text:
    Otis Steel Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7520.
    Promulgated March 2, 1927.
    1. Depreciation rates based on a physical examination of the assets and consideration of the various factors, such as the extent of operations, effect of repairs, etc., indicative of the amount of wear and tear during the period involved, more accurately represent depreciation sustained than do rates computed by a straight-line method, for the purpose of determining allowable depreciation deductions as well as adjustments of invested capital on account of depreciation sustained in prior years.
    2. Good will value of a business purchased determined, for invested capital purposes, by capitalizing the excess of average net earnings over a fair return on tangibles for the five-year period preceding the purchase.

      J. W. Reavis, Esq-., and J. G. Little, Esq., for the petitioner.

      John D. Foley, Esq., for the respondent.

      This proceeding results from the determination by the Commissioner of a deficiency in income and profits taxes for the year 1918, in the amount of $298,025.61. The petitioner avers error in the determination of the deficiencies in three respects: (1) In determining invested capital for the year 1918, the Commissioner increased depreciation to be charged off for years prior to 1918, from $1,245,-263.42 to $1,791,657.78; • (2) the Commissioner decreased the depreciation charged off by petitioner for the taxable year 1918, from $558,236.33 to $411,770.70, resulting in an increase in taxable income for the year of $146,465.83; (3) the Commissioner refused to allow' any amount of invested capital based upon the purchase by petitioner, during the year 1912, of good will having an actual value of at least $770,000.
    FINDINGS OF FACT.
    The Otis Steel Co. of Cleveland, Ohio, was incorporated under the laws of the State of Ohio, on January 1, 1912, and is engaged in the manufacture and sale of steel. It was the successor to the Otis Steel Co., Ltd., of Great Britain, which was successor to the Otis Iron & Steel Co. of Cleveland, Ohio. :
    The Otis Iron & Steel Co., the original owner corporation, was organized and incorporated under the laws of the State of Ohio, January 13, 1873, and continued in business as such until about January 1, 1890, when all the business and net assets were sold to the Otis Steel Co., Ltd., by a'transfer of all the outstanding capital stock to the latter corporation. No data are available showing the consideration which the latter paid the Otis Iron & Steel Co. for its assets. The books of account of the Otis Steel Co., Ltd., are not available, and it is, accordingly, impossible to determine the book values of the property transferred by it to the petitioner. The revenue agent found that an appraisal had been made at about January 1, 1912, which set up the values of the real estate, buildings and equipment, and he used this appraisal as his basis for property accounts as of January 1, 1912, basing his calculations for depreciation on such values, plus subsequent additions to the property accounts. The values or cost of depreciable assets for the years in question is not in dispute. He classified the depreciable assets and attributed to the assets in each classification their useful life; computed the depreciation on a straight-line method, and, in the computation of invested capital, allowed no amount for either good will or intangibles. The Commissioner approved the action of the revenue agent and determined the deficiencies in question.
    Petitioner was organized to purchase the assets, business, and good will of the Otis Steel Co., Ltd., and began business with an authorized capital stock of $10,000,000 — $5,000,000 thereof being 7 per cent cumulative preferred stock and $5,000,000 common stock — and immediately after its organization the petitioner purchased the good will, plant, and business of thS Otis Steel Co., Ltd., by issuing $4,145,000 of common stock and $2,Y64,000 of preferred stock in payment therefor.
    The only tangible property owned by the Otis Steel Co., Ltd., was what was known as the “ Lakeside Plant,” located at Cleveland, Ohio. This was a large and extensive plant, devoted exclusively to the manufacture and sale of steel. When petitioner purchased this plant, it also acquired a large tract of adjoining land and began the construction of an additional unit known as the “Riverside Plant.” The “ Riverside Plant ” was completed in 1914 and the petitioner operated the plant for a few months, but depression in the steel industry forced it, for business reasons, to close down the plant until the year 1916. During the time the Riverside plant stood idle, petitioner maintained a corps of watchmen and machinists to oil the machinery and prevent deterioration of the same.
    Petitioner charged off on its books of account depreciation for the years 1912 to 1918, inclusive, in the following amounts:
    1912- $100,000.00
    1913- 91, 987.05
    1914- 50, 000.00
    1915- 150, 000. 00
    1916-^_ 300, 000. 00
    1917- 550, 000. 00
    1918- 550, 000. 00
    The production of steel for the years 1912 to 1918, inclusive, was as follows:

    The depreciation charged off by petitioner during the years 1912 to 1918, inclusive, was determined by the company official who was the operating head of the property and who has been with the several companies since 1873. He was familiar with the daily production, the character and degree of use to which the property was put, the character of labor employed, and the average cost of the machinery and equipment used; the experience of petitioner in the past, reflecting the useful life of its assets, and the repairs made during each year. I-Ie did not use the straight-line method, or any mathematical dormida, for determining the depreciation suffered during the years in question. The buildings housing the steel plants are merely a shelter for the machinery and are inexpensive, while the machinery and equipment is of a massive character, and the depreciation sustained on the latter is largely in proportion to the actual use. When the machinery and equipment is run to ca-pácity, the depreciation is correspondingly greater than when run to one-half capacity.
    The production at the Lakeside plant ivas not large during the years 1912, 1913, and 1914, and depreciation was calculated on the Use to which the machinery and equipment was put, together with the other factors mentioned. The Riverside plant was completed in the last months of 1914, and little depreciation was charged on same during the year 1914. Depreciation charged on the books during the year 1914, on its assets, was relatively small, that year being one of depression, and production was the lowest during the history of petitioner.
    The Riverside plant was operated only a few months in 1914, producing a few thousand tons of steel, and was shut down in the first months of 1915 and did not resume operations until 1916. During the years 1912 to 1916, inclusive, ordinary and necessary repairs were made at both plants, as the condition of the machinery and equipment demanded. During the years 1917 and 1918, both plants of'the petitioner were operated twenty-four hours per day, seven days a week. The usual shut-downs for repairs were abandoned and only those repairs absolutely required were made. The quality of labor employed during these years was poor. This period of maximum production was taken into account in determining depreciation during the years in question.
    The depreciation charged varied in dollars during the several years, but bore a consistent relation to the production of tons of steel. From the date of completion of the Riverside plant, the rate of depreciation per ton of production was as follows:
    Vear. Depreciation per ton.
    1915_$1. 611
    1916_ 1. 656
    1917_ 1. 951
    1918_1. 661
    The petitioner purchased the assets, business, and good will of the Lakeside plant from a British corporation in January, 1912, issuing over $3,000,000 of its capital stock for the good will purchased. No books of the predecesssor company are available; they were kept in London and apparently have been destroyed. The examining revenue agent built up petitioner’s invested capital by taking certain appraisals of the physical assets of tbe Lakeside plant, as of date of purchase, and adding subsequent additions. In his report, the revenue agent stated as follows:
    That this satisfactorily determines the proper invested capital to be used for excess profit tax purposes for the year 1917 would be a ridiculous assertion, but it is the best that can be obtained for a tax calculation. It is evident that the tawpayer is the possessor of a certain valuable good will, perhaps intangibles, of a value in excess of the amount returned herewith, but the amount cannot positively be determined. (Italics ours.)
    The Lakeside plant, at date of purchase, had been established and operated for thirty-nine years, and possessed an established business and a commanding position in the steel industry. Prior to the building of the Lakeside plant, locomotive fireboxes and boilers were made of copper and cast iron. These materials were more expensive than steel, which was thought to be unfit for such use. The Xireclecessor companies spent large sums of money in perfecting suitable steel for use in locomotive fireboxes and boilers. They were pioneers in this field. Their products sold at from $2 to $20 a ton above the market price, without additional cost. The predecessor companies had a dominant position in this field, as well as in the production and sale of steel castings, and sold their products at an increased price, not only to the railroads themselves, but also to builders of locomotives, who were required by their, customers to use “Otis Steel.” The petitioner issued a financial statement, in 1912, stating it valued its good will at $1,800,000, deriving such figure from a capitalization of its earnings over a period of 10 years.
    The net earnings, before deducting for depreciation of the Otis Steel Co., Ltd., from the “Lakeside Plant,” and the net tangible assets of said “Lakeside Plant,” were as follows, for the years noted:

    The above figures are for net earnings, based upon the audit reports prepared by a firm of accountants employed by the Otis Steel Co., Ltd. The values are based upon an appraisal of plant and equipment as at date of acquisition by petitioner, and the appraisal is based on sound values at that time and not on the basis of reproduction cost.

      To the value of plant and real estate, at January 1, 1912, have ' been added values of other tangible assets, as shown by the audit report as at January 1, 1912. . After finding the total tangible assets at January 1, 1912, the figures for prior years have been obtained by working backward, giving effect to capital additions as shown by the audit reports for each year. The amount shown as net tangible assets for each year is obtained by adding the tangible assets as at the beginning and end of each year and dividing by two. The average amount shown above for the five years is obtained by totaling the figures for the five years and dividing by five.
    The net profits for the years 1907 to 1911, inclusive, should be reduced by depreciation sustained on the property of the Otis Steel Co., Ltd. The maximum depreciation sustained during those years did not exceed $80,000 per year.
   OPINION.

