author: Trascmell:

text:
    Sonora Bank & Trust Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7838.
    Promulgated May 25, 1927.
    1. On the facts, held that alleged agencies of petitioner in Mexico were not, in fact, its agents, and that income received by such agencies was not thereby constructively received by petitioner.
    2. Debts tentatively ascertained in one year by an officer of petitioner to be worthless, such action being finally approved by the board of directors and the debts charged oil pursuant thereto in the following year, held to be a proper deduction from income for the latter year under section 234 (a) (5) of the Revenue Act of 1918.

      George M. Morris, Esq., for the petitioner.

      W. H. Lawder, Esq., for the respondent.
    This is a proceeding for the redetermination of deficiencies in income and profits taxes for the calendar years 1919 and 1920 in the amounts of $1,706.30 and $10,377.91, respectively. Approximately the amount of $9,000 only is in dispute. The issues raised involve the correctness of the Commissioner’s action (1) in adding to petitioner’s income certain amounts representing profits alleged to have been received through agencies in Mexico; (2) in disallowing deductions claimed by petitioner for bad debts; and (3) in adding to petitioner’s income amounts representing donations by the Mexican agencies.

      FINDINGS OF FACT.
    Petitioner is a banking corporation, organized in 1914 under the laws of Arizona, with a capital of $100,000. Its principal office and place of business is at Nogales.
    The Banco de Sonora was and is a Mexican corporation, which for many years prior to 1910, conducted a banking business in the Republic of Mexico. Its home office was at Hermosillo, Sonora, and it operated branches at various other places in the State of Sonora. It was the largest banking institution in the northwestern part of Mexico, having resources of approximately 15,000,000 pesos, or $7,500,000 American money. In 1910, the Madero revolution was started in Mexico, which brought about a condition of chaos and disrupted the banking business. Thereupon, the Banco de Sonora transferred all of its movable assets to the United States and in 1914 organized the petitioner, with a view to preserving and carrying on its former business as far as possible. Certain immovable assets, including its banking houses in Mexico, were left in charge of a representative at each place who had formerly been an employee of the corporation. All of petitioner’s capital was contributed by the Banco de Sonora, and all of its stock was issued to and held in the names of the directors of the Mexican corporation. Because of the absence of adequate banking facilities in Mexico, former depositors and customers of the Banco de Sonora applied to its representatives in Mexico to accept deposits of money for them, to transfer money to the United States, to forward mail and to peform other acts pertaining to banking functions. At first the representatives or agents of the Banco de Sonora operated under their own individual names, but later, with a view of affording such agents further protection in the handling of their business, the directors of petitioner authorized them to use the title “Agenda, Sonora Bank & Trust Company, Nogales, Arizona.” Petitioner did not contribute capital to any of the agencias or agencies, and made no contracts with them. The primary function of the agendas was to look after the business of the Banco de Sonora and to preserve its assets, but in connection with the performance of this function, they handled their business through petitioner’s bank at Nogales. The agendas were soley responsible to their customers for deposits and petitioner assumed no responsibility until money was actually received by it. Petitioner paid no expenses in connection with the operation of the agendas and did not pay them any salary or other compensation. The agendas accepted deposits, made loans and transacted other business without any control or regulation by petitioner; they operated entirely independently of petitioner. Petitioner received no income or profits arising from transactions between the agendas and their customers. It received income only on such business as it transacted directly with the depositors, which income was reported in its returns and is not in controversy here. Losses sustained by the agendas were not claimed by nor entered in the accounts of petitioner as such. Petitioner did not receive during 1919 or 1920 any cash or other property from any agenda other than for credit to the agenda, and during said years petitioner received no income earned by or through said agendas. Petitioner had no authority under the laws of Arizona to operate branches beyond the borders of the State and had no authority under the laws of Mexico to transact any banking business in that country. The State Banking Department of Arizona treated the agendas as correspondents of petitioner, and in its books of account petitioner recorded its transactions with the agendas in the same manner as those with its bank correspondents in the United States.
    In December of each year, the secretary of petitioner, after consultation with other local officers and directors, would prepare a list of notes or obligations owing to petitioner, which had been determined by him in that year to be worthless. Prior to placing an obligation on such list, a thorough investigation was made through acquaintances, employees, or local banks, and any other available sources of information respecting the debtor’s financial condition. In case any assets were found which could be subjected to payment of the obligation, the note would be turned over to an attorney with instructions to begin suit. If no assets could be found and petitioner had no collateral security or it had become worthless, or if the debtor was insolvent, or had left and his whereabouts were unknown, the obligation would be determined by the secretary to be worthless and would be placed on the Kst of bad debts. Such lists would be thereafter presented to the directors of petitioner at their next annual meeting, usually held about the middle of February of each year. The lists of bad debts so prepared would invariably be approved by the directors as a matter of form without alteration or amendment.
    In December, 1918, the secretary of petitioner j>repared a list of eight items aggregating the sum of $4,985.68, which he determined at that time to be worthless. At the annual meeting of the directors held in March, 1919, the list was approved and on March 21,1919, the amount was charged off as bad debts as of December 81,1918.
    In December, 1920, the same officer of petitioner prepared a list of debts determined by him at that time to be worthless, consisting of fourteen items and aggregating the total sum of $10,263. This list was submitted to the directors at a meeting held on March 28, 1921, and was duly approved. Thereafter, on April 6, and April 9, 1921, the items were charged off the books as bad debts. These entries purported to be made as of December 31, 1920, and were made concurrently with the closing entries for that year.
   OPINION.

