author: Momns:

text:
    Greensboro News Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 69759, 74021.
    Promulgated November 30, 1934.

      Charles D. Hamel, Esq., Alan E. Gray, Esq., and E. B. Zane, G. P. A., for the petitioner.

      Paul A. Sebastian, Esq., for the respondent.
   OPINION.

Momns:

The respondent having determined deficiencies in income tax of $2,172.26 and $2,633.02, for the calendar years 1930 and 1931, respectively, the petitioner brings these duly consolidated proceedings for the redetermination thereof, alleging error on the part of the respondent by reason of his failure and refusal to permit the deduction of the respective amounts of $13,049.49 and $25,761.43, as interest upon so-called preferred stock, in the computation of its net taxable income for said years.

The petitioner, a newspaper publisher, was organized and incorporated under the laws of the State of North Carolina in 1912, with an authorized capitalization of $500,000, $250,000 of preferred and $250,000 of common, both having a par value of $100 a share. The outstanding preferred on January 1, 1930, was $71,000, and common $31,680.

After somewhat protracted negotiations, occasioned by the inability of the interested parties to agree upon a proper plan of financing, an agreement was entered into, under date of June 7, 1930, between Julian Price, individually, at that time president of the Jefferson Standard Life Insurance Co., referred to in such agreement, and E. B. Jeffress, individually, president of the petitioner, for the acquisition of the Record Co., also engaged in the newspaper publishing business in the city of Greensboro, which provided as follows:

Whereas, the undersigned Julian Price is now the sole owner of the total capital stock of the J. M. Reece Publishing Company, now known as The Record Company, consisting of two hundred and five (205) shares of the par value of $100.00 per share;
And Whereas, the undersigned E. B. Jeffress, President of the Greensboro News Company, and a dominant stockholder thereof, desires, pursuant to an agreement entered into between him and the said Julian Price, to merge the two properties;
And Whereas, preliminary to the perfecting of the necessary legal documents and changes of charter necessary to accomplish this purpose, it is desired by the said Julian Price and the said E. B. Jeffress that a memorandum evidencing the terms of the agreement should be executed by them;
Now, Therefore, This Aseeement Witnesseth,
That the said Julian Price hereby agrees to assign and transfer to the Greensboro News Company the above mentioned two hundred and five (205) shares of the total capital stock standing in the name of J. M. Reece Publishing Company, and in connection therewith to pay off a total bond issue aggregating $85,000.00 now outstanding against The Record Company, and also to deposit in bank the sum of Fifteen Thousand Dollars ($15,000.00) in cash to the credit of The Record Company, all upon the completion of the terms of the merger agreement entered into between the two said parties.
The said E. B. Jeffress, on his part, agrees to accept the said two hundred and five (205) shares of the J. M. Reece Publishing Company stock, and to cause and procure the Greensboro News Company to have its charter amended and authority given and the company to issue four thousand two hundred (4,200) shares of preferred stock of the par value of One Hundred Dollars ($100.00) each, 7% Cumulative and deliver to the said Julian Price for and in consideration of the stock of the J. M. Reece Publishing Company above referred to delivered by him to the Greensboro News Company.
It is further understood and agreed that the said E. B. Jeffress will carry through the merger upon the above considerations, accepting as true the balance sheet of The Record Company, copy of which is attached to an assignment by John Stewart Bryan, of Richmond, Virginia, S. E. Thomason, of Chicago, Ill., and Bryan-Thomason Newspaper, Inc., a Delaware corporation, of Chicago, Ill., executed on the 6th day of June, 1930, and accepted as of that date by Julian Price.
All guaranties in assignment by Bryan and associates to Price shall inure to the benefit of the Greensboro News Co.
It is further stipulated and agreed that said E. B. Jeffress and associates will cause the charter of the Greensboro News Company to be amended so as to authorize the issuance of five thousand (5,000) shares of preferred stock of the par value of One Hundred Dollars (§100.00) per share, and that in view of the fact that it is proposed to sell 4,200 shares of this preferred stock to the Jefferson Standard Life Insurance Co., that the charter authorizations and by-laws of the Greensboro News Company shall be so changed and amended as to safeguard the rights, privileges and protection of the holders of this preferred stock as will be mutually satisfactory to the directors of Greensboro News Company and the Jefferson Standard Life Insurance Company.
It is understood that the two newspaper properties above referred to are to be merged and operated under one management, and that upon the signing of this agreement, the Greensboro News Company shall take charge and management of the Record properties, and that as promptly as the necessary papers and documents can be prepared, that the agreement hereinbefore recited shall be perfected and put into permanent form.

At a meeting of the board of directors of the petitioner, held on June 11, 1930, the foregoing agreement between Price and Jeffress was formally approved and a resolution was adopted providing for an amendment to the charter authorizing the issuance of 5,000 shares of cumulative preferred stock, par value $100, and 10,000 shares of common stock, without nominal or par value, the stocks to carry the following “ rights, privileges, voting powers, restrictions and qualifications ”:

(a) The payment of cumulative “ dividends ” of $7 a share, “ when and as declared * * * out of earned surplus or net profits ”, upon the preferred shares from January 1, 1931,

(b) While the preferred stock remains outstanding, the company shall not, without written assent of 75 percent of such outstanding preferred stock:

(1) Issue any stock having preference over or parity with such preferred stock, nor

(2) Mortgage the properties of the company to secure any indebtedness, with certain exceptions therein provided for but which are immaterial here.

(c) In the event of failure on the part of the company to pay four semiannual dividend installments upon the preferred shares after January 1, 1932, the entire voting privilege to vest in the holders of such shares with the right in them to replace the officers and directors in control, with a similar right in the common stockholders, exercisable upon the payment of such dividends as may then be in arrears.

(d) The preferred shares to be issued “subject to the condition and right vested in the corporation ” to retire “ all or any part ” thereof at $105 a share.

(e) In the event of liquidation or dissolution of the company the preferred stockholders to receive par for their holdings, plus whatever dividends remain unpaid, before any payment upon the common shares.

(f) On July 1 of each of the years 1932 to 1935, there shall be set aside, in a stated depository, out of the “ earned surplus or net profits ” of the company, $10,000, and $25,000 on such date thereafter, for the retirement of the preferred stock until all of such stock has been retired.

The resolution provided that the rights and privileges of the common stock should be as follows:

(a) That it should be entitled to dividends after the payment of all dividends owing upon the preferred stock and provision made for the retirement thereof, as hereinabove provided, except that annual dividends thereon in excess of $7 per share should not be paid until the preferred stock issued and outstanding should be reduced to $100,000.

(b) Subject to the other provisions contained in said resolution, respecting the voting rights of the preferred stock, the common stock “ shall have exclusive voting rights ”, and

(c) In the event of liquidation or dissolution it should be entitled to the entire assets remaining after satisfaction of all provisions for the preferred stock.

The foregoing action of the board of directors was ratified and approved by the stockholders at a meeting held on the same date, to wit, June 11, 1930.

The $71,000 par value of the old preferred stock of the petitioner was retired and replaced with the new, share for share. The certificate representing the old stock carried the following provisions:

It is mutually agreed between the holder hereof and the Greensboro News Company and its stockholders as follows: That this certificate of stock is a part of an authorized issue amounting in all to Two Hundred and Fifty Thousand Dollars, par value, authorized by an amendment to the Certificate of Incorporation of the Greensboro News Company, filed in the office of the Secretary of State of North Carolina on August 20th, 1924. This certificate of stock is issued subject to the terms and conditions therein set forth, which are made a part of this contract.
The holders of this Preferred Stock of the Corporation are entitled, as provided in its amended charter, to receive out of its net profits, cumulative dividends at the rate of, but never exceeding, seven per centum per annum, payable January 1st and July 1st of each year, before any dividend shall be paid to the holders of common stock, and on dissolution of the Corporation or distribution of its assets are also entitled, before any amount shall be paid to the holders of common stock, to be paid the par value of their stock and all unpaid cumulative dividends thereon at the rate aforesaid. The Preferred Stock shall have no voting power.
The Preferred Stock in whole or in part, by lot, may, at the option of the Corporation, at the time of paying any dividends, be retired by the Corporation at par, upon sixty days’ notice in writing, by paying the owner thereof par value together with any dividends due thereon.

At a meeting of the board of directors of the petitioner on June 21,1930, a resolution was adopted approving the charter as amended by the state, in the manner provided for in its previous resolution, hereinabove summarized, also the form of the preferred stock certificate to be issued thereunder, which form embodied the terms and conditions extracted from the previous resolution. Authorization was also given at that meeting to proceed with the purchase of the stock of the Record Co., as theretofore agreed upon between Price and Jeffress, for the payment of the purchase price, $420,000 par value of preferred stock, therefor, .for the retirement of 710 shares of the old preferred stock, for the issuance of a similar number of shares therefor, and for the sale of the remaining 90 shares to the Jefferson Standard Life Insurance Co. pursuant to its offer to purchase said shares.

The $85,000 of first mortgage bonds which Price agreed to “ pay off ” in connection with his sale of 205 shares of stock of the Record Co., under the agreement of June 7, 1930, were canceled or paid off in accordance with that agreement.

Twenty thousand dollars of the newly issued preferred stock has been duly canceled in compliance with the plan set forth in the resolution of the board of directors of June 11, 1930.