Milliken :

Two of the three errors alleged by the petitioner relate to depreciation. The Commissioner increased depreciation for the years prior to 1918 and decreased it for the year 1918.

The depreciation written off on the books of petitioner, for the years 1912 to 1918, inclusive, results from an actual physical examination and inspection of its plant, machinery and equipment, made by the official in charge of production and one who, for over thirty years, had been in active touch with the business. He took into consideration the actual use and extent of operations of the plant, the cost and age of the various types of depreciable assets; had before him the experience of the company in the past, reflecting the useful life of its assets; and was intimately connected with repairs made to the machinery and equipment each year. With this information before it, the petitioner charged off depreciation. The amount to be charged off as depreciation has been changed by the respondent, both in years prior to and for the year 1918. We are of the opinion that the long experience of the official of petitioner and the relevant factors which he used in determining depreciation, are to be preferred to depreciation determined upon a straight-line basis. A straight-line basis for depreciation has been adopted by the Commissioner, writing off a specified percentage each year, quite apart from the actual conditions affecting depreciation. Years when production was practically at a standstill have borne the same rate as years in which production was at a maximum. The year 1915, when the petitioner produced 93,000 tons of steel and a large unit of its plants was idle, has borne the same theoretical rate of depreciation as the year 1918, when all the plants of petitioner wore operating on a basis of twenty-four hours per day and seven days per week, with the annual production of 331,000 tons of steel. Which method results in petitioner having the reasonable allowance provided for by statute ? The method of the petitioner, which takes into account all factors having an actual bearing upon depreciation — the facts and circumstances peculiar to each year, or the method of the Commissioner, which apparently gives no consideration to such actual facts, but, instead, is based upon a theoretical and mathematical formula ? We are of the opinion that the method used by petitioner, of establishing the depreciation actually sustained during the years in controversy, is more accurate and reasonable than the one used by the Commissioner.

We have, after diligence, been unable to find any case where the courts have laid down the rule that depreciation is to be determined by theories or mathematics. The cases are legion, however, holding that the depreciation in each case must be determined from the. facts of each particular case. In the Appeal of Kinsman Transit Co., 1 B. T. A. 552, we had occasion to pass upon the factors entering into the determination of a rate of depreciation, and stated:

Depreciation is a matter of judgment, and must be determined from evidence rather than by mathematics or formulas.

In the case of Landon v. Court of Industrial Relations of State of Kansas, 269 Fed. 433, the court, in speaking of the question of depreciation, stated:

It may also not be amiss to say further that in my judgment the element of depreciation should not be measured by a theoretical yardstick, but should be determined by a careful consideration of the actual facts touching the physical condition of each particular plant under consideration.

In Pacific Gas & Electric Co. v. San Francisco, 265 U. S. 403, the United States Supreme Court stated:

Facts shown by reliable evidence were preferable to averages based upon assumed probabilities.

The courts have also held that the actual personal physical exami- • nation of the property by persons competent to testify is to be preferred to a theoretical basis. As the court stated in Southern Bell Telephone & Telegraph Co. v. Railroad Commission of South Carolina, 5 Fed. (2d) 77:

My own view is that certainly in • a case of this kind the actual personal physical examination of the property by competent witnesses and their estimate and opinion of the actual depreciation is a better guide than any of the theoretical methods that have been suggested. The decisions practically sustain this conclusion. Pacific Gas & Electric Co. v. San Francisco, 265 U. S. 403; Landon v. Court of Industrial Relations of State of Kansas (D. C.) 269 F. 445; N. Y. Telephone Co. v. Prendergast (D. C.) 300 F. 825.

In the case of Westinghouse Electric & Mfg. Co. v. Denver Tramway Co., 3 Fed. (2d) 285, the court stated:

Accrued depreciation is a fact to be ascertained by inspection.

The court in the case of Pacific Telephone & Telegraph Co. v. Whitcomb, 12 Fed. (2d) 279, in summing up the decisions of the courts relative to the method by which depreciation is to be ascertained, stated:

In other words,, it was held that accrued depreciation is to be ascertained by an inspection of the property — by going and looking at it and making estimates based upon the facts which such examination discloses.

This was just what the petitioner did in ascertaining the depreciation sustained for the years in question.

In the case of Southwestern Bell Tel. Co. v. Ft. Smith, 294 Fed. 102, one of the questions involved was with reference to depreciation, and. the engineers of Fort Smith, Ark., contended that the engineers of the telephone company had not taken into account sufficient allowance for the age of the property. The court, in approving the rate of depreciation used by the plaintiff, stated :

While the city may prescribe rates for telephone service, it is not the owner of the telephone plant. The telephone company is the owner of the plant and operates it. Its officers and employees are charged with the responsibility of its operation. Their experience enables them to form a judgment with reference to the amount to be reserved for depreciation. Until the Interstate Commerce Commission through its investigation shows the amount reserved by the company to be excessive, prudence would dictate that the judgment of the company upon that point should be permitted to stand.

To the same effect, also, see Re Virginia Railway & Power Co., P. U. R. 1922D, 352; Birmingham v. Telephone Co., P. U. R. 1919B, 791; Arhansaw Water Co. v. Little Rock, P. U. R. 1924C, 73.

In view of all the evidence with reference to depreciation sustained and written off by the petitioner for years prior to 1918, we are of the opinion that the invested capital of petitioners for 1918 should be increased by $546,394.36. Cleveland Home Brewing Co., 1 B. T. A. 87; Russell Milling Co., 1 B. T. A. 194; Rub-No-More Co., 1 B. T. A. 228; When Clothing Co., 1 B. T. A. 973; City National Bank, 2 B. T. A. 623; Kansas Milling Co., 3 B. T. A. 709; Northeastern Oil & Gas Co., 5 B. T. A. 332. We are also of the opinion that the method used by the petitioner for determining the depreciation applicable to the year 1918, based upon a physical examination of the assets by' one fully competent to make such an examination, and taking into consideration the necessary known factors,' more correctly represents the reasonable depreciation to which petitioner is entitled, and especially so when it is shown that the Commissioner did not take into account essential factors in determining depreciation on a straight-line basis. Accordingly, the net income for the year 1918 should be reduced by $146,465.83.

The remaining issue upon which error is alleged relates to the failure of the Commissioner to include any amount in petitioner’s invested capital for the year 1918 for intangibles, it being claimed by petitioner that it purchased good will in 1912, which had a cash value at that time of at least $770,000. None of the books of account of the predecessor company are available, they having been destroyed. The report of the revenue agent, which was approved by the Commissioner and upon which the deficiency in question is based, frankly admits, as set forth in the findings of fact, that the petitioner is the possessor of a certain valuable good will. The question is to determine its cash value. The plant purchased in 1912 had been oj>erating for thirty-nine years. An established business and a commanding place in the steel industry were present. The predecessor company had spent a large amount of money in perfecting a steel that was suitable for locomotive fireboxes and boilers. The quality of their work had been excellent, together with the fact that they were pioneers in this field. Without additional cost, they were able to get from $2 to $20 per ton more for steel than their competitors. Concerns, in ordering fireboxes built, specified “ Otis Steel.” The business was so well established and the demand for its product so insistent that the stability of the business and its earnings were assured when petitioner purchased the plant.

How may the value of good will be established? We are much in the same situation as in determining depreciation. There is no specific rule for the determination of the value of good will. No rigid and unvarying rule can be laid down to govern all cases. Each case must be considered and determined in the light of the facts surrounding and connected with it. In valuing good will, more or less arbitrary rules have been adopted as befit the facts in each case. See Appeal of Grant Trust & Savings Co., 3 B. T. A. 1026. The decisions of the courts of the State of New York, in inheritance tax cases, probably afford the best criterion as a basis for such a valuation. The method used in inheritance tax cases is to average the net profits for a short period of years and multiply the average so obtained by the number representing the number of years’ annual profits taken, or, as expressed in some cases, the number of years’ purchase. Three years’ purchase, based on an average of profits for five years, was taken by the court in valuing good will in In re Ball's Estate, 161 App. Div. 79; 146 N. Y. S. 499; and In re Ulrici’s Estate, 111 Misc. 55; 182 N. Y. S. 516. In the valuation of stock in the well-known firm of Tiffany & Co., the average annual net profit was multiplied by ten. In re Moore's Estate, 97 Misc. 238; 161 N. Y. S. 142. See also Von Au v. Magenheimer, 115 App. Div. 84; 100 N. Y. S. 659; In re Bolton's Estate, 121 Misc. 51; 200 N. Y. S. 325. In In re Hearn's Estate, 182 N. Y. S. 363, the court had before it the question of determining the good will value of a dry goods business established since 1879, and stated:

In view of the length of time during which the business has been established, its reputation, its extensive advertising, and its prominence in the dry goods trade, I think 5 years’ average of the annual net profits is a reasonable value of the good will of the business. Von Au v. Magenheimer, 126 App. Div. 257; 110 N. X. Supp. 629. But in order to ascertain the average net annual jiroilts, which is to be multiplied by 5, a period of at least 6 years immediately prior to the date of decedent’s death should be taken into consideration. The average annual profits thus ascertained, multiplied by 5, would represent the value of good will of the business of James A. Hearn & Son at the date of the decedent’s death, if his executors could sell it on that day.