Trascmell:

Petitioner contends that, in the determination of the deficiencies involved herein, respondent erred (1) in adding to petitioner’s income for the year 1919 the sum of $6,044.66 and for the year 1920, the sum of $17,672.63 representing profits or income received by or through agencies in'Mexico; (2) in disallowing for the year 1919, a deduction for bad debts in the sum of $4,985.68, and for the year 1920, a deduction for bad debts in the sum of $10,263; and (3) in adding to petitioner’s income for the year 1919 the sum of $500.60, and for the year 1920, the sum of $592.55, representing donations made by the Mexican agencias.

With respect to the first issue, it appears that respondent added to petitioner’s income the amounts above mentioned, as profits of the Mexican agendas, on the theory “that the corporation had an enforceable right to the profits of the agencies which were being operated by agents and employees of the corporation and the profits made by them were income to the corporation as and when realized by the agencies, regardless of when such income was actually turned over.” It also appears that the alleged profits in question were not shown by the books of the petitioner but were obtained from the report of a revenue agent.

It may well be that if the Mexican agendas were in fact the agents of petitioner and operated branch offices for it, any income received by such agents or branches would be income to petitioner, as asserted by the respondent. However, the evidence before us discloses an entirely different state of-facts. It is shown that, during the years involved in this proceeding, the agendas were not in fact agents of petitioner but were no more than correspondents; that the English word “ agents ” is not an accurate or exact translation of the Spanish word “ agendas ”; that petitioner had no contracts with them nor any enforceable right to their profits; paid them no salaries or other compensation; did not bear or share their losses; received from them no money or other property except for credit to their accounts, and did not in fact receive any profits or income from or through them. The agendas were representatives of the Banco de Sonora and operated entirely independently of petitioner. On these facts, we are unable to agree with the contention of respondent that income received by the agendas was thereby constructively received by petitioner. We must, therefore, hold that respondent erred in adding to petitioner’s income for the year 1919 the amount of $6,044.66 and for the year 1920 the amount of $17,672.63 as profit or income from said agendas.

The second issue involves the correctness of 'respondent’s action in disallowing deductions claimed by petitioner in its return for 1919 and 1920 on account of so-called bad debts. These deductions were claimed under section 234 (a)- (5) of the Revenue Act of 1918 which reads as follows:

Sec. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
# ij; # # ífc ❖
(5) Debts ascertained to be worthless and charged off within the taxable year.

Prior to December 31, 1918, an officer of petitioner prepared a list of obligations owing to it, aggregating the total sum of $4,985.68, which he determined through investigation to be worthless at that time, and this list was submitted to the directors at a meeting held in March, 1919. The action of the officer in determining the debts to be worthless in December, 1918, was approved by the directors, and on March 21, 1919, the amount was charged off the books as bad debts. For the year 1920, substantially the same procedure was followed. The same officer prepared a list of obligations owing to petitioner, consisting of fourteen items aggregating the sum of $10,263, which he determined in December of that year to be worthless. The list was thereafter presented to the directors at a meeting held on March 28, 1921, and was formally approved. On April 6, 1921, twelve of the items were charged off the books as bad debts. Three days later, on April 9, the two remaining items were charged off as bad debts.