In the preparation of its corporation income tax returns for- the years 1930 and 1931 the petitioner claimed deductions of $13,049.49 and $25,761.43, respectively, as interest, representing the payments of dividends upon its preferred stock aforesaid. The respondent held that such payments did not constitute interest but were, in fact, dividends and he increased the net income for each of the taxable years by those respective amounts.

The petitioner contends that because of the many restrictions included in the terms of its new preferred stock and because of the rights and privileges reserved to the holders thereof, such stock was essentially equivalent to a bond and, being so, the payments in question constituted interest upon indebtedness under section 23 of the Revenue Act of 1928 and are therefore deductible in the computation of net taxable income.

We are quite willing to concede, as the petitioner contends, that the name by which the instrument of indebtedness is known is not conclusive as to. its true character, I. Unterberg & Co., 2 B. T. A. 274 — though the name given it may not be ignored, nor may we lightly assume that the parties have given an incorrect name to the instrument, Kentucky River Coal Corporation, 3 B. T. A. 644 — but where, as here, the respondent has determined that the instrument represented preferred stock and that the payments thereupon constituted ordinary dividends, the burden is placed upon the petitioner to show clearly that something different was actually accomplished. The lawyer who prepared the agreement between Price and Jeff-ress testified, when asked the purpose of the parties to the agreement, that “ I would say that the purpose of the instrument which I prepared was to issue a preferred stock which in the hands of any holder would be entitled to all the privileges and protections that were possible under the laws of this state for preferred stock.” In reply to the question propounded to him upon cross-examination as to whether or not it was his understanding that the security was to be issued in the nature of a bond he said No, I did not say the nature of a bond. I said it would be prepared so as to carry as many of the elements of protection under the law as was applicable to bonds, as nearly as might be.”

The certificate here carried not the slightest intimation of an indebtedness, as such. It shows upon its face that it is preferred stock, that it is a part of the authorized capitalization of the company, and that the amounts payable thereon were to be paid as dividends. There is nothing in the contract between the parties, in the resolutions of the directors, nor in the certificates of stock guaranteeing, or even promising, the repayment of the amount invested.

Indeed it appears that the properties paid in were intermingled with the other assets of the business and subjected to the risks and hazards thereof without qualification or limitation. Dividends were not payable in any event, but only when and if declared by the board of directors, and even then payments were restricted to the earned surplus or net profits of the business. Interest, as such, would not have been so restricted but would have been payable from the gross revenues of the business as all other true expenses are. While there was a provision for a retirement reserve, thus giving rise to a probable maturity date, the right to retire was specifically “ vested ” in the corporation and the individual holder of stock was powerless to dictate when, if ever, the stock should be retired. Furthermore, the right vested in the corporation was to retire all or any part of the stock. Even though a reserve was provided for, and even assuming that the positive mandate to create the reserve created a right in the individual stockholder to demand retirement as and when such reserve was set aside, the reserve itself depended upon and was limited to “ earned surplus or net profits ” of the business. Therefore, if the business was unsuccessful there may never have been a retirement, a condition over which the stockholders individually or collectively had no control. Consequently, there was no positive obligation to pay dividends and there was no positive maturity date.

We are convinced from the facts that there was no intention to create a debtor-creditor relationship between the petitioner and its stockholders nor was any such relationship in fact established. As we see it the interested parties were primarily concerned with reserving to the preferred stockholders as much preference over the common stockholders as the common stockholders themselves were willing to permit and to surround themselves with as many protective measures as consistent with the laws of the state governing the issuance of preferred stock. Cf. Alexander Sprunt & Sons, Inc., 24 B. T. A. 599; reversed on other grounds 64 Fed. (2d) 424; Northern Fire Apparatus Co., 11 B. T. A. 355; Leasehold Realty Co., 3 B. T. A. 1129; McCoy-Garten Realty Co., 14 B. T. A. 853; Badger Lumber Co., 23 B. T. A. 362; Finance & Investment Corporation, 19 B. T. A. 643; affd., 57 Fed. (2d) 444.

A case strongly resembling the instant case, upon the facts, and reaching the result which we feel must be reached here, is William Cluff Co., 7 B. T. A. 662. There, as here, the certificate of stock provided for the payment of 7 percent cumulative “ dividends * * * out of surplus or net profits when and as determined by the board of directors.” In that case there was a somewhat more positive right to redemption and the stock had no voting rights whatsoever, whereas, here, the stock had voting rights upon the failure in the payment of certain specified dividend payments. In that case, as here, there was provision against the issuance of other shares having priority and against encumbrance by mortgage of the corporate assets. .There was, in that case, as here, a sinking fund provided for the redemption of the stock at a fixed price. Notwithstanding the reasonable probability of redemption and notwithstanding the many preferences retained and advantages gained by the preferred stockholders under their contract, as there shown, we held the amounts paid thereon to be dividends in fact and not interest, saying:

Considering tlie contract between tbe petitioner and tbe preferred stockholders, we are of the opinion that there is nothing therein which takes the holders of the preferred stock out of the class of stockholders. To be sure the holders of this class of stock are preferred in such a manner that they are almost certain to have their stock redeemed. However, a preference over common stockholders makes them none the less stockholders. It appears to us that the contract between the petitioner and the preferred stoekholdérs evidenced only an intention to create and maintain a preference in favor of the preferred as against the common stock.

The Proctor Shop, Inc., 30 B. T. A. 721, to which the petitioner directs our attention, is clearly distinguishable.

For the above and foregoing reasons we are of the opinion that the respondent’s determination that the amounts in controversy represented dividends, and not deductible interest, must be sustained.

Judgment will be entered for the respondent.


source: Caselaw Access Project

author: Goodrich:

license: Public Domain

text:
    Carrie G. Cox and Attilla Cox, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 69698.
    Promulgated November 30, 1934.

      E. J. Wells, Esq., for the petitioners.

      Hartford Allen, Esq., for tbe respondent.
   OPINION.

Goodrich:

Petitioners, who are husband and wife and filed a joint return, assail respondent’s determination of a deficiency in income tax of $16,614.70, for the year 1930. Since the items here in dispute apparently relate only to the income of Carrie G. Cox, hereinafter we will speak of her as the petitioner, without further reference to Attilla Cox.

The controversy concerns two problems: First, what is the proper basis for computation of gain or loss upon sales of stocks made by petitioner in 1930? and, second, should there be included in petitioner’s income for 1930, the income received by an estate of which petitioner was the residuary legatee?

There is no dispute as to the facts. The parties, by counsel, submitted a stipulation, augumented by a deposition and some documentary evidence. The facts material to an understanding of the issues we summarize:

Petitioner, a resident of Louisville, Kentucky, is a daughter of Hattie R. Gaulbert who died, a resident of Louisville, on December 30, 1929, leaving a will which named petitioner residuary legatee. The Gaulbert estate was valued at $1,615,976.59. Specific bequests totaled $137,500; debts of the decedent, $826.56. All of these items were paid in full on or before April 4, 1930. The only claims against the estate remaining unpaid after that date were the several tax liabilities — income tax of the decedent, the Federal estate tax, the estate inheritance tax and local property taxes — which totaled $120,702.97 and were not then due and payable.

For quite a time prior to decedent’s death, the Fidelity & Columbia Trust Co. had acted as her agent in the management of her properties. Thereafter it qualified and acted as executor under her will. Upon the death of her mother, petitioner appointed the trust company as her own agent, and instructed it to take possession of her inheritance and continue to manage it for her in the same manner as the company had acted for her mother. The trust company accepted the ajop ointment and has since acted in that capacity. Both for the Gaulbert estate and for petitioner it carried on its books three accounts, designated respectively “ income ”, “ investment ”, and “ principal.”

Included in the residuary estate going to petitioner were 227 shares .of the. stock of Louisville & Nashville Railway Co. (hereinafter called L. &-N.) and 3,380 shares of stock of the Banco Kentucky Corporation. On April 4, 1930, the former had a market value of $138 a share, and the latter a market value of $24 a share. Both stocks were issued in the name of the trust company and were in its custody.

On October 16, 1930, the trust company, by appropriate entries on its records, transferred 200 shares of the L. & N. stock to the account of . petitioner. On October 29, 1930, petitioner (acting through her agent, the trust company) sold these shares for $21,942. On November 4, 1930, a certificate for 27 shares of L. & N. stock was forwarded to that company for reissue in the petitioner’s name, and on December 10, 1930, she sold these shares for $2,612.52. The market value of the L. & N. stock was $110 a share on October 6,1930.

On November 19, 1930, the certificate representing the Banco Kentucky stock was forwarded to that company for reissue in petitioner’s name. On the same day she sold 530 shares of it for $449.19, and on November 21, 1930, she sold the remaining 2,850 shares for $1,333.80. The market value of the Banco Kentucky stock on October 6, 1930, was $15,375 a share. The company was taken over by a receiver on November 24, 1930.

