author: Geeen

text:
    Appeal of ALEXANDRIA PAPER CO.
    Docket No. 2271.
    Submitted May 22, 1925.
    Decided December 23, 1925.

      Held that, in computing invested capital, earned surplus should be reduced by the depreciation sustained.

      George S. Olive, G. P. A., and Frank G. Olive, Esq., for the taxpayer.

      Arthur J. Seaton, Esq., for the Commissioner.
    Before SteRnhagen, Lansdon, GREEN, and Love.
    The Commissioner has asserted a deficiency in income and profits taxes for the year 1917 in the sum of $12,539.44. The taxpayer admits the correctness of a part of the determination and there is here in controversy only $6,879.92. So much of the deficiency as is in controversy grows out of the refusal of the Commissioner to allow for 1917 the amount of depreciation claimed by the taxpayer and the reduction by him of the invested capital of the corporation as of January 1, 191T, by the amount of $84,875.95, which amount is the excess of the depreciation theretofore claimed by and allowed to the taxpayer over the depreciation set up on its books.
    FINDINGS OF FACT.
    The taxpayer is an Indiana corporation engaged in the manufacture of newsprint paper at Alexandria. For the years 1909 to 1916, inclusive, it claimed on its tax returns, and was allowed as depreciation, a total of $122,468.72, of which amount it set up on its books, as the depreciation claimed and taken for the years 1914, 1915, and 1916, the sum of $37,592.83. No depreciation or similar account was kept prior to 1914. The Commissioner computed the 1917 depreciation on the basis of the values shown on the taxpayer’s books.
    DECISION.
    The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 10 days’ notice, in accordance with Rule 50.
   OPINION.

Geeen

: As to the first of the questions in this appeal — namely, the amount of depreciation which the taxpayer should be-permitted to deduct in the computation of its net income for the year 1917— the record is in a state of hopeless confusion. The secretary and treasurer of the company appeared before the Board as a witness and testified that he had charge of the books of the company; that he was familiar generally with the machinery and plant assets of the company; that he paid the bills for equipment, machinery, and tools purchased; that he was familiar with the values of such' assets from his examination of catalogues and conversation with salesmen and the representatives of other companies; that an appraisal had been made September 29, 1915, and that the appraisers determined the reproduction cost of all the plant assets to be $282,-777.74; that by the same appraisal the sound value of such assets as of that date was determined to be $235,790.25, and that the sound values as of that date properly reflect the sound values of the plant assets at March 1, 1913. On cross-examination he stated that $235,000 represented the estimated selling value “on March 1, 1913.

The taxpayer then introduced in evidence a table, of which the following is a summary:

The witness then identified the ledger of the company and his counsel offered in evidence copies of two pages thereof, the same being the improvement account for the years 1913 and 1914. Shortly thereafter the same witness testified that there were no additions to . the plant asset account for the years 1913, 1914, and 1915..

A statement of the depreciable assets as shown by the books of the company was then admitted in evidence and it showed a total of $204,521.34 at January 31, 1913, and $216,545.84 at December 31, 1916.

In the taxpayer’s brief appears the following paragraph:

Beginning with the year 1914, the taxpayer took the advice of accountants and started keeping a depreciation reserve. At January 1, 1917, the books showed the cost of its assets which had been charged to plant accounts as $209,045.94, with a depreciation reserve of $37,592.83, making a net value thereof of only $171,453.01. This amount, the taxpayer contends, is much less than the cost of the plant assets properly depreciated. It contends that the fair values as of March 1, 1913, as determined by the computation based upon the summary of sound values made by Goats and Burchard, plus the cost of subsequent additions, should be used instead of the value as shown by its books. Said fair value as of March 1, 1913, was $235,790.25, and the cost of said additions was $11,524.60, making the total, as of January 1, 1917, $U7,814.t5.

We regard the appraisal admitted in evidence as of little value, not only because it fixes the value of the assets at a time when such value is not in controversy, but because the persons who made the appraisal were not before the Board to subject themselves to cross examination thereon. The witness, using this appraisal as a basis, testified that the value of the assets on March 1, 1913, was the same as their value on September 29, 1915. Evidence as to the improvements made subsequent to March 1, 1913, was offered without regard to the fact that these improvements were included in the list of assets appraised and used as a basis for the March 1, 1913, value. The Commissioner and the taxpayer are far from being in accord as to the additions to the plant and equipment subsequent to March 1,1913. The Commissioner offered no evidence as to the value of the depreciable assets at any time. In view of the conflicting statements offered by the taxpayer, we must approve the determination of the Commissioner as to this point.

The taxpayer contends that its invested capital should be reduced only by the amount of its depreciation reserve as the same appears on its books and which contains only the depreciation claimed by it and allowed by the Commissioner for the years 1914, 1915, and 1916. For the years prior to 1914 no depreciation account was set up on its books. It contends that the depreciation claimed by it on its tax returns and allowed by the Commissioner in the years 1909 to 1913, inclusive, can not be added to its depreciation reserve. The taxpayer does not contend that the amount of depreciation which it claimed and which was allowed to it by the Commissioner was in any year incorrect, and we therefore assume that it actually sustained in all years the amount of depreciation which the Commissioner allowed.*

Where it exists, earned surplus is included in and becomes part of the invested capital of a corporation. Earned sui-plus can not be accurately determined without due allowance for depreciation. 'It follows logically that, to the extent that this corporation had an earned surplus on December 31, 1911, such earned surplus, before being added to the other elements of invested capital, should be reduced by any depreciation sustained by the corporation and not already deducted in computing the earned surplus. No other element of invested capital may be reduced by depreciation. In the event the total depreciation sustained by this taxpayer exceeds the earned surplus of the corporation in the year in question, the invested capital of the corporation may not be reduced by the amount of such excess.

The taxpayer also contends that the appreciation of its assets from 1909 to 1913, inclusive, more than equaled its sustained depreciation and that, therefore, its invested capital should not be reduced on account of depreciation allowed.

That unrealized appreciation may not be included in invested capital is no longer an open question. La Belle Iron Works v. United States, 256 U. S. 377.


source: Caselaw Access Project

license: Public Domain

text:
    Appeal of CHARLES HENRY MATTLAGE.
    Docket No. 2116.
    Submitted May 19, 1925.
    Decided December 23, 1925.