Petitioner claimed a deduction in its return for 1919 of the amount of the debts ascertained by its secretary to be worthless in December, 1918, but which was not finally determined to be worthless until the meeting of the directors in March, 1919, and which was thereafter charged off on March 21, 1919. Respondent disallowed the deduction for 1919 and allowed it for the year 1918. With respect to the obligations ascertained by the secretary to be worthless in December, 1920, but not finally determined by the directors to be worthless until March, 1921, and not charged off until in April, 1921, petitioner claimed a deduction in its return for 1920, which was disallowed by respondent. Petitioner now contends that it is entitled to have these deductions treated in the same manner, and that they should be allowed for the years 1918 and 1920, respectively, or .that they should be allowed for the years 1919 and 1921, respectively. On the facts before us, we must agree with this contention.

The evidence shows that an officer of petitioner, who was in charge of collections and had general supervision over its accounts, tentatively ascertained the debts in question to be worthless in December, 1918, and in December, 1920, respectively. This officer testified at the hearing at length and in detail respecting the methods by which he ascertained the obligations to be worthless. Each item was carefully investigated and in each instance it was found that the debtor had become insolvent or had departed from the country and his whereabouts were unknown, leaving no property subject to execution. In some cases, the obligations also were secured by stock or other collateral, which had become entirely worthless.

From all the evidence before us, we are satisfied that the debts in question were in fact worthless, and that their elimination from petitioner’s assets was an exercise of sound business judgment.

There is no dispute as to when and in what manner the debts were charged off. The only question respecting the deductions claimed for bad debts is whether or not' the debts were ascertained by petitioner to be worthless within the taxable year in which they were so charged off. We are not convinced from the evidence that the secretary of petitioner was authorized to make a final ascertainment and charge off the debts tentatively determined by him to be worthless. This conclusion is supported by the fact that for each of the years involved, the matter was submitted to the board of directors for action. We must hold, therefore, that the debts aggregating the sum of $4,985.68 which were formally ascertained by the board of directors of petitioner in March, 1919, to be worthless, and which were charged off on March 21, 1919, constituted a proper deduction from petitioner’s income for 1919, as claimed by it in its return for that year. The action of respondent in disallowing the deduction for 1919 is disapproved. Likewise, the debts aggregating the sum of $10,263, which were ascertained by the board of directors on March 28, 1921, to be worthless, and which were charged off the books on April 6, and April 9, 1921, constituted a proper deduction from petitioner’s income for the year 1921. The action of respondent in disallowing the deduction of this amount as claimed' for 1920, is approved.

With respect to the third and remaining issue involved herein, no evidence was offered at the hearing. ' Accordingly, the action of the respondent in that regard is sustained.

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

Murdock dissents on the second point.


source: Caselaw Access Project

author: TRAMjviell :

license: Public Domain

text:
    Thomas H. Mastin, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 3425, 20834.
    Promulgated May 25, 1927.
    Amounts paid out to petitioner’s mother and aunt as part consideration for stock held to be capital expenditures and not deductible from gross income.

      Olías. M. Howell, Esq., James Hagerman, Jr., Esq., Daniel V. Howell, Esq., and Joseph S. Brooks, Esq., for the petitioner.

