author: ARNOLD:

text:
    E. C. Gatlin, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 68444.

    Promulgated March 6, 1936.

      Philip D. Johnston, Esq., for the petitioner.

      Eugene G. Smith, Esq., for the respondent.
   OPINION.

ARNOLD:

Under the above state of facts was the $135,223.28 received by petitioner from Pacific Factors, Inc., prior to the incorporation of petitioner’s business, income to petitioner from the sale of his accounts, or was it money advanced to him in the nature of loans? Respondent contends that under the contract of March 15, 1929, petitioner sold and Pacific Factors, Inc., bought outright the accounts of petitioner’s customers and the use of the words, sale and purchase, and other like expressions in the contract are controlling on the issue here presented. He further contends that any evidence tending to prove the moneys received from Pacific Factors, Inc. were received as advancements in the nature of loans, is in conflict with the contract of March 15, 1929, and is incompetent, and that such construction would be in effect placing the stamp of approval on a contract in violation of the law of California as to usury. While the contract carries language indicating a sale and purchase of the accounts, we should consider the whole contract and all facts and circumstances in connection with the method of conducting the business to ascertain the merits of the controversy. Pacific Factors, Inc., advanced petitioner 80 percent of the face value of the accounts which was determined as the accepted value. Petitioner was charged with a discount at the rate of 1¾ percent per month, prorated per day until the amounts received were repaid. This discount was not taken when the money was advanced but collected when repayment was made by a charge against petitioner. This so-called discount of 1½ percent per month, prorated per day over the time required to make collections, was equivalent to interest at the rate of 15 percent per annum during the time petitioner had the use of the money. In addition to that there was a service charge of ½ of 1 percent of the accepted value of the accounts in the schedules. Petitioner was required to take up the schedules listing accounts which were not paid and substitute new schedules of accounts, or pay the difference between the amount advanced and the amount collected in cash. The schedules were then returned to petitioner. Collections on accounts in schedules returned to petitioner were retained by him. Pacific Factors, Inc., never had the accounts in its possession and had nothing to do with their collection. Pacific Factors, Inc., brought suit to recover the amount it claimed petitioner owed it, which shows that it considered the transactions as loans. The method of handling the business indicates petitioner considered it as advancements in the nature of loans. It is proper in the construction of contracts to take into consideration the acts of the parties themselves under the contract in arriving at the true intention of the parties in entering into the contract. This does not do violence to the rule against varying the terms of a written contract by parol. 13 Corpus Juris, p. 546, sec. 511; 13 Corpus Juris, p. 549, and cases thereafter cited. Woodard v. Glenwood Lumber Co., 153 Pac. 951; 171 Calif. 513. In the appeal of J. W. Solof, 1 B. T. A. 716, acquiesced in by the Commissioner, evidence was held admissible to show that a transaction with a bank, while in the form of a sale of stock to the bank, was a pledge for a loan and the amount so received was not proceeds of a sale but a loan to taxpayer.

In Peugh v. Davis, 96 U. S. 332, it was held that the rule against varying or contradicting writings by parol evidence obtained only in suits between, and was confined to, the parties to the contract and their privies and had no operation with respect to third persons, or even the parties themselves in controversy with third persons. Sigua Iron Co. v. Greene, 88 Fed. 207; O'Shea v. New York C. & St. L. R. Co., 105 Fed. 559; Mitchell v. McShane Lumber Co., 220 Fed. 878. See also Gates v. Helvering, 69 Fed. (2d) 277, affirming 26 B. T. A. 998, on the points here involved. In William J. Snyder, 11 B. T. A. 807, an, absolute conveyance for a recited consideration of $23,385.41, receipt of which was acknowledged in the instrument, was shown to be a conveyance in trust, the proceeds of sale to be used by trustee to pay grantor’s debts, and the acknowledged consideration not taxable to grantor as income. In First National Bank in Wichita, 19 B. T. A. 144; aff'd, 57 Fed. (2d) 7, a customer of the bank, a dealer in securities, could not get a sufficient line of credit by direct loans on account of the limitations of the Federal banking laws. Certain tax-exempt bonds were turned over to petitioner bank, under a contract on its face a sale and purchase, with a repurchase agreement. Interest coupons on the bonds at maturity were delivered to the customer, who collected them and paid the bank at a rate of interest provided to be paid in the sale and repurchase agreement. Taxpayer claimed it acquired complete title to the bonds, and as the interest on the bonds was tax exempt it was entitled to exclude such interest from his income tax returns. Holding against petitioner’s contentions, the Board said:

The question here, as we view it, is not dependent upon who held the bare legal title to the bonds during the dates of sale and repurchase, but rather upon the broader issue as to whom, under the understanding between the bank and its customers, was entitled to receive, and who, as carried out, did receive the interest payments made by the issuing authorities of such bonds when collected and paid. The record shows that the true relationship between the petitioner and its customers, in these transactions, was that of a lender of money in consideration for the legal rate of interest payable on the amount advanced, and not that of an investor in the securities assigned to it by such customers. The history of these transactions and the manner in which they were carried out can lead to no other conclusion.
*******
The true relationship between the petitioner and the customer, in these transactions, was that of borrower and lender, in which the securities were employed as a mere convenience. In these circumstances, the ad interim ownership of the bare legal title to the bonds would not affect the character of the transactions between the parties or change their true relationship. Peugh v. Davis, 93 U. S. 332; Jackson v. Laurence, 117 U. S. 679; Morris v. Nixon, 1 How. 117; and see also Russell v. Southard, 12 How. 139.

Also compare Sioux Falls Metal Culvert Co., 26 B. T. A. 1324. Arthur R. Jones Syndicate v. Commissioner, 23 Fed. (2d) 833, reversing Arthur R. Jones Syndicate, 5 B. T. A. 853.

Arthur R. Jones Syndicate v. Commissioner, supra, was a case where resort was had to a scheme to issue and in form sell preferred stock "and provide for dividends to be paid at the rate of 14 percent per annum to avoid the transaction from being usurious under the Illinois law. Notwithstanding it violated the Illinois law as to usury and the form of the transaction was an outright sale of the preferred stock, it was held to be a loan and the usurious interest deducted from taxpayer’s income. The Seventh Circuit Court of Appeals, in reversing the Board, said :

But the better reasoning sustains the view that a borrower whose necessities lead him to the door of the usurer may always show — by evidence aliunde the contract — the real character of the transaction. The very necessities of the borrower who pays a usurious rate of interest make it necessary for courts to admit his oral testimony to dispute his written word. Houghton v. Burden, 228 U. S. 161, 170, 33 S. Ct. 491, 57 L. Ed. 780, 27 R. C. L. 212. For an additional reason such evidence is admissible against third parties. [Citing authorities.]
⅜ ⅜ ⅜ * * * ⅜
We therefore conclude that a taxpayer who borrows money at a usurious rate of interest and who, to conceal the usury, is compelled to execute a document which does not correctly describe the relationship of the parties, may, as against the government, disclose the true relationship of debtor and creditor. Sums by it paid as interest, regardless of the name by which it is called, may be deducted by the taxpayer from its income.

We hold the $135,228.28 received by petitioner from Pacific Factors, Inc., was advancements in the nature of loans and not money received outright on sales to be accounted for as gross income. The moneys received by petitioner from his customers should be included in his gross income.

Petitioner contends that the unsold goods in the hands of his customers at the time the business was incorporated was out on consignment and should therefore be included in the inventory at the time of incorporation and not treated as gross income from sales. Under Regulations 74, article 101, applicable to the year in question, it is provided that only merchandise, title to which is vested in the taxpayer, should be included in the inventory and that there should be excluded from the inventory goods sold, title to which had passed to the purchaser. The Grape Juice Concentrates were sold and delivered to petitioner’s customers and a bill for the purchase price was rendered when the merchandise was shipped. Under the contract between the petitioner and his customers and the method of billing and handling the accounts, it was a sale and purchase on a deferred payment plan, with the obligation on the part of the petitioner to repurchase such quantities as were not sold in accordance with the terms of the contract. Petitioner so treated it in his dealings with Pacific Factors, Inc. The schedules delivered to Pacific Factors, Inc., contained a list of accounts, together with bills of lading, and petitioner in the schedules on which he received money certified to Pacific Factors, Inc., that the amounts listed were due and owing to him" in the amount specified for personal property sold and delivered; that the accounts listed in the schedules were undisputed, open accounts for bona fide sales and deliveries of merchandise; that there were no offsets or counter claims. A form of contract between petitioner and his customers was submitted in evidence as an exhibit, in which the transactions were treated as sales, and provided for repurchase of any unsold portions of grape concentrates if the required amount had not been resold by him. Under such circumstances, the merchandise outstanding which petitioner had not repurchased or revested title in himself should not be included in the inventory of property taken over by the corporation.

Judgment will be entered under Bule 50.


source: Caselaw Access Project

author: Sternhagen :

license: Public Domain

text:
    John K. Howard, John Gaston, Roger Amory, William H. Claflin, Jr., Trustees Under the Will of William A. Gaston, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 52163, 62309.
    Promulgated March 6, 1936.