      O. J. McGuire and J. Marvin Haynes, Esqs., for the taxpayer.

      Willis D. Nance, Esq., for the Commissioner.
    Before Ivins, Marquette, and MoRris.
    This appeal is from the determination of a deficiency in income tax for the year 1919 in the amount of $5,115.12. Three questions are presented: (1) The amount of salary received by the taxpayer in 1919: (2) the deductibility of an alleged bad debt; and (3) the deductibility of the amount paid to an accountant for services in connection with the rendering of the Federal tax return.
    FINDINGS OF FACT.
    The taxpayer is a resident of New York City. He reported his income for taxation on the cash receipts and disbursements basis for the calendar year 1919.
    During the years 1913 to 1920, both inclusive, the taxpayer was president and a member of the board of directors of Charles F. Mattlage & Sons, a corporation organized under the laws of the State of New York, the other directors being the taxpayer’s son-in-law and one Henry A. Gaede, who, together with the taxpayer, was an executor of the estate of the taxpayer’s father.
    Throughout the years 1918 and 1919, the taxpayer owned 614 shares of the voting stock of said corporation out of a total of 3,500 shares issued and outstanding. The voting control of 2,383 shares was exercised by the taxpayer and the said Henry A. Gaede, as executors of the estate of the taxpayer’s father. Of the remaining shares, 50 were owned by the taxpayer’s wife, 191 by his son-in-law, 150 by his daughter, 1 by his brother-in-law, and 1 by the said Henry A. Gaede.
    The books of account of said Charles F. Mattlage & Sons were kept on the basis of a fiscal year ending on the 30th day of April.
    During the period that the taxpayer was president, he directed all the activities of the corporation. It was agreed by all of the directors of the corporation that the taxpayer, taking into consideration the net income of the corporation, should determine the amounts to be paid by the corporation to executives, including himself, and that the board of directors would ratify his decision in this respect. For the years prior to the fiscal year ended April 30, 1919, the taxpayer did so fix the amount of the salary to be paid to him by the corporation and the board of directors ratified his decision in this respect.
    In accordance with the said understanding, he determined that the amount to be paid to him by said corporation as compensation for services rendered during the fiscal year ended April 30, 1919, should be $25,000, and the board of directors of said corporation, at a meeting held on June 22, 1919, ratified his decision in this respect. The said amount of $25,000 was credited to the taxpayer’s account on the books of the said corporation as of April 30, 1919.
    In his tax return for the calendar year 1919, there was included $8,333.33, being that part of the sum of $25,000 paid for services rendered for the period from January 1 to April 30, 1919. The Commissioner, in determining the deficiency, included all of the said amount of $25,000 in the taxpayer’s gross income for the calendar year 1919.
    No money was actually paid as salary, but it was the practice of the corporation to pay all of the personal and household expenses of the taxpayer and to charge the same to his account upon the company’s books, his account also being credited with his salary. No separate books of account were maintained by the taxpayer. All of his personal financial transactions went through, the company’s books. At December 31, 1918, there was a debit balance on the company’s books against him of $7,100. At December 31, 1919, the debit balance was about $36,000. At a meeting of the company’s board of directors, held on June 22, 1919, it was voted that the taxpayer give the company his note for the overdraft of $7,100. At the same meeting the directors ratified the salary of $25,000 to the taxpayer covering the company’s fiscal year from May 1, 1918, to April 30, 1919.
    Of the amount of $25,000 so ratified as salary for said fiscal year, the taxpayer actually received, as income during the calendar year 1919, the amount of $8,333.33. During the balance of the taxpayer’s calendar year 1919, he received as salary $16,666.67.
    In the year 1913, the taxpayer, as president and on behalf of the said Charles F. Mattlage & Sons, employed one Alexander E. Lawson as a bookkeeper. In 1914 said Lawson misappropriated moneys of said corporation amounting to $1,894.40. The taxpayer paid the amount of the said misappropriation to the said corporation, taking from said Lawson said Lawson’s promissory note for $1,894.40, and, as collateral security, an assignment of a 20-payment life insurance policy for $2,000 on the life of said Lawson issued by the Pittsburgh Life & Trust Co. The said policy had theretofore been pledged by said Lawson as security for a loan of $328. In 1917, the liability of said Pittsburgh Life & Trust Co. under said policy was assumed by the Metropolitan Life Insurance Co', of New York. During the years 1914 to 1919, inclusive, the taxpayer paid' the premiums upon said policy in the aggregate amount of $299.04.
    In 1919 the said policy became paid up, and in October, 1919. the taxpayer, as assignee, received from said Metropolitan Life Insurance Co. of New York the sum of $722.55, being the cash surrender value of said policy, amounting to. $1,079.70, less the loan of $328 and interest thereon of $29.15.
    Thereafter, and during the calendar year 1919, the taxpayer paid $25 to one PI. J. Schultz, a collection agent of 299 Broadway, New York City, for services rendered in connection with an unsuccessful attempt to collect the balance due from said Lawson.

      In his return for 1919 he charged off $1,495.89, the balance of the account then owing from Lawson as a bad debt. In 1920 a judgment by consent was obtained against Lawson in a suit brought in the Pennsylvania courts, and the judgment was returned unsatisfied. The judgment was obtained for the purpose of preventing the running of the statute of limitations.
    The amount of $1,495.89 represented a debt which was ascertained to be worthless and was charged off in 1919.
    In 1919 the taxpayer paid $152.50 to a firm of accountants for services rendered in connection with the preparation of his individual Federal income-tax return for the year 1918.

       This decision was prepared during Mr. Iyins’s term o£ office.

   DECISION.

The deficiency should be computed in accordance with the foregoing findings of fact, disallowing the deduction of the $152.50. Final determination will be settled on 10 days’ notice, under Rule 50.


text:
    Appeal of LARROWE MILLING CO.
    Docket No. 2733.
    Submitted June 23, 1925.
    Decided December 23, 1925.

      J. H. Amich, O. P. A., for the taxpayer.

      F. O. Graves, Esq., for the Commissioner.
    Before Marquette and Morris.
    This appeal is from the determination of a deficiency in income and profits taxes for the year 1918 in the amount of $31,775.48. The portion of the deficiency involved in this appeal is less than $10,000.
    The questions presented are:
    1. Whether expenditures made during the years 1909 to 1912, inclusive, for office furniture and equipment, and charged out of income, should be now capitalized with resulting increase in invested capital for the year 1918 and reduction in income by reason of depreciation on the amount so capitalized.
    2. Whether the excessive cost of machinery, charged off as expense in 1918, should be capitalized and depreciated.
    3. Whether, in disallowing the deduction as expense of the excessive cost of machinery and additions to buildings, the Commissioner made a duplication in the increase in the taxpayer’s income for 1918.
    FINDINGS OE FACT.
    The taxpayer is an Ohio corporation, with principal office in Detroit, Mich., and during 1918 was engaged in the manufacture and sale of feed for dairy cows.

      During the years 1909 to 1916, inclusive, the taxpayer followed the practice of charging to expense account all expenditures made in the acquisition of office furniture and equipment, including typewriters, desks, chairs, and similar articles. The amount totaled $7,483, as follows.
    1909 $176. 67
    1910 1, 030. 71
    1911 5, 235. 94
    1912 35. 00
    1913
    1914 386. 36
    1915
    1916 618.30
    In ascertaining the taxpayer’s invested capital for 1918, the Commissioner included therein the cost of furniture and office equipment acquired in the years 1914 and 1916,-as shown above, in the ' total amount of $1,004.66, but did not include in invested capital for the year 1918 any part of the cost of the furniture and office equipment purchased in the years 1909 to 1912, as set forth above. In determining the taxpayer’s net income for 1918, the Commissioner allowed depreciation at the rate of 10 per cent on the cost of the furniture and office equipment acquired in the years 1914 and 1916, but made no allowance by way of depreciation for such purchases in the years 1909 to 1912, inclusive.
    A reasonable allowance for the exhaustion, wear and tear in 1918 • of the furniture and office equipment, which cost the taxpayer $7,483 during the years 1909 to 1916, inclusive, is $748.30.
    During the year 1918 the taxpayer increased its plant facilities by additions to buildings and machinery. It considered a part of that cost to be exorbitant and charged that portion to expense. The total amount of capital expenditures improperly charged off as expense was $5,714.37. Of this amount, $3,270.89 represented the amount charged off to profit and loss on account of machinery, and the balance of $2,443.48 represented the amount charged off in-respect to the cost of buildings.
    The Commissioner restored said amount of $5,714.37 to the income of the taxpayer, but neglected to allow any depreciation upon that. portion of the cost of buildings and' machinery so improperly charged to expense. The Commissioner admits that deductions for depreciation should be allowed, and the Board finds that the allowance for the exhaustion, wear and tear on the excess cost of said property should be at the same respective rates as were applied to the property of which such amounts were a part of the cost.
    When the Commissioner restored said amount of $5,714.37 to the taxpayer’s income for 1918, he treated that amount as written off by the taxpayer under the designation of depreciation.

      The Commissioner also increased the taxpayer’s income for 1918 in the amount of $3,720.89 under the heading “ Excess cost of machinery.” Said amount of $3,720.89 was included in the amount of $5,714.37, and the action of the Commissioner constituted a duplication of the increase in the taxpayer’s income to the amount of said $3,720.89. Accordingly, the net income of the taxpayer for 1918 was overstated by the Commissioner in the amount of $3,720.89.
   DECISION.