      John D. Foley, Esq., for the respondent.
    These proceedings, which were consolidated for the purpose of hearing and decision, are for the redetermination of deficiencies in income taxes for the calendar years 1918, 1919, 1920, and 1922, in the amounts of $6,394.60, $13,937.41, $7,309.46, and $3,483.58, respectively.
    The questions involved are (1) whether amounts paid by the petitioner during the years involved to his mother and aunt in accordance with the provisions of the terms of a written instrument are deductible as ordinary and necessary expenses, or whether such amounts represent capital expenditures or gifts, and (2) the deducti-bility of an amount paid by the petitioner for the purpose of advertising real estate owned by a corporation of which he was a stockholder.
    FINDINGS OF FACT.
    The petitioner is an individual and a citizen of the United States, residing in Kansas City, Mo. In 1905 the petitioner, his aunt, Julia Mastin, his mother, Elizabeth Simpson Mastin, and his sister, Theo Mastin, were the owners of properties, or equities therein, some of which consisted of mining interests and lands. A few of these interests were productive of income. On the death of petitioner’s father in 1904, it became necessary for the petitioner to look after the interests that his father had been looking after in addition to the interests he had been looking after prior to his father’s death. There was at that time an indebtedness of about $800,000. The taxes and interest, in addition to the above amount, amounted to approximately $100,000 a year. The income from the properties was not sufficient to meet the obligations and it became necessary to refinance the properties.
    An agreement was made and entered into between Julia Mastin, Elizabeth Simpson Mastin, Theo Mastin, Thomas EL Mastin and Martha B. Mastin, wife of the petitioner, which was as follows:
    This Agkeembnt, made and entered into, in quadruplicate, tbis 21st day of July, 1905, by and between Julia Mastin, Elizabeth Simpson Mastin, Theo Mastín and Thomas H. Mastín, Martha B. Mastín, the wife of Thomas H. Mastín, joining herein as such wife, Witnesseth, That,
    Whereas, Julia Mastín and Elizabeth Simpson Mastín and Thomas H. Mastín are the owners of the interests and properties mentioned in the schedule hereto attached and described in such schedules as schedules of the assets of the respective parties mentioned; and
    Whereas, because of the liens upon certain of such assets, it is necessary to provide for money or credit in order to protect, preserve and realize upon same to the best advantage, and said Thomas H. Mastín and Elizabeth Simpson Mastín are willing to furnish such money and credit to the extent of their personal resources as so scheduled and upon the conditions hereinafter set forth; and
    Whereas, said Julia Mastín and Elizabeth Simpson Mastín are advanced in years and desire to provide for the business management of their said assets scheduled by them to the extent and upon the conditions of the trust hereinafter set forth, and said Thomas H. Mastín is willing to undertake such management upon the conditions hereinafter set forth; and,
    Whereas, the parties hereto are related and desire that said Thomas H, Mastín and Theo Mastín and their consorts and descendants shall, subject to provision for an income for life to said Julia Mastín and Elizabeth Simpson Mastín, enjoy the benefits of the common estate as hereinafter provided, and to effect this purpose said Thomas H. Mastín and Elizabeth Simpson Mastín are willing to contribute the property scheduled by them, and the said Thomas H. Mastín is willing to undertake the trust herein provided for upon the condition of provision for his sister and himself, as hereinafter set forth.
    Now Therefore, In consideration of the premises and mutual love and affection, and of the respective contributions and agreements of the parties hereto, it is agreed that a corporation shall be caused to be formed.by said Thomas H. Mastín under the laws of such -jurisdiction as may bo selected by him upon the advice of attorneys, with a capital stock of at least Fifty Thousand Dollars, ($50,000.00), to be divided into shares of One Hundred Dollars ($100.00) each, which corporation shall be authorized to acquire, hold, manage, dispose of, sell and reinvest in any property of the character scheduled and other similar properties, the particular form of the statement of corporate purposes and the name of the corporation, and the general terms of its charter to be determined by said Thomas H. Mastín upon the advice of attorneys for the purpose of effecting the ends of this agreeriient; and that all of the foregoing interests as scheduled shall be conveyed, transferred, assigned and delivered to such corporation in payment for the capital stock thereof, and the same is hereby conveyed, transferred and assigned to said Thomas II. Mastín, in trust for such corporation to be formed on account thereof; that all of the capital stock of such corporation, except the number of shares necessary to qualify the persons other than said Thomas H. Mastín, acting as directors, shall be held by said Thomas H. Mastín, as trustee upon the following conditions.
    First: Said trustee shall vote such stock according to his best judgment for the purpose of controlling and managing the business of such corporation and of the corporations in which such corporation to be formed may be a stockholder.
    Second : Such trustee, shall, during the life of Julia Mastín, Elizabeth Simpson Mastín, Theo Mastín and Thomas H. Mastín distribute the dividend declared on such capital stock held in trust to each of such four undivided interests in equal amounts..