Upon the death of Hattie Gaulbert, or immediately thereafter, the trust company, as executor, received in cash, as a part of her estate, $52,833. During 1930, it received as income of the estate, including dividends of $676 upon Banco Kentucky stock paid October 2, a total of $52,380.44 (less certain expenses). The cash in its hands during the year, therefore, totaled $105,213.44. The demands upon the estate for which the executor needed cash — the debts, tax liabilities, specific bequests and administration expenses — totaled $182,-758.41 (after partial payment of a specific bequest by the delivery of securities to the value of $99,825.08). The excess of the cash demands over the cash available was, therefore, $77,544.97, which had to be met through sales of securities. During 1930, the executor sold securities of an aggregate par value in excess of $150,000, crediting the proceeds to the various estate accounts.

Petitioner directed the executor to hold the income of the estate to meet the tax liabilities or other cash demands. However, upon her order the executor paid out during the year items totaling $8,350, which were charged against income account and which apparently discharged certain of petitioner’s personal commitments. The demands against the estate were all discharged by the end of the year, and on December 31,1930, the trust company, by appropriate entries, closed its book accounts for the Gaulbert estate, and transferred to petitioner’s account a cash balance of $17,132.51, “ in full settlement of all funds in the hands of the executor.”

Between October 16 and December 31, 1930, all the other assets in the accounts of the estate had been transferred to petitioner’s accounts. No final settlement or accounting was filed by the executor during 1930 in a local court of competent jurisdiction, nor did any such court confirm a settlement or enter a decree of distribution of the estate.

On her return for 1930, petitioner claimed a loss of $65,767.01 upon the sales of the Banco Kentucky stock, which respondent disallowed. She claimed also a loss of $4,676.81 upon the sales of the L. & N. stock, of which respondent allowed $1,318.86. The propriety of respondent’s action respecting these losses is the first issue for our decision.

Moreover, respondent has included in petitioner’s 1930 income $39,660.24 of the income of the Gaulbert estate in that year, regarding that amount as having been paid or credited to petitioner. The propriety of that action is the second issue in the case.

Whether losses were sustained by petitioner upon the sales of the stocks mentioned depends upon the basis used to determine gain or loss. That basis is prescribed by statute, and section 113 (a)(5), Revenue Act of 1928, is controlling. Under it the basis for determining gain or loss upon these sales is the fair market value of the stock “ at the time of distribution to the taxpayer.” Consequently, the primary inquiry here is, When were these stocks distributed to petitioner ?

Respondent has determined that the L. & N. shares were distributed to petitioner on October 16, and November 4, 1930; that the Banco Kentucky shares were distributed on November 19, 1930. It is his view that the term “ distribution ” necessarily implies some definite action indicating a severance of the shares from the estate, and their transfer to the legatee’s ownership. Such action he finds in the elimination of the shares from the estate’s accounts on the executor’s books, coupled with the listing of them in petitioner’s accounts; and the forwarding of the certificates for reissue. Consequently, he uses as the basis, the fair market values of the shares on those dates, and has determined that petitioner’s loss on all the sales was only $1,318.86.

Petitioner contends that the basic date is April 4, 1930, when all the claims against the estate then payable had been discharged, leaving unencumbered assets to a value of $1,510,000. She was the residuary legatee; at that time she acquired substantial ownership of the residuary assets, she argues, and the acquisition of such ownership was equivalent to a distribution to her.

With that, we cannot agree. It is well settled that a residuary legatee acquires substantial ownership of the property bequeathed to him at the time of the testator’s death, Brewster v. Gage, 280 U. S. 327. Were petitioner’s argument sound, the value as of the date of decedent’s death of the assets of the residuary estate would be the basis for determining gain or loss upon their later disposition. That possibility, the Congress expressly eliminated in the case of residuary estates, by providing in the cited section of the 1928 Act that the basis should be the value at the time of distribution.

“Distribution * * * does not necessarily mean passing into the uncontrolled possession and disposition of the beneficiary. It means separation or segregation from the trust estate so that it (the bequeathed property) no longer forms any part or parcel thereof.” Willcuts v. Ordway, 19 Fed. (2d) 917. See also Fidelity & Columbia Trust Co. v. Lucas, 66 Fed. (2d) 116; Matthiessen v. United States, 65 Ct. Cls. 484 (2 B.T.A. 921).

We agree with respondent that the first acts indicating a separation from the estate of the particular stocks here involved were the entries on October 16, 1930, transferring 200 shares of the L. & N. stock to petitioner’s account; followed by the forwarding of the certificates for both stocks on November 4 and November 19, respectively, for reissue in the name of petitioner. Which of these acts effected a separation, we need not decide. Certainly, so far as this record shows, nothing was done prior to those dates toward a segregation of these stocks from the estate either on April 4, 1930, when the debts and specific bequests were paid, or nine months thereafter when, under the laws of Kentucky (sec. 3860, Carroll’s Kentucky Statutes) the estate might have been distributed without peril to the executor. On the contrary, such dividends as were paid on the shares, as late as October 2, 1930, were taken into the income of the estate, evidencing that title, custody and management of the stocks were in the executor. Since, apparently, it is conceded that the value respondent used as the basis for each stock was correct, according to his view as to the basic date, we approve his determination as to the first issue. Cf. William B. Huntley, 30 B.T.A. 931; Ralph W. Harbison, 26 B.T.A. 896 (reversed on another issue, 68 Fed. (2d) 1004, and certiorari granted) ; Lillian McDonald Brinton, 28 B.T.A. 472.

As to the second issue, we are of opinion that respondent’s determination is .erroneous, except as to the sum of $8,350. We are convinced that the balance of the $39,660.24 income received by the estate during the year 1930 was neither paid nor credited to petitioner, within the meaning of section 162 (c), Revenue Act of 1928.

Respondent, in support of his determination, cites us cases (which are inapplicable because of divergent facts) where, by direction of will, certain income was paid to named beneficiaries, who were held to be taxable thereon. Here, the will was silent as to the estate’s income during administration, and petitioner was to receive the residue of the estate — the amount remaining after payment of all specific bequests, taxes, claims and expenses. The laws of Kentucky (sec. 3854, Carroll’s Kentucky Statutes) do not require the executor to pay or credit the estate’s income to a residuary legatee, but permit its use for the payment of debts of the decedent; Harding v. Harding, 151 Ky. 398. Here, the cash demands upon the estate were substantially in excess of the estate’s income; a part of the corpus was sold to meet them. We are satisfied that the greater part of the income was applied in satisfaction of those demands, and was not properly paid or credited to petitioner. United States v. Woodward, 256 U. S. 632. Cf. Jackson v. Price, 6 Fed. Supp. 182; Elnora C. Haag, 19 B. T. A. 982; Robert B. Honeyman, Jr., 24 B. T. A. 126.

The items totaling $8,350, however, were paid out by the executor from income upon petitioner’s order, for her own ends. We have no reason to suppose that the payments were not proper, within the meaning of section 162 (c), Revenue Act of 1928. That amount, therefore, should be included in petitioner’s income. Cf. Harold A. Whitlock, 22 B. T. A. 1355.

Judgment will be entered voider Rule SO.

         These taxes were paid during 1930:
      Income tax of decedent, 1928- $199. 44
      Income tax of decedent, 1929- 6, 567. 97
      State and county taxes_ 2, 338.19
      State inheritance tax__ 92, 381. 94
      Federal estate tax_ 19,170.11
      Federal stamp tax_ - 45. 34
      120, 702. 99

       See S. Kept. No. 960, 70th Cong., 1st sess., p. 26.

        Walter S. Gurnee et al., Executors, 13 B. T. A. 262; Everett J. Esselstyn, Executor, 26 B. T. A. 181 (affd., 65 Fed. (2d) 1015) ; Little v. White, 47 Fed. (2d) 512.


author: Adams : Murdock,

text:
    Washington Fireproof Building Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 70306.
    Promulgated November 30, 1934.

      A. Galder MaoJeay, Esq., for the petitioner.

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

Adams :

In this proceeding petitioner seeks a redetermination of a proposed deficiency in income tax for the year 1930 in the sum of $1,998.31, and asserts that it overpaid taxes that year and seeks refund.

Petitioner, the Washington Fireproof Building Co., is a corporation with its principal place of business in Los Angeles, California. During the year 1930, and for many years prior thereto, it owned and operated a class A office building, in the city of Los Angeles, known as the Washington Building.