Also compare method used for ascertaining the value of corporate franchises and other intangibles. People v. State Board of Tax Commissioners, 145 N. Y. S. 226; Nevada-California Power Co. v. Hamilton, 240 Fed. 485.

Compare the method for valuing good will in Appeal of Dwight & Lloyd Sintering Co., 1 B. T. A. 179; Appeal of Hampton Co., 2 B. T. A. 302, and the published ruling of the Commissioner, A. R. M. 34 (C. B. 2, p. 31).

A consideration of the nature of the business, its known stability with reference to earning power, the length of time during which it had been conducted at time of purchase by petitioner, the extent to which the manufactured product had become known, and the demand for same, convinces us that the good will purchased had a cash value and the same may, in this case, be measured by attributing an 8 per cent return on not tangibles and the excess of the net earnings, after deducting $80,000 for depreciation for the years 1907 to 1911, inclusive, to be capitalized at 15 per cent. The average net profits, after providing for depreciation for the years 1907 to 1911, inclusive, .was $481,845.09. Eight per cent on average net tangible assets of $4,590,988.12,. or $367,279.05, produces an excess of $114,566.04, which, when capitalized at 15 per cent, results, in a good will value of. $763,773.60. The value thus obtained,. subject to the statutory limitation on intangibles, should be allowed in computing the invested capital of petitioner.

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


source: Caselaw Access Project

author: SteRNhagen :

license: Public Domain

text:
    Marigold Garden Co. and Randolph Hotel Co., Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 1580.
    Promulgated March 2, 1927.
    1. Where the usefulness of business property is lost to a taxpayer through the operation of the prohibition law, and the property is neither abandoned nor sold but is placed in storage, the cost thereof is not deductible as a loss.
    2. Earned surplus may not .be reduced by the difference between the depreciation reserve shown on taxpayer’s books and the amount of accumulated depreciation for prior years computed at a fixed percentage on a straight-line basis, where it is not shown that the books do not reflect depreciation actually sustained or that the property had a value or was in a condition other than that shown by the books.
    3. Depreciation on personal property used in operation of a hotel computed on basis of 10 per cent of book value at beginning of year after excluding amount of write-up made to conform books to detailed physical appraisal made in prior year, and on basis of 5 per cent of cost of additions during the year.

      Edward B. Johnston, Esq., for the petitioners.

      W. H. Lawder, Esq., for the respondent.
    Deficiency for 1919 of $8,384.56. After the concession by respondent of errors in the determination, there are left in issue: (1) The disallowance of a deduction of $1,710.07 loss in respect of bar glass made valueless by prohibition, (2) the disallowance in part of deduction for exhaustion, and (3) the charging of additional accumulated exhaustion of property for ■ prior years against earned surplus and thus reducing invested capital.
    FINDINGS OF FACT.
    Petitioners are Illinois corporations, organized in 1896, with their principal offices at Chicago. The Marigold Garden Co. conducted a beer garden and amusement park, and the Randolph Hotel Co. conducted a hotel and restaurant. Roth maintained bars and sold intoxicating liquors until the War Time Prohibition Act became effective June 30,1919.
    Before prohibition one of the principal sources of income of the Marigold Garden Co. was the sale of liquor. It carried a considerable quantity of glassware for the conduct of this’ part of its business. Some of this, consisting of bar steins, wine glasses and fancy goblets, mostly imported, was useful only in serving certain alcoholic drinks. The book value of all of the glassware, at January 1, 1919, was $4,448.84. During the year 1919 the sale of alcoholic drinks was discontinued and the glassware which was not suitable for other purposes became useless to petitioner. Some of it was stored and not thereafter used.- The cost of this was $1,710.07. Some has been given away. None has ever been sold. The amount of $1,710.07 was deducted as- a loss in 1919, and the deduction has been disallowed by the Commissioner.
    - From the date of its organization until 1915, the books of account of the Randolph Hotel Co. were kept by one of its executive officers. Annually during this period there was charged off as depreciation of personal property such amounts as in the opinion of the officers of the company were fair and reasonable. The amounts so charged off were not determined upon any definite basis or by any particular method of calculation, but represented- the be.st judgment of the officers of the company as to the wear, tear, and exhaustion actually sustained. During the same period the cost of renewing the equipment of the hotel, such as curtains, carpets, chairs and other furniture, was charged to repairs and treated as expense, except where the replacements were extensive. Subsequent to 1915 the books of account were kept under the supervision and direction of certified public accountants, and the company charged off such, depreciation of its personal property as the accountants advised was proper.
    In 1916 a detailed physical appraisal of the personal property of the Randolph Hotel Co. was made by an appraisal company. The values set out in the appraisal report were taken up oh the books of account, and the several personal property accounts were readjusted to reflect the values established by the appraisal. The taking up on the books of the appraisal values resulted in no change in the real property accounts and in an increase of $13,420.99 in the aggregate of the personal property accounts. At the same time the depreciation reserve was credited with the sum of $13,420.99, Prior to taking up the appraisal values the books showed .personal property $100,835.25 and building $131,687.63, and the’reserve for depreciation stood at $97,727.67. After taking up' the appraisal values, personal property appeared on the books in the amount of $114,256.24, and building remained unchanged at $131,687.63. The total reserves for depreciation stood at $111,148.66, of which $31,001.71 was carried as depreciation reserve for furniture, fixtures and equipment, and $80,146.95 as depreciation reserve for building.
    Between the date in 1916 of the adjustments referred to above and December SI, 1918, the books show additions to personal property accounts of $27,746.25 and to building accounts of $16,559.71 and additions to the depreciation reserve for furniture, fixtures and equipment of $30,998.29, and depreciation reserve for building of $51,853.05. At January 1, 1919, the personal property appeared on the books in the aggregate amount of $142,002.49, which included an erroneous charge of $9,000 representing the cost of building improvements, and the depreciation reserve for furniture, fixtures and equipment stood at $62,000. At the same date.the building.appeared on the books at a value of $148,247.34, and the. depreciation reserve for building stood at $132,000.
    The Commissioner, using a fixed percentage basis, computed the depreciation on personal property for all years from 1897 to 1918, inclusive, and, assuming that certain assets included in the personal property accounts had been exhausted by depreciation, determined that the amount at which the personal.property should be included in invested capital for the year 1919 was less than the value at which such property was carried on', the' books of account after deducting the erroneous charge of $9,000 previously .referred to. ■
    In the return which the petitioners-filed, for the year under consideration, a deduction in the amount of $18,000 was claimed as depreciation on the personal property of the Eandolph Hotel Co. The amount of this deduction is greater than 10 per cent of the value at which this property was carried on the books less the erroneous chárge to personal property accounts of $9,000. The total cost of additional personal property acquired during the year under consideration was $2,941.94. The cost of bar' equipment, carried in the personal property accounts, charged off during the year, was $3,352. Of the total deduction claimed, the Commissioner has allowed the sum of $8,162.14, and disallowed the remainder as excessive. ■
   OPINION.

SteRNhagen :

The respondent concedes thnt his determination of net income included a duplicate disallowance of one item and hence that his determined net income should be reduced by $1,710.07, and also that his determined invested capital should be increased by $4,289,63. ‘

May the petitioner deduct as a loss the $1,710.-07 cost of glassware which prohibition made useless to it in its business but which it kept in storage? It was not abandoned,- for petitioner has it'in its exclusive possession, where, should' an occasion arise, it may call it into use. It was not sold, and it does not appear whether any effort was made to sell. The evidence is only that it became useless to petitioners and was stored.

In considering the principle, the particular cause of the claimed loss matters little, if at all. Uselessness to á taxpayer’ does' not determine a deductible loss any more when attributable to a statutory prohibition than when attributable to any other extraneous cause 6ver which the owner has no control.- A change in style or market, or an exhaustion of the supply of raw materials for manufacture may destroy the utility of equipment just as effectually as the intervention of the law, and the detriment to the owner may be just as great.