      Third: Each of such four interests shall terminate with the death of the parties entitled to enjoy respectively such respective interests and such dividends shall thereupon be apportioned among the still surviving interests equally to each interest until there shall be but one interest still surviving, in which last event such trust shall terminate and such trustee shall transfer the title to such stock pro rata to the parties then entitled to the benefits thereof in proportion to their then respective rights to dividends.
    Fourth : In the use of the term “interest” as aforesaid, it is understood and agreed that said Julia Mastin and Elizabeth Simpson Mastin shall each personally and solely constitute one interest; that the said Theo Mastin and her husband and lineal heirs of her body, if she shall have such or either thereof, shall constitute one interest; that said Thomas H. Mastin and his wife and lineal heirs of his body, if he shall have such, shall constitute one interest.
    Fifth : While said Theo Mastin shall live, the dividends apportionable to her interest shall be payable to her individually. If the said Theo Mastin die leaving a husband or lineal heirs of her body, the dividends apportionable to her interest shall be paid to such husband and such heirs, so long as there shall be a husband or such heirs, in proportion to their interests as surviving husband or such heirs of such Theo Mastin.
    If said Theo Mastin shall die without leaving a husband or lineal heirs of her body, or if she die leaving a husband or such heirs, and such husband and such heirs all die before the termination of all the other interests hereunder, then the interest of said Theo Mastin shall terminate and be extinguished.
    Sixth: While said Thomas H. Mastin shall live, the dividends apportionable to his interest shall be payable to him individually, and if he shall die leaving a wife or lineal heirs of his body, such dividends shall be paid to such wife and such heirs in proportion to their interest as surviving wife and such heirs of said Thomas H. Mastin:
    If said Thomas H. Mastin shall die leaving a wife or lineal heirs of his body, and such wife and such heirs all die before the termination of all the other interests hereunder, then the interest of said Thomas H. Mastin shall terminate and be extinguished.
    Seventh : Upon the death of all the parties hereto, or in case said Julia Mas-tin, Elizabeth Simpson Mastin and Thomas H. Mastin shall die before said Theo Mastin, this trust shall terminate, and such stock shall thereupon be transferred by the trustee to the persons who are then entitled to the dividends therefrom in the ratio of their respective interests therein.
    Eighth : Collateral heirs or consorts of descendants of said Theo Mastin and Thomas H. Mastin shall not be considered as or become entitled to any rights as heirs under the provisions of this trust.
    Ninth : Such Trustee, shall, before the distribution of dividends, pay the actual expenses of household maintenance and sustenance for such beneficiaries of said trust as shall then continue to reside in the residence now jointly occupied by the parties hereto or as a common family in any other place of residence selected by such trustee in case of the sale of the present residence; and in the absence of dividends such trustee may advance the funds necessary for such expenses and deduct same from dividends thereafter earned.
    Tenth : In the case of the death, disability or refusal of said Thomas H. Mastin to act as Trustee, a successor in such trust may be appointed by instrument in writing signed by a majority in number of the adult individuals then entitled to the benefits of said trust, signed, acknowledged and recorded in the office of the Register of Deeds of Jackson County, Missouri, in the manner then provided by law for tbe execution, acknowledgment, and record of instruments conveying interests in real estate situated in said Jackson County, Missouri; and in the event of further vacancies by death disability or refusal of any successor trustee such vacancy may be filled in like manner. In the case of the refusal or inability of such majority to so agree for thirty days after the existence of any vacancy, a successor trustee may be appointed by the Circuit Court of Jackson County, Missouri, upon the petition of any party in interest after ten days notice of the time and place of the presentation thereof, by publication in any newspaper of General Circulation in Kansas City, Missouri, and by service by the sheriff of Jackson County, Missouri, or any of his deputies, of a copy of such notice upon each of the parties in interest then resident of and actually being in said Jackson County, Missouri, in the same manner as may then be provided by law for .the service of summons, at least ten days before the presentation of such petition, and proof thereof made to such Court by the return of such officer. Upon the appointment of any successor trustee, such trustee shall immediately become vested with the legal title to the stock so held in trust, and be entitled to perform the duties and become subject to the obligations of such trust.
    It is undeestood That as to the interest in the Mastin, Drennon, Schafer Company, described in the above referred to schedule of Thomas H. Mastin, it is contemplated that a trust is to be created between the said Thomas H. Mastin and his co-stockholders, in the said Mastin, Drennon, Schafer Company, providing for certain changes in interest in case of death of such stock-holders or their failure to continue as active officers and employees of such corporation, and this agreement is made subject to the creation of such proposed trust, and the right is reserved to Thomas H. Mastin to substitute such personal interest as may pertain to himself individually under such proposed trust arrangement for the interest in the Mastin, Drennon, Schafer Company as scheduled by him.
    In witness whereof, The parties hereto have hereunto set their hands on the day and year first above written.
    Pursuant to the terms of that contract a corporation was organized under the name of the Mastin Realty & Mining Co., to which the parties conveyed all of the interests they had in the properties, and in addition thereto another corporation was organized as a holding company for the purpose of holding the stock of the Mastin Realty & Mining Co. This corporation was known as the Mastin Estate, and the stock of the Mastin Realty & Mining Co. was conveyed to that corporation. The stock of the holding company was held by the petitioner as trustee in accordance with the contract. The petitioner managed and directed the corporations. He did considerable financing for the purpose of protecting the properties and the equities therein which had been conveyed to the corporation. He arranged a loan of $400,000, which was secured by a bond issue. Only $272,000 of that amount, however, was needed and used by the corporation. A number of the equities were sold and the proceeds applied to the payment of debts against other properties. Up until 1914 there was not enough income coming into the corporation to meet the expenses.