The Federal Reserve Bank leased a part of the Washington Building by four leases, the first executed November 1, 1919; another, March 1, 1920; another, November 10, 1922; and another, December 1, 1922, under which leases and the renewals thereof the bank occupied all of the second and third floors of the building, together with part of the fourth floor and part of the basement. These leases, except the first, and renewals contain the following provisions:

* * * That the premises are now in a tenantable and good condition; that the lessee shall take good care of the premises, and they shall not be altered, repaired or changed without written consent of the lessor, and that unless otherwise provided by written agreement, all alterations, improvements and changes that may be required shall be done either by or under the direction of the lessor, but at the cost of the lessee; that all alterations, additions and improvements made in and to the premises shall, unless otherwise provided by written agreement, be the property of the lessor, and shall remain upon and be surrendered with the premises; that all damage or injury done to the premises by the lessee or by any person who may be in or upon the premises with the consent of the lessee, shall be paid for by the lessee; and that the lessee shall at the termination of this lease, surrender the premises to the lessor in as good condition as reasonable and proper use thereof will permit.
* * * The lessee agrees when premises are surrendered that all injury or damage of every kind and character to the interior of the rooms occupied by it, and any part of the floors, wall or ceilings, shall be repaired by the lessor and the amount expended therefor shall be paid by the lessee to the lessor upon demand.
* * * It is understood and agreed that the lessee may remove such partitions, wardrobes, plumbing fixtures and lighting fixtures, from the said premises as may be necessary to satisfactorily accommodate the requirements of the banking business of said lessee; all of said changes and alterations and replacements to be made in a good and workmanlike manner, and at the expense of said lessee and under the direction of said lessor, or its representative. All plaster and waste material shall be removed through, the windows by chute to Third Street. All doors, door casings, mouldings, baseboards, chair rails, plumbing and lighting fixtures are to be marked and carefully removed and stored in the storage room of said lessee.
At the expiration of this lease, or in event of the renewal of this lease, at the expiration of such renewal period, all partitions, plumbing, woodwork, lighting fixtures, marble, etc., are to be restored and put in the same position as is shown on the enclosed plat which is intended to represent the original plan of the Fourth Floor. All said renewals are to be done in a good and workmanlike manner, and at the expense of said lessee, and to conform to original woodwork and finish which corresponds with floors above in said building. It being understood that the lessee is to pay monthly rental for said premises as called for in this lease to and including such time as the above described premises are turned over to the said lessor in accordance with the conditions as specified in this paragraph. * * *

Similar provisions to those set out above were added to the original lease after its execution.

Pursuant to the terms of the leases as set out above, the bank made many changes in the building, such as the construction of vaults, the cutting away of some of the floor space to provide additional stairways, the removal of partitions, and various other alterations.

Upon the termination of the leases in 1930, petitioner and the bank agreed upon settlement of the bank’s obligation to restore the property to its original condition. This matter was stipulated upon trial as follows:

They (the petitioner) got $45,000 of which they (the petitioner) allocated $6,000 to rent and $39,000 to the amount requisite for putting the building in the condition in which they (the bank) agreed to leave it. The $6,000 was paid as rent to compensate petitioner for the use of its building during the period of three months, which it was estimated would be required to make the necessary repairs and replacements.

The petitioner’s books show the $6,000 was credited to rents; $24,000 to miscellaneous income; and $15,000 to a reserve account for replacements. The company made partial restoration during the year at a cost of $8,634.46, which was charged to expense. This did not constitute full restoration of the building.

In the income tax return filed by petitioner for the year 1930, $24,000 of the amount so received from the bank was included in general income; $8,634.46 was deducted as expense and $15,000 was set up as reserve for replacements.

In his determination respondent holds that the $39,000 received by petitioner, less the $8,634.46 expense for replacements, was income to petitioner for the year 1930.

Petitioner now contends that the $39,000 received by it was not income and, therefore, not taxable; and that it overpaid its income tax for the year 1930 and seeks a refund. Respondent says that such sum was income in the nature of rent and so taxable to petitioner during the year of its receipt.

Under the authorities such payment is not rent in its proper sense. The term “ rentals ” must be taken in its usual and ordinary sense, that is, as applying a fixed sum to be paid at stated dates for the use of the property. Duffy v. Central Railroad Co. of New Jersey. 268 U. S. 55: Frank & Seder Co. v. Commissioner, 44 Fed. (2d) 147.

There was no testimony introduced upon the hearing showing what sum of money would be necessary to make the required replacements except the stipulation between the parties that the $39,000 was received in lieu of the bank obligation to make replacements. If it had appeared that such sum was necessary for such purpose and was expended by petitioner to make the replacements provided for in the leases, then, under the authorities, such receipt by the petitioner would not have constituted income. Eisner v. Macomber, 252 U. S. 189, 208.

There was no testimony introduced upon the hearing showing what sum of money would be necessary to make the required replacements. Testimony does not show the value of the building before or after the alterations were made. Unless it can be said that the agreement between the parties by the terms of which the bank paid petitioner the sum of $39,000 to relieve itself of the obligation to make the replacements establishes what such replacements would have actually cost in money, then we have no way of determining under the facts whether this item was income or return of capital, or whether it was partial income and partial return of capital. If petitioner had made the replacements and put its building in the condition in which the bank agreed to leave it for a sum less than $39,000, then the excess over and above the sum so expended would be income, while that expended for that purpose would be a return of capital. The agreement between the parties as to the payment is not sufficient to establish that the sum paid was necessary for the purpose of making the replacements.

Petitioner treated this matter on its books so as to suggest the replacements could be made by the expenditure of the $8,634.46 which it did expend, plus the additional amount of $15,000 which it set up as reserve for that purpose. It treated the $24,000 of the amount so received as income.

There is no authority found in the law for the reserve set up by the petitioner.

The record is in such a condition that we are unable to make a determination as to how much of the sum received by petitioner was return of capital, if any, and how much, if any, was income. In this state of the record, the testimony being insufficient to enable us to make a finding of fact on this question, it is not sufficient to overcome the presumption of the correctness of the respondent’s determination and such determination must, therefore, be approved.

Keviewed by the Board.

Decision will be entered, for the respondent.

Murdock,

concurring: This case is correctly decided for the respondent because of a failure of proof on the part of the petitioner. However, the statements, that there would have been no income had the money been no more than was necessary to replace the portions of the building removed and had it been expended for that purpose, are fundamentally wrong and should be disregarded as dicta. The realization and computation of gain under the Federal income tax statutes never are affected by the use to which the taxpayer puts his money after he receives it. Standard Slag Co., 20 B. T. A. 503; Mary M. Shea, 31 B. T. A. No. 513. His gain, may go unrecognized under certain circumstances, but that is because of some special provision of the statute. Cf. section 112 (f) of the Bevenue Act of 1928. Such special provisions deal with recognition, not with realization or computation of gain, and their very presence in the statutes indicates that in all other cases all of the gain shall be recognized regardless of what use is made of the money received. There is no suggestion that any special provision applies in this case.

Money was paid to a lessor by a lessee in lieu of replacing substantial parts of a building which the lessee had removed and had agreed to replace. The question is, How much of the money settlement is income to the lessor ? The answer to that question does not depend upon what the lessor did with the money nor upon how much money would have been necessary to restore the building. If all or some part of the money might be considered rent that would be all income. If all or any part of the money was not rent but a payment to the lessor for portions of his building, then to that extent the transaction was substantially similar to a sale and must be treated for income tax purposes as a “ sale or other disposition ” of a portion of his building. Sec. 111. In such case he is entitled to have returned to him tax-free the original cost of the portion of the building removed but no more. If the amount of money paid for the portion of the building removed is in excess of the basis for gain or loss which the property removed had in the hands of the owner, adjusted for depreciation and obsolescence, gain is realized. If the amount received were less than the adjusted basis, loss would be sustained. If the lessee had completely removed the building and, rather than replace it, had settled in cash, clearly the excess of the cash over the basis of the building for gain or loss to the lessor would have been income to the lessor. The principle is the same where only part of the building is removed and paid for in cash. Even if the difficulty of determining the portion of the basis against which to apply the cash were insurmountable, it would hardly change this fundamental method of determining income under the statute. Cf. Burnet v. Houston, 283 U. S. 223. But there are-practical ways of determining the portion of the basis applicable to the portion of the building removed. Cf. Harry Johnston Grant, 30 B. T. A. 1028. When and if the taxpayer expends any of the money for making replacements, those expenditures will be capital expenditures which will increase the basis for subsequent depreciation and gain or loss. The Commissioner determined that gain was realized. His determination must be approved in the absence of proof that the excess of the amount received over the adjusted basis for the property which had been removed was less than the amount of gain determined. There was no proof of the basis, and, therefore, approval of the determination of the Commissioner is proper.

Black, Smith, Sternhagen, MoRRis, Matthews, Goodeioh, and Leech agree with the above.


author: Van Fossan:

text:
    Hal Roach Studios, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 61750.
    Promulgated November 30, 1934.

      Ka¡rl W. Krarne, Esq., for the petitioner.

      M. B. laming, Esq., for the respondent.
   OPINION.

Van Fossan:

This proceeding was brought to redetermine a deficiency in income tax of the petitioner for the fiscal year ending July 31, 1929, in the sum of $7,879.39, of which amount the sum of $5,548.92 is in controversy.

The sole question involved is whether or not, for the purpose of carrying forward net losses, the phrase “ taxable year ”, as used in section 206 (b) of the Eevenue Act of 1926 and section 117 (b) and (e) of the Eevenue Act of 1928, means a year of 12 months, notwithstanding the fact that because of a change in the affiliated status of the corporation a separate return may have been required and filed for a part of a year.

The facts were stipulated substantially as follows:

The petitioner is a domestic corporation, incorporated April 27, 1926, under the laws of the State of California, and is engaged in motion and sound picture production. Its principal place of business is located on Washington Boulevard, Culver City, California.

The petitioner commenced business on April 3,1926, when the production end of the motion picture business of Hal E. Eoach Studios was transferred to it by the parent company in exchange for capital stock of the petitioner.

Hal E. Eoach Studios, a corporation organized under the laws of the State of California, and the petitioner, were affiliated within the meaning of the Eevenue Acts of 1926 and 1928 only for the period from April 3,1926, to April 13,1927, inclusive. The affiliated status, under the Eevenue Acts of 1926 and 1928, terminated on April 14, 1927.