      Edward G. Thayer, Esq., and Earle W. Garr, Esq., for the petitioners.

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

Sternhagen :

The respondent determined a deficiency in the income taxes of the petitioner trust of $2,082.92 for 1928 and $4,100.37 for 1929 by disallowing a deduction taken by the trustees for each year of the net income of the trust which was distributed by them to the beneficiary. The facts are stipulated and need only to be briefly stated for the purpose of the decision.

William A. Gaston, the decedent, died July 17, 1927, and the petitioners are the trustees under his will. The trust received income (omitting immaterial adjustments) of $29,984 in 1928 and $51,246.13 in 1929, and these amounts it distributed to the surviving widow by virtue of article 21 of the will. This article, condensed to its essentials, is as follows:

All the residue of my property * * * I give, * ⅜ * to my trus- ■ tees * * * in trust ⅜ * ⅜ to pay the income quarterly or oftener to my wife, May L. Gaston, for life, * * *. The trustees may also, in case in their discretion they deem it proper and advisable, pay to my wife from time to time any portions of the principal of the trust property in case they believe her income to be insufficient for her own reasonable individual personal needs.

In their fiduciary return the trustees acting, as they thought, under Revenue Act of 1928, section 162 (b), took as a deduction the amount of the distribution to the life beneficiary, which consisted of the entire income.

The Commissioner contends that the estate is entitled to no such deduction and cites Helvering v. Pardee, 290 U. S. 365, and Hartford-Connecticut Trust Co. v. Eaton, 8 Fed. Supp. 218. This is upon the theory that the trustees’ discretion to pay to the wife a part of the principal if believed necessary to supply her individual needs operates to make her entire right to distribution a charge against the principal, and thus no more to be ascribed to income alone than a fixed annuity would be. This, however, ignores the twofold character of the beneficiary’s interest. As to the income of the trust the trustees have no discretion whatever; they are bound to distribute all. The net income is “to be distributed currently by the fiduciary to the beneficiary”, Avhich is literally within the statute. Nothing else in the will affects this clear right of the life beneficiary. It is not described in terms of a fixed amount and has none of the characteristics of an annuity, cf. Burnet v. Whitehouse, 283 U. S. 148, but gives the widow the rights and obligations of an income beneficiary of the trust, Irwin v. Gavit, 268 U. S. 161, and not of a legatee, cf. Boston Safe Deposit & Trust Co. v. Commissioner, 66 Fed. (2d) 179; Bridgeport-City Trust Co., Trustee, 32 B. T. A. 1181 (on review C. C. A., 2d Cir.); Houston Land & Trust Co., Trustee, 33 B. T. A. 73; Old Colony Trust Co., Trustee, 33 B. T. A. 311. The provision for the discretionary distribution to the widow from corpus is separate and supplemental. The trustees may not, in their discretion, choose to satisfy the widow’s rights by distributions from principal. There is no room for doubt as to whether a distribution is from income or principal. To the extent that there is income, the duty is to distribute it to her; and if no more than the amount of income is distributed, the distribution is necessarily charged to income. In the present case, that is precisely what occurred, the distribution being of all the income and no more. It is, therefore, not a matter for present decision as to how the trustees’ taxes may he affected by a discretionary distribution out of principal.

The Commissioner states his contention thus, “that it is only when the trustees are permitted to distribute nothing but income that the distribution is to be treated as income and therefore deductible under the Butterworth case, and that as soon as the trustees have a discretion to do something else, that colors every distribution that is made with the character of something besides income and thus brings it” within the Pardee case.” This we are unable to sustain in a case such as this where the trustee is under two separate duties, one of which is to distribute income and the other to exercise his discretion as to the distribution of corpus. . We need say nothing about such a contention if the trustees were under a single duty to make a distribution which, for one reason or another, is not necessarily to be identified with trust income. Here the distribution is, by virtue of the trust itself, necessarily identified with income, and we see no reason to say that the further power of the trustee serves to change or becloud the character of the distribution so as to attract the doctrine of the Pardee case.

Judgment will be entered for the petitioners.

       SEC. 162. NET INCOME.
      The net income of the estate or trust shall be computed In the same manner and on the same basis as in the case of an individual, except that—
      ****** *
      (b) There shall be allowed as an additional deduction in computing the net income of the estate or trust .the amount of- the income of the. estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. Any amount allowed as a deduction under this paragraph shall not be allowed as a deduction under subsection (c) of this section in the same or any succeeding taxable 3rear;


author: TURNER:

text:
    John Kehoe and Wife, Sarah Kehoe, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 64609.
    Promulgated March 10, 1936.

      R. M. O'Hara, Esq., Leo W. White, Esq., and W. H. Gillespie, Esq., for the petitioners.

      M. B. Leming, Esq., and H. E. Lucas, Esq., for the respondent.
   OPINION.

TURNER:

It is admitted that the assessment and collection of the deficiency involved in this proceeding is barred by the provisions of section 271 (a) (l) of the Revenue Act of 1926, unless the return filed by the petitioners for the taxable year was false and fraudulent with intent to evade tax, in which case the tax may be assessed at any time, under the provisions of section 278 (a) of the same act. It is also admitted that the petitioners executed a final closing agreement in the form prescribed by section 1106 (b) of the Revenue Act of 1926 and that the assessment and collection of the deficiency here in question is prohibited by that agreement, unless there was “fraud or malfeasance or misrepresentation of fact materially affecting the determination and assessment” of the tax covered by the agreement.

In support of his allegations that the income tax return for the calendar year 1925 was false and fraudulent and the further allegation that petitioner John Kehoe was guilty of fraud, malfeasance, or misrejiresentation of facts materially affecting the determination and assessment which formed the basis for the said final closing agreement, the respondent presented in evidence numerous documents and the oral testimony of a great number of witnesses. The petitioners presented no evidence or proof of any kind. Petitioner Sarah Kehoe rested her case on a motion for no deficiency on the respondent’s admission that she derived no income .from the brewery business and the further admission that she was not guilty of fraud in connection with the assessment and collection of the tax thereon. Petitioner John Kehoe asked for a finding of no deficiency upon the ground that the respondent had failed to sustain the burden of showing fraud, malfeasance, or misrepresentation of fact in connection with the final closing agreement, and, further, that he had not sustained the burden of showing that the original return for 1925 was .false or fraudulent.

The basic question in this case is one of fact and is whether or not petitioner J ohn Kehoe was the real party in interest in the operation of the brewery at Kingston, Pennsylvania, commonly known as Bar-tels Brewery, but often referred to during the period here in question as the Patrick F. McGowan Brewery. It is strenuously argued that the respondent has failed to show any connection between petitioner John Kehoe and the operation of the brewery business, except through the testimony of Patrick F. McGowan, whose credibility is seriously questioned. On the other hand, the respondent has made much of the fact that petitioner J ohn Kehoe was present throughout the hearing and failed to take the stand to refute the allegations made against him and to deny in any way whatsoever the statements made by the various witnesses which tended to show that he was the operator of the brewery.

Regardless of whether or not McGowan’s testimony, standing alone, would be considered sufficient to sustain the respondent’s allegations, and regardless of any inferences that might be drawn from the failure of the petitioner to take the stand or to present other evidence, the facts, circumstances, and happenings described and disclosed by documentary proof and the testimony of witnesses convince us that the petitioner was the real party in interest in the operation of the brewery during the taxable year. Furthermore, we had the opportunity to observe the witness McGowan on the stand, and we have carefully examined the transcript of his testimony, and we believe that McGowan told us the truth. Many of the specific events and happenings which make up the entire picture have been set forth in our findings of fact. Others might be described, such as the conference held in the office of Evan C. Jones, on the night in December 1924, just prior to the hearing on the revocation proceedings, when McHugh, the known manager of the brewery, introduced John Kehoe as his boss to the witness Mullaghy, yardmaster for the Lackawanna Railroad, who had been called in for a discussion of the circumstances surrounding the seizure of the four cars of beer in the railroad yards. However, there is no doubt in our minds that John Kehoe owned the brewery business, and a further recital of events or review of evidence to show his connection therewith would serve no useful purpose.

Further, the petitioner argues in substance that there is no direct evidence of the actual payment to him of money during the taxable year from the brewery or any other source and that, regardless of the facts and circumstances that may be disclosed by the record, the respondent’s charge of fraud fails. It is, of course, elementary that actual physical payment of money to the petitioner is not essential to a determination against him. We have found as a fact that the brewery business was his, and that McHugh, McGowan, and others were his employees. Any of the proceeds of the brewery business coming into their hands would be chargeable to the petitioner, regardless of whether he ever had actual physical possession of the money. It should also be kept in mind that the operation of the brewery at the time and in the manner described in this proceeding was extremely hazardous. The margin of profit was necessarily great, and success was largely dependent upon the ability of those so engaged to make no direct record in writing or otherwise of the things done and the transactions completed. It does not follow, however, that the absence of the usual written records and customary books of account showing the receipt of income means the absence of other proof equally as positive and convincing as any written record that might be presented.