The deficiency should be computed in accordance with the foregoing findings of fact. The invested capital for 1918 should include the sum of $7,483 as the cost of furniture and office equipment, less depreciation to the taxable year. Final determination will be settled on 7 days’ notice, under Rule 50.


author: MoRRis:

text:
    Appeal of WEBB PRESS CO., LTD.
    Docket Nos. 2404, 2724.
    Submitted August 17, 1925.
    Decided December 23, 1925.
    1. Two-thirds of the net profits paid under a royalty agreement, held to be a proper deduction under the circumstances of this appeal.
    2. A stockholder owning 494 out of 500 shares of stock of the taxpayer corporation left in the business for working capital for the years 1918 and 1919 the sums of $288,137.36 and $283,478.98, respectively. These sums represented the amounts due him as royalties but not withdrawn. Held, that said sums may not be included in invested capital.
    3. The value of certain patterns, tracings, blue-prints, etc., disallowed as invested capital for lack of proof of value.
    4. The income derived from a certain contract to install a cotton compress held to have accrued in the year 1920.

      E. W. R. Ewing, Esq., for the taxpayer.

      Benjamin H. Saunders, Esq., for the Commissioner.
    Before Maequette and Moeeis.
    This is an appeal from the determination of deficiencies for the years 1918 and ■ 1919 in the sums of $1,652.11 and $9,380.95, respectively. Separate appeals were filed for each year but, it appearing that similar issues were involved for each year, the appeals were consolidated. The controversy involves mainly the proper treatment of certain royalties paid for patents in respect to income and invested capital.

      FINDINGS OP PACT.
    1. The taxpayer is a domestic corporation, organized under the laws of Louisiana in 1896, with its principal place of business at Minden. Its capital stock was $50,000, divided into 500 shares of the par value of $100 each, 494 of which were, during the years in question, owned by one it. D. Webb. The taxpayer was engaged in the business of manufacturing and installing cotton compresses and the supplying of the necessary material and parts thereof. It manufactured its product under patents owned by It. D. Webb, for the use of which patents the taxpayer was to pay him two-thirds of the net profits of the business each year.
    2. The pertinent events leading up to the royalty agreement were as follows: It. D. Webb and his'brother, S. J. Webb, owned certain patents for devices for compressing cotton. In the year 1900 the taxpayer manufactured the compresses under certain royalty agreements with the Webbs. About the year 1902 there arose a dispute between the Webbs, the corporation, and certain stockholders as to the proper amount to be allowed as royalties. In 1904 a decision was rendered by the Supreme Court of Louisiana, in which the court fixed the amount of royalties to be received by the Webbs at two-thirds of the net profits of the corporation. Oriehton v. Webb Press Go., Ltd., 113 La. 167; 86 So. 926. Under the decision this arrangement was to be continued until changed by agreement or the withdrawal of the patents by the Webbs from the corporation. Soon after the decision above mentioned, the Webbs purchased the stock of the other stockholders and operated the business. S. J. Webb died in the year 1909 and R. D. Webb purchased his stock and also his interest in the patents. On August 8,1911, the taxpayer corporation passed a resolution definitely fixing the amount of the royalties to be paid substantially as fixed by the decision above referred to. The resolution relating to the royalty agreement read as follows:
    Whereas this Company has been manufacturing and selling compresses and compress machinery under certain patents owned by S. J. and Robt. D. Webb since the date of its organization, and whereas the rights and interests of said owners of the patents have been recognized by resolutions of the stockholders and the Board of Directors of this Company, and whereas by judgment of the Supreme Court of Louisiana some of the resolutions were construed as related to certain issues presented, and whereas other resolutions while not being construed yet it was indicated that a proper distribution would be that this Company should receive one-third of the net profits accruing from the manufacture and sale of compresses under patents, and whereas this Company had not formally acted upon this matter since the date of such judgment, while at all times recognizing the rights of the owners of the patents, and it now being desirable to harmonize all former resolutions passed by this Company relative to its rights under its manufacture and sale of compresses ancl compress machinery under said patents for the past as well as for future, and whereas said Robt. D. Webb owns said patents, and whereas the said Robt. D. Webb now offers to fix the amount of royalty to be paid to him for the use of said patents at two-thirds of the net profits of the Company in the past as well as in the future, provided that it be especially agreed, understood and stipulated that the said Robt. D. Webb does not grant this Company the -use of his patents for any certain time, but that the rights granted may be terminated by him at any time at his will and pleasure; therefore be it resolved that the royalties for the use of said patents be and are hereby fixed at two-thirds of all the net profits of this Company, and that such royalties be maintained until such time as either the said Robt. D. Webb or this Company shall revoke same by written notice.
    At the time of the passage of the above resolution the books of the taxpayer showed profits of approximately $525,000, consisting mostly of commercial paper received for the compresses sold. The share of E. D. Webb from the royalty agreement was approximately $350,000. E. D. Webb was also the principal stockholder, owning 494 shares out of the 500 shares. He did not withdraw his share of the royalties at that time, as it would have crippled the business, but left it to be used in the operation of the business. During each of the subsequent years he withdrew approximately two-thirds of the net profits as royalties, but, on January 1, 1918, there was still in the business $288,137.36 out of the original $350,000 he left in the business August 8, 1911. This sum was further reduced to $283,-487.98 by January 1, 1919. It is these amounts that the taxpayer claims as invested capital for the years 1918 and 1919, respectively, and which the Commissioner disallowed.
    There was no written agreement nor any resolution of the taxpayer as to the status of the royalty money left in the business. There was an understanding that Webb would charge no interest and, in case of losses, would expect the losses to be paid prior to his claim. In subsequent years, 1920 and 1921, however, he drew from the company amounts in excess of the amounts due for current royalties until he owed the company approximately $18,000.
    For the year 1918 the taxpayer deducted as royalties to E. D. Webb, representing two-thirds of the net income, the sum of $101,-042.21, and for the year 1919 it likewise deducted $182,812.79.
    3. During the existence of the taxpayer it had accumulated various patterns, blue-prints and tracings for the manufacture and installation of its products. These had been worked upon and developed by E. D. Webb and S. J. Webb almost from the inception of the business. No separate account of the cost of these patterns and blue-prints was kept upon the books of the taxpayer. • They were used, however, during all this time and during the taxable years 1918 and 1919. In its income-tax return for 1918 and 1919 the taxpayer originally set up a value of $15,000 for these items, all of which was disallowed by the Commissioner. In its amended petition herein the taxpayer alleged a value of $75,000, and at the ■ hearing it • presented an itemized account of these items totaling $86,834. This cost is not shown upon the books of the company, but the taxpayer attributes the value from an allocation of the amounts paid as salaries to the Webb brothers.
    4. On June 28, 1919, the taxpayer entered into a contract with John W. Wright and H. F. Underwood to install a cotton compress at $32,000, to be paid for as follows:
    $5,000 Cash to be deposited in the Royal National Bank of Palestine, Texas, to the credit of the party of the first part upon signing this contract, but made subject to its order upon arrival of the attachment in Jacksonville.
    $5,000 During the erection of the attachment in Jacksonville, and by the time it is completed ready for work, to pay for freights, labor, material, etc., as the bills for same are presented.
    $5,000 On the day the attachment is completed ready for operation on said premises in Jacksonville, Texas. Making $15,000 cash payments.
    $2,000 Jan. 1st, 1920_$3,000 May 1st, 1920
    $3,000 Jan. 1st, 1921_$3,000 May 1st, 1921
    $3,000 Jan. 1st, 1922_$3,000 May 1st, 1922
    The contract contained the following provision:
    During the first thirty days after the erection of this attachment in Jacksonville ready for operation it is to be tested, and if found to meet the guarantee herein given it is to be at once accepted and the said six notes with the security securing same, are to be at once properly executed in accordance herewith by the parties of the second part and delivered to the party of the first part.
    By the terms of the contract the balance of $17,000 was to be paid by notes, which were to be executed upon a test and acceptance by the purchasers. It was also provided that the contract could be assigned to the Jacksonville Compress Co., a corporation to be organized for the purpose of operating this compress. Through delay the test and final acceptance by the purchasers did not occur until January, 1920, and the notes were executed January 26, 1920. A deed of trust on the compress and the land it occupied was given to the taxpayer on the same date to secure the notes. The taxpayer made a profit of $3,814.99 on this transaction. The Commissioner allocated this income to the year 1919, while the taxpayer claimed it should have been included in the income ofi the year 1920.
    DECISION.
    The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 15 days’ notice, in accordance with Bule 50.
   OPINION.

