the gains derived from the sale of the lots in the subdivided tract were ordinary gains and not capital gains, Revenue Act of 1936, section 117 (b), the amount of which is taxable to the extent of 60 percent, section 117 (a). The evidence establishes that the petitioner bought this property for the purpose of subdividing it into lots and selling the lots and the finding has been made in the language of the statute. There is, in our opinion, no escape from the finding. It must be said here, as it was in Julius Goodman, 40 B. T. A. 22, 25, “the petitioners have established that they bought this property * * * for subdivision and sale in lots to customers as they could be found.” It does not detract from the finding that the petitioner’s greater interest was in building the houses. Both were parts of his business. Indeed he sold one of the lots and did not build a house on it. The Commissioner’s determination is sustained.

2. On one of the lots petitioner built a house primarily as an exhibition house as a sample of his building. He and his wife have occupied it since as a residence. Petitioner contends that he has the right to a deduction of $342.53 (3 percent of the cost of $11,417.83) for depreciation of the house. The depreciation deduction of the statute is “a reasonable allowance for exhaustion, wear and tear of property used in the trade or business.” The use of the house was twofold — as a residence and as a business sample and office. If it were solely the latter, depreciation would be allowable. Simons Brick Co., 14 B. T. A. 878; affd., 45 Fed. (2d) 57; certiorari denied, 283 U. S. 834. If it were solely the former it would not. “No such allowance may be made in respect of * * * a building used by the taxpayer solely as his residence.” Regulations 94, art. 23 (l)-2; Paul and Mertens, Law of Federal Income Taxation, §§20.12, 20.54. If the extent of business use were substantial and appeared in the evidence there might be a question of a proper apportionment and a resulting proportionate deduction. Of. Robert H. Montgomery, 37 B. T. A. 232. The evidence, however, does not provide any basis for such apportionment but rather indicates a comparatively slight use of the house for business — too slight to provide a mathematical factor to measure depreciation. There is nothing from which one could infer whether any particular part of the house was an office, and if that were the fact it would have been easy for the petitioner to prove it. It appears only that he regarded the house as more than he and his wife could afford, and he showed it to prospective lot buyers. Simons Brick Co., supra, is inapposite, for there it was held that a house built by a corporation for business purposes is no less subject to a depreciation deduction because it is sometimes occupied by one or more of the corporation’s officers. The Commissioner’s determination is sustained.

3. The petitioner demands a depreciation deduction upon the house sold to Minardi in 1932 and taken back in 1933 after the purchaser’s default in payments. The issue is the proper basis for the depreciation; the petitioner claims a basis of the original cost of construction of the house before its sale in 1932, which is shown to be not less than $5,800. The gross sales price in 1932 was $7,900, of which $400 was paid down and $320.83 was an installment payment. Its value when reacquired is not shown.

How this transaction has been treated for income tax purposes in its several stages does not appear. The petitioner suggests that the $320.83 may have been rent, but the evidence shows that the house was sold. Thus the gain upon the sale was taxable on the installment basis. The original sale and the reacquisition were two separate transactions. Jacob M. Dickinson, Jr., et al., Executors, 18 B. T. A. 790. If there was gain to petitioner in the disposition in 1933 of the installment rights which he presumably held, as of purchase money notes, the basis of depreciation of the reacquired house would have been the same figure of value as measured the gain. Without this data it can not be said from the evidence of only original cost, sale price, default, and reacquisition that the Commissioner’s basis of depreciation was incorrect.

The determination is sustained.

Decision will be entered for the respondent.


author: SteRNhagen:

text:
    Producers Oil Corporation, Petitioner, v. Commissioner of Internal Revenue. Respondent.
    Docket No. 93839.
    Promulgated December 5, 1940.

      ■Ralph M. Andrews, Esq., Robert R. Bo/rrett, Esq., and A. E. Sw-dam, O. P. A., for the petitioner.

      Loren P. Oahes, Esq., and E. 0. Algvre, Esq., for the respondent.
   OPINION.