The fiscal year of the petitioner and of Hal E. Eoach Studios ended on July 31, in the years 1926, 1927, 1928, and 1929, and the accounting records of the petitioner and Hal E. Eoach Studios were kept on a fiscal year basis and were closed each fiscal year on July 31 in the years 1926, 1927, 1928, and 1929.

The petitioner and Hal E. Eoach Studios, or either of them, did not change the date of the ending of their respective fiscal years from July 31 to any other date in the years 1926, 1927, 1928, and 1929, and did not request a change of accounting period from July 31 to any other date in the years 1926, 1927, 1928, and 1929.

The petitioner filed a waiver of the statute of limitations on the fiscal years 1928 and 1929, extending the period to December 31,1931, to permit the examination of its records by the field agents of the respondent.

The petitioner had the following taxable net income and statutory net losses for the following periods, as computed by the respondent in the revenue agent’s supplemental report dated November 18, 1981.

Hal E. Roach Studios had the following statutory net losses and taxable income: For the period from April 3, 1926, to J uly 31,1926, a statutory net loss of $8,437.36; for the period August 1, 1926, to April 13, 1927, a loss of $583.02, reduced by nontaxable interest of $475.44 and domestic dividends of $1,473.73, resulting in no statutory net loss of taxable income for this period.

The consolidated statutory net losses of the petitioner and Hal E. Roach Studios are as follows: For the period from April 3, 1926, to July 31, 1926, a statutory net loss of $57,023.79; for the period August 1, 1926, to April 13, 1927, a statutory net loss of $226,511.90, which sum is made up entirely of the statutory net loss of the petitioner.

The petitioner originally made and filed a consolidated return as provided by Regulations 69, with Hal E. Roach Studios, parent, and included therein the operations of the petitioner for the period from April 3, 1926, to July 31, 1926, and the operations of Hal E. Roach Studios from August 1,1925, to July 31,1926.

The petitioner made and filed later an amended separate return, including therein its operations only, and for the period April 3, 1926, to July 31, 1926, and such return was filed by the petitioner without first securing the permission of the Commissioner, required by article 632, Regulations 69.

The petitioner made and filed later an amended separate return, period August 1, 1926, to July 31, 1927, and included therein only the operations of the petitioner for such period, and no other return has been made and filed by the petitioner covering the same period. The petitioner did not make and file either a consolidated return or a separate return for the period August 1, 1926, to April 13, 1927, nor was a separate return made and filed by the petitioner covering the period April 14, 1927, to July 31, 1927, which periods cover the affiliated and the nonaffiliated periods, respectively, in the respondent’s determination.

The petitioner made and filed separate returns for the periods August 1,1927, to July 31,1928, and August 1,1928, to July 31,1929, and included therein only the operations of the petitioner for such periods, and no other returns of any kind, nature, or description were ever filed by the petitioner for those periods.

The petitioner never made or filed any return for a fractional part of any year prior to August 1, 1930, other than for the period April 3, 1926, to July 31, 1926, inclusive, which period is from the date of inception of its corporate entity and activities to the date adopted by the petitioner as the close of its fiscal year.

Hal E. Roach Studios did not make or file any return for a fractional part of any of the years 1926, 1927, 1928, and 1929.

The respondent computed the deficiency of $7,879.39 for the period August 1, 1928, to July 31, 1929, inclusive, as follows:

Statutory net loss (of petitioner) applicable to the period commencing April 3,1926, and ending July 31,1926-$48, 586.43
Statutory net loss (of petitioner) applicable to the period from August 1, 1926, to April 13, 1927_'_ 226, 511. 90
Statutory net loss (of petitioner) covering the period from April 14, 1927, to July 31, 1927_ 123, 905.04
Total statutory net losses of petitioner applicable as above from August 1, 1926, to July 31, 1927_ 350, 416. 94
Less: Net income (of petitioner) for the period ending July 31,1928_ 353,399. 67
Statutory net loss (of petitioner) applicable to 1929- None
Computation of Tax — July SI, 19B9
Net Income for taxable year_$69, 016. 58
Statutory net loss (of petitioner) applicable_._ None
Net income__ 69, 016.58
Less: Credit for $3,000 for domestic corporation having net income less than $25,360.00 for 1929_ None
Balance subject to tax_$69, 016.58
Proportion of the tax applicable to the proportionate basis that the time in 1928 is to the time in 1929' — A of $69,016.58, at 12%- 3,450.83
Proportion for the year 1929 would be A of $69,016.58 at 11%_ 4,428. 56
Total tax due_ $7, 879. 39
Tax previously assessed_ None
Deft caencor in Tax_ $7,879.39

The identical question here presented was before the Board in Weissberger Moving & Storage Co., 26 B. T. A. 1375; Arnold, Constable Corporation, 26 B. T. A. 1427; Joseph & Feiss Co., 26 B. T. A. 852; Morgans, Inc., Memorandum Opinion, Nov. 5, 1932; Wishnick-Tumpeer, Inc., 27 B. T. A. 548, and other cases, in all of which the Board sustained the Commissioner’s ruling and held that where two corporations became affiliated during a taxable year and consequently two returns were required for the appropriate periods, each of such periods became a “ taxable year ” for the purpose of applying net losses. The Board was reversed by four Circuit Courts of Appeal to which appeal was prosecuted in various cases, Morgans, Inc. v. Commissioner, 68 Fed. (2d) 325 (C. C. A., 1st Cir.); Arnold Constable Corporation v. Commissioner, 69 Fed. (2d) 788 (C. C. A., 2d Cir.); Crossett Western Co. v. Commissioner, 73 Fed. (2d) 307 (C. C. A., 3d Cir.); and Joseph & Feiss Co. v. Commissioner, 70 Fed. (2d) 804 (C. C. A., 6th Cir.), and was affirmed by the Court of Appeals for the District of Columbia in Wishnick-Tumpeer, Inc. v. Commissioner, - Fed. (2d) - (March 12, 1934).

A conflict existing, the Supreme Court granted certiorari in Helvering v. Morgans, Inc., supra. On November 5, 1934, the decision of the Supreme Court was delivered, in which the ruling of the Circuit Court of Appeals reversing the Board, was affirmed. Helvering v. Morgan's, Inc., 293 U. S. 121.

Decision will be entered under Bule 50.


author: Aeundell:

text:
    Niagara Share Corporation of Maryland, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 70813.
    Promulgated December 5, 1934.

      Ralph M. Andrews, Esq., and A. E. Swdam, Esq., for the petitioner.

      Elden McFarland, Esq., for the respondent.
   OPINION.

Aeundell:

The petitioner has brought this proceeding for the purpose of redetermining the income tax liability of itself and its affiliated companies for 1930. The respondent has determined a deficiency against petitioner for that year of $15,947.43. In its petition the petitioner set forth four allegations of error as the basis for its appeal, but at the hearing waived all but one error, namely, the failure of respondent to allow a deduction of $339,869.11 as the full amount of a loss sustained on the sale of stock and notes of the Commercial Funding Corporation.

According to the stipulated facts, which are incorporated herein by reference, the alleged loss grew out of the following circumstances. The Niagara Share Corporation of Maryland, the petitioner herein, was incorporated June 18, 1929, under the laws of the State of Maryland, and has its principal place of business and office at Baltimore, Maryland.

During 1929 Niagara Share Corporation of Delaware, hereinafter referred to as Niagara of Delaware, was a corporation organized under the laws of the State of Delaware, having its office and principal place of business at Wilmington, Delaware.

On July 24, 1929, Niagara of Delaware entered into two written contracts. The first of these was with the Lincoln Interstate Holding Co., a New Jersey corporation, and therein it was agreed that Niagara of Delaware was to acquire the Lincoln Co.’s assets. The consideration therefor was 45,000 shares of common stock of Niagara of Delaware and the assumption of certain of Lincoln’s obligations by Niagara of Delaware.

The second contract of July 24, 1929, was between Niagara of Delaware and three individuals, namely, Joseph C. Braelow, Harry L. Tepper, and Albert Fried, hereinafter called the guarantors, as they are designated in the contract. This contract in the preamble is described as “ an instrument of guaranty.” It recites that the guarantors are stockholders in the Lincoln Co., and have requested Niagara of Delaware to enter into the agreement for the acquisition of Lincoln’s assets; that they have represented to Niagara of Delaware that it will realize $1,074,000 from certain of Lincoln’s assets. These assets, hereinafter called the guaranteed assets, included demand notes of Commercial Funding Corporation, a New Jersey corporation, in the principal amount of $380,000, and all of the outstanding stock of the same corporation consisting of 7,000 shares of common stock of no par- value,' and 1,387 shares of 8 percent preferred stock of the par value of $100 per share. The agreement further provided that if the sums realized by Niagara of Delaware upon the sale of the guaranteed assets did not equal $1,074,000 (including dividends, interest, and rights received from the assets) then upon the sale of the last of those assets the guarantors would pay to Niagara of Delaware an amount equal to the difference between $1,074,000 and the aggregate amount realized from the guaranteed assets. The liability of the guarantors under this contract was limited to $400,000. As partial security for performance the guarantors pledged corporate stocks of a value of $200,000, and authorized their deposit with a trust company. The promises of the guarantors were by the terms of the contract to inure to the benefit of Niagara of Delaware “ and its successors, and the assignee or assignees of all or substantially all of its assets.”