MoRRis:

There are four questions involved in this appeal: (1) Whether or not the payments to Webb, as royalties in 1918 and 1919, were in fact a distribution of earnings and profits under the guise of royalties; (2) whether or not the sums of $288,137.36 and $283,487.98, the balance of royalties due Webb but retained in the business of the taxpayer, under the circumstances of this appeal, were invested capital for the years 1918 and 1919, respectively; (3) whether or not certain patterns and blue-prints had a value for invested capital purposes, and, if so, what was the value; and (4) whether or not the profit derived from the sale of a certain cotton compress, amounting to $3,814.99, was income for the year 1919 or the year 192'0.

As to the first question, the Commissioner contends that the payments of royalties in 1918 and 1919 were in fact a distribution of earnings and profits under the guise of royalties. He bases this contention upon the facts that R. D. Webb, the recipient, owned 494 out of the 500 shares, and that the royalty payments were two-thirds of the net profits which the said Webb received in addition to a salary of $12,000 per year and the regular dividends of the corporation. It appears from the evidence, however, that the royalty agreement was regularly made in the year 1911. The amount of royalties is substantially the same as determined to be a reasonable amount by the Supreme Court of Louisiana at a time when there was friction between the stockholders and the corporation and when the holdings of the Webbs were much less than at this time. The profits of the corporation were directly attributable to the use of the patents. Even this large percentage of profits paid as royalties was a profitable arrangement to the taxpayer corporation, irrespective of the ownership of the stock. We are of the opinion that it was a bona ;fide arrangement and reasonable when considered in connection with the history and development of the business of the taxpayer.

We shall now consider whether or not the Commissioner erred in not allowing the said sums of $288,137.36 and $283,487.98 as invested capital for the years 1918 and 1919, respectively. It appears that in 1911 the taxpayer passed a resolution definitely fixing the royalty basis for the past as well as the future. It was fixed at two-thirds of the net profits each year. At that time the accumulated net profits were approximately $525,000, of which Webb’s share was approximately $350,000. He did not withdraw this amount, but left it in the business as working capital. During subsequent years he withdrew as royalties two-thirds of the net profits for each year, encroaching somewhat upon the original $350,000 until, in the year 1918, the amount remaining was $288,137.38. He also withdrew two-thirds of the net profits in 1918 and, in addition, reduced the $288,-137.36 to $283,487.98 by January 1, 1919. It is these sums that the taxpayer contends were invested capital. There was no written agreement as to the status of this fund, but it seems to have been left there for the best interests of the company. Webb testified that he left it there as working capital and that he intended to charge no interest for the use of the money; neither did he intend it for an absolute gift. He stated that he meant to allow it to be subject to losses, if any, in preference to his own claims. Even after repeated questioning by counsel for the taxpayer, the members of the Board, and the counsel for the Commissioner, he was unable satisfactorily, to define the exact status of this balance. It is our opinion, after a careful analysis of his testimony, that he in fact really intended to leave in the business as much of this fund as was necessary to advantageously run the company and to withdraw it gradually as the business justified. This view seems to be borne out by the actual facts. In 1911 the amount was $350,000, by 1918 it had been reduced to $288,137.36, and by 1919 to $283,487.98, and later, in 1921, it was all withdrawn. During all this time Webb in fact considered it his individual money, subject to withdrawal at times convenient to the taxpayer corporation.

The taxpayer’s contention is based upon a misconception of the meaning of invested capital. While this fund may have been used as capital, nevertheless, it belonged to Webb and not to the corporation. It did not fall within the well-known classes of statutory invested capital. It was not cash or other assets paid in for stock; neither was it surplus or undivided profits.

Even were it a fact that the amount due Webb was subordinated to claims of general creditors and was a restricted indebtedness, this would not necessarily take it out of the class of borrowed capital, Appeal of I. Unterberg & Co., Inc., 2 B. T. A. 274; nor would the fact that no interest was charged change the character of the fund to invested capital. Appeal of Kelly-Buckley Co., 1 B. T. A. 1154. It is clear to our minds that these sums were not invested capital.

The taxpayer claims additional invested capital for certain patterns, blue-prints, tracings, etc. In support of this claim the taxpayer has presented a long detailed list of patterns upon which it placed a value of $86,834. In its amended petition it places the value at $75,000, and in its original returns for 1918 and 1919 it had placed the value at $15,000. The taxpayer seems to have kept no account of these patterns upon its books, nor had it capitalized them in prior returns. We are satisfied from the evidence that these patterns did have a substantial value and could be capitalized for invested capital purposes were it possible to fix the value. The taxpayer has presented no books or other evidence to show how or in what way it arrived at the valuation submitted. It was vaguely stated that the values were an allocated portion of the salaries paid E. D. Webb and S. J. Webb, who had spent much time and labor upon them while in the employ of the taxpayer since 1896. However disposed we are to allow invested capital for those items, we are unable to do so from the data and evidence submitted.

The last issue involves the proper allocation of $3,814.99, income received from the sale of a certain compress to the Jacksonville Compress Co. The question is whether the income should be returned as of 1919 or 1920. The contract for the sale of the cotton compress reserved the title' in the taxpayer, provided for substantial cash payments, and made provision for payments by notes after a test and acceptance by the purchaser. The contract in question was entered into June 28, 1919. The total purchase price was $32,000, of which $15,000 had been paid in various amounts in the year 1919. The contract provided for a test and acceptance within 30 days after the installation of the compress. It was installed in October, 1919, but, through some cause or other, the test and acceptance were delayed until January, 1920.. On January 26, 1920, there was an acceptance, the purchaser executed notes for $11,000, the balance of the purchase price, and at the same time executed a trust on the land and compress to secure the notes. The Commissioner contends that the sale was consummated in 1919 and that the 1920 transactions involved only the payment of the money. The taxpayer claims that the sale was contingent upon the test and acceptance in January, 1920. This latter view, we think, should prevail under the circumstances of this case. Surely, the transaction was not completed until the cotton compress was tested and the acceptance made by the purchaser. This is borne out by the fact that the notes and securities for the balance of the purchase price were not executed until January 26, 1920. If the compress did not meet the test or was not accepted, this would clearly mean delay or a loss. At any rate, a profit could not be computed until the final acceptance. The income from this transaction, in our opinion, should be allocated to the year 1920. The test was a condition precedent and not a condition subsequent, the transaction was not a closed one until after January 1, 1920, and hence the income arising therefrom could not have accrued before that date.


author: Arundell:

text:
    Appeal of J. P. BELL CO., INC.
    Docket No. 4566.
    Submitted September 21, 1925.
    Decided December 31, 1925.
    Tbe Commissioner has five years from the date of filing a delinquent return due under the Revenue Act of 1918 within which to assess the tax.

      L. 0. Mitchell, Esq., for the Commissioner.
    Before Sternhagen and Arundell.
    This is an appeal from the determination of a deficiency for the fiscal years ended June 30, 1919, and 1921, in the amount of $564.95. The errors alleged are the proposal of the Commissioner to assess a tax for the fiscal year ended June 3Ó, 1919, more than five years after the return was due, and his failure to deduct $140.53 interest on United States obligations before computing the income tax for the fiscal year ended June 30, 1921.
    FINDINGS OP PACT.
    The taxpayer is a Virginia corporation, with its principal office at Lynchburg.
    The corporation income and profits-tax return of the taxpayer for the fiscal period begun July 1, 1918, and ended June 30, 1919, was filed with the collector of internal revenue at Richmond, Va., on October 20, 1920. The Commissioner, under date of April 2, 1925, mailed to the taxpayer the 60-day deficiency letter from which the appeal herein has been taken.
    Interest received on United States obligations in the amount of $140.53 was included in the gross income of the taxpayer for the fiscal year ended June 30, 1921, and resulted in an overstatement of tax for that year in the amount of $14.05.
    DECISION.
    The deficiency is $550.90.
   OPINION.