It seems clear that property is not ipso facto lost to a taxpayer because it is no longer useful to him. Ownership and possession still exist, and in some cases value may not wholly disappear. Yalue and usefulness are not necessarily interdependent, even though they very commonly look to each other for support. The want of either does not make certain the absence of the other. It should be kept in mind that the considerations in ascertaining net income must always be expressed in money and that all the factors relied upon must be translated into terms of money. Use is only significant to the extent that it is susceptible of such expression. hTo one would urge that an income deduction may be claimed because a fixture or tool proves less useful than expected when the purchase was made! Until the investment is converted into terms-of money by sale or other disposition or its worthlessness otherwise demonstrated, there is neither loss nor gain and income is neither greater nor less.

So when we put aside the legislative cause of petitioners’ misfortune, and find further that the evidence shows only that the glass could no longer be used by petitioner in its business, we are still far removed from the establishment of such a loss as offsets income. It is not necessary to consider whether we should be brought closer if no sale or disposition could have been made after reasonable effort, for there is no evidence of an effort; and voluntary storage is not a final disposition. The respondent is' on this point sustained.

The respondent, using a fixed-percentage basis and applying the straight dine theory of depreciation, has recomputed the depreciation on the personal property of the Randolph Hotel Co. for all years from 1897 to 1918, inclusive, and. has determined that the total accumulated depreciation is in excess of the amount thereof shown in the depreciation reserve on the books of 'account. This has reduced earned surplus on account of alleged inadequate depreciation charged off in prior years.

From 1897 to 1915, during which period the books of the company were kept by one of its executive officers, the company had not accounted for depreciation at constant rates, nor according to any particular method of -calculation.- Such amounts were charged off as in the well considered opinion of its officers were sufficient to take care of the wear, tear and exhaustion actually sustained. They also charged to expense certain items which might property have been capitalized. After 1915, when the books were kept under the supervision and direction of certified public accountants, such depreciation was charged off as the accountants advised was proper. The appraisal of 1916 indicated a higher value than that shown on the books. There is no evidence othér than the result of a straight-line calculation to show that the depreciation on the books did not represent the actual depreciation sustained or that the property of the company had a value or was in a condition other than that shown by its books. The issue is controlled by Cleveland Home Brewing Co., 1 B. T. A. 87; Russell Milling Co., 1 B. T. A. 194, and Rub-No-More Co., 1 B. T. A. 228, and the Commissioner’s action in reducing the earned surplus on account of alleged inadequate depreciation charged off in prior years is in error.

In the return which the petitioners filed for the year under consideration, a deduction in the amount of $18,000 was ■ claimed as depreciation on the personal property of the Randolph Hotel Co. Of the total deduction claimed, the Commissioner allowed the sum of $8,162.14, and disallowed the balance. The Commissioner’s allowance appears to have been computed upon the basis of 10 per cent of the book value of the personal property after deducting therefrom the book value of certain items which, under the method used by him in computing the accumulated depreciation reserve for prior years, he treated as exhausted by depreciation. The petitioners do not dispute the rate per cent which the Commissioner has used, but contend that the basis to which it should be applied is the book value of the personal property at January 1, 1919, after deducting the erroneous charge of $9,000 to the personal property accounts, with an additional allowance for additions made during the year computed on the basis of 6 per cent of the cost thereof. The total allowance contended for by the petitioners is $13,447.34.

The book value of the personal property, after eliminating the erroneous charge of $9,000 described in the findings of fact, at January 1,1919, was $133,002.49, and the cost of additions made during the year was $2,941.94. To apply the rates of 10 per cent and 5 per cent, respectively, to these amounts would result in a sum which the petitioners contend is a proper allowance. However, it will be noted from the findings of fact that the corrected book value of $133,002.49 includes a write up of $13,420.99 in the personal property accounts resulting from taking into the books of account the appraisal values. This amount should be excluded. Deducting tin's item of $13,420.99 from the book value of $133,002.49, the result is $119,581.50; and applying to this basis the rate of 10 per cent ($11,958.15) and a rate of 5 per cent to the cost ($2,941.94) of additions made during the year ($147.10), the petitioners are entitled to a deduction of $12,105.25 for depreciation of the personal property of the Randolph Hotel Co. The deficiency should be redetermined by (1) making the adjustments conceded by respondent, (2) restoring to surplus the depreciation erroneously assumed to have occurred in prior years, and (3) recomputing the current depreciation as indicated.

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

Trammell and Trussell dissent.


author: Love :

text:
    Tom S. Craven, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 1995.
    Promulgated March 2, 1927.

      Gabe P. Allen, Esq., for the petitioner.

      Robert A. Littleton, Esq., for the respondent.
   Love :

This is a proceeding to redetermine a deficiency amounting to $80 in income tax for the year 1923. It was submitted on the pleadings. The deficiency' arose from the disallowance by the respondent of a deduction of an alleged loss claimed by the petitioner to have resulted from the facts set forth in the findings, which are the only facts before us.

EINDINGS OE FACT.

The petitioner owned $5,000 par value of the capital stock of the Federal Reserve & Guaranty Co. At a meeting of the stockholders of that corporation held March 4, 1922, it was determined to reduce the amount of the outstanding capital stock by one-half. On March 4, 1923, the petitioner, surrendered to the corporation his $5,000 of stock and received in .exchange therefor stock of the par value of $2,500.

The deficiency is redetermined to be $80. Order will be entered accordingly. See Appeals of Charles A. Gordon, 1 B. T. A. l%®3f Coney ds Parker Co., % B. T. A. JfiO.


author: KoRNER, Chairman:

text:
    Fanny Newman and May N. Rosenblatt, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 21295.
    Promulgated March 2, 1927.
    Return was made of estate tax and the tax paid; deficiency taxes were thereafter assessed and paid; a portion of the latter taxes was subsequently' refunded by the Commissioner; the refunding of the tax reduced the sum of the taxes returned and the taxes paid to an amount less than that asserted by the Commisr sioner to be the true tax liability; the result was the determination of a deficiency and a notice of such determination constitutes a statutory notice from which an appeal lies to the Board.

      Lowndes C. Conncdly, Esq., for the petitioners.

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

      Hearing on respondent’s motion to dismiss for lack of jurisdiction in the Board.
    FINDINGS OF FACT.
    The petitioners are residuary legatees of the estate of Sigmund Joseph Newman, who died July 13, 1917. The estate tax on the transfer of said decedent’s net estate was due July 13, 1918.
    An estate-tax return was filed for the estate of the decedent, and in Such return the entire value of certain community property was included in the gross estate. This return was filed on or about July 13, 1918, and showed a tax of $19,975.55. Taxes in the amount of $19,975.55 wore paid on said return on December 19, 1918.
    Thereafter, the Commissioner determined an additional estate tax to be due as a deficiency in the amount of $1,720.64. This amount was assessed and, on May 8, 1919, was paid. Thereafter, on March 5, 1920, there was paid certain interest in the amount of $41.50. Again, and in the year 1920, the Commissioner determined a further additional tax to be due as a deficiency in the amount of $7,602.48. This amount was assessed and, on March 27, 1920, was paid. The amount of estate taxes so paid was $29,298.67 which, together with $41.50 interest, made a total sum paid of $29,340.67.
    In the month of March, 1924, a claim for refund of certain of the taxes so paid was filed with the Commissioner on the ground that the value of the wife’s interest in certain community property had been erroneously included in decedent’s gross estate and taxed by the Commissioner. This claim for refund was received and considered by the Commissioner, and in compliance with said claim, the Commissioner determined that the value of the separate estate of the decedent was, for purposes of estate tax, $93,644.44, and that the one-half interest of the decedent in the community property was, for purposes of estate tax, $278,421.69. All of the property was situate in the State of California.
    As a result of his determination set out above, the Commissioner allowed the claim for refund and, on October 24, 1925, authorized a refund of estate taxes in the amount of $7,643.98. The amount of the refund so allowed and authorized was paid on or about the date of October 24, 1925.
    Thereafter, on September 16, 1926, there was forwarded to the petitioners the following notice:

      Treasury Department
    Office of Commissioner of Internal Revenue

      Washington Sept 16 1926

    MT-ET-616-Cl.-CLMcG
    District of First California
    Estate of Sigmund Josepli Newman
    Date of deáth — July 13, 1917 ■
    Unpaid tax $5,881.84'
    Eariny Newinan, 6t ah, Residuhry Legatees,
    Estate of Sigmund Joseph Newman,
    C/o Lowndes C. Connally, Esq., . . ',
    724 Colorado Building,
    Washington, D. C.
    Mesdames: ■
    Reference is made to the above-named estate and to Bureau letter of October 24, 1925, addressed to Lowndes C. Connally, Attorney-ih-Fact, authorizing a refund of tax amounting to $7,643.98. The entire value of the community property was included in the gross estate of this decedent upon which tax was paid, and tax was refunded in the amount above stated on account of the elimination of the value of the wife’s community interest in the estate.
    In view of the decision of the United States Supreme Court in the case of the United States v. Robbins, 269 U. S. 315, rendered January 4, 1926, and an opinion of the Attorney General of the United States issued June 24, 1926 (Treasury Decision 3S91), the Bureau has redetermined the-tax.in this estate and included, the entire value of the community, property, in the gross estate of this decedent. . ¡ .
    As the returned and determined values placed upon the property and the claimed and allowed deductions were fully set forth in Bureau' letter of February 28, 1920, a repetition thereof is herein considered unnecessary.
    The following tabulation shows the unpaid tax:
    Gross Estate_r>---,--— $650,487. 81
    Deductions____— 102,780.75
    Net estate_______$547, 707. 06
    Tax determined herein_:i_'_1_ 27, 57$. 03
    Tax paid on return_h__$19,975.55 [Dec. 19,1918]