      The petitioner’s mother and aunt needed funds for their living expenses and maintenance. As a consequence another contract was entered into in 1914. That contract is as follows:
    This agreement, made and entered into this 2nd day of April, 1914, by and between Julia Mastin, Elizabeth Simpson Mastin, Theo Mastin Lovejoy, Thomas H. Mastin, Martha Brent Mastin and George Edgar Lovejoy, all of Kansas City, Jackson County, Missouri, Witnesseth :
    That, whereas, Julia Mastin and Elizabeth Simpson Mastin are each owners of certain shares of stock in Mastin Estate and Mastin Realty and Mining Company, corporations organized and existing according to the laws of the State of Missouri, and other property in Jackson County, Missouri, and elsewhere, and,
    Whereas said Julia Mastin and Elizabeth Simpson Mastin are advanced in years and desire to provide for the care and management of said shares of stock and the property and business they represent and all the other property by them owned, and desire to divest themselves of the title, management and control of the said shares of stock and properties, and the said property above-said, and to vest the title to same in said Thomas H. Mastin and Theo Mastin Lovejoy upon the agreements and considerations hereinafter set forth; and
    Whereas said Thomas H. Mastin is willing to undertake the management and control of said shares of stock and properties and has this day agreed, and does hereby agree to undertake the management and control thereof, for the purpose of realizing an income and profit therefrom for the benefit and use of all the parties hereto.
    Now therefore, in consideration of the premises and in consideration of the relationship of the parties, and in consideration of mutual love and affection and certain large sums heretofore advanced and paid out by the said Thomas H. Mastin for them, they, the said Julia Mastin and Elizabeth Simpson Mastin, do hereby transfer, set over and assign to the said Thomas IT. Mastin and Theo Mastin Lovejoy all their right, title and interest in and to all the shares of stock in Mastin Estate and Mastin Realty and Mining Company by them owned, together with all dividends thereon accrued, and all the other property, of whatever character, by them owned as herein'above mentioned, for and in consideration of the premises and considerations above set forth, and upon the further consideration that said Thomas H. Mastin and Theo Mastin Lovejoy shall pay the actual expenses and household maintenance and sustenance and support of the said Julia Mastin and Elizabeth Simpson Mastin during their natural lives, respectively whether they shall continue to reside in the residence now occupied by them or shall reside in some other place of residence by them hereafter selected.
    And it is further hereby agreed by and between the parties hereto that in the event the dividends and profits derived from the shares of stock herein-above mentioned and described shall not be sufficient to provide for the said expenses and household maintenance and sustenance and support of the said Julia Mastin and Elizabeth Simpson Mastin that the said Thomas H. Mastin and the said Theo Mastin Lovejoy will provide and furnish such further sum or sums as shall be necessary for providing such expenses for household maintenance and sustenance and support, and they, the said Thomas H. Mastin and Theo Mastin Lovejoy hereby agree'to pay same in the manner hereinabove agreed upon.
    And the said Julia Mastin and Elizabeth Simpson Mastin do hereby assign, transfer and set over and deliver to the said Thomas H. Mastin and the said Theo Mastin Lovejoy all the property hereinabove described, being all the property, of whatever character, by them owned at the date of this contract, it being the intent of the said Julia Mastin and Elizabeth Simpson Mastin to assign, transfer and convey all their property, of every hind and nature, to the said Thomas H. Mastin and Theo Mastin Lovejoy for and in consideration of the other considerations, covenants and agreements herein entered into, and upon consideration whereof the said Thomas H. Mastin and Theo Mastin Lovejoy do hereby agree to perform all the agreements herein made on their part, and to the full execution, consummation and performance of this contract they do hereby bind themselves, their heirs, executors and administrators unto the said Julia Mastin and Elizabeth Simpson Mastin.
    This contract is made in substitution for and in lieu of all other contracts heretofore entered into by and between the parties hereto, and all rights, and interests raised or created therein and hereby abrogated, particular reference being hereby made to a contract of date February 6, 1906, between the parties hereto, which said contract is hereby cancelled and annulled as of date of its execution.
    In witness whebeof the parties hereto have hereunto subscribed their names to quadruplicate copies hereof, this 2nd day of April, 1914.
    When the expenses of maintaining the properties and paying interest, taxes and other expenses exceeded the income from the properties, the petitioner paid the excess himself out of his own personal funds, he being engaged in another business at the time.
    During the taxable years in question, the petitioner paid out to his mother and aunt $12,346.64 in 1918, $11,783.64 in 1919, $14,852.24 in 1920, and $10,567.18 in 1922. These amounts were paid out by him for their support and maintenance pursuant to the terms of the written instrument dated April 2, 1914, a copy of which is set out above.
    The contract dated July 21, 1905, under which the petitioner managed the affairs of the corporations as trustee, was canceled and annulled by the contract of April 2, 1914, which contract was substituted for and took the place of the prior contract.
    Under the terms of the agreement of April 2, 1914, the petitioner’s mother and aunt conveyed to the petitioner and Theo Mastin Lovejoy all of their right, title and interest in the shares of stock in the Mastin Estate and the Mastin Realty & Mining Co. owned by them, together with all dividends thereon accrued and all of the other property of whatever character by them owned as set out in that instrument. In consideration thereof the petitioner and Theo Mastin Lovejoy agreed, among other things, to pay the actual expenses and household maintenance,' sustenance and support of the said Julia Mastin and Elizabeth Simpson Mastin, the mother and aunt of petitioner, during their natural lives, and it was further agreed that if the dividends and profits from the shares of stock were not sufficient to provide for the said expenses, household maintenance, sustenance and support of the two persons named, the petitioner and Theo Mastín Lovejoy should provide and furnish such further sums as should be necessary.
    The petitioner in 1919 paid out the sum of $4,245.25 to Brent & Crittenden, real estate agents, for advertising real estate owned by the Mastín Realty & Mining Co. The petitioner owned stock in the corporation but did not own any of the real estate which was to be advertisedi The other stockholders of the corporation did not pay out anything in this connection. The petitioner paid out the money because he deemed it an advantageous movement for the corporation and its stockholders. The Mastín Realty & Mining Co. and others owned large property interests on the southern border of the principal business district in Kansas City. A movement was started by the parties to advertise this section. The amount so paid to Brent & Crittenden was to be distributed by them.
   OPINION.