Arundell:

Section 221 (a) of the Revenue Act of 1918 provides that “returns shall be made on or before the fifteenth day of the third month following the close of the fiscal year,” which, in the instant case, would fix the due date of the return as September 15, 1919, the fiscal year of the taxpayer having ended on June 30, 1919. Section 277 (a) (2) of the Revenue Act of 1924 provides that the “income, excess-profits, and war-profits taxes imposed by * * * the Revenue Act of 1918, and by * * * such Act as amended, shall be assessed within five years after the return was filed.” From the foregoing it is clear that it is the date of filing the return and not the date that the return was due that determines the period within which the tax may be assessed by the Commissioner. The return of this taxpayer for the fiscal year ended June 30, 1919, was not filed until October 20, 1920, and it is from that date that the period of assessment runs. In this connection it is significant that section 218 (a) of the Revenue Act of 1924 provides that, upon 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. Thus, if the taxpayer had not filed his return at all, the tax could be assessed at any time — having filed his return after it became delinquent, the date of filing fixes the period within which the assessment may be made.

The Commissioner in his answer admits that for the fiscal year ended June 30, 1921, there was improperly included in income interest from United States obligations in the amount of $140.53, resulting in an overstatement of the tax in the amount of $14.05.


author: Littleton:

text:
    Appeal of NORTHERN MICHIGAN TRANSPORTATION CO.
    Docket No. 3168.
    Submitted July 6, 1925.
    Decided December 31, 1925.
    The taxpayer which, by its charter, was authorized to operate steamships for hire upon the Great Lakes and upon the high seas, purchased from the United States two steamships which were delivered to it in the ports of New York and Boston. In order that certain repairs and changes necessary for profitable operation might be made, and in order that the vessels might be more profitably operated in its business, taxpayer caused the vessels to be removed under their own power from New York and Boston to its dock at Milwaukee, at a cost of $45,627.97. Held,, that the cost of transporting the vessels was a legal deduction from gross income as an ordinary and necessary business expense.

      Robert Ash, Esq., for the taxpayer.

      M. N. Fisher, Esq., for the Commissioner.
    Before James, Littleton, Smith, and Tiutssell.
    This is an appeal from the determination of a deficiency in income and profits tax for the calendar year 1919 in the amount of $21,876.94, arising from the refusal of the Commissioner to permit the taxpayer to deduct as an ordinary and necessary business expense for the calendan year 1919 the sum of $45,627.97, paid by it in transporting from New York and Boston to Milwaukee two steamships purchased by it from the United States Government.

      FINDINGS OF FACT.
    The taxpayer is a Wisconsin corporation with its principal office at Chicago, Ill., and is engaged in the business of transportation for hire upon the Great Lakes and the high seas. In 1919, it operated steamers between Chicago, Milwaukee, and other Lake ports, and, in addition, chartered to others certain of its ships for service to points' designated by the charterer. Its charter provided in part as follows:
    To carry on a general transportation business for passengers and freight upon the Great Lakes, and all other lakes and rivers and harbors and all ot-her waters tributary thereto, both within, without, or contiguous to the borders of the United States, and also upon the high seas.
    In November, 1919, the taxpayer, being in need of additional ships, purchased from the United States Government the S. S. Puritan and the S. S. General O'Reilly ¡ which were at the time of purchase lying in the ports of New York and Boston, respectively, where they were delivered to the taxpayer; These vessels had previously operated on the Great Lakes and were well known to taxpayer. They were acquired by the taxpayer upon competitive bids. At the time of purchase the vessels were in condition to be operated by the taxpayer, but, in order to be thoroughly satisfactory and operated profitably, certain repairs and changes were necessary. These repairs were subsequently made and charged to capital account. Immediately upon delivery of the vessels the taxpayer caused them to be transported under their own power from the ports of New York and Boston to its dry dock at Milwaukee at an expense of $45,627.97.
    On its voyage from New York to Milwaukee the Puritan carried about four carloads of supplies, consisting of lifeboats, life rafts, life preservers, mattresses, blankets, etc., which were also purchased by the taxpayer from the United States Government.
    The General O'Reilly on its voyage from Boston to Milwaukee came upon a wrecked coal vessel in the St. Lawrence River, from which taxpayer purchased 600 tons of coal at $7 per ton. This coal was transported on the General O'Reilly for use by the taxpayer in its business. The General O'Reilly, with minor changes, was put into service soon after its arrival at Milwaukee.
    The Puritan had been converted by the United States Government into a hospital ship, and considerable repairs and changes were necessary to make it fully serviceable. It was placed in service some time during the year 1920.
    Had taxpayer desired, it could, under its charter, have placed these ships in service for hire at the ports of delivery. It concluded, however, that it was to the best interest of its business to move the vessels to winter quarters at Milwaukee, and, after certain changes and repairs, to place them in service from that port.
    DECISION.
    The deficiency, if any, should be computed in accordance with the following opinion. Final determination will be settled on 10 days’ notice, under Rule 50.
   OPINION.

Littleton:

The taxpayer contends that the cost of removing to Milwaukee the two vessels purchased from the United States Government and delivered to it in the ports of New York and Boston was an ordinary and necessary business expense and deductible from gross income. The Commissioner, on the other hand, contends that the cost of moving the vessels was a part of their cost and should be capitalized.

We are of the opinion that the Commissioner was in error in refusing to allow the taxpayer to deduct as an ordinary and necessary business expense the cost of transporting the vessels from New York and Boston to Milwaukee.

Taxpayer for many years had been engaged in the business of transporting freight and passengers for hire under a charter which authorized it to engage in this business upon the Great Lakes and upon the high seas. Upon delivery of the vessels to it by the United States Government, taxpayer deemed it to its best interest to remove them to Milwaukee for repairs and changes and to place them in service at that point. Accordingly, they were transported under their own power to Milwaukee at a cost of $45,627.97, for wages, fuel, food, insurance, etc.

The fact that the ships might have carried a cargo for hire, or supplies for taxpayer, or no cargo at all, does not, in our opinion, change the character of the expenditure. We are of the opinion from the evidence in this appeal that the cost of transporting the vessels from New York and Boston to Milwaukee was an ordinary and necessary business expense and deductible from gross income for the year 1919.

On reference to the Board, Trammell dissents.


author: Trammell

text:
    Appeal of H. J. KELLY.
    Docket No. 1796.
    Submitted June 12, 1925.
    Decided December 31, 1925.

      Held, that notes received as part consideration for tbe sale of stock constituted taxable income in 1919.

      Irvine P. Aten, Esq., for the taxpayer.

      A. Galder Maehay, Esq., for the^Commissioner.
    Before Grattrner, Trammell, and Phillips.
    This appeal involves a deficiency in income tax for 1919 in the amount of $27,484.89. It is based upon the action of the Commissioner in treating the sale of certain stock as a closed transaction instead of as an installment sale, as was done by the taxpayer in his income-tax return, and in the action of the Commissioner in holding that certain of the stock was the property of the taxpayer and not that of another individual in whose name it appeared on the corporation’s books.
    FINDINGS OE PACT.
    The taxpayer was one of the original incorporators of the Dakota Iron Store, a corporation organized and existing under the laws of South Dakota, with its principal place of business at Sioux Falls. The original paid-in capital stock of the corporation was $25,000, divided into 250 shares of a par value of $100 each. The stock was issued 125 shares to H. J. Kelly, 115 shares to. D. S. Reardon, and 10 shares to G. W. Gillispie. The corporation was successful in its operation and made large profits from the date of its organization until 1918. During the years 1910 to 1919 the corporation declared large stock dividends.
    On March 1,1918, Kelly, having received 125 shares as stock dividends, was the owner of 250 shares of the corporation’s stock. It had a fair market value on that date of $590.62 per share. On April 30, 1915, he received an additional 125 shares.of stock. On February 1,1917, he received 250 shares of the same stock. On January 8, 1918, he received another 250 shares. On January 8, 1918, he purchased 125 shares at $100 per share, making a total cost of $12,500. On January 14, 1919, he received 250 more shares, making a total of 1,250 shares of stock of the Dakota Iron Store owned by Kelly on the day of the sale in 1919.
    Gillispie had received stock dividends so that, in June, 1919, he was the owner of 100 shares of stock of the corporation. Kelly was owner of record of. 1,240 shares and Margaret Kelly was owner of record of 10 shares. They belonged, however, to Kelly.
    The stock received by Kelly, except that subscribed by him originally, which was owned on March 1, 1913, and except that which he purchased on January 8, 1918, was received as stock dividends.
    The stock appearing in the name of Gillispie belonged to Gillispie and was sold by Kelly as his agent. No part of the income from the sale of such stock belonged to Kelly.