Pursuant to the first contract mentioned of July 24, 1929, the Lincoln Co. duly assigned to Niagara of Delaware its assets, including the stock and notes of Commercial Funding Corporation.

On December 20, 1929, Niagara of Delaware entered into a written contract with petitioner under which petitioner acquired all the property and assets of Niagara of Delaware as of tbe close of business on December 31, 1929, in consideration of the assumption by petitioner of the liabilities of Niagara of Delaware and the issuance to stockholders of Niagara of Delaware of one share of petitioner’s preferred stock for each share of preferred stock of Niagara of Delaware, and one and one-half shares of petitioner’s common stock for each share of common stock of Niagara of Delaware. The transfer of assets from Niagara of Delaware to petitioner was made by bill of. sale dated January 10, 1930. Included in the assets transferred were the demand notes and stock of the Commercial Funding Corporation above referred to.

The property and assets acquired from Niagara of Delaware were recorded on petitioner’s books and records at the fair market value thereof on December 31, 1929. The common and preferred stock of the Commercial Funding Corporation had a fair market value on December 31,1929, of $38,602.48. The 14 demand notes of the Commercial Funding Corporation, aggregating $380,000, had a fair market value on December 31, 1929, of $380,000, and were included in the item of “ notes receivable ” of $417,500 from the Commercial Funding Corporation entered on petitioner’s books of account. The excess of $37,500 of these notes represents advances to the Commercial Funding Corporation by Niagara of Delaware prior to December 31, 1929.

On various dates prior to October 10, 1930, all of the guaranteed assets except the Commercial Funding Corporation stock and notes were sold for $652,806.66. The stock and notes of the Commercial Funding Corporation were the last of the guaranteed assets to be sold, and these were sold by petitioner on October 16,1930, at public auction for $99,000.

In recording this sale petitioner placed on its books an amount of $322,193.34, representing its claim against the guarantors. At the time of the sale the Commercial Funding Corporation stock and notes were carried on petitioner’s books at $438,869.11, consisting of notes, $380,000, accrued interest, $20,266.63, and preferred and common stock, $38,602.48. The sale of these assets on October 16 reduced the balance in the account to $339,869.11, of which $322,-193.34 represented the claim against the three guarantors and $17,-675.77 was set up as a loss on the sale of the stock and notes. The amount of $322,193.34 represents the difference between $751,806.66, being the aggregate amount realized from the sale of all the guaranteed assets, and $1,074,000, the amount which the guarantors represented would be realized.

On October 22, 1930, petitioner served notice on the guarantors that the sale of the guaranteed assets had brought an aggregate of $751,806.66, and demanded payment under the guaranty contract of $322,193.34. Payment of any amount pursuant to the demand was formally refused by the guarantors on November 3, 1930.

On November 10, 1930, petitioner instituted an action against the-guarantors in the District Court for the Southern District of New York, for the recovery of the $322,193.34, with interest. The cause was referred to and heard by a special master on various dates between August 5, 1931, and January 5, 1932, the testimony being concluded on the latter date.

The action was defended on the following grounds: First, that the contract of July 24, 1929, was a contract personal to Niagara of Delaware, which placed credit, trust, and confidence in Niagara of Delaware, hence was not assignable, and defendants were not liable to the assignee, the petitioner herein, in any amount; second, that the sale o.f assets by Niagara of Delaware to petitioner was a sale of the guaranteed Commercial Funding assets within the meaning of the contract of guaranty; and, third, that the Commercial Funding Corporation’s stock and notes were improperly sold on October 16, 1930, and the auction on that date improperly conducted.

The special master filed his decision and report on January 15, 1932, finding against the guarantors and for the petitioner on all three issues. On February 3, 1932, the report of the special master was formally approved and confirmed by decree of the District Court, and on September 12, 1932, this decree was in all respects affirmed on appeal by the Circuit Court of Appeals for the Second Circuit, Niagara Share Corporation of Maryland v. Fried, 61 Fed. (2d) 740.

Up to and including March 31, 1934, the petitioner has been able to collect on the judgment against the guarantors the sum of $96,-412.40. On November 10, 1930, the defendant Fried was financially able to pay an amount of $322,193.34.

Petitioner kept its books and accounts and filed its tax returns on the accrual basis and for the calendar year.

On its 1930 consolidated return petitioner deducted $17,675.77 as a loss on the sale of Commercial Funding Corporation assets. Also on its consolidated return petitioner claimed an operating loss for the period of affiliation in 1930 of the Commercial Funding Corporation of $45,624.85, plus an operating loss o.f theDalco Co. of $2,305.81, less an operating profit of the Empire Brokerage Co. of $1,377.77, or a consolidated net loss of $46,552.89. This figure was reduced by $4,000 dividends received by the Commercial Funding Corporation, which owned all the outstanding stock of the Empire Brokerage Co. and Dalco Co., making a consolidated net loss for these three com-pañíes of $42,552.89. The respondent disallowed the deduction of $42,552.89 with the following explanation:

To adjust loss sustained from sale of stock of Commercial Funding Corporation during consolidated period in 1930 in accordance with the provisions of article 34(c) (2) of Regulations 75.

Neither party disputes the figure at which the Commercial Funding Corporation stock and notes were carried on petitioner’s books as representing the proper basis for determining gain or loss.

The basis of the stock and notes for gain or loss purposes being $438,869.11, and petitioner having sold them in 1930 for $99,000, it now claims that not only did respondent err in disallowing the loss of $17,675.77 claimed in the return, but that there should be allowed as a loss $339,869.11, this being the difference between the basis of $438,869.11 and the amount realized, $99,000.

Section 23 (f) of the Revenue Act of 1928 provides for the deduction of losses by corporations as follows: “ In the case of a corporation, losses sustained during the taxable year and not compensated for by insurance or otherwise.”

General rules applied in loss cases are that “ the income tax law is concerned only with realized losses ”, Lucas v. American Code Co., 280 U. S. 445, and claimed losses must “usually be evidenced by closed and completed transactions.” United States v. White Dental Manufacturing Co., 274 U. S. 398; art. 171, Regulations 74. In Lewellyn v. Electric Reduction Co., 275 U. S. 243, it is said:

The statute was intended to apply not only to losses resulting from the physical destruction of articles of value but to those occurring in the operations of trade and business, where the business man has ventured on a course of action in the reasonable expectation that the promised conduct of another will come to pass. Not only the future success of the business but its present solvency depends on the probable accuracy of his prophecy. Only when events prove the prophecy to have been false can it be said that he had suffered.

In the case before us, the sale of the Commercial Funding Corporation securities no doubt was a completed transaction in so far as those securities themselves are concerned. But they cannot be considered alone, for along with them petitioner acquired other property, namely, the guaranty of the three individuals. And this must be taken into consideration to determine whether there was a “realized loss ” and if so whether it was “ compensated for by insurance or otherwise.” The destruction of property by fire unquestionably brings about a loss of that particular property, but does not necessarily give the owner a deductible loss; the amount of insurance is taken into consideration and the deductible loss determined by comparing the basis with the amount of insurance. It is even possible to realize a taxable gain if the insurance exceeds the basis for gain or loss. In cases involving losses offset by insurance or other claims for compensation, we have held that no deduction is allowable in the year of the loss of the property, but is allowable for the year when the claim for compensation is settled. Allied Furriers Corporation, 24 B. T. A. 457. This is in line with the holding in Leweltyn v. Electric Reduction Co., supra, that where one relies on the promised conduct of another it is only when events occur proving the reliance to have been misplaced that it can be said he has suffered. Similarly in the American Code Co. case, supra, loss was denied in the year of breach of contract where the amount to be paid “ depended in large part on the course of future events.” In John Thatcher & Sons, 30 B. T. A. 510, we reviewed at length the cases dealing with claimed losses where the taxpayer had a claim over against others which was not settled until later years. In that case the taxpayer was a contractor, who, upon default of its subcontractors, was obliged to construct buildings under its contracts. The cost of construction, started in 1917 and completed in 1919, was in excess of the price received for completing the work. The taxpayer thereupon sought to recover the excess from the surety company that had bonded the subcontractors. The ensuing litigation was terminated in 1928 by decision adverse to the taxpayer. In deciding the case we overruled the contention of the Commissioner that the loss had been sustained between 1917 and 1919, pointing out that at that time “there was merely the possibility of a loss ” in view of the taxpayer’s right of action against the subcontractors and their surety. We sustained the taxpayer’s claim to a loss deduction for 1928, saying that upon settlement of the litigation in that year “the possibility of loss became a reality.”

The above cases point the way to the solution of the question presented here. The petitioner sold its securities for an amount less than their basis, but it had in hand at the time a written contract upon which reliance was placed to indemnify it against loss and its claims under the contract were sustained by the courts. The validity of petitioner’s claim being judically established and the guarantors being financially able to réspond to the full amount of the claim in 1930, it cannot be said that the claim was worth any less than the full amount which petitioner sought to recover on it. Whether inability to collect on the judgment gives rise to a loss in later years is not before us for decision. Here, as in Lewellyn v. Electric Reduction Co., supra, there is nothing to indicate that in the taxable year the taxpayer “ had ceased to regard his rights under the contract as having value or that there was then reasonable ground to suppose that efforts to enforce them would be fruitless.”