That such is the situation here is clearly shown by a resume of some of the known facts. We know that the near beer business was a front for the under-cover manufacture and sale of the so-called high powered beer; that the records kept at the brewery covered only the near beer business, the proceeds of which were not sufficient to keep the brewery open; that the freight on the high powered beer shipped by rail was in excess of the entire sales shown on the brewery books; that the employees were paid a cash bonus of $8 weekly, which was furnished by McHugh, and was not reflected in the books of account; that, in spite of a loss of $82,325.97, reflected by the brewery books for the year 1925, on a gross business of $97,713.19, the petitioner was actively engaged in securing and did secure a renewal of the permit for operations in 1926; that on such a business only approximately $30,000 is disclosed in the bank records during the taxable year; that with the exception of one month in 1924, McGowan’s salary for the years 1924, 1925, 1926, and 1927 was paid in cash either by the petitioner or McHugh; that Harry Kenny paid cash to the petitioner for eight carloads of beer bought by him in 1924; that the price of high powered beer, in 1925, ranged from $12 to $17 per barrel; that approximately 885 carloads of such beer were shipped from the brewery over the Delaware, Lackawanna & Western Railroad Co. lines in 1925; that freight on these shipments in the approximate amount of $98,648.60 was paid in cash by McHugh, Kearns, and Tom Kehoe; that a carload of beer was approximately one hundred barrels, and by applying the minimum price of $12 per barrel, these shipments represented sales aggregating at least $1,062,-000; and, further, we know that a beer broker by the name of William Y. Loughran, of Scranton, Pennsylvania, often during the taxable year sent envelopes which at times were known to contain money to the petitioner’s office in Pittston. The messenger was told to deliver them to McHugh, but on one occasion they were accepted by Tom Kehoe, the petitioner’s brother.

These and other facts previously stated in our findings lead us to the conclusion that large amounts of income were received in cash by or for the petitioner from the operation of the brewery in 1925, and that the receipt of this income has never been reported nor disclosed by him. To hold otherwise would be to ignore the obvious. He not only failed to disclose and report in his return the income from the operation of the brewery, but has at all times denied and still denies any connection whatever with its operation. We accordingly hold that the return of petitioner John Kehoe for 1925, was false and fraudulent with intent to evade tax and that under the provisions of section 278 (a), supra, the tax may be assessed at any time.

We further hold that the facts disclosed definitely show fraud, malfeasance, and misrepresentation of facts materially affecting the determination and assessment of the tax covered by the final closing agreement and that the respondent, acting with the approval of the Secretary of the Treasury, was justified in going behind the said closing agreement in making the determination which forms the basis of this proceeding. Holmes & Janes, Inc., 80 B. T. A. 74. We have found that the petitioner, with intent to evade tax, failed to report in his return income received from the operation of the brewery and on the record it is apparent that he made no disclosure of such income at the time of executing the closing agreement, nor at any other time. While the filing of a return and the signing of a closing agreement are separate and distinct and fraud in one does not necessarily indicate fraud in the other, the same or a continuing act, that of wilfully concealing income, may be, and on the facts in this case, is a sufficient basis for finding that the return was fraudulent with intent to evade tax and further that there was a misrepresentation of a material fact in the execution of the closing agreement. Cf. Thomas J. Ingram, 32 B. T. A. 1063, and Ethel H. Hoge et al., Executors, 33 B. T. A. 718.

The petitioner contends that the respondent has not only the burden of proving fraud in order to overcome the defense that the period within which the tax may be assessed has expired, but also has the 'burden of proving the amount of the tax. Or, in other words, it is the petitioner’s contention that in cases where the respondent charges fraud and the burden of showing fraud is placed upon him by the statute, his determination of a deficiency is not prima facie correct as in cases where fraud is not involved. In support of this contention the petitioner relies upon Taplin v. Commissioner, 41 Fed. (2d) 454; Budd v. Commissioner, 43 Fed. (2d) 509; and Central Union Trust Co. of New York, Executor, 25 B. T. A. 757. These cases are not in point. In the first case cited, it does not appear that fraud was pleaded and the court held that the petitioner had presented plausible testimony showing error in the determination of the deficiency and that this testimony had not been contradicted except by inference. In the two remaining cases the respondent failed to sustain the burden of proving fraud and there was no occasion to consider and determine the question here raised by the petitioner. In this case the respondent has sustained that burden. While it is usually true that in order to show that a return is false and fraudulent with intent to evade tax, it is necessary to prove the receipt of income not reported by the taxpayer in such return, but, once it is shown that the return is false and fraudulent, the burden of proving the respondent erred in determining the deficiency is on the petitioner. The issues are clearly separate. L. Schepp Co., 25 B. T. A. 419, 436. Here the petitioner introduced no evidence to show that the amount of the deficiency as determined by the respondent is erroneous, but elected to stand on the fraud issue alone. Having resolved the fraud issue against the petitioner, the respondent is affirmed on this issue.

Furthermore, we are of the opinion that, even if the rule were as contended for by the petitioner, the determination of the respondent should be sustained. The evidence clearly indicates gross receipts from the operation of the brewery in an amount much greater than the amount upon which the computation of the deficiency here under consideration was based, and we do not understand that the respondent, even under petitioner’s theory, should also be required to prove his deductions for him.

We have found as a fact that the deficiency herein was due to fraud with intent to evade tax, and' on that finding the penalty determined by the respondent attaches as provided by statute. Sec. 275 (b), Kevenue Act of 1926.

The final issue relates to the! liability of Sarah Kehoe. No proof was offered by either party and this issue was submitted on a motion for a finding of no deficiency, the basis for the motion being the admissions contained in respondent’s answer.

The notice of determination of deficiency was addressed to “Mr. and Mrs. John Kehoe.” The petition herein is a joint petition and designates John Kehoe and Mrs. John Kehoe as the petitioners. It was signed and verified by each of them. In paragraph 1 thereof the petitioners describe themselves as individuals, husband and wife, residing at 143 William Street, Pittston, Pennsylvania, and state that they filed a joint return of their income for the year 1925. In paragraph 5 (a) of the petition, which contains the allegations of fact as to the return, it is alleged that on or about March 15, 1926, the petitioners, being husband and wife, duly filed a joint return of their income on form 1040, provided therefor by the Bureau of Internal Revenue. They also plead the statute of limitations and the execution of a final closing agreement. The respondent, in paragraph 1 of his answer, admits that the petitioners are individuals, residing at 143 William Street, Pittston, Pennsylvania, and that they are husband and wife, but in paragraph 5 denies that they filed a joint return of their income, and in connection with this denial, alleges that on March 15, 1926, petitioner John Kehoe filed an income tax return, whereon he answered in the affirmative the question, “Is this a joint return of husband and wife?” and alleges further that the said return was executed and signed by John Kehoe and by no other person. Further, in the answer, after admitting that none of the income involved in this proceeding was income to Sarah Kehoe, and that she was guilty of no fraud, malfeasance, or misrepresentation of a material fact in connection with the closing agreement, the respondent concludes with a prayer for a determination that the final closing agreement was induced by the fraud and deceit of John Kehoe, that the return of John Kehoe was false and fraudulent, and that the assessment of the tax against him might be made at any time. The answer asks for no determination as to Sarah Kehoe.

In their reply the petitioners admit the respondent’s allegation that John Kehoe filed an income tax return for the calendar year 1925, whereon he answered in the affirmative the question, “Is this at joint return of husband and wife?” and further admit that the said return was executed by John Kehoe and no other person.

Although the nature of the return filed by John Kehoe was put in issue by the respondent’s denial that it was a joint return, no proof was submitted, by either party, other than the return itself,, and it disclosed nothing that was not already covered by the pleadings. Obviously the pleadings do not show that the said return was or was not the joint return of the petitioners.

On this state of the record petitioner Sarah Kehoe asks for a finding of no deficiency, while the respondent argues for a determination of the full deficiency and penalty against her, and as a basis for this argument assumes the filing of a joint return by the petitioner’s, John Kehoe and Sarah Kehoe, contending on this assumption that there is joint and several liability. Regardless of whether there is joint and several liability where a joint return by husband and wife is filed and a determination based on such a return is made, the respondent by his answer has precluded such .an argument in this case. The assumption of a joint return is directly contrary to the allegations contained in the answer, which has not been amended and with reference to which no request to amend has been made.

It thus appears that the respondent has not proved the filing of a false or fraudulent return except in the case of a return which he alleges was executed and signed by John Kehoe alone and which he denies was a joint return. The record does not show the filing of a false or fraudulent return by or for the petitioner, Sarah Kehoe. On these facts, supplemented by the admission that none of the income herein involved was the income of Sarah Kehoe and the further fact that she was guilty of no fraud or malfeasance in connection with the closing agreement signed by her, her claim of ne deficiency is sustained.

As to the petitioner, John Kehoe, decision will he entered for the respondent. As to the petitioner, Sarah Kehoe, decision will he entered for the petitioner.

       Sue. 277. (a) Except as provided in section 278—
      (1) The amount of income taxes imposed by this Act shall be assessed within three years after the return was filed, and no proceeding in court without assessment for the collection of such taxes shall be begun after the expiration of such period.