      On July 21, 1919, Kelly sold his stock to Reardon, and, acting as the agent for Gillispie, included Gillispie’s stock in the sale. For the 1,250 shares owned by Kelly he received $55,700 in cash on July 1, 1919; $32,300 in 1920; $54,000 in 1921; $54,000. in 1922, and $54,000 in 1923. The sum of $20,000 in cash was paid to Kelly for Gillispie on account of the sale of the 100 shares owned by Gillispie.
    The deferred purchase price was evidenced by promissory notes which were secured by a deposit of the stock as collateral. There was no competent evidence as to the value of the notes received in payment.
    DECISION'.
    The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 20 days’ notice, under Rule 50.
   OPINION.

Trammell

: On July 21, 1919, the taxpayer owned 1,250 shares of stock. Of this number, 125 shares of the par value of $12,500, which had been acquired at that price in 1910, had a market value on March 1, 1913, of $590.62 per share. In 1918 he purchased an additional 125 shares at $100 per share. The remaining stock was received by him as stock dividends. The stock owned by the taxpayer was sold in 1919 for a total consideration of $250,000. Since the sale of the stock received as dividends and the stock originally acquired was consummated in one transaction, the entire cost of the stock was represented by the purchase price of that stock which had been purchased.

The Commissioner considered that the 100 shares appearing in the name of Gillispie belonged to Kelly and that the initial payment of $75,700 was in excess of one-fourth of the purchase price of the stock sold. The evidence convinces the Board that the Commissioner was in error in that respect and that Gillispie was the owner of the stock appearing in his name on the books of the corporation. Of the cash received, $20,000 was for Gillispie’s stock and should not be included in the gross income of the taxpayer. It thus appears that taxpayer received $55,700 in cash of a total sales price ■of $250,000, the balance being represented by notes.

It was not shown that the notes received for the property sold were not worth their full face value or that there was not a market therefor. In the absence of such showing the transaction amounted to the receipt of cash and notes which were the equivalent of cash, and as such the transaction was a single closed transaction in the year 1919. The taxpayer received cash and the equivalent of cash for the stock.


author: Smith: James,

text:
    Appeal of HELENE R. McCONNELL.
    Docket No. 435.
    Submitted May 21, 1925.
    Decided January 6, 1926.
    The taxpayer received income from an estate under the provisions of the will of a decedent .who died in 1905. Held,, that the total amount of the income received was liable to income tax. Irwin v. G-avit, 268 U. S. 161. Held, further, that the taxpayer is not entitled to a deduction from gross income for exhaustion by reason of the fact that her interest in the estate of the decedent was only a life interest.

      H. F. Garrity and L. G. Gooper, Esqs., for the taxpayer.

      John D. Foley, Esq., for the Commissioner.
    Before Giíaitpner, Lansdon, Littleton, and Smith.
    This is an appeal from the determination of a deficiency in income and profits tax for the years 1918, 1919, and 1920, in the amount of $1,638.86. The appeal was submitted on the petition and answer.
    FINDINGS OP PACT.
    The taxpayer is an individual residing in Philadelphia, Pa. She is the granddaughter of one Frederick A. Poth, who died January 21, 1905, leaving a will with two codicils attached. So much of the will and codicils as is pertinent to the issues involved in this appeal reads as follows:
    The residue of my estate shall be held and invested by my Executors and Trustees in the following manner. They shall not be obliged to dispose of my investments but shall continue the same as long as they deem it advisable, they may sell the personal estate in whole or in part, and only so far as regards the real estate as hereinbefore provided, they shall keep all my real estate in first class order and repair, they may also sell and resell any personal investments they may make, they are authorized to invest and reinvest any funds coming into their hands in only good income yielding real estate, first class mortgages and in the United States, state or municipal bonds as the laws of the' State of Pennsylvania authorize Trustees to make. Provided, however that my Executors and Trustees shall retain and make investments in such personal securities as can be readily turned into cash, so much of my estate as may be necessary to meet the bequests hereinafter directed to be paid out of the principal of my estate to my children or their issue when the same shall become payable to them under the terms of this will.
    Eighth. I direct my Executors and Trustees to pay out of the principal of my estate, not earlier than one year after my death unto such of my daughters as may then have attained the age of twenty one years and such as may thereafter and as they attain the age of twenty one years, and unto such of my sons as may then have attained the age of twenty four years and such as may thereafter and as they attain the age of twenty four years, each the sum of twenty five thousand dollars. And I further direct as each of my children male or female, arrive at the age of forty years there shall be paid unto her or him, each the further sum of twenty five thousand dollars, Provided however, from the sums so as aforesaid ordered to be paid to them, there shall be first deducted from the share of each respectively the total amount appearing and charged on my books against such respective child as advancements or loans. In the event of the death of any of my said children, before receiving the sums so directed to be paid to them, leaving issue, then such issue shall receive the parent’s share when as he, she or they arrive at the age of twenty one years and in default of such issue the same.to revert to and become part of my estate.
    Ninth. I direct that for, during and ensuing the term of ten years from the date of the execution of my will the income of my estate shall be distributed and applied as follows. That after the payment of the sum of twenty four thousand dollars to my wife for life, one half of the net income thereof shall be distributed semi-annually to and among my children in the following proportions and shares the said one half of the' net income shall be divided into as many shares as there are children, or representations of deceased children, and such of my daughters that have attained and shall attain the age of twenty one years and such of my sons as have attained and shall attain the age of twenty four years shall each receive one equal share of the said one half net income of my estate, and those of my daughters under the age of twenty one years and my sons under the age of twenty four years shall each receive but one half of such share which form of distribution shall continue in such ratio or proportions until all my daughters arrive at the age of twenty one years and all of my sons arrive at the age of twenty four years and thereafter said one half of the net income of my estate shall be equally divided amongst them share and share alike. Provided the share of each of my daughters who have attained or shall attain the age of twenty one years and of each of my sons who have attained or shall attain the age of twenty four years shall not exceed the sum of twelve thousand dollars per annum, and the shares of daughters under the age of twenty one years and sons under the age of twenty four years shall not exceed the sum of six thousand dollars each per annum, and the surplus shall fall into and become part of my residuary estate.
    And the remaining one half of the net income and surplus of the above mentioned one half, if any there be, shall fall into and become part of my residuary estate during the continuance of the said ten years after the execution of this will to be by my executors and trustees invested as hereinbefore provided.
    After the expiration of ten years from the date of this will subject to the annual payments of twenty four thousand dollars to my wife, the entire net annual income of my estate shall be distributed semi-annually in equal shares to and among my children for and during the term of their natural lives. Should any of my children die during the continuance of the trust under this will leaving issue surviving at the time of the death of such child, then such issue shall take the share of the income the parents would haye taken if living during the continuance of the trust under this will. Provided however in the event of the death of any of my children who may be or should become married leaving issue or not to survive them, the husband of any of my daughters and wife of any of my sons so surviving shall receive one fourth of the income said daughter or said son would have received under the terms of this will had she or he have lived, only during the term of the natural life of such husband of any of my daughters who may become deceased and during the term of the natural life of such wife of any of my sons who may become deceased. Should such husband of any of my daughters so dying or the wife of any of my sons so dying remarry, or should he or she in any way commit any crime or lead an immoral life and not continue to be possessed of a good moral character said bequest of such income shall immediately cease and determine. Any of my daughters or sons may by a last will or any paper writing in the nature thereof expressly provide that her husband or his wife shall not receive the said one fourth of her or his share of the income so given by me after her or his death.
    Tenth. It shall be the duty of my Executors and Trustees to collect the rents issues and profits of the residue of my estate and after deducting therefrom the expenses of the trust taxes, charges, repairs and other expenses, thereof, I will and direct they shall pay semi-annually, the balance of the income as follows, subject to and in the proportions and shares aforesaid:
    a. They shall hold the net income in trust for my children surviving me at the time of my decease and the lawful issue of such as may then be dead. ■ Such issue taking by representation the share the deceased parent would have taken if then alive.
    b. They shall pay to each of my children who may have arrived at the age of twenty one years at the time of my death or who may thereafter arrive at said age, and to the lawful issue of such as may then be dead, their shares respectively of the said income, subject as hereinbefore provided.
    c. Should any of my children die during the continuance of the trust under this will leaving issue surviving at the time of the death of such child, then such issue shall take the share of the income the parent would have taken if living during the continuance of the trusts hereunder.
    d. No one of the beneficiaries under the provisions of this will shall have any right to anticipate, sell, assign encumber or in any manner or way whatever to dispose of such income or the principal of his, her or their estate or interest before the same shall be actually received by and come into such beneficiaries possession and that the same shall not be liable for the debts, contracts or engagements of such beneficiarios in any way whatever.
    e. I direct that during the minority of my said children or the issue of any deceased child, the Trustee shall expend for the maintenance and support of each of them out of the foregoing income that they will receive into their hands for said minors, such sums as they may deem advisable, the balance of ■such income remaining they shall hold for such minor children or the issue of any deceased child until they arrive at the age of twenty-one years, or the lawful issue of any of them as may become deceased, otherwise said balance shall lapse and become part of my residuary estate.
    f. In all instances touching the distribution of the income of my estate, in which the question may arise, the issue of any deceased child or descendant of such child shall take per stirpes and not per capita.
    Eleventh. The Executors and Trustees shall retain possession of my residuary estate during the life time of my last surviving child, and during this time the income shall be divided among my children and their issue as hereinbefore provided.
    At the termination of the trust, after the death of my last surviving child, the principal, of the estate then remaining in the hands of the Executors and Trustees shall then he divided among the issue of my children per capita, and the issue of any of them that may then be deceased taking per stirpes and not per capita. I desire such distribution of such remaining residue to be made between my grandchildren equally per capita, so that each of my grandchildren shall be treated alike and take alike, the issue however of any deceased grandchild to take per stirpes.
    Upon the determination of the foregoing trust my Executors and Trustees may, if they deem it advisable, divide my estate in the shares as above pro-Tided among the beneficiaries in kind, first placing upon the same a iair and just valuation and dividing the same into lots as may be convenient and adopt any method which may be equitable to the parties in interest. I direct my Executors and Trustees shall hold meetings as they may determine and keep minutes and records of their actions, which books shall be open to reasonable inspection of any party in interest. I further direct that no inventory and appraisement of my estate be filed unless my Executors and Trustees shall otherwise deem it advisable.
    * * * * * * *
    I Frederick A. Poth the within named testator do hereby make and publish this second codicil to my last will and testament bearing date the 31st day of May A. D. 1898, in the manner following to wit: * ⅝ *
    Second. I do hereby revoke absolutely such portions of my will which provide that in the event of the death of any of my children leaving issue, such issue shall take by representation the share or shares of my estate his, or hel- or their parent or parents would have taken if living, and instead thereof, I do hereby direct that in the event of the death of one of my children, leaving issue, then such issue shall take by representation such share of the principal or income of my estate, his, her, or their parent would have taken if living, subject of course to the shares of the husband or wife of my said child would be entitled to receive under the terms of this will. And in the event of the death of more than one of my children, leaving issue, then such issue of all of my children that may be deceased, shall take per capita the collective shares of principal and income of my estate their deceased parents would have taken if living, subject of course to the share the husband or wife of my said children would be entitled to receive under the terms of this will.
    On August 30, 1915, Mrs. George J. Roesch, mother of the taxpayer, died, leaving two daughters, the taxpayer and Claire Roesch. The taxpayer’s father died within a few months after the death of her mother.
    On May 26, 1907, an agreement was executed between the trustees of the estate of Frederick A. Poth, deceased, and F. A. Poth and Sons, Inc., whereby the corporation leased the premises upon which the brewery buildings owned by the estate were located for the sum of $120,000 per annum, plus 70 per cent of the net profits of the brewery in excess of $60,000. With these changes the business and estate continued unaltered from that time until the year 1921. In that year the rental paid by the corporation to the estate was reduced, the corporation having suffered during the previous year heavy loss due to the advent of prohibition.
    The book value of the various properties owned by the éstate of Frederick A. Poth was as follows:
    Parkside Avenue, west of Forty-second Street_ $449, 999.96
    Viola Street_ 185, 000.00
    Parkside Avenue, east of Forty-second Street- 381,178.76
    Forty-second Street, Memorial and Marlton Avenues- 305,987.34
    Powelton Avenue, east of Tfiirty-fourtb Street_ 126, 815.17
    Nortfi Tfiirty-fourtb Street_ 39, 837.45
    Powelton Avenue, west of Tfiirty-fourtb Street_ 105, 974. 30