There is a valid distinction between the cases holding as above set out and those cited by petitioner, including H. P. Robertson Co., 14 B. T. A. 887, Gottlieb Realty Co., 28 B. T. A. 418, and United States v. White Dental Manufacturing Go., supra. This is aptly pointed out in the Gottlieb Realty case, where we said: “ The mere possibility or the bare hope of a future development permitting recovery does not bar the deduction of a loss clearly sustained.”

Such was the situation in the White Dental case where, as the Court said, what would ultimately be recovered would not be “ as a matter of right, but as a matter of grace to the vanquished or exaction by the victor.” A claim as tenuous as that is not to be seriously considered in the practical matter of determining income.

We accordingly hold that to the extent of -petitioner’s claim against the guarantors it sustained no deductible loss on the sale of Commercial Funding Corporation securities in 1930. That claim amounted to $322,193.34, while the amount of $99,000 realized was $339,869.11 less than the basis of the securities. Consequently if no further adjustment need be made petitioner sustained a loss, not compensated for by insurance or otherwise, in the amount of $17,675.77 ($339,-869.11 — $322,193.34). This is the amount petitioner claimed in its return.

In the year 1930, from January 1 to the time affiliation was broken by the sale of the Commercial Funding Corporation stock, that corporation and its subsidiaries sustained a net operating loss of $42,552.89. While, as stated above, deduction of $42,552.89 was disallowed, the explanation given in connection therewith would indicate that it was not a disallowance of the operating loss as such, but effected an adjustment of basis of the stock. However this may be, the operating loss of $42,552.89 was clearly an allowable deduction in computing consolidated net income, and if it has not been allowed it should be. In accordance with article 34 (c) (2), Regulation's 75, this operating loss must be used to adjust the basis for gain or loss on the sale of the stock. Ilfeld Co. v. Hernandez, 292 U. S. 62. So applying the operating loss against the basis of $38,602.48 leaves the petitioner with a basis of zero for the stock. The loss on the sale of the Commercial Funding Corporation stock and notes computed on this adjusted basis amounts to less than the guaranty of $322,193.34, and in view of what we have already said petitioner has not suffered a loss that is deductible in 1930.

Decision will be entered under Rule 50.


author: Matthews :

text:
    Robert Carey, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 54033, 60432, 67415.
    Promulgated December 5, 1934.

      Robert Carey, Esq., pro se.

      L. W. Creason, Esq., for tbe respondent.
   OPINION.

Matthews :

There is presented in these proceedings the sole issue whether the salary of $7,500 a year received by petitioner in the years 1928, 1929, and 1930, from the New Jersey Interstate Bridge & Tunnel Commission (later known as the New Jersey Holland Tunnel Commission and merged in May 1930 with the Port of New York Authority) should be included in the petitioner’s taxable income for those years. The facts are clear and not disputed.

In 1918 the State of New Jersey enacted legislation to extend the system of highways in the state by providing for the construction of a -bridge over the Delaware River in conjunction with the State of Pennsylvania and for the construction of a vehicular tunnel under the Hudson River in conjunction with the State of New York. The original acts were amended and supplemented in later years, as it became necessary, in order to carry out the projects. See vol. 2, Cum. Laws of N.J., p. 3692, et seq. Both of these projects were ultimately carried out. The “ Holland Tunnel ”, named for its engineer, built at a cost of about $50,000,000 under the Hudson River, now connects the highway system of New Jersey with that of New York. The history of this great engineering project is so generally known that it is unnecessary to dwell on it here.

The original act of 1918, section 3, as amended by the laws of 1924, chapter 2, is as follows:

3. The commission is hereby authorized to appoint either for itself or in conjunction with the commission or agency of the State of New York; * * * engineers, consulting engineers, assistant engineers and such other employees, clerks and assistants as may be necessary or convenient for carrying on the work of constructing the Hudson River Vehicular Tunnel * * * in conformity with the authority heretofore vested in the commission. It shall also have the sole power either for itself or in conjunction with the New York Commission * * * to fix the compensation, the period and terms of employment, and to define the duties of such engineers, consulting engineers, assistant engineers, employees, clerks and assistants as it shall deem advisable and to pay such engineers, assistants and employees out of the funds made available to it for the purpose of carrying out the work heretofore or hereafter authorized; and it shall also have the sole authority to employ counsel, assistant counsel, or consulting counsel as may be requisite or necessary, either for itself, to protect the independent interests of the commission and the State of New Jersey, or in conjunction with the New York Commission, * * * and to pay such counsel such salary or fees as may be necessary or requisite out of the funds heretofore or hereafter made available to the said commission.

The original New Jersey legislation provided that the legal work of the commission be done by the state attorney general or his deputy, but the increase in the work required a- lawyer who could devote more time to it than was possible for regular state officers. The amendment of the original act by the 1924 act, quoted in part above, followed. Counsel was appointed, and when his resignation took place petitioner was named counsel on July 8, 1924. He continued to perform the legal duties required of him by the commission until July 1, 1930, about two months after the merger of the New York and New Jersey commissions, in the Port of New York Authority.

Respondent contends that petitioner was not an officer or employee of the State of New Jersey, or of a political subdivision of the state engaged in the performance of an essential governmental function, but that petitioner was an independent contractor. He points out the rule that exemptions from taxation must be strictly construed when express, and a fortiori strictly, when the immunity is merely implied; and relies on Metcalf & Eddy v. Mitchell, 269 U. S. 514, and other cases which will be hereafter considered.

The first question is whether the New Jersey Interstate Bridge & Tunnel Commission, and its successors, exercised governmental functions, for if it did not, we need not consider the second question of petitioner’s employment.

The commission was to have “ such duties in connection with the providing of interstate bridges and tunnels as shall from time to time be conferred upon it by the Legislature, and shall have all the powers appropriate and necessary for the performance of such duties.” It was empowered to enter into contracts in its own name or the name of the state. It had full power in its name or the name of the State, to acquire, by purchase, gift, grant or condemnation, all lands * * * necessary for the construction of such bridges or tunnels.” Further powers for purchase or condemnation of lands were given by the law of 1919, ch. 69. In connection with the Hudson River Tunnel, the commission was authorized to enter into contracts with the State of New York or its agency for building the tunnel, and to provide for the collection of tolls and charges after its completion. Congress authorized such an agreement between New York and New* Jersey. The commission, acting for the state, was authorized to accept delegated authority from the President or Congress of the United States. An agreement was entered into by the New Jersey Commission with the New York Commission for the joint construction, operation, and maintenance of the tunnel, under which each state was to pay half of the cost of construction and maintenance and each state was to receive half of the tolls. As to the cost, the agreement provided in Article IV (p. 3714, vol. 2, Comp. Stat. of New Jersey, 1911-1924):

216-69. What constitutes cost. 2. The cost of the tunnel or tunnels shall include the cost of all labor, materials and equipment entering into construction; the cost of any real property or interest therein, hereafter acquired, extinguished or appropriated, together with the actual and necessary expenses in connection with such acquisition, extinction or appropriation; payments made on account of claims for damages of whatsoever hind, for which either State may be liable, arising out of the construction; salaries and expenses of the engineering staff; any liability arising out of the operation of any Workmen’s Compensation Law, resulting from a claim of an employee employed jointly by the parties hereto; premiums paid for insurance, if any, of whatsoever kind, except as hereinafter more specifically provided; also rent for offices maintained by the two commissions and the salaries and expenses of their clerical staffs. (L. 1920, c. 76, p. 143.)
216-70. Costs m&u.rred by both commissions. 3. Nothing herein contained shall be construed to' include any costs or disbursements for any of the above purposes except such as are incurred by both commissions exclusively in connection with the construction of such tunnel or tunnels, as evidenced whenever so required by the provisions of this contract by resolutions identical in form and substance. (L. 1920, c. 76, p. 144).

The act ratifying the agreement for the construction of the tunnel, in its preamble, states that “ The State of New Jersey, acting by and through the New Jersey Interstate Bridge & Tunnel Commission * * * ” had entered into such agreement. Each state acquired title to all land within its territorial limits necessary for the tunnel. Under the agreement the two commissions, acting jointly, were given the power to fix, determine, and levy tolls and charges for the use of the tunnel. See, generally, the collected provisions in Cum. Supp. to Comp. Stat. N. J., 1911-1924, vol. 2, pp. 3696-3742. New Jersey imposed a tax (L. 1918, ch. 51, p. 142-147), and authorized two bond issues in the aggregate of $36,000,000 (C.L. 1920, ch. 352, p. 863; L. 1924, ch. 262, p. 677) to raise the necessary revenue, and also used other public moneys to pay its share of the cost of the tunnel construction.

There would seem to be no reason to doubt, after reviewing the legislative sanctions for the commission, that the New Jersey InterState Bridge & Tunnel Commission was intended to be an agency of the state, exercising to some extent sovereign functions. Its powers go far beyond the franchise powers occasionally conferred on public utilities. Here the social and economic welfare of the people of New Jersey and of New York demanded readier means of intercourse than could be had by river ferries. The public interest in such a project is obvious. To accomplish this public end required the exercise of sovereign powers to supersede the conflicting interests of individual property holders and the employment of public funds to make possible such a vast undertaking. These powers, to the extent necessary, were conferred by New Jersey on its commission.