    Interest paid — -_ ' 41.40 [Mar. 5,1920]
    Additional tax paid_'__ 1,720.64 [May 8,1919]
    Additional tax paid_;___ 3, 801. 24 [Mar. 27,1920]
    Additional tax'paid_1_ 3, 801. 24 [Mar. 27,1920] .
    Total paid_ 29,340.17
    Tax refunded___I_ 7,643.98 [Oct. 25,1924]
    Tax discharged-- 21, 696:19
    Unpaid tax- $5, 881.84
    Upon payment of $5,881.84 to the Collector of Internal Revenue at San Francisco, California, the records of the Bureau relating to this estate will be closed.
    Respectfully, ■ R. M. Estes,
    MHP Deputy Commissioner.

      The petitioners filed this proceeding with the Board on November 15, 1926.

       Letters and figures appearing in brackets are supplied.

   OPINION.

KoRNER, Chairman:

The petitioners appeal from the notice of September 16,1926, alleging that it constitutes a notice of a deficiency under the provisions of section 318 (a) of the Revenue Act of 1926. They further contend that since more than five years have elapsed since the due date of the estate tax on the estate, of the decedent, the respondent is without power or authority to assess the deficiency asserted in the notice by reason of the provisions of sections 1106 and 1109 of the Revenue Act of 1926.

The respondent contends that the notice of September 16, 1926, was not a notice of deficiency within the meaning of section 318 (a) of the Revenue Act of 1926, and that the Board is without jurisdiction in the -premises because there has not been, since the enactment of the Revenue Act of 1926, a determination of a deficiency by the Commissioner. 'He offered no defense to the petitioners’ plea in respect of the statute of limitations.

Two major elements must first be considered: (1) Do the facts give rise to a deficiency as defined by the statute, and (2) does the notice of September 16, 1926, constitute a statutory notice of the determination of the Commissioner of that deficiency ?

Section 307 of the Revenue Act of 1926 which is made to apply to the assessment of estate taxes by section 318 (a) of the Revenue Act of 1926, defines a deficiency in estate tax as follows:

Sec. 307. As used in this title in respect of a tax imposed by this title the term “ deficiency ” means—
(1)The amount by which the tax imposed by this title exceeds the amount shown as the tax by the executor upon his return; but the amount so shown on the return shall first be increased by the amounts previously assessed (or collected without assessment) as a deficiency, and decreased by the amounts previously abated, refunded, or otherwise repaid in respect of such tax * * *.

The facts set out herein square precisely with the foregoing definition. Let us apply the facts graphically.

(1) Amount imposed-$27,578.03
(2) Shown on return-1_$19,975.55
(3) Increased by amounts assessed or collected_ 9,364.62
29,340.17
(4)Decreased by amount previously refunded_ 7,643.98
- 21,696.19
Amount by which (1) exceeds (2) plus (3) minus (4)_ 5,881.84

We can find no reasonable predicate for holding that under these circumstances the item of $5,881.84 does not constitute a deficiency within the definition of the statute.

We tlien come to the second query. If this be a deficiency, wds the letter o.f September 16, 1926, a statutory notice of the Cominissioner’s determination of it? We are of opinion that it was.. The language employed in the notice is most specific in terms. It notifies the petitioners that the Bureau '(which must mean the Commisr sioner) has redetermined the tax in view'of a decision of the Supreme Court of the United States and of the opinion of the Attorney General, and that the entire value of the community property has been included by that redetermination in'the gross estate.of the decedent. A letter far less specific and pointed in, its terms than the one now under,consideration has been held by,the Court of Appeals of the District of Columbia to be a notice of the determination of a deficiency. Dascomb ex rel. Hilgard Lumber Co. v. Board of Tax Appeals, 16 Fed. (2d) 337, As far as the express language and intendment of the notice of September 16, 1926, is concerned, there can be little doubt that it conveyed to the petitioners a notice of the redetermination of a deficiency.

But the respondent contends that the tax has heretofore been assessed and that the letter of September 16, 1926, can not be considered otherwise than a notice to pay.an unliquidated balance on such assessment. *If it be true that the $5,381.84 is, in fact, under assessment and. unpaid, the contention of the respondent would present serious difficulties. There is no evidence whatsoever in this record on that point, and this would preclude us from making any finding or passing any comment upon it. Again, we doubt seriously if the method of entering debits and credits in the accounts of the collectors can be binding on the taxpayer as to the correctness of the method of entry. If an assessment were made and discharged by payment on the part of the taxpayer, and the payment thus made was subsequently refunded to the taxpayer, it is at least open to grave question whether the assessment is automatically revived in the process. - But we do not deem it necessary to decide that point, because we are on sure ground when we conclude that book entries can not change or modify the statute. The statute says that the taxes returned, and the taxes paid as deficiencies, shall be added together and from the sum thereof there shall be subtracted the amounts previously refunded in respect of such tax, and that, to the extent that the remainder is less than the true tax liability, there is a deficiency. Since this is so, then the notice of September 16, 1926, was not a notice to pay an outstanding assessment, but a notification of the determination of a deficiency. We are convinced that the notice in question was precisely that.

The remaining contention of the respondent is that the notice of September 16, 1926, was not signed by the Commissioner and that, therefore, it does not appear that there has been any determination by the Commissioner within the meaning of the statute. We have observed above that the notice states that “ the Bureau has redetermined the tax in this estate.” Since only the Commissioner can determine taxes under the statute, the notice can only mean that the Commissioner has so determined the tax. If this be not so, then the taxpayers would be under no obligation to pay the amount noticed in the letter of September 16,1926, because without a determination, the matter would stand as closed by the authorization of refund and the payment of that refund on October 25, 1924. We must conclude, therefore, that there was a determination by the Commissioner of the taxes here in controversy, and as we have shown, that determination was the determination of a deficiency.

The Board will take judicial notice of the fact that one of the major divisions of the Bureau of Internal Revenue is the -Estate Tax Unit, and that a Deputy Commissioner is in charge of that division. We must assume that the Deputy Commissioner was acting regularly and under proper authorization' of the Commissioner in this instance, or else be led to the conclusion that the Commissioner could, by the expedient of having notices sent out over the signature of unauthorized persons, defeat the right of appeal given by the statute to the taxpayer. And since deficiencies in tax (except in jeopardy) can be collected only after notice of their determination, we must likewise conclude that the Commissioner has acted regularly and orderly through the Deputy Commissioner — to do otherwise would defeat the collection of the tax, an action we do not attribute to the respondent.

Motion domed. Sixty days from date allowed for answer.


author: Kobnee, G hair man:

text:
    Maud N. Wilson and Lillie N. McCusker, Executrices, Estate of Henry Temple Newell, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 21333.
    Promulgated March 2, 1927.
    Return was made of estate tax and the tax paid; deficiency taxes were, thereafter assessed and paid; a portion of the latter taxes was subsequently refunded by the Commissioner; the refunding of the tax reduced the sum of the taxes returned and the taxes paid to an amount less than that asserted by the Commissioner to be the true tax liability; the result was the determination of a deficiency and a notice of such determination constitutes a statutory notice from which an appeal lies to the Board. Fanny Netvmun v. Commissioner, 6 B. T. A. 373.