      North Thirty-fifth Street_ 45,000.00
    Spring Garden Street_ 79, 976.75
    North Twenty-ninth Street_ 35, 683. 65
    216 North Thirty-third Street and 1804 Pacific Avenue_ 128,475. 00
    Sundry houses- 94, 757.74
    Saloon properties_ 187, 567.49
    Narragansett and Haines Streets_ 140,000. 00
    Lots_ 85, 501.69
    Brewery property_ 1. 052, 038.45
    Value of brewery stock, 2,348 shares, at $250_ 587, 000.00
    Mortgages- 33, 000. 00
    4, 064,093.00
    Under the second codicil of Poth’s will, the taxpayer, so long as Poth’s remaining children lived, took one-half the income of the sixth portion theretofore distributed to her mother, and, as others of Poth’s children died, she took her per capita share of the total of such children’s shares added together, and her ultimate income from and share of the corpus of the estate is measured by the number of per capita shares into which its income and corpus may be divided as sons and daughters of Poth die from time to time until the death of the last survivor of Poth’s children. But for this contingency of a different per capita division from the per stirpes division, the value of the taxpayer’s expectancy would be $112,891.49. Under the conditions of the will, however, that amount is subject to increase or decrease, depending upon the number of grandchildren who survive their parents.
    For the five years immediately preceding March 1, 1913, the total income of the estate from the brewery was as follows:
    . 1908-$274, 685. 68
    1909- 285,139.16
    1910- 331, 723. 76
    1911_ 252; 568.00
    1912- 197, 898. 59
    For the years 1920 and 1921 the income of the estate from the brewery was as follows:
    1920_$371, 610. 57
    3921_ 100,000.00
    DECISION.
    The determination of the Commissioner is approved.
   OPINION.

Smith:

The appeal of the taxpayer is based on three points: First, that the receipts from the estate of Frederick A. Poth did not constitute income; second, that if the amounts received from the estate during the taxable years are considered income they should be reduced by depreciation of the taxpayer’s life estate due to the lapse of time; and, third, deductions should be allowed for obsolescence of the life estate due to the passage of the prohibition amendment.

Under the will of Frederick A. Poth, the residue of his estate was left to trustees, who were to exercise absolute control over the property so long as any of the children of the testator should live, and to pay the income of the estate to these children annually in the proportions specified in the will. In the event of the death of one child leaving issue, such issue would take, by representation, the parent’s '-hare of the income, subject to an allowance for life of one-fourth of such share to the husband or wife, as the case might be, of such deceased child, or, in the event of the death of more than one child, the issue of such deceased children were to take per capita the combined shares of their parents, subject to the allowance for life to the surviving parents.

On August 30, 1915, the taxpayer’s mother died leaving two children, the taxpayer and a sister. Within a few months after the death of the mother their father died, leaving the mother’s share of income from the estate to the daughters.

It is argued in behalf of the taxpayer that the amounts received by the taxpayer from the income of the estate are in the nature of a devise or bequest, and that, under the provisions of section 213 (b) of the Revenue Act of 1918, devises and bequests are excluded from gross income. It is also argued that the amounts in question do not come within the meaning of the word “ income ” as used in the sixteenth amendment, and that the mere fact that, under section 219 (d) of the Revenue Act of 1918, the income of an estate which is distributed to beneficiaries periodically in accordance with the provisions of the will is included in the income of the beneficiary, can not convert the amounts distributable into income if they are not in fact income within the meaning of the sixteenth amendment.