       Sec. 278. (a) In the case of a false or fraudulent return with intent to evade tax or of a failure to file a return the tax may be assessed, or a proceeding in court for'- the collection of such tax may be begun without assessment, at any time.

       Sec. 1106. (b) If after a determination and assessment in any case the taxpayer has paid in whole any tax or penalty, or accepted any abatement, credit, or refund based on such determination and assessment, and an agreement is made in writing between the taxpayer and the Commissioner, with the approval of the Secretary, that such determination and assessment shall be final and conclusive, then (except upon a showing of fraud or malfeasance or misrepresentation of fact materially affecting the determination or assessment thus made) (1) the ease shall not he reopened or the determination and assessment modified by any officer, emloyee, or agent of the United States, and (2) no suit, action, or proceeding to annul, modify, or set aside such determination or assessment shall be entertained by any court of the United States.


author: Mellott:

text:
    The Bettendorf Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 68246.
    Promulgated March 10, 1936.

      K. W. Welsch, Esq., and A. J. Kreuger, Esq., for the petitioner.

      €. B. Marshall, Esq., for the respondent.
   OPINION.

Mellott:

The petitioner appeals from a determination by the respondent of a deficiency in income tax for the calendar years 1929 and 1930 in the amounts, respectively, of $6,726.94 and $8,519.84, and claims an overpayment of not less than $124.37 for the year 1930.

Two issues are raised by the pleadings, but upon the second, which relates to certain expense items incurred and paid by petitioner-in 1930, no evidence was submitted. The first issue, and the only one submitted to us, is whether or not respondent erred in increasing; petitioner’s taxable income for the years 1929 and 1930 by including therein interest admittedly due from the Zimmerman Steel Co. and the Westco Pump Corporation for those years, but not accrued by petitioner upon its books or reported in its returns of income.

All of the facts, which were stipulated, have been carefully considered. The following summary of them, however, will be sufficient for present purposes.

The petitioner is a corporation duly organized and existing under the laws of the State of Iowa. It was incorporated in 1913, and maintained its principal office and place of business at Bettendorf, Iowa. It kept its books, records, and accounts on the accrual basis and its income tax returns, which were duly filed, were made upon the same basis.

J. W. Bettendorf — now deceased — was an officer and the principal stockholder of three corporations, the Bettendorf Co., petitioner-herein, which will hereinafter be referred to as “petitioner”; the-Zimmerman Steel Co., which will hereinafter be referred to as the-“Steel Co.”; and the Westco Pump Corporation, which was formerly the Westco-Chippewa Pump Co., which in turn was the successor on reorganization of the Western Pump Co., all of which will hereinafter be referred to as the “Pump Co.” During the taxable years his interests in said corporations were as follows:

Petitioner — “An officer ancl the principal stockholder” (Stip. 13).
Steel Oo. — 1855 of a total of 3425 shares common — 84.534 in 1929 and 139.515 in 1930 of a total of 2232.325 shares preferred.
Pump Co. — 6331 of total 9863 shares common and 440 of a total of 1000 shares preferred (31).

While the businesses of the three corporations were apparently somewhat related, the corporations were not affiliated or subsidiary, each maintaining its distinct and separate entity. Both the Steel Co. and Pump Co., however, borrowed extensively from the petitioner, and this controversy arises over the interest due it upon such loans. Petitioner, contending that such interest “should not be included in its gross income for those (the taxable) years for the reason that such interest was uncollectible, and for the further reason that there was no assurance that it would ever be received” (quotation from its brief), did not report such interest; but the respondent added the amount, admittedly due, to its income and determined the deficiency.

The following table shows the situation during the period from 1923 to 1930 with respect to all interest due to petitioner from the Steel Co. and Pump Co.

The amounts appearing in the above table under the heading “admitted to be due”, were accrued on the books of the Steel Oo. and Pump Co., deducted by them on their income tax returns, and the deductions were allowed by the revenue department. Petitioner, however, having accepted notes of the companies for the years 192T to 1930 in lesser amounts ($1), accrued upon its accounts said lesser amounts and reported them as income. Respondent, asserting that the same amounts which were deducted by Steel Co. and Pump Co. should have been reported by petitioner as income accrued, determined the deficiency by including them, as follows:

Petitioner, admitting that it changed its method of treating the interest due from Steel Co. and Pump Co. in 1927, and admitting that the amounts due are as shown above, seeks to justify its failure to report such amounts for taxation, claiming, as such justification, the history of said companies as shown in detail in the stipulation. We shall therefore advert with some particularity to such history.

Steel Co. was first incorporated in 1914. In 1915 J. W. Bettendorf purchased 250 shares of its capital stock. In 1916 he purchased some of its preferred stock. In 1919, by action of its creditors, the company was placed in the hands of a creditors’ committee and Bettendorf was appointed as its managing director, in which position he continued until 1923. A reorganization and recapitalization occurred in that year, after which Bettendorf was elected president, and he held such office until his death, which occurred in 1933.

After the reorganization of the Steel Co. it operated at a loss for the years 1923 to 1927, both inclusive, but during the years 1928, 1929, and 1930 it operated at a profit. Its record of profits and losses for said years is, as follows:

Deficit, 1&22. $28,457.87
Loss:
1923-46, 589. 03
1924_ 101, 599. 68
1925_ 147,197. 35
1926— 45, 027. 06
1927 — —. 55,282. 60
Profit:
1928 — . 35,998.98
1929_ 108, 097. 25
1930— 1, 496. 53

Its net operating deficit December 31, 1928, was $388,154.61, December 31, 1929, $280,057.36, and December 31, 1930, $278,560.83.

During the years 1921 to 1930, inclusive, petitioner made various cash advances to Steel Co. and charged against it various items of interest. Certain payments upon account were received and there is shown in the following table a summary by years of all such transactions.

Aside from the notes receivable due from the Steel Co., petitioner had no financial interest in said company prior to or during the taxable years. The notes were demand notes, bearing interest at rates of 6 percent and 5 percent, but were unsecured except as hereinafter shown.

In addition to the amounts borrowed from petitioner, Steel Co. also borrowed from banks, its notes payable to banks aggregating during the years in question, the following: 1928, $130,000; 1929, $82,000; and 1930, $82,000.

It paid the banks upon its indebtedness the sum of $48,000 in 1929, and during the same year paid petitioner the sum of $44,-829.35 upon its notes. While no written evidence could be found guaranteeing Steel Co.’s notes to banks, it is apparent, and we find as a fact, that J. W. Bettendorf had orally agreed that such notes should be paid ahead of the notes due petitioner. On September 21, 1931, petitioner paid the $82,000 due from Steel Co. to banks, and received in consideration therefor Steel Co.’s note in that amount. (See schedule above.)

While petitioner’s notes from Steel Co. were unsecured during a portion of the taxable period, on December 29, 1929, two Guaranty Life Insurance Co. policies for $100,000 each, on the life of Arthur K. Beading, general manager, were secured by and for the benefit of Steel Co. and assigned to petitioner on January 7, 1930, as security for said notes. The policies had no cash surrender value until after payment of the third annual premium, due in December 1931. The insured named in said policies is still living.

An additional circumstance bearing upon the interest due from the Steel Co. to petitioner is reflected in paragraphs 11 and 12 of the stipulation, which we set out herein, substituting the name “Steel Co.” for the name “Zimmerman Co.” therein contained.

(11) The total sales of “Steel Co.” for the years 19191 to 1933, inclusive, segregated to show sales to one customer, International Harvester Company, and to all other customers, were as follows:

(12) During the years in which “Steel Co.” received business from International Harvester Company, as set forth in (11) above, officers and employees of the latter company, using such business with “Steel Co.” as a “lever” endeavored to sell pig iron (to be furnished by Wisconsin Steel Company, a subsidiary of International Harvester Company) to the Bettendorf Company (petitioner herein). As a result of negotiations between International Harvester Company, “Steel Co.”, and the Bettendorf Company, the latter company purchased 1,000 tons of pig iron from Wisconsin Steel Company in June, 1930. This purchase was made to enable “Steel Co.” to retain the business referred to above. Because of business conditions in 1930 and thereafter, the Bettendorf Company was unable to make further purchases from Wisconsin Steel Company. In the absence of such purchases, the officers of The Bettendorf Company and “Steel Co.” were, during the taxable years, of the opinion that the business of “Steel Co.” with International Harvester Company would be lost. The situation described' above did result in the loss of most of the requirements of International Harvester Company, as indicated in (11) above. The reduction in volume of “Steel Co.” sales to International Harvester Company was also produced by the general business depression which reduced the requirements of International Harvester Company for the kind of products produced by “Steel Co.”

The principal assets of Steel Co. as shown in the balance sheet attached to the stipulation, consisted of plant property and equipment, accounts receivable, merchandise, and patents. Its liabilities and assets as per its books, in condensed form, were as follows:

The history of the Pump Co. is likewise set out with some particularity in the stipulation, but we shall set out herein only the substance of the stipulated facts.