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

      Hearing on respondent’s motion to dismiss for lack of jurisdiction in tlie Board.
    FINDINGS OF FACT.
    The petitioners are the executrices of the estate of Henry Temple Newell, who died testate on June 19, 1920, a resident of the State of California. The estate tax on the transfer of said decedent’s net estate was due June 19, 1921.
    Within one year after the death of decendent, to wit, oh June 18, 1921, petitioners filed an estate-tax return for the estate of the decedent, with the collector of the sixth district of California, and paid the tax as shown by said return in the amount of $14,506.51.
    Thereafter, the Commissioner determined that there was a deficiency in estate tax due from said estate and assessed such deficiency. This assessment was abated by the Commissioner in the amount of $513.25, and the remaining portion of the assessment in the amount of $2,941.75 was paid by the petitioners. This appears to have been in the year 1922.
    Thereafter, the petitioners filed a claim for refund of certain of the taxes paid, on the ground that the value of the wife’s interest in certain community property had been erroneously included in the .gross estate of the decedent and so taxed by the Commissioner. This claim for refund was received and considered by the Commissioner, and in compliance with said claim the Commissioner, after review and audit of the return, determined that the value of the interest of the wife in the community property should not have been so included in the gross estate of the decedent. Accordingly, adjustments were made by the Commissioner and the claim for refund filed by the'petitioners was, on May 20, 1926, allowed and payment of the refund was authorized. In accordance with the said determination and" authority of the Commissioner, the refund- was paid to the petitioners in the year 1926 in the amount of $12,465.22.
    Thereafter, on September 24, 1926, there was forwarded to the petitioners the following notice:
    Treasury Department
    Office of Commissioner: of Internal Revenue
    MT-ET — C1.-824-ATC

      Washington Sep 2k 1926

    District of 6th California
    Estate of Henry Temple Newell
    Date of death — June 19, 1920.
    Maud N. Wilson, Executrix,
    Estate of Henry Temple Nowell,
    1001 Stock Exchange Building,
    Los Angeles, California.
    Madam:
    Reference is made to Bureau letter of November 2, 1922, disclosing the result of a review and audit of the return on Norm 706 filed for the above-named estate. Reference is also made to Bureau letter of March 30, 1923, wherein certain specific adjustments were made and to Bureau letter of May 20, 1926, wherein the tax liability was adjusted on the basis of the allowance of the interest of the widow in decedent’s community property and a refund authorized therein amounting to $12,465.22.
    In view of the decision of the United States Supreme Court in the ease of United States vs. Reuel D. Robbins, 269 U. S. 315, decided January 4, 1926, and an opinion of the Attorney General of the United States, issued under date of June 24, 1926 (Treasury Decision 3891) it now appears that such allowance was erroneous. Accordingly, the estate tax return has been reexamined, and the tax due from this estate is therefore redetermined by including the entire value of the community property as a part of the gross estate of this decedent.
    Accordingly, the gross estate as redetermined is $571,733.32, the deductions $55,945.67, and the net estate $515,787.65, the tax upon the transfer of which is $17,447.26. The following is a statement of the tax liability as redetermined :
    Correct amount of tax_$17,447.26
    Tax assessed on return_'_$14, 506.51
    Additional tax assessed_ 3,454. 00
    Tax abated_ 513.25
    Total tax paid_$17,447. 26
    Tax refunded_ 12, 465.22
    Tax discharged_' 4, 982. 04
    Tax liability_■-$12,465.22
    The tax liability of $12,465.22 bears interest at the rate of six per centum per annum from June 19, 1921, until payment is received by the collector. Upon payment of the above amount to the Collectoi', together with interest, the records of the Bureau relating to- this case will be closed.
    Respectfully
    (Signed) R. M. Estes
    BGC Deputy Commissioner.

    The petitioners filed their petition with the Board on November 17, 1926.
   OPINION.

Kobnee, G hair man:

The facts disclosed by this record are on all fours with those set out in the findings of fact in the case of Fanny Newman v. Commissioner, 6 B. T. A. 373, decided this day. The decision in that case is determinative of the issues here.

Motion denied}. Sixty days from date allowed for answer.


author: Milliken:

text:
    Raleigh Smokeless Fuel Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7767.
    Promulgated March 2, 1927.
    1. A liability incurred through a breach of contract is a deductible loss for the year in which the breach occurred, where liability was admitted, an offer in compromise was made, and an amount representing the estimated liability was accrued on the books, though the amount of the loss was undetermined until compromise settlement was effected during the succeeding year.
    2. Debts owed by bankrupts were ascertained to be worthless and charged off within the year to the extept that deductions therefor were claimed.

      Moultrie Hitt, Esq., and Clarence A. Miller, Esq., for the petitioner.

      A. B. Marrs, Esq., for the respondent.
    This proceeding results from the determination by the respondent of a deficiency in income and profits taxes for the fiscal year ended June 30, 1921, in the amount of $18,022.38, of which approximately $14,700 is in controversy. Four errors are assigned by the petitioner : (1) The inclusion in income of the sum of $3,900 as “ estimated loss on 1,300 tons of coal due the Birch Fork Coal Company ”; (2) the disallowance as a deduction from and the inclusion in net income of $16,602.56, as a liability for damages incurred' in the regular course of business on account of the breach of a contract occurring during the months of January, February, and March, 1921; (3) the disallowance as a deduction from and the inclusion in net income of the sum of $5,786.03, representing a liability to the Norfolk & Western Railway Co. for demurrage incurred during the fiscal year ended June 30, 1921; (4) the disallowance as a deduction from and inclusion in income of bad debts, determined to be worthless in part and charged off on the books, in the amount of $22,317.92. At the hearing petitioner withdrew his third assignment of error.
    FINDINGS OF FACT.
    Petitioner is a corporation, incorporated August 18, 1919, under the laws of the State of West Virginia, and is engaged in the general coal brokerage business. The books of account of the petitioner, during the fiscal year ended June 30, 1921, were kept on the accrual basis, and its income and profits-tax return was filed upon that basis. In carrying on its business of general coal brokers, it was necessary for petitioner to make and enter into contracts with coal-mining companies for the delivery to it of quantities of coal at agreed prices and for fixed periods of time. It then secured purchasers for the coal it was under contract to purchase. An extensive business was carried on during the fiscal year 1921, the gross business being approximately $3,500,000.
    On or about April 1, 1920, the petitioner entered into a contract with the Birch Fork Coal Co., by the terms of which the latter agreed to sell and the petitioner agreed to buy the entire output or amount of coal mined by the' seller from its mines during the period April 1, 1920, to March 31, 1921, at the fixed price of $4.40 per ton of 2,000 pounds, f. o. b. cars at seller’s mine.
    Upon execution of this contract, both parties entered upon the performance thereof.. During the latter part of 1920 and the first part of 1921, the coal market was in a very depressed state, and, due to the unexpected slump in the selling price of coal, the petitioner found itself unable to market the coal it was under contract to purchase, and, had it sold the coal, loss would have resulted. Finding itself in the position of being under contract to purchase coal it could not then market, the, petitioner, in January, 1921, elected to and did breach the contract with the Birch Fork Coal Co. and defaulted in its obligation to take the coal called for by the contract. Immediately upon breach of the contract in January, 1921, the petitioner endeavored to effect a settlement and compromise its liability for damages. The petitioner admitted the liability pursuant to the breach of the contract, but was unable to agree with the Birch Fork Coal Co. as to the extent of the liability. The general counsel for the- petitioner, and its officers and directors, endeavored to effect a settlement, and as a result a revision of the contract was made in January, 1921, by which petitioner was required to receive a lesser amount of coal than called for in the original contract. The revision of the contract was executed by an official of the Birch Fork Coal Co., whose authority to sign the contract was denied by his principal, rendering it ineffective and causing the parties to revert to the terms of the original contract of April 1, 1920. On March 31, 1921, the general counsel for the petitioner, upon proper authority, offered to pay the Birch Fork Coal Co. $10,000 in settlement of its liability by reason of the breach of the contract. When the petitioner closed its books for the fiscal year ended June 30, 1921, it estimated that it would be called upon to pay for 1,300 tons of coal under the revised contract of January, 1921, estimated the amount of damages as $3,900, set that sum up on its books as an accrued liability for the fiscal year, and claimed the same as a deduction from gross income. In November, 1921, the Birch Fork Coal Co. filed suit against the petitioner, claiming $77,000 on account of breach of contract. Petitioner interposed no defense and filed no answer. On December 8, 1921, petitioner compromised and settled the suit by paying the Birch Fork Coal Co. $15,000 and crediting the seller’s account in the sum oí $1,602.56.
    On March 1, 1921, Coale & Company, a customer of the petitioner, was indebted to the petitioner in the sum of $26,024.25. Repeated efforts were made to collect the account, but without success. Drafts were drawn on the debtor which were returned unpaid. Petitioner secured reports from R. G. Dun & Co. and the Bradstreet Company, which showed that the debtor was heavily involved. Petitioner then turned the account over to its attorneys for collection. On March IB, 1921, petitioner’s attorneys received notice of a meeting of Creditors of Coale & Company, to be held in New York City, on March 14, 1921. The meeting was attended by .the attorney. Immediately thereafter, the debtor was placed in the hands of receivers appointed by a Federal District Court by virtue of involuntary bankruptcy proceedings. The officers of petitioner and its attorney made an exhaustive investigation of the assets and liabilities of the debtor in April, 1921, and found that the liabilities exceeded $1,000,000, while the assets were of doubtful value, consisting principally of an unliquidated claim against a company that was then in receivership. Officials of petitioner conferred with other creditors of the debtor and, as a result of such investigation, it was concluded, prior to J une 30, 1921, that not over 25 per cent of the amount of the debt of Coale & Company could be collected. On June 3,1921, the petitioner requested an opinion from its attorney as to the value of the account, and its attorney advised it that it was his opinion that not over 25 per cent of the debt could be collected. Before the closing of the books for the fiscal year 1921, petitioner charged off on its books 75 per cent of the account of Coale & Company, or $19,525.69.
    The Central West Virginia Fuel Co., on January 1, 1921, was indebted to petitioner in the sum of $2,792.23. In February, 1921, the president of;the debtor corporation died, and it was reported that there were defalcations of $35,000. The debtor was a small corporation. Petitioner placed the account in the hands of its attorney for collection, and in March, 1921, brought suit for collection of the account. Judgment was obtained, upon which execu-tioh 'was had, and á writ of attachment was sent to the sheriff of the proper' county. The execution was returned by the sheriff marked “ No property found.” A second execution was issued, but prior to service of same the debtor was adjudged ‘a bankrupt. Petitioner made and caused its attorney to make an investigation as to the assets of the debtor. The only assets found consisted of a possible claim, against the estate of the deceased president of the debtor, which claim was for money said to have been taken out of. the treasury of the company, and a few fixtures of no value. In May or the early part of June, 1921, attorneys for petitioner, having completed their investigation of the assets of the debtor, advised that there was- no possibility of collecting the account. ThG officers of petitioner, having also made an investigation with the same results, determined the account to be worthless prior to June 30, 1921, and charged .the account off the books in the amount of the debt, i. e., $2,792.23.
   OPINION.