TRAMjviell :

The petitioner contends that the payments to his mother and aunt were made pursuant to an obligation assumed in a business transaction in which they were associated, and that as such they were losses incurred in business or in a transaction entered into for profit within the meaning of the Revenue Act of 1918, and as such are deductible. The respondent, on the other hand, contends that the payments represent either gifts or capital expenditures and did not constitute allowable deductions as losses.

The contract of 1914 by its terms canceled the contract of 1905 under which the petitioner was acting as trustee. The 1914 contract was entirely different. It specifically provided that the petitioner’s mother and aunt conveyed to the petitioner .and Theo Mastín Lovejoy all their right, title and interest in the shares of stock which belonged to them. One of the considerations for this was the agreement on the part of the petitioner and Theo Mastín Lovejoy to provide for the maintenance and support of their mother and aunt. The amounts paid out during the taxable years for the support of these people was in accordance with the terms of that agreement. In our opinion, these payments constitute consideration for a capital asset. It is no different than if petitioner’s mother and aunt had sold the stock for a cash consideration. In that event it could hardly have been contended that the cash paid for the stock was deductible as a loss unless, or until the stock became worthless or the loss had been realized. Here the stock was to be paid for over an indefinite number of years until the death of the persons who were being paid for it. Both of these people died in 1922.

We, therefore, agree with the Commissioner in holding that the payments were capital expenditures.