Pump Co. was first incorporated in 1918, with its principal office and place of business at Moline, Ill. It acquired a license contract for the manufacture, use and sale of a new type rotary pump. The pump first produced failed to perform satisfactorily and it was necessary to conduct extensive experiments and to make extensive replacements of pumps sold to customers on approval, the money for which was obtained in large part by the issuance of capital stock and bonds. The stipulation does not disclose the relationship of petitioner and its stockholders with said Pump Co. during the early years of its existence, but merely recites that J. W. Bettendorf “became interested in” it in 1921, at which time he purchased some of its common stock. During that year, petitioner advanced to Pump Co. $86,001.50 and during the following year (1922) $102,503.79, taking its demand notes for said amounts.

In 1923 a new corporation was organized, which took over all the assets and liabilities of the old Pump Co. and the old company was liquidated. The new company issued common stock to the old stockholders for total cash of $117,500.

The Pump Co., like the Steel Co., operated at a loss after its reorganization, its record of profits and losses for the years 1923 to 1930 being as follows:

Year: Loss Profit
1923. $25, 586. 01
1924. 83, 292. 70
1925. 39,734. 78
1926. 36, 423. 08
1927. 22, 857. 53
1928. 18, 324. 81
1929. 32, 660.12
1930. _$20,170. 09

Its net operating deficit December 31, 1928, was $226,218.91, December 31, 1929, $258,879.03, and December 31, 1930, $238,708.94.

During the years 1921 to 1930, inclusive, petitioner made various cash advances to Pump Co. and charged against it various items of interest. Certain payments upon account were received and there is shown in the following table a summary by years of all such transactions:

The cash received from Pump Co. in 1930 was applied against a note dated December 31, 1924, which was for the balance due petitioner at that date. This note included interest of not more than $13,593.92, $5,341.42 for 1923 and $8,252.49 for 1924. This interest was reported in petitioner’s returns for 1923 and 1924, and additional amounts were received and reported in the years 1922 and 1925.

Aside from the notes receivable due from Pump Co., petitioner had no financial interest in said company during the taxable years, the capital stock and bonds which it had received having been disposed of prior to such years. The notes were demand notes, bearing interest at 6 percent, but were unsecured except as hereinafter shown.

In addition to the amounts borrowed from petitioner, Pump Co. also borrowed from banks, its notes payable to banks aggregating during the years in question the following: 1928, $203,000; 1929, $122,000; and 1930, $50,000.

It paid the banks upon its indebtedness the sum of $81,000 in 1929 and $31,000 in 1930, and during the same period, paid petitioner the sum of $26,965.34, reducing its indebtedness from $209,962.06 to $182,996.12.

The notes of Pump Co. held by petitioner were unsecured except as follows: At December 31, 1928, the note dated December 31, 1924, in the amount of $209,962.06 was secured by Pump Co. bonds aggregating $159,000, and notes aggregating $15,215.63 were secured by accounts receivable pledged. During the year 1929 the pledged accounts receivable were released. On December 26, 1929, two «Guaranty Life Insurance Co. policies for $100,000 each, on the life of Frank S. Main, general manager, were secured by and for the benefit of Pump Co. and assigned to petitioner on January 7, 1930, as security for the Pump Co.’s notes. This security was retained by petitioner throughout the remainder of the taxable years. The policies had no cash surrender value until after payment of the third annual premium, due December 26, 1931, and the insured named in said policies is still living.

At December 31, 1928, 1929, and 1930, the assets and liabilities, per books of the Pump Co., in condensed form, were as follows:

Under the above facts, was petitioner justified in failing to accrue upon its books and report as taxable income the interest due from the two debtor corporations?

It was stipulated that the three corporations kept their books and accounts upon the accrual basis, and, upon such basis, made their returns of income. It is significant — though not controlling — -that the debtor corporations accrued upon their books all items of interest due petitioner and deducted them on their income tax returns. The action of the debtor corporations, however, even though their stock ownership, directorate, and management were identical to that of petitioner, is not binding upon petitioner and should not — and in. our approach to the problem before us will not — in any wise militate against petitioner. We shall consider the question purely from the viewpoint of petitioner.

Upon brief, petitioner contends, first, that the interest due from the debtor companies was not “something of exchangeable value * * * coming in or being derived” by it; second, that it should “not be compelled to accrue income where the collection thereof would impair the principal investment”; third, that it was justified in failing to accrue as income the interest due “if there was a doubt of its being received or a doubt as to the time of its receipt”; fourth, “that income should not be taxed until it is certain that it will be received and then only when it becomes available”; and, fifth, that, “the cash received from the debtor companies in the taxable years; was not income for those years.”

We are of the opinion, and hold, that petitioner is correct in its fifth contention. It was upon an accrual basis, and the payments received by it were applied against, and extinguished, liabilities of the debtor corporation for prior years. Such application of payments was proper; but the fact that they were made, materially weakens petitioner’s other contentions, and especially its major contention, that the interest accruing at the very time the payments were being received, was uncollectible.

Petitioner’s first contention to the effect that the interest can not be considered as income, is untenable. It has been held many times by the courts and by this Board that interest may be subject to accrual either as income or for the purpose of deduction. Cf. Peyton-DuPont Securities Co., 25 B. T. A. 554; affirmed on this point, 66 Fed. (2d) 718; Umpqua Timber Co., 27 B. T. A. 135; John W. Butler, Inc., 1 B. T. A. 1105; Newaygo Portland Gement Co., 27 B. T. A. 1097; aff'd., 77 Fed. (2d) 536. It must be reported or deducted when accrued or incurred by a taxpayer on the accrual basis. George D. Davidson Co. of California, 14 B. T. A. 91; Cumberland Glass Manufacturing Co. v. United States, 44 Fed. (2d) 433. The general rule is undoubtedly familiar to petitioner, for it so treated all interest due it for the years immediately preceding' the taxable years. We shall give this question further consideration,, however, in passing upon petitioner’s other contentions.

The third and fourth contentions may be considered together; they are based primarily upon the holding of this Board in Great Northern Railway Co., 8 B. T. A. 225-265, and especially upon that portion of the opinion reading as follows:

Under either method [cash or accrual] the taxpayer must have before him some definitely ascertained item of income to record before it can be reportes and if a given transaction does not correspond to tlie definition of income then there is no income to record whether the taxpayer keefis its books on a cash or an accrual basis. Where books are kept on the accrual basis there is no requirement that there shall be accrued as income that which may never be received.

See also Corn Exchange Bank v. United States, 37 Fed. (2d) 34; American Cigar Co., 21 B. T. A. 464; aff'd., 66 Fed. (2d) 425; certiorari denied, 290 U. S. 699.

In Corn Exchange Bank v. United States, supra, it was said:

When a tax is lawfully imposed on income not actually received, it is upon the basis of a reasonable expectancy of its receipt, but a taxpayer should not be required to pay a tax when it is reasonably certain that such alleged accrued income will not be received and when, in point of fact, it never was received. A taxpayer, even though keeping his books upon an accrual basis, should not be required to pay a tax on an accrued income unless it is good and collectible, and, where it is of doubtful collectibility or it is reasonably certain it will not be collected, it would be an injustice to the taxpayer to insist upon taxation. Edwards v. Keith (C. C. A.) 231 F. 110; United States v. Frost, 25 Fed. Cas. 1221, No. 15172; Spencer v. Lowe (C. C. A.), 198 Fed. 961.
A taxpayer can not be charged to have realized an income unless there exists reason for believing that the income is likely to be paid or can be collected. Such has been the ruling of the Board of Tax Appeals. Turner’s Falls Power & Electric Co. v. Commissioner of Internal Revenue, 15 B. T. A. 983; Great Northern Ry. Co. v. Commissioner of Internal Revenue, 8 B. T. A. 225.

In tlie case of Atlantic Coast Line Railroad Co., 31 B. T. A. 730; aff'd., 81 Fed. (2d) 306, the rule above enunciated was recognized and applied to the facts before the Board in that case. It was also said, however:

Decision of the issue in controversy here must rest upon the determination of a question of fact. If the facts indicate that there was a reasonable expectancy of receipt of the interest involved or that the petitioner would probably be able to collect such interest, then the full amount should have been accrued on its books and reported as taxable income, notwithstanding the obligation afterwards became uncollectible or worthless, and even though this occurred within the same taxable year. [Cf. Umpqua Timber Co., 27 B. T. A. 135.]

The stipulation does not indicate that there was any agreement between petitioner and the debtor corporations that the notes for $1. were to be in full settlement for, and in discharge of, the indebtedness admittedly due as interest for the years 1929 and 1930. On the contrary, both of the debtor corporations accrued upon their books the interest actually due and petitioner upon brief states, “The liability of the debtor companies is not disputed; the question here is the collectibility of the amounts due petitioner.” We shall therefore address ourselves to this question, which epitomizes petitioner’s third and fourth contentions.

Do the facts indicate that there was a reasonable expectancy during the taxable years that petitioner probably would be able to collect the interest clue from the debtor corporations? If they do then petitioner should have accrued such interest upon its books and reported it as income. An examination of the facts will enable us to find the correct answer to the question.