Milliken:

Petitioner’s claim for a deduction of the sum of $16,602.56 paid as a result of the liability resulting from the breach of the contract with the Birch Fork Coal Co., is clearly an allowable deduction for the fiscal year ended June 30, 1921. The case at bar comes squarely within our decision in the Appeal of Producers Fuel Co., 1 B. T. A. 202.

We have made our findings of fact in great detail. The evidence in this appeal clearly shows that petitioner, after a most careful and painstaking' consideration of all the facts, the attendant and surrounding circumstances, ascertained the debt owed by Coale & Company to be worthless to the extent of 75 per cent thereof, and the debt owed by the Central West Yirginia Fuel Co. to be entirely worthless. The ascertainment was made within the taxable year, and to the extent that these debts were ascertained to be worthless, they were charged, off on the books of the petitioner. The respondent erred in his failure to allow the deductions.

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


author: Love:

text:
    J. H. Armstrong and Bird Armstrong, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3297.
    Promulgated March 2, 1927.

      J. M. McMillin, Esq., for the petitioners.

      Robert A. Littleton, Esq., for the respondent.
   Love:

This is a proceeding to redetermine deficiencies in income tax for 1923 in the following amounts, respectively: J. PI. .Armstrong, $171.86; Bird Armstrong, $133.69. The only question is whether the petitioners are entitled to deduct certain alleged business expenses.

FINDINGS OF FACT.

The petitioners are husband and wife and reside in Dallas, Tex. For 1923 they made separate income-tax returns of community income, and each claimed as a deduction one-half of the amount alleged to have been paid by the husband as ordinary and necessary expenses of carrying on his business.

J. H. Armstrong is a traveling salesman representing four firms, whose offices are in New York City. He was employed entirely on a commission basis, and bore his own traveling and other expenses incurred in carrying on his occupation. He received different rates of commission from his different employers and the rates on sales to jobbers were different from those to retailers. The rates ranged from 1 to 5 per cent and averaged about 2% per cent. In 1923 he sold more than $560,000 worth of goods and his commissions aggregated $13,630.51. The petitioner deducted as ordinary and necessary expenses of carrying on his business $5,850! The Commissioner disallowed this deduction in full and determined the deficiency accordingly.

Armstrong’s territory embraced the States of Texas, Oklahoma, Arkansas, Mississippi and Louisiana; he also visited Memphis and Jackson, Tennessee. In 1923 he was away from.Dallas on his business about three-fourths of the time. He traveled to the different towns in which he sold goods in this territory from two to six times during the year except those near Dallas, to which he went more frequently. Twice during the year it was necessary to visit the headquarters in New York City of the concerns he represented, and he also met some of his customers while in that city. He was in .New York City on these trips a total of ninety days. He spent money for railroad fares, hotel rooms, including sample rooms, meals, baggage transfer and other traveling expenses, and for entertainment of customers. He expended for these purposes in the taxable year in carrying on his business the sum of $5,000.

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


author: Littleton :

text:
    O. L. Moon, Petitioner, v. Commissioner of Internal Revenue, Respondent. Annie Moon, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 8674, 8675.
    Promulgated March 2, 1927.

      John E. Hughes, Esq., for the petitioners.

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

The Commissioner determined deficiencies of $1,395.89 against each of the petitioners for the calendar year 1920. Petitioners claimed that notes, amounting to $23,586.27, received by them as part consideration upon the sale of certain real estate for $45,000 had no fair market value. The Commissioner treated the face value of the notes as income.

The proceedings were consolidated for hearing and decision.

FINDINGS OP PACT.

Petitioners are residents of Mineral Wells, Tex. In 1920 they were the owners of certain property designated as the South one-third of Block 4 in the town of Breckenridge, Stephens County, Texas. In March, 1920, property valuations in Breckenridge were inflated and in that month petitioners sold this property to Fred Bottorff and Nelson Puitt for a total consideration of $45,000; of this amount $21,413.73 was paid in cash and five first-trust notes in equal amounts, payable six, twelve, eighteen, twenty-four and thirt} months after date, respectively, with interest at 8 per cent, were given for the balance.

At the time of the sale of this property Bottorff and Puitt had reached the limit of their credit.

Petitioners acquired this property at a cost of $2,050 and made improvements costing $5,118, resulting in a total cost to them of $7,168. The Commissioner determined the total profit upon the sale at $37,832. The price at which petitioners sold the property was highly speculative. The fair market value of the trust notes received by them was 50 per cent of the face amount thereof.

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


author: Lansdon:

text:
    Inglewood Park Cemetery Association, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3249.
    Promulgated March 2, 1927.
    1. By formal corporate action petitioner set apart 25 per cent of receipts from the sale of cemetery lots as a fund for tlie perpetual care of burial lots. Held, that the fund so set apart is not income and should not be included in invested capital.
    2. Value of unimproved cemetery lots owned by the petitioner at March 1, 1913, determined.

      Ralph W. Smith, Esq., for the petitioner.

      D. D. Shepard, Esq., for the respondent.
    The respondent has asserted a deficiency in income and profits taxes for the year 1920 in the amount of $6,036.64. Four issues are involved: (1) Whether that part of the amount received from the sale of burial lots during the taxable year, and set apart as a fund for the perpetual care of such lots, should be included in the petitioner’s gross income; (2) whether interest from investments of the perpetual care fund was income to the petitioner; (3) whether the fund set apart for perpetual care of burial lots shall be included in the computation of the petitioner’s statutory invested capital; and (4) the fair market value at March 1, 1913, of burial lots sold during 1920.
    FINDINGS OF FACT.
    Petitioner is a corporation organized in 1905, under the laws of the State of California, for the establishment and conduct of a cemetery in Los Angeles County. It purchased the land for the purposes of its organization in 1906, and immediately set about making the necessary surveys, building roads, sinking wells, and erecting buildings for the conduct of a cemetery.
    The minutes of the board of directors of the association, dated August 8, 1911, contain the following:
    On motion of O. B. Hopper, seconded by G. II. Latteau, and unanimously carried, it was resolved that beginning with the month of August, 1911, the amount set aside and invested on account of perpetual care fund be increased from IS per cent to 25 per cent on the gross monthly sales.
    Salesmen employed by the petitioner were instructed to assure the purchasers of burial lots that 25 per cent of the purchase price would go into a fund for the perpetual care of the lots. Each deed executed to convey title to purchasers of lots contains the following:
    Said lot is granted with right to the grantee for perpetual care thereof by and at the expense of said Cemetery Association.
    All receipts from sales of burial lots were accounted for in a lot account, and at the end of each month 25 per cent of such receipts was transferred and charged by appropriate journal and ledger entries to an account designated as “ Perpetual Care,” and the amounts so charged, were also deposited in a special bank account designated as “Trust Account for Perpetual Care.” From time to time, the principal amount of the fund for perpetual care of graves was invested in Liberty bonds, municipal bonds, real estate mortgages, and other interest-bearing securities. No part of the funds so segregated and invested was ever used for any of the. operating expenses of the petitioner or the payment of dividends. The income from the invested perpetual care fund for the year 1920 was commingled with the other income of the petitioner and was used for general corporate purposes, including the perpetual care of burial lots. Prior to 1920, the amounts expended for perpetual care were somewhat in excess of the income from the invested perpetual care fund.