SteRNhagen:

The Commissioner determined deficiencies in petitioner’s income tax of $2,571.45 for 1934 and $1,534.18 for 1935. The case has been submitted on a stipulation. It has been stipulated that there are no deficiencies and that petitioner has made an overpayment for each year. But this overpayment may not be refunded “unless the Board determines as part of its decision that it was paid within three year before * * * the filing of the petition.” Revenue Act of 1934, sec. 322 (d). A petition was filed within three years after payment (except as to the first installment paid March 11, 1935) and the question is whether this was a petition putting in issue the point upon which the overpayment is founded, as the petitioner contends, or whether that point was omitted from the petition, as the respondent contends. If the point was not put in issue by the petition, the determination necessary to a refund could not be made by the Board. Commissioner v. Rieck, 104 Fed. (2d) 294; certiorari denied, 308 U. S. 602; Commissioner v. Dallas, 110 Fed. (2d) 743; Denholm & McKay Co., 41 B. T. A. 986; Alfred L. Rose, 41 B. T. A. 1073 (on review, C. C. A., 2d Cir.); Adolph B. Spreckels, 41 B. T. A. 1204 (on review, C. C. A., 9th Cir.). These cases hold that such a determination can not be made unless the timely petition squarely raises the point upon which the overpayment depends; an original or amended petition filed more than three years after payment raising a new and unrelated point will not support the determination. Although the petitioner made a motion to amend the petition, this motion was abandoned; and the question is therefore confined to the scope of the original petition.

The petitioner is an oil producer. Its return showed a deduction for depletion. Such a deduction is given by the Revenue Act of 1934, section 23 (m) and section 114 (b) (3). The depletion was computed by the percentage method. The Commissioner reduced the percentage deduction by recomputing the gross and net income upon which the 2T% percent and its 50 percent limitation are based. The petition assigns as error the failure to allow deductions for depletion in specified amounts which result from a percentage computation. In neither the notice of deficiency nor the petition is mention made of the unit method or of any of the facts upon which a proper deduction by that method would be computed.

From the stipulation it appears that the return contained the usual facts for computation by both methods and it also appears that the return shows that the unit method deduction would be lower than the percentage method. The stipulation contains all the facts and among them is a statement showing as to each property the figures in separate columns of gross sales, net income, unit depletion, 27% percent of sales, 50 percent of income, and the allowable depletion resulting from the applicable method, being sometimes one and sometimes the other. This is because under the last clause of section 114 (b) (3) the allowance under the percentage method may in no case be less than under the unit method. To one using the percentage method a computation by the unit method is always necessary, for “in no case shall” the allowance be less than such a computation shows. This is mandatory.

And it is important that it should be mandatory. Section 114 is primarily one which prescribes the basis not only for depreciation and depletion, but also for future determination of gain or loss from sale or other disposition. Thus the larger depletion serves to reduce the remaining basis and to increase a taxable gain or reduce a tax-reducing loss in the future. This taxpayer had adopted the percentage method, and the statutory requirement prohibits a deduction under that method of less than a deduction based on cost. The computation is inevitable; and, even if there had been no stipulation and the entire proceeding had been tried at an open hearing with nothing said about cost depletion, a recomputation under Rule 50 would still have required the comparison of the two methods of computation so that the decision should comply with the statute. Mountain Producers Corporation, 34 B. T. A. 409; affirmed on another point, 303 U. S. 376; Transcalifornia Oil Co., Ltd., 37 B. T. A. 119, 127; Cook Drilling Co., 38 B. T. A. 291, 297. Cf. John E. Zimmermann, 36 B. T. A. 618. And any evidence offered at the trial to show the unit cost depletion would be admissible and it would be error to exclude it. There would have been no variance, for both methods were always inherently necessary. Cf. United States v. Garbutt Oil Co., 302 U. S. 528.

Thus the petition, filed within three years after overpayment, raised the question of the propriety of the Commissioner’s determination of depletion which comprehended the proper computation under either method, and the finding will be made that the stipulated overpayment (except the portion paid March 11, 1935) was made within three years before the filing of the petition.

Decision will be entered for the petitioner'.

       Depletion. — In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. * * * (For percentage depletion allowable under this subsection, see section 114 (b), (3) and (4).)

       (b) Basis foe Depletion.—

      (3) Percentage depletion foe oil and gas wells. — In the case of oil and gas wells the allowance for depletion under section 23 (m) shall be 27% per centum of the gross income from the property during the taxable year, excluding from such gross income an amount equal to any rents or royalties paid or incurred by the taxpayer in respect of the property. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no ease shall the depletion allowance under section 23 (m) be less than it would be if computed without reference to this paragraph.

       Regulations 86, article 23 (m), requires this information.