The facts, shown in detail in the stipulation and summarized above, indicate that the Steel Co. had substantial earnings during both of the taxable years, while the Pump Co. during the year 1930 had earnings of more than $20,000. Steel Co. at the beginning of the period had total assets of approximately $880,000, and at the end of the period $940,000. During the period it reduced its bonded indebtedness by $10,000, paid petitioner upon its notes nearly $55,000, reduced its obligations to banks by payments aggregating $48,000, and decreased its net operating deficit by approximately $100,000— from $388,154.61 at the beginning of the period to $278,560.83 at the end of the period. Pump Co., during the same period, paid petitioner $26,965.34, which included $13,593.92 of interest, paid $153,000 upon its indebtedness to banks, and, notwithstanding the fact that it reduced the carrying figure of patents in its assets by approximately $111,000, its debit balance in surplus remained substantially the same at the end of the taxable years as it was at the beginning. These facts clearly show that there was a reasonable expectancy of the receipt of the interest, and, unless there is reason for holding otherwise under petitioner’s second contention, the respondent’s determination of a deficiency should be approved.

The substance of the second contention, which we will now consider, is that, even though the balance sheets disclose that the debtor corporations are solvent and the indebtedness could be collected by legal process, the interest need not be accrued and reported as income where such legal action could only result in a sacrifice of, or impairment to “the principal investment.” Manifestly such a holding is correct where the creditor corporation is the parent of the debtor corporation or where it is the holder of all, or a substantia] portion of, its capital stock. Thus, in Great Northern Railway Co., supra, the petitioner owning a substantial portion of the capital stock of the debtor corporation, it- was held that while the indebtedness might possibly have been collected through receivership proceedings, “⅝ * * this would have been at the sacrifice of petitioner’s * * * investment in the stock of these companies”, and would not have resulted in income to the petitioner. Of. also Atlantic Goast Line Railroad Co., supra.

But the above rule is not applicable here. “Aside from the notes receivable * * * petitioner had no financial interest in” either of the debtor corporations. (Stip. 24 and 41.) The relation between it and said companies was merely that of debtor and creditor. We may presume that Bettendorf, the principal stockholder and officer of all of the corporations, would not have wished one of his corporations to wreck the others by requiring payment. But the fact nevertheless remains that the creditor corporation could have collected all interest due it from its debtors during the taxable years, and in doing so would not, in any sense of the word, sacrifice or impair its principal investment, for it had none in the debtor corporations.

We are of the opinion that, under the facts before us, petitioner should have accrued upon its books and reported as income the interest due from the debtor corporations for the years 1929 and 1930. It follows that the respondent did not err in determining the deficiency and such determination should be, and is, approved.

Judgment will be rendered for the respondent.


author: Seawell :

text:
    Daniel Thew Wright, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 76104, 76105.
    Promulgated March 10, 1936.

      Meredith M. Daubin, Esq., for the petitioner.

      Nathan Gammon, Esq., and F. 8. Gettle, Esq., for the respondent.
   OPINION.

Seawell :

The question is whether the deficiency notice mailed by the respondent on March 10, 1934, meets the requirements of section 272 (a) of the Revenue Act of 1928, which provides that when the Commissioner determines a deficiency in income tax he “is authorized to send notice of such deficiency to the taxpayer by registered mail/’ The petitioner says that such notice was sent to “Daniel Thew Wright, 915 15th Street, N. W., Washington, D. C.” and can not be treated as a deficiency notice to him, in view of the fact that the address given by him in his income tax return was 917 15th Street, N. W., Washington, D. C. The contention made is devoid of any merit.

Numerous cases decided by this Board and the courts are cited by the petitioner to show that deficiency notices mailed to an incorrect address of taxpayer do not meet the requirements of the statute. All of them involved facts clearly distinguished from those here. None of them go so far as to hold that an incorrectly addressed notice actually received by the addressee ⅛ invalid.

In Dilks v. Blair, 23 Fed. (2d) 831, the notice was held to have been properly mailed even though it was improperly addressed to New York City instead of the taxpayer’s correct address in Chicago, Ill.

Similar facts prevailed in Whitmer v. Lucas, 53 Fed. (2d) 1006. There the taxpayer’s correct address was 200-202 South State Street, Chicago, Ill. The deficiency notice was mailed to 206 South State Street, Chicago, Ill., and was delivered by the mail carrier to the office of the National Life Insurance Co. at 200-202 South State Street, Chicago, Ill., at which address the taxpayer maintained an office. The registered letter was receipted for by an employee who for many years had received mail for the taxpayer addressed to him at the same address. In holding that the notice was valid the court said:

The statute provides only that notice shall be sent “by registered mail.” It is reasonable to conclude that, even though a slight error may be made in the street address, the taxpayer is not harmed if the letter is actually and promptly delivered to his proper address. The purpose of the statute has been fully accomplished when the taxpayer is notified of the deficiency or additional assessment proposed to be made by the Commissioner.
While, under the statute, it is not necessary to prove the delivery of such ■notice, yet in the instant case the evidence is uncontradicted that the appellant was not only “notified of such deficiency by registered mail,” but that such notice was actually delivered to his proper address. * * *

To the same effect is Kay Manufacturing Co., 18 B. T. A. 753; aff'd., 53 Fed. (2d) 1083.

While the respondent did not direct the deficiency notice to the address shown in the petitioner’s return, it fully satisfied the requirements of the statute. It bore another address of the same building, which office building the petitioner recognizes on his letterheads as being his address.

The petitioner is in no position to deny the receipt of the deficiency notice. It was actually received in his office by an employee duly authorized to take delivery of his mail. Receipt by the servant was, under the circumstances, receipt by the master. United States v. Sander, 27 Fed. Cases 949; United States v. Driscoll, 25 Fed. Cases 914. Thus the petitioner was duly notified of the deficiency even, though his employee did return the letter to the sender because of the slight but immaterial discrepancy in the address.

The letter mailed by the respondent to Daniel Thew Wright, 915 15th Street, FT. W., Washington, D. C., on March 10, 1934, is held to be a deficiency notice mailed to the petitioner pursuant to the provisions of section 272 (a) of the Revenue Act of 1928. Accordingly, the motion to dismiss for lack of jurisdiction is denied, and the cases will be placed upon the general calendar for hearing on the merits as one proceeding.


author: Leech:

text:
    F.-K. Land Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 77027.
    Promulgated March 10, 1936.

      Sidney M. E hr man, Esq., and Richard E. Guggenfdme, Esq., for the petitioner.

      G. W. Brooks, Esq., for the respondent.
   OPINION.

Leech:

Although in determining the deficiency the respondent made no allowance for depletion on the bonus, he now concedes that petitioner is entitled to a deduction of 27½ percent of the bonus received, under section 114 (b) (3) of the Revenue Act of 1928. Petitioner contends that it is entitled to a depletion allowance computed on the basis of March 1, 1913, value and, since respondent has made no estimate of the royalties “expected to be received” as the basis for computation of the allowance under Regulations 14, article 236, that it is entitled to treat the bonus as a recovery of capital to the extent of the March 1, 1913, value of the leased property.

The rule is established that the $130,000, received as a bonus payment by petitioner, was gross income from the property and not consideration for capital assets sold. Burnet v. Harmel, 287 U. S. 103; Murphy Oil Co. v. Burnet, 287 U. S. 299. This is true even though there was no production from the property prior to its lease or in the year in which the bonus was received. Herring v. Commissioner, 293 U. S. 322.

The Revenue Acts of 1918, 1921, 1924, and 1926 carried the same provisions for depletion: “* * * a reasonable allowance * ⅛: * according to the peculiar conditions in each case, based upon cost, * * * to be made under rules and regulations to be prescribed by the Commissioner * * The regulations issued by tire Commissioner under the first three of these acts (article 215, Regulations 45 and 62; article 216, Regulations 65) provided for treatment of a bonus payment as a return of capital, deductible in full if less than the recoverable base of the property. Article 216 of Regulations 69, promulgated under the Revenue Act of 1926, included an amendment changing the treatment of bonus payments. Under this regulation such payments were treated as income from the property. It was there provided that depletion deductions on a bonus be allowed in an amount equal to that proportion of the basis of the property which the bonus bore to the sum of the bonus and the royalties expected to be received. That the amended regulation provided a correct rule for computation, in cases where the necessary factors are determinable, can not now, we think, be disputed. It is, in effect, approved by the decision of the Court in Murphy Oil Co. v. Burnet, supra, and is further sustained by the above cited decisions holding that bonus payments, in fact, constitute income from the property and not consideration for the sale of capital assets.

The Revenue Act of 1928, which is applicable here, reenacted the provision of the preceding revenue act with respect to depletion.

The Commissioner’s Regulations 74, article 236, heretofore set out in the margin, construing the latter act, included the same provision as Regulations 69.