In Leon S. Moisseiff, 21 B. T. A. 515, we held that the Delaware River Bridge Joint Commission and the Port of New York Authority were respectively governmental instrumentalities of Pennsylvania and New Jersey, and of New York and New Jersey, and the compensation received by the petitioner for services performed as an employee thereof was held to be exempt from income tax. We can find no reason to distinguish the present case. Cf. Thomas Fitzgerald, 29 B. T. A. 1113. Likewise in Ralph Modjeski, 28 B. T. A. 1051; 75 Fed. (2d) 468, we held the Delaware River Bridge Joint Commission a governmental instrumentality of Pennsylvania and New Jersey, and the taxpayer, who was chief engineer for the commission, an employee of the commission, and his salary received as such, exempt. So also in George H. Harlan, 30 B. T. A. 804, we held exempt the salary of counsel for the Golden Gate Bridge & Highway District, quoting with approval the Moisseijf case to the effect that “ the construction of bridges has always been regarded as an essentially governmental function.” In the same case we pointed out additional factors as of importance, and they are present in the case at bar, that the district had the power to fix tolls, and that the bridge was part of the highway system of the state.

Finally, it may be added that since a state makes a compact with another only in its sovereign capacity, and to do so under the Constitution (Art. I, sec. 10) must first obtain the consent of Congress, an agency employed for such a purpose, as the New Jersey Interstate Bridge & Tunnel Commission was here, must necessarily be empowered to exercise governmental functions.

We turn now to the next question, Was petitioner an officer or employee of the commission, or merely an independent contractor?

The New Jersey law of 1918, as amended in 1924, provided that the commission should have the sole authority to employ counsel and to pay such counsel’s salary out of the commission’s funds. Moreover, the salary of counsel, unlike those of the engineering staff, did not constitute part of the cost of the tunnel to be borne by the two states jointly, but was paid by the State of New Jersey alone. See Article IY of the agreement between New Jersey and New York quoted above.

Here, as already said, petitioner took an oath of office. He was on a pay roll, which he had to sign. Only the commission’s secretary was on the same pay roll. His duties were not prescribed by statute, but as they embraced all the legal work which the commission had to do, however varied in character, such a statutory description would seem superfluous. He was performing the same work which had earlier been delegated to the attorney general of the state but which became too onerous for that officer to cope with in addition to his other duties. The commission’s counsel was appointed for no definite term, but his duties were continual and required for several years far the greater part of petitioner’s time. His salary was fixed on an annual basis and had no relation to the amount of time which petitioner spent on commission business. In this relation, respondent’s insistence that petitioner kept memoranda of his legal work for the commission indicates nothing more to us than that he was a methodical man, and cannot in the circumstances suggest that it was done in order to afford petitioner a basis on which to calculate his fees. Petitioner had kept such memoranda of all legal work done since he first began to practice law.

The Supreme Court said, in Louisville etc. Railroad Co. v. Wilson, 138 U. S. 501, 505:

The terms “ officers ” and “ employees ” both, alike, refer to those in regular and continual service. Within the ordinary acceptation of the terms, one who is engaged to render service in a particular transaction is neither an officer nor an employee. They imply continuity of service, and exclude those employed for a special and single transaction.

Here petitioner gave all the time that the commission demanded to its legal work, and the extent of his service appears when it is recalled that the commission, notwithstanding its multifarious work, found it unnecessary to employ additional counsel. During the years before us he was in the regular and continual service of the commission. The fact that petitioner also maintained a law office seems to us immaterial. Cf. United States v. Butler, 49 Fed. (2d) 53; Burnet v. Livezey, 48 Fed. (2d) 159.

Respondent’s contention that petitioner was not an employee because the commission did not wholly control petitioner’s legal work is readily disposed of. It was not necessary that there should be complete and detailed supervision of all his work. He was generally at the call of the commission; that he had to rely on his own legal knowledge and experience is immaterial. United States v. Butler, supra. Petitioner here was employed by an agency o.f the State of New Jersey used by the state in extending its highway system, his employment was authorized by statute, he had a fixed salary, signed a pay roll and was generally at the call of the commission; he had a free discretion to perform his professional duties as he liked and maintained his private law office, but his services for the commission were regular, continual, and a paramount charge on his time, and in their performance generally he was the servant of the commission, and not an independent contractor. He took an oath of office, had the responsibility and much of the dignity of a state officer. In all these circumstances, we think it clearly appears that petitioner was not an independent contractor as defined in Metcalf & Eddy v. Mitchell, supra, but a state employee performing an essentially governmental function.

We hold petitioner’s salary of $1,500 a year, therefore, for all the years in question, immune from Federal taxation and find no deficiency in the three proceedings before us.

Reviewed by the Board.

Judgment will T>e entered under Rule 50.


author: SteRNI-iagen :

text:
    First National Bank of Birmingham, Guardian of Leta Duffy Shropshire, Petitioner, v. Commissioner of Internal Revenue, Respondent. First National Bank of Birmingham, Guardian of Courtney W. Shropshire, Jr., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 60667, 60668.
    Promulgated December 5, 1934.

      Grampion Harris, Esq., for the petitioners.

      John D. Kiley, Esq., for the respondent.
   OPINION.

SteRNI-iagen :

Respondent determined deficiencies of $4,812.50 and $4,816.04 in income taxes for 1929, by basing the profit on sales of stocks acquired by bequest, upon the values of the stocks at the djjie of the testator’s death. Petitioners contend that the basis is the fair market value at the date of actual distribution. The facts are stipulated.

Leta Duffy Shropshire, mother of the two minor petitioners, died testate, March 18,1920. At that time she owned, among other property, 30 common shares of the Ohio River Sand Co. These shares passed by clause third or fifth, bequeathing all corporate stocks, bonds, cash, and other personal property not otherwise disposed of to decedent’s husband and their surviving children equally. -In the will the testator directed that these shares should not be disposed of to anyone but her sisters or brothers or until after their refusal, the intention being expressed to keep them in decedent’s family.

The will was admitted to probate April 13, 1920, and executors were appointed. In June 1921, or thereabouts, the executors rendered an account showing no outstanding claims against the estate, and this account was approved by the probate court. Up to this time the shares were worth $1,000 each. Thereafter the corporation, by stock dividend and otherwise, readjusted its capital structure, but these need not be set forth because the parties are not in controversy as to how they shall be taken into account.

The estate remained open until February 1, 1929, when by final decree it was settled and the executors discharged. On that date the fair market value of the common was $450 a share. Thereupon, on May 11, 1929, delivery was made to each petitioner of the 100 shares of common to which he was entitled. On that date each common share was converted into 2% first preferred, 4 second preferred, and 10 common. On July 13, 1929, each sold all but 300 common for $44,500.

The Commissioner takes the value in 1920 or 1921 as the basis for gain or loss, and the deficiency which would result from that computation is stipulated. The petitioners contend that the proper basis is the value on February 1, 1929, and upon that hypothesis the resulting deficiency is also stipulated.

Respondent at first regarded the shares as acquired by petitioners by specific bequest, thus by section 113 (a) (5), Revenue Act of 1928, necessitating a basis of the fair market value at the time of death. But this contention is no longer argued and can not be sustained. The shares were acquired by a general legacy. Kenaday v. Sinnott, 179 U. S. 606; Willis v. Barrow, 218 Ala. 549; 119 So. 678. As to this, section 113 (a) (5) provides that the basis shall be the fair market value of the property at the time of the distribution to the taxpayer.”

That there was no actual distribution of the estate until 1929 is clear, and the petitioners’ position is literally within the statute. But respondent urges that there may be distribution without manual delivery and that such distribution must -be taken to have occurred in 1921, when it was apparent that debts would not impair the receipt by the legatees of these shares. He cites Alabama law to the effect that actual distribution might have been ordered at the end of a year if applied for or insisted upon. But such an order would only be founded on more evidence than we have in this record. We could not say that there was an undue or capricious delay in actual distribution. , If we are to make any assumptions, it is more reasonable to suppose that the estate was closed as soon as possible than that it was unnecessarily held open. Where the inferences are evenly balanced, regularity and efficiency should be inferred rather than unwarranted delay. If there were evidence of capricious delay, there would be justification for entertaining the idea of constructive distribution, but such evidence must be more than the executor’s tentative report of no claims against the estate. Cf. J. H. Anderson, 30 B. T. A. 1274; Lillie V. Kohn, 16 B. T. A. 662; Garrett J. Donnelly, Executor, 31 B. T. A. 577.

It should be noted that the change in the language of the Revenue Act of 1928 impairs the value of precedents such as Brewster v. Gage, 280 U. S. 327, and Lillie V. Kohn, supra. See also Report of Senate Finance Committee on Revenue Bill of 1928 (70th Cong., 1st sess., Sen. Kept. 960, p. 26) indicating that certainty and uniformity were important purposes of the statutory change.

Judgment will be entered in aceordcmee with the stipulation upon the basis of the vahue in 19H9.