      At December 31, 1D19, the fund set apart by the petitioner for perpetual care of burial lots was $172,257.31. During the year 1920, the receipts from burial lots amounted to $272,937.50, and approximately 25 per cent of such receipts, in the amount of $67,297, was transferred to the perpetual care fund. In its income and profits-tax return for 1920, the petitioner included the amount of $67,297 in its gross income, and paid the tax thereon, and included the amount of $172,257.31 — its perpetual care fund at the beginning of the year — in the computation of its statutory invested capital for such year.
    The value of the improved cemetery-lot land owned by this petitioner at March 1, 1913, was 41.65 cents per square foot, of the partially improved land 36.65 cents per square foot, and of the unimproved land 15 cents per square foot. The cost of converting unimproved into improved lands was 10 cents per square foot. During the year 1920 the petitioner sold 15,566 square feet of land that was unimproved at March 1, 1913.
    In its income and profits-tax return for 1920 the petitioner reported that its unimproved land had a value of $1,500 per acre, or 3.44 cents per square foot. This valuation was accepted by the respondent. Subsequently, the petitioner filed an amended return for the year in question, and thereon reported that its unimproved lands had a value of 31.65 cents per square foot. This valuation was not accepted by the respondent.
   OPINION.

Lansdon:

The four issues involved in this proceeding will be discussed and decided in the order in which they are set forth in our preliminary statement, supra. The evidence discloses that the petitioner set apart 25 per cent of the total monthly receipts from the sale of burial lots as a fund for the perpetual care of such lots; that salesmen employed by the petitioner were instructed to call the attention of all purchasers of lots to the provision for perpetual care; that each deed conveying title to burial lots sold by the petitioner contained a perpetual care guaranty; that 25 per cent of all receipts from the sale of burial lots was transferred to the perpetual care fund at the end of each month; that the perpetual care' fund was deposited in a special bank account designated as “ Trust Fund for Perpetual Care ”; that the principal amount of such fund was invested in income-producing securities and was maintained inviolate for the purpose for which it was set apart.

The Board has decided the following cases involving similar questions — Los Angeles Cemetery Association, 2 B. T. A. 495; Greenwood Cemetery Association, 2 B. T. A. 910; Springdale Cemetery Association, 3 B. T. A. 223; and Metairie Cemetery Association. 4 B. T. A. 903 — all, except that of the Springdale Association, in favor of the petitioners.

The Springdale Cemetery Association case was decided in favor of the respondent. It differed from the instant case in the following particulars. The Springdale “ corporation’s by-laws contained no provisions for appropriating any part of the receipts from the sale of lots as such perpetual care fund, and no resolution to that effect was passed by the directors.” In the instant case such a resolution was duly passed by the directors. The Springdale Cemetery certificates of purchase covering each lot sold contained the following:

The Association will clean and keep in proper order, tlio surface of, and the walks belonging to, the above lot, without further charge, during the existence of said Cemetery.

This was hardly equivalent to an agreement for perpetual care. Such agreements usually extend also to the care of shrubbery and trees, the stones which mark the graves, and such markings as may be used to indicate the boundaries of the lots. Each of the Inglewood Cemetery deeds of conveyance of lots contains the following:

Said lot is granted with right to the grantee to perpetual care thereof by and at the expense of said Cemetery Association.

But if possible, a clearer and more pronounced difference lies in the fact that the officials and other salesmen of the Inglewood Association were instructed by those in charge to assure all purchasers and prospective purchasers of lots that 25 per cent of the purchase price would go into a fund for the perpetual care of the lots, and such assurance was given. We are of the opinion that this promise did not vary the terms of the written contract between the owners of the cemetery and the purchasers of its burial lots, but made the assurance as to its meaning doubly sure to both. It was in the nature of a perpetual reminder of the meaning of the contract. However, admitting for the sake of a more complete examination of the facts, and only for that purpose, that the writings did not constitute a contract for the creation of a perpetual care fund of 25 per cent of the monies received for burial lots, then, and in such case, the parol agreement, not being in contravention of the writings, would itself become an enforceable agreement. In our opinion in the case of Metairie Cemetery Association, supra, at pages 909 and 910, we said:

The great weight of authority is to the effect that the statute of frauds does not extend to trusis of personal property and that such trusts may be created and proved by parole. Chew v. Brumagen, 13 Wall. 497; Allen v. Withrow, 110 U. S. 119; Trubey v. Pease, 240 Ill. 513; 88 N. E. 1005; Coyne v. Supreme Conclave, 106 Md. 54; 66 Atl. 704; Bork v. Martin, 132 N. Y. 280; 30 N. E. 584; Pittman v. Pittman, 107 N. C. 159; 12 S. E. 61.
There is no conflict in the evidence here with respect to the contracts. The evidence is that at the time the contracts were entered into it was agreed that the money would be held in trust for the specific purposes of the contract. This being true, we are of the opinion that a valid trust was created by parole in those contracts where there was no specific provision to that effect. The only reason that certain of the contracts contained that express provision was the fact that those lot owners insisted upon the agreement being included in writing in the contract. The same agreement, however, was actually made with all of the lot owners verbally.
The funds received by the taxpayer from the lot owners having been received in trust for the specific purpose of caring for and maintaining burial places gave rise to no taxable income to the taxpayer. See Appeal of Los Angeles Cemetery Association, supra.

A marked difference between the Springdale case and this is found in the laws of the States within which the two cemeteries are located. The Springdale Cemetery was governed by the laws of Illinois. We stated in our opinion in that case that:

The taxpayer voluntarily set up a reserve based on an estimate, but there is lacking the clear evidence necessary to establish a trust. So far as the record shows, the directors might at any time reduce the fund or perhaps wipe it out, without restraint, their liability, if any, being one for breach of covenant or contract.

In the instant case the association is governed by the laws of the State of California. As we said in our opinion in the case of the Los Angeles Cemetery Association, supra, at pages 496 and 497:

Regarding contracts between cemetery corporations and lot owners, the statute provides as follows:
“Any cemetery corporation or association under contract for the perpetual care of a certain lot or lots in the cemetery of said corporation or association, is hereby expressly forbidden to use the funds received for the perpetual care of any lot or lots under such contract or contracts, for any other purpose than to provide the perpetual care mentioned in said contract, and it shall be the duty of the board of directors or board of trustees of a cemetery corporation or association receiving funds from perpetual care contracts to invest or reinvest such funds in bonds of the United States or the State of California, or in first mortgages on real estate, or in centrally located income producing improved real estate in any city or city and county in this State. (Civil Code, see. 617.)”

We are clearly of the opinion that the purchase price of the burial lots in the Inglewood Cemetery was in each instance paid to the association under a contract, one condition of which required that a certain fixed percentage thereof should be used for the perpetual care of the lots purchased; that under the laws of California the association was expressly forbidden to use it for any other purpose, and that this constituted the amounts so received a trust fund from the very instant they passed into the hands of the association.

Having determined that 25 per cent of the amo'unts received from the sale of burial lots becomes a trust fund for the perpetual care of such lots from the date of payment by the purchaser, it follows that issues 1 and 2 must be determined in favor of the petitioner. The additions to the principal of the trust fund were not income to the petitioner, and therefore can not be included in Statutory invested capital as earned surplus. The income received from the investment of the trust fund can not properly be used for any purpose except perpetual care of burial lots sold by the petitioner. We are of the opinion that, like the principal amount of such fund, the interest thereon is not income, but is a liability for which the petitioner must account to the beneficiaries of the trust created by its acts and policies. In the instant proceeding, however, there is no evidence to enable us to identify this income, as it was used for corporate purposes, including the care of burial lots under the guaranty made to purchasers. The determination of the Commissioner as to this point, therefore, is not disturbed. Greenwood Cemetery Association, supra.

The parties agree that at March 1, 1913, the improved lands of the petitioner had a value of 41.65 cents per square foot, and that the cost of converting unimproved cemetery acreage into improved burial lots was 10 cents per square foot. Nelying on this stipulation, the petitioner contends that the value of its unimproved cemetery acreage at March 1, 1913, was 31.65 cents per square foot. The Commissioner denies such value and has determined a value about one-tenth as great, or about $1,500 per acre.

In support of its contention for a high value at March 1, 1913, the petitioner adduced evidence that at that date restrictive ordinances of the City of Los Angeles, the City of Inglewood, and the County of Los Angeles, had been enacted and were then in effect, which assured it against competition thereafter. We are also asked to take notice of the great growth in population of the Los Angeles metropolitan district between 1906 and 1913, and the consequent rapid increase in the value of land. The Commissioner rejects the basis of value employed by the petitioner, and has determined that such unimproved acreage had a value of not more than $1,500 per acre at the basic date. We believe that the fair market value or price of this land lies somewhere between these very widely separated extremes, and have fixed the value of the petitioner’s unimproved acreage of cemetery lands at March 1, 1913, at 15 cents per square foot.

Judgment will be entered on HO days’ notice, under Rule 50.

Murdock, Phillips, Smith and Trammell concur in the result only.