In Murphy Oil Co. v. Burnet, supra, arising under the 1918 Act, the taxpayer contended that a bonus constituted taxable income not subject to depletion and, consequently, the entire cost base was to be recovered from royalties received. In this case the Court held that since the royalties to be received were not shown to be subject to ascertainment with reasonable accuracy, the respondent’s action under his then Regulations (article 215, Regulations 45) in treating the full amount of the bonus received in an earlier year as a return of capital and a reduction, to that extent, of the cost subject to depletion, was, under the conditions there existing, n.ot unreasonable. In the face of that treatment of the bonus received in a prior year, failure to give eifect to that action here by reducing the basis of the property subject to depletion by the amount of that bonus would have ulimately resulted in recovery by depletion allowances of more than the recoverable basis for the property. Such allowances would have been unreasonable.

In that case certain of the circumstances, upon which the disputed reasonable allowance for depletion was to be determined, had become fixed before the there pending taxable year. Here, there were no such fixed past circumstances. Our decision must rest here upon the record picture of the tax year before us and the future.

The present question arises under the Act of 1928, which includes the provision for percentage depletion. It is quite apparent that this addition to the statutory provisions, long in eifect, was in recognition of the difficulty experienced in many cases in determining what would be the “reasonable allowance” permitted by the statute. Senate Rept. No. 52, 69th Cong., p. 17; Helvering v. Twin Bell Oil Syndicate, 293 U. S. 312. As the court said in Signal Gasoline Corporation v. Commissioner, 77 Fed. (2d) 728:

The theory upon which a fixed percentage is allowed for depletion is that the mineral product to he mined or produced when still in the ground has a value of 27.5 per cent of its value when mined or produced. Consequently, the 27.5 per cent, represents a return of capital while the balance represents income to the taxpayer subject to the usual deductions in determining the net income.

In the present case the respondent denied any deductions for depletion of the bonus in view of the fact that there was no development or production from the property in the year in which the bonus was paid and consequently no royalties received. However, in view of the decision of the Supreme Court in Herring v. Commissioner, supra, he now concedes that petitioner is entitled to deduction of the 27½ percent provided by section 114 (b) (3). Petitioner, on the other hand, contends that he is not limited to the percentage depletion provided by section 114 (b) (3) but is entitled to demand the computation be made under Regulations 74, article 236 (a), on the basis of the bonus plus royalties to be received.

Whether the known factors are sufficient upon which to determine with reasonable accuracy the oil subject to recovery, and thus the royalties expected, the record fails to disclose.- Petitioner does not attempt to make such computation. It makes no claim for depletion in any amount based on bonus plus expected royalties. Its position appears to be that the failure of the respondent to determine expected royalties entitles it to treat the entire bonus as recovered capital up to the full extent of the March 1, 1913, value of the property, which we have found to be $104,000.

With, this we do not agree. Petitioner overlooks the fact that on it is the burden of proving not only that it is entitled to depletion but the correct amount thereof. Burnet v. Thompson Oil & Gas Co., 283 U. S. 301; Burnet v. Houston, 283 U. S. 223; Helvering v. Taylor, 293 U. S. 507; Reinecke v. Spalding, 280 U. S. 227; Lomita Gasoline Co., 33 B. T. A. 385. It has received $130,000 in the taxable year, as a bonus for an oil and gas lease. This is income from the property (Herring v. Commissioner, supra), taxable except as to such portion petitioner may be able to show represents return of capital. The sole condition which would entitle petitioner to deduction of the entire cost of this property is that the only probable return anticipated from the property is that represented by the bonus. We do not think petitioner has established that fact by merely pointing out that no determination has been made as to anticipated royalties. For all we are advised, this factor can be determined with reasonable accuracy.

We may also add that, in any event, all that the statute permits to be deducted as representing depletion, is a reasonable allowance to be determined with due consideration for the peculiar conditions in each case. A taxpayer is never entitled to more than a reasonable allowance. Any formulae devised for computation are correct and usable only if and when they achieve this result. No taxpayer is entitled to use some particular formula merely because its application in some other case, on other facts, was deemed to have resulted in the computation of a reasonable allowance.

In the present case petitioner executed, in 1930, an oil and gas lease upon its property, receiving a cash bonus of $130,000 plus an agreement for royalties of one sixth of the oil produced or one seventh, if production was 500 barrels or less per day. The lease was not in an unproven field but one which had been in production for nearly twenty years, although this particular leased tract had not yet been operated. The bonus paid exceeded petitioner’s recoverable base. The comparatively large bonus paid, together with the fact that the property lay in a proven field, indicates strongly the probability that substantial royalty payments would result from operation of the lease. Such, evidently, was the opinion of the lessee for a bonus of this amount does not indicate a mere speculative exploration of the property, especially in view of its location in an old, established oil field.

The foregoing facts constitute the peculiar conditions of this particular case upon which the statute requires that a reasonable allowance for depletion in reference to the bonus payment shall be determined. It is only upon a reasonably justified anticipation of no future royalties that allowance of the contested deduction in the entire amount of petitioner’s base could be sustained. We con-elude upon the conditions presented, that substantial royalty payments were reasonably to have been expected even if their amount could not be accurately determined. The deduction of the full recoverable base here sought is, on the pending record, unreasonable.

This conclusion leaves us with the determination of a reasonable allowance for depletion upon the basis of one factor — gross income of $130,000 from the property in the taxable year. Under such conditions we hold that a reasonable allowance for depletion is 27½ percent of that amount as conceded by the respondent.

Judgment will be entered wnder Rule 50.

       SEC. 114. BASIS FOR DEPRECIATION AND DEPLETION.
      (⅞) Basis for Depletion,—
      (8) Percentage depletion for oil and gas wells. — In the case of oil and gas wells the allowance for depletion shall be 27 ½ per centum of the gross income from the property during the taxable year. Such allowance shall not exceed 50 per centum ofi the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance be less than it would be if computed without reference to this paragraph.

       Art. 286. Depletion — Adjustments of accounts "based on bonus or advanced royalty.— (a) Where a lessor receives a bonus in addition to royalties, there shall be allowed as a depletion deduction in respect of the bonus an amount equal to that proportion of the cost or value of the property on the basic date which the amount of the bonus bears to the sum of the bonus and the royalties expected to be received. Such allowance shall be deducted from the amount remaining to be recovered by the lessor through depletion, and the remainder is recoverable through depletion deductions on the basis of royalties thereafter received.
      * * * ⅜ * % ⅜
      (d) In lieu of the treatment provided for in the above paragraphs the lessor of oil and gas wells may take as a depletion deduction in respect of any bonus, royalties, and other income from the property for the taxable year 27½ per cent of the amount thereof, but the deduction shall not exceed 50 per cent of the net income (computed without allowance for depletion) from the property.


author: Muedock: Black,

text:
    City National Bank Building Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 75104, 76141.
    Promulgated March 10, 1936.

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

      Gerald W. Brooks, Esq., for the respondent.
   OPINION.

Muedock:

The principal claim made by the petitioner in these proceedings is that it has never ceased to be the owner in fee simple of the City National Bank Building property and, as such, it is entitled to deduct in each year 3 percent of $750,000, or $22,500, as depreciation on the building. It has already been allowed a deduction for the exhaustion of its leasehold and for the rent which it paid as lessee. The question of discount is not raised, and the Board must assume that the petitioner has been allowed such amortization of discount (for example, discount on its bonds) as it is entitled to deduct in computing its net income for each year. The Revenue Act of 1928 provides for the deduction of “a reasonable allowance for the exhaustion, wear and tear of property used in the trade or business.” Sec. 23 (k). The basis for depreciation is the cost of the property. Secs. 23 (m), 114(a), 113(a). This means the cost of the property to the owner who is using the property in Ms trade or business. “The amount of the allowance for depreciation is the sum which should be set aside for the taxable year, in order that, at the end of the useful life of the plant in the business, the aggregate of the sums set aside will (with the salvage value) suffice to provide an amount equal to the original cost.” United States v. Ludey, 274 U. S. 295, 300-301. Deductions for depreciation are allowed for the purpose of restoring to the owner his capital investment in exhausting property over the period of its use from untaxed earnings derived from its use. When the owner of depreciating property sells his property, he thereby recovers all or a part of his capital investment in the property, and the difference is made up in gain or loss. He is not entitled thereafter to deductions for depreciation based upon the cost of the property, even though he may immediately lease it. Weiss v. Wiener, 279 U. S. 333.