This point is governed by the decision handed down by the United States Supreme Court on April 27,1925, in the case of Irwin v. Gavit, 268 U. S. 161. In that case an individual was entitled to receive a certain proportion of the income of an estate until such time as the testator’s granddaughter, who was 6 years of age at the time of the testator’s death, should reach the age of 21, unless she should die before reaching the age of 21, in which event the individual’s right to receive the income would terminate on the death of the granddaughter. The court held that the income of the estate distributable to the taxpayer under the will was income to the taxpayer within the meaning of the sixteenth amendment, the Revenue Act of 1913, and the definition of income as previously laid down by that court in Eisner v. Macomber, 252 U. S. 189. The court said:

The statute in Section II, A, subdivision 1, provides that there shall be levied a tas “ upon the entire net income arising or accruing irom all sources in the preceding calendar year to every citizen of the United States.” If these payments properly may be called income by the common understanding of that word and the statute has failed to hit them it has missed so much of the general purpose that it expresses at the start. Congress intended to use its power to the full extent. Eisner v. Macomber, 252 U. S. 189, 203 [U. S. Tax Cases, 196], By B. the net income is to include gains or profits and income derived from any source whatever, including the income from but not the value of property acquired by gift, bequest, devise or descent.” By D. trustees are to make “ return of the net income of the person for whom they act, subject to this tax,” and by E. trustees and others having the control or payment of fixed or determinable gains, &c., of another person, who are required to render a return on behalf of another are “ authorized to withhold enough to pay the normal tax.” The language quoted leaves no doubt in our minds that if a fund were given to trustees for A for life with remainder over, the income received by the trustees and paid over to A would be income of A under the statute. It seems to us hardly less clear that even if there were a specific provision that A should have no interest in the corpus, the payments would be income none the less, within the meaning of the statute and the Constitution, and by popular speech. In the first case it is true that the bequest might be said to be of the corpus for life, in the second it might be said to be of the income. But we think that the provision of the act that exempts bequests assumes the gift of a corpus and contrasts it with the income arising from it, but was not intended to exempt income properly so called simply because of a severance between it and the principal fund. No such conclusion can be drawn from Eisner v. Macomber, 252 U. S. 189, 206, 207 [U. S. Tax Cases, 196]. The money was income in the hands of the trustees and we know of nothing in the law that prevented its being paid and received as income by the donee. ♦
* * * This is a gift from the income of a very large fund, as income. It seems to us immaterial that the same amounts might receive a different color from their source. We are of opinion that quarterly payments, which it was hoped would last for fifteen years, from the income of an estate intended for the plaintiff’s child, must be regarded as income within the meaning of the Constitution and the law. It is said that the tax laws should be construed favorably for the taxpayers. But that is not a reason for creating a doubt or for exaggerating one when it is no greater than we can bring ourselves to feel in this case.

The remaining contentions of the taxpayer that, in the event the Board should decide that the amounts received under the will from the income of the estate were income to the taxpayer, allowance should be made for the depreciation of the taxpayer’s life estate due to the lapse of time and for obsolescence of such life estate due to the passage of the prohibition amendment, will be considered together, since the deductions claimed on account of depreciation and obsolescence are governed by the same provisions of law. Section 214 of the Revenue Act of 1918 reads in part as follows:

(a) That in computing net income there shall be allowed as deductions:
⅝ ⅜ ■* * * * *
(8) A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence ; * ⅞ *

The taxpayer does not contend that she is entitled to deductions on account of the property belonging to the estate or on account of obsolescence of the brewery business because of the advent of prohibition. She does claim, however, that she has a life estate of determinable value and is entitled to an allowance for the exhaustion of this estate due to lapse of time, and, further, that prohibition has seriously impaired the value of the life estate for which allowance should be made by way of obsolescence. From the language just quoted, it is clear that there is no basis for such deductions as contended for by the taxpayer. Deductions for exhaustion, wear and tear, and obsolescence are allowable to an individual only in respect of property used in trade or business, and, regardless of whether or not the taxpayer has a life estate of the value contended for, and regardless of whether or not her share of income from the estate was.materially reduced by the advent of prohibition, it can not be said, under the most liberal construction, that the taxpayer’s right to share in the income of the estate was property used in the trade or business.

James,

concurring: I am of the opinion that the decision in this appeal is governed by Irwin v. Gavit as above set forth, and I concur in the decision only for that reason. I agree also that the question here involved is not a question of depreciation of a life interest, but is the more fundamental question whether the so-called income received through an estate or trust by life tenants is in fact in any proper sense all income to the life tenant.

We have been for many years familiar with the valuation of estates for inheritance, transfer, and estate-tax purposes, whereby definite and determined values are placed on the inheritance, or transfer or bequest of property to life tenants. These values, plus the values of the remainders, are necessarily the values assigned to the entire property transferred by the devise. The difference in these estates is well recognized both in law and in fact, and it is recognized that the life tenant receives under such circumstances something which has capital value, and upon which taxes on inheritances and bequests are imposed and paid. The Federal Government has itself imposed inheritance taxes (in 1898), although in later years it has chosen to impose the death duties in the form of an estate tax which graduates the tax in accordance with the entire property passing instead of in accordance with the value passing to each particular heir, legatee, or devisee. It would be an anomalous situation, indeed, if the Federal Government, imposing an inheritance tax, held that for the purpose of that tax a life tenant might be in receipt of something of capital value, and then held, after that transfer had paid its contribution to the public revenue, that all of the amounts received year by year constituted income subject to taxation again. It seems to me perfectly clear that the amount received under these circumstances is a mixture of capital and income, the life tenant year by year receiving a portion of that value which was originally estimated as his capital, thereby diminishing his interest in the capital as the years go by. It is likewise true, it seems to me, that the remainderman, as the .years pass and his expectancy of ultimate receipt of the property approaches, has a greater and greater interest in the capital which comes to fruition at the death of the life tenant and the actual passing of title and possession. Whether upon the happening of the latter event the remainderman is in receipt of income in the amount of the difference between the value of the property received at that time and the value based upon the remainder interest when the original estate or trust came into existence, is a further question of interest not immediately at issue in this appeal, but probably a necessary corollary of the reasoning set forth above.

It seems to me that the fallacy of treating as income all the receipts, under the circumstances of this appeal, becomes clear if we consider the effect which would result from such a rule in the case of an outright purchase of an annuity, an uncommon thing in the United States, but a very common practice in most European countries. Annuities may readily be purchased on the basis of the life expectancy of the annuitant and, like ordinary life insurance, are figured upon the period of time expected to elapse between the beginning of the payment of the annuity and the death of the annuitant. The computation is merely the reverse of the computation involved in life insurance. It seems perfectly clear to me that if a person purchased an annuity for $100,000 he would be entitled to treat as a return of capital that pro rata portion of each annuity payment necessary to produce $100,000 out of the total expected annuities.

Such an annuitant is in no different position from the recipient of a life estate or from the recipient of an annuity from a life insurance company in those cases where provision has been made that the beneficiary should taire a certain sum per annum for life in lieu of the gross face amount of the policy.

I am not unmindful of the fact that in the instant appeal the interest of the taxpayer in her grandfather’s estate which she inherited on the death of her mother was contingent upon the total number of grandchildren then living who should survive their respective parents, and upon her surviving the last of Poth’s children to die, and that her annual distribution was subject to be increased or decreased as her uncles and aunts died leaving more or less than two children surviving. As set forth in the findings of fact, this contingency was apparently not considered in the facts pleaded by the taxpayer, and the value of the life interest of the taxpayer at the death of her mother can not, therefore, be computed from the data submitted. In view of the decision in this appeal, this point is immaterial. It is introduced merely to show one of the elements of difficulty surrounding the treatment of a portion of a life estate with a contingent remainder in corpus as a return of capital, although such difficulty is in .the last analysis a mere problem in valuation, far less difficult in its intrinsic features than many problems of March 1, 1913, value, with which the Board and the courts are constantly struggling.

Littleton concurs in the views above expressed.