The petitioner does not hold the legal title to the building in question, but is only a lessee. The Union Trust Co. holds the legal title, and the holders of the land trust certificates are the beneficial owners of the land and building. Senior v. Braden, 295 U. S. 422. The holders of the land trust certificates paid about $1,000,000 for their interest. It is a real interest. The petitioner sold the property to the Union Trust Co. of Cleveland, Ohio, by a warranty deed, and received therefor $930,000 in cash and a valuable leasehold. The $930,000 in cash which it received was obviously a return to it of so much of its capital investment in the property and, since it thus recovered that portion of its capital investment, the same amount should not be again recovered by it through deductions for depreciation on the property of others. The remainder of its original cost was recovered through the receipt of a valuable leasehold, and that part of its original capital investment in the property should not be again recovered by it through deductions for depreciation on the property of others. The value of this leasehold is demonstrated by the fact that the petitioner was able immediately to mortgage the leasehold interest for $600,000. The petitioner received $540,000 in cash for the bonds secured by this mortgage. The petitioner is entitled to and has received the benefit of proper deductions for the exhaustion of the leasehold. It may also be entitled to deductions for amortization of discount on its bonds secured by the mortgage on the leasehold. It has claimed and has been allowed deductions for the rent which it pays under the lease. Not only is there no statutory authority for allowing the petitioner a deduction on account of depreciation of the building, but on principle the petitioner is not entitled to such a deduction since, as has been demonstrated, it does not need such deductions to return its capital outlay. Weiss v. Wiener, supra,; Belt Railway Co. of Chicago v. Commissioner, 36 Fed. (2d) 541; certiorari denied, 281 U. S. 742; affirming 9 B. T. A. 304. Cf. Terminal Realty Corporation, 32 B. T. A. 623.

The fact that the petitioner is not entitled to depreciation on the building may be further demonstrated. If a new building is ever to replace the present building during the term of the lease, the petitioner will probably have to pay for its erection. That cost will represent additional cost of the leasehold, since the building will not belong to the petitioner. That additional cost, if paid, will be recoverable through annual depreciation charges. Belt Railway Co. v. Commissioner, supra; Brevoort Hotel Co., 1 B. T. A. 132; Brevoort Hotel Co. v. Reinecke, 36 Fed. (2d) 51. The petitioner may not anticipate such future additional costs of its leasehold. Weiss v. Wiener, sufra. A present deduction in anticipation of future additional cost would not be a “reasonable” deduction. If the petitioner decides to forfeit the lease when the present building wears out, its loss will be no more than the unexhausted cost of the leasehold. It can not lose the entire original cost to it of the building, because it sold the building in 1925 and most, if not all, of its original cost was restored to it at that time. If it were allowed annual deductions of $22,500, and then were to default on the lease-when the present building wears out, it would have received a substantial amount of income tax free. Congress did not so intend. The question of depreciation allowance to the trustee and the land-trust certificate holders is not before the Board. They may, perhaps, sustain no loss from depreciation, due to the provisions of the lease. Cf. A. Wilhelm, Co., 6 B. T. A. 1; Terre Haute Traction Light Co., 24 B. T. A. 197; affirmed on this point, 67 Fed. (2d) 697; Atlantic Coast Line Railroad Co., 31 B. T. A. 730. But that question need not confuse the present issue, for the mere fact that the lessors may not be entitled to deductions for depreciation is not a. sufficient reason for allowing deductions for depreciation to the lessee. A taxpayer, in order to be entitled to a deduction, must show that it comes within some provision of the statute allowing a deduction. New Colonial Ice Co. v. Helvering, 292 U. S. 435; Pennsylvania Co. for Insurances v. Commissioner, 75 Fed. (2d) 719; Barhour Coal Co. v. Commissioner, 74 Fed. (2d) 163. This the present, petitioner has failed to do.

The petitioner argues that the sale of the property to the Union Trust Co., the declaration of trust, and the sale of the land trust-certificates, must be treated as a mortgage and not as a sale by the-petitioner. The decision of the Board in F. and R. Lazarus & Co., 32 B. T. A. 633, now on appeal to the Court of Appeals for the Sixth Circuit, and the decision of the Sixth Circuit in Commissioner v. Neighbors Realty Co., 81 Fed. (2d) 173, affirming an unpublished opinion of the Board, are cited as authorities in support of this argument. The opinions of the Board in the above mentioned cases were promulgated prior to the decision of the Supreme Court in Senior v. Braden, supra. The appellate court in the Neighbors case considered Senior v. Braden, but was of the opinion that that decision did not reach the issue in the Neighbors case. It allowed the taxpayer a deduction for depreciation on the building on the ground that it still owned the building. The court stated:

Neither are we required for purpose of decision to hold with the Board that the deed, declaration of trust and lease together constituted a mortgage. * * ⅜ We see nothing in the Senior v. Braden holding inconsistent with the existence of a relationship of borrower and lender between the taxpayer and the certificate holders or their trustee, or that compels a holding that the taxpayer’s financing plan resulted in a sale rather than a loan, even when applying the doctrine there announced in the full import claimed for it by the Commissioner to the estate held by the trustee or the certificate holders in the present case.

The facts in the present case are different in some respects from the facts in the Lazarus and Neighbors cases. It may be that these differences serve to distinguish the cases. The transactions in the Lazarus and Neighbors cases were initiated by existing corporations in order to refinance their indebtedness. Here the transactions were initiated by bankers who desired some business. The petitioner was given the right to mortgage its leasehold estate. No such right was given under the Lazarus and Neighbors .leases. The petitioner actually mortgaged its leasehold estate, bonds secured by the mortgage were sold to the public, and the petitioner received $540,000 of the proceeds. In the present case and in the Lazarus case the land trust certificates were not delivered to the taxpayer but were sold by either the trustee or the bankers, while in the Neighbors case the trustee delivered the land trust certificates to the former owner, which then sold them to bankers. The lease in the Neighbors case contained provisions relating to separate property owned by the lessee. No such provisions are found in the Lazarus leases or in the lease involved in the present case. The question of gain or loss which was involved in the Lazarus and Neighbors cases is not involved in the present case.

The Supreme Court in Senior v. Braden, supra, considered the same land trust certificates issued on the City National Bank Building of Omaha which are involved in this present proceeding. Although the court had a very different question before it, nevertheless, we think that its decision points the way for our decision of the present question. The Court there concluded that the trustee held legal title to the real estate, and the owners of the trust certificates had an interest in the land. The Court, including the dissenting members, was obviously of the opinion that the sale was a real sale and not merely a loan or a mortgage. Had the Court been of the opinion that the owners of the trust certificates were merely owners of an equitable interest in a mortgage or in something which amounted to no more than security for a loan, it would have either reached a different conclusion or have based its decision upon some other ground than that upon which it did base it. Thus the transactions in the present case were in law and in fact exactly what they purported to be. The petitioner sold its property, benefited from the method which it used, and now can not deny the fact of sale in order to claim tax benefits which would have resulted from the use of a mortgage or some other form of loan. The test is what was done, not what might have been done. United, States v. Phellis, 257 U. S. 156. The above discussion also disposes of the petitioner’s alternative contention.

Reviewed by the Board.

Decision will be entered for the respondent.

Black,

dissenting: I do not think that the facts in the instant case are sufficiently different to justify a distinction in this case from what we held in F. and R. Lazarus & Co., 32 B. T. A. 633, now on appeal to the Sixth Circuit, and in a memorandum opinion in H. F. Neighbors Realty Co., affirmed by the Court of Appeals for the Sixth Circuit, 81 Fed. (2d) 173.

I think that the court in the Neighbors case rightly held that the Supreme Court’s decision in Senior v. Braden, 295 U. S. 422, does not control the decision of the question which we have here to decide. As to the effect of the Supreme Court’s decision in Senior v. Braden, the court said in part:

We see nothing in tile Senior v. Braden holding inconsistent with the existence of a relationship of borrower and lender between the taxpayer and the certificate holders or their trustee, or that compels a holding that the taxpayer’s financing plan resulted in a sale) rather than a loan, even when applying the doctrine there announced in the full import claimed for it by the Commissioner to the estate held by the trustee or the certificate holders in the present case.
A collateral issue is involved with respect to depreciation taken by the taxpayer upon the buildings located upon the leased property, on the theory that the taxpayer still had the beneficial interest in the property, and on the theory that the investment in the buildings was of its capital as owner. The Board allowed the depreciation. We. think it was right, and that the case of Weiss v. Wiener, 279 U. S. 333, does not here apply. See also Cogar v. Commissioner of Internal Revenue, 44 Fed. (2d) 564 (C. C. A. 6).

The decision of the Board of Tax Appeals is affirmed.

. Of course it seems clear that petitioner would not be entitled to a deduction for both amortization of its so-called leasehold and & deduction for depreciation. If petitioner is entitled to a deduction for depreciation, and I think it is, then its so-called leasehold should simply be regarded as a part of its plan for securing the certificate owners in the loans which were made to petitioner and petitioner should not be allowed any deduction for exhaustion of leasehold.

A deduction for depreciation would take care of its return of capital invested in wasting assets. Therefore I think an opinion in this proceeding should hold that petitioner is entitled to the deduction for depreciation which it claims and should be disallowed the deduction for amortization of leasehold which it claimed on its income tax return and was allowed by the Commissioner.

Arttndell, McMahon, and Leech agree with this dissent.

       See discussion of the depreciation charge by Mr. Justice Brandéis in a dissenting opinion in United Railways v. West, 280 U. S. 234, 259, et seg.

       Section 23 (ft) provides that “in the case of property held in trusb the allowable deduction [for depreciation] shall be apportioned between the income beneficiaries and) the trustee in accordance with the pertinent provisions of the instrument creating the-trust, or, in the absence of such provision, on the basis of the trust income allocable-to each.’’