On the question of a deduction on account of the payment of the sum for advertising the property owned by the corporation, the petitioner contends that this amount was deductible either as a loss sustained directly in the management and control of the stock which had not been compensated for by insurance or otherwise, or that it was deductible as a contribution. We. can not agree with either theory advanced by the petitioner. It clearly can not be allowed as a contribution. The amounts paid out for advertising might properly have been allowed if paid out by the corporation as ordinary and necessary expenses, but in this case it-was not paid out by the corporation. The petitioner did not pay it out for advertising his own property. The only benefit he could have obtained from it was the benefit which it might have added to his stock through the increase in value that might have resulted to the property of the corporation. If the payment be held to represent an additional investment, it could not be allowed as a loss unless or until the stock was sold or determined to be worthless. In our opinion, the amount is not deductible in determining the petitioner’s net income.

Judgment will ~be entered for the respondent.

MilliiceN not participating.


author: TRUSsell:

text:
    Grelck Condensed Buttermilk Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3691.
    Promulgated May 25, 1927.
    1. License fob Use of Patent. — Value oí a certain license for the use of patents, paid in for. stock of a corporation, for the purposes of invested capital and exhaustion deduction determined.
    2. Buildings and Equipment. — The value of certain buildings and operating equipment for a part of which stock was issued determined for the purposes of invested capital and exhaustion deduction.
    3. Patent Litigation. — An amount advanced by a patent licensee toward the payment of cost of patent litigation held not to be a deduction as ordinary and necessary expense.

      Milton B. Firestone, Esq., and Maurice W. Stoffer, Esq., for the petitioner.

      A. S. Fast, Esq., for the respondent.
    A statutory deficiency letter issued February 25, 1925, to the above-named petitioner asserted a deficiency in income and profits taxes for the calendar year 1919 in the amount of $1,343.94. In arriving at this deficiency the Commissioner eliminated from invested capital $75,000 claimed as the value of a certain patent license paid in for stock and $20,000 of the claimed cost of buildings and equipment for which stock had been issued. He also disallowed a deduction of $500 claimed as ordinary and necessary business expense. . Contending that each of the foregoing acts of the Commissioner were erroneous, the petitioner brings this action.
    At the trial counsel for the parties stipulated that inasmuch as the Grelck-Hovey Co. of Nebraska was no longer in existence and the petitioner had acquired all of said company’s assets, the amount of the deficiency, if any, should be charged against the petitioner.
    FINDINGS OE PACT.
    William P. M. Grelck since 1888 has been a specialist in feeds, a food expert, and a milk engineer. During some time prior to 1917 he developed a process whereby the buttermilk from creameries could be condensed into a semisolid mass to be used as a feed for livestock. Prior to the development of this process creameries discarded buttermilk as a waste product. Under the Grelck process condensed buttermilk becomes a self-preserving lactic acid milk product capable of being reduced to a semisolid mass for packing in water-tight containers.
    .On June 19, 1917, United States Patent No. 1230479, covering this process was issued to Bertha H. Grelck, wife and assignee of William P. M. Grelck. This is a basic patent and the product was the first of its kind in the milk industry.
    On June 11, 1917, Grelck, his wife, and one Hovey, incorporated the Grelck-Hovey Co., under the laws of Nebraska, for the purpose of engaging in the production and the selling of condensed buttermilk.
    On June 28, 1917, this company entered into an agreement with Bertha H. Grelck whereby for a consideration of $75,000 in cash, or 750 shares of the common stock, this company secured a license to manufacture and sell condensed buttermilk under said patent during its life. The license secured under this agreement was unlimited but not exclusive. The board of directors of said company placed a value of $75,000 upon the license and authorized the issue of 750 shares of common stock in payment therefor and said 750 shares were issued to Bertha H. Grelck.
    The license agreement acquired by the petitioner for stock had a cash value on June 28,1917, of $30,000.
    During 1917, the said company erected manufacturing plants at Duluth, Minn., Grand Forks, N. Dak., and Sioux Falls, S. Dak., which were operated during 1917 and 1918 and more than 100,000 pounds of condensed buttermilk were produced each year. There was an instant market for the product.
    William P. M. Grelck was chosen president of the company and his duties were to manage the production and sale of condensed buttermilk. He was to receive an agreed salary based upon the volume of business and profits produced. He was also charged with the superintendence of the erection and equipment of the three manufacturing plants above mentioned. He superintended and directed all the work of constructing these three plants, made the designs, and directed the construction and installation of all the equipment which became a part of these plants. The monies actually disbursed by the company in the construction of these plants were $28,200. Grelck received no part of this amount, but in consideration of his expert services in the construction of the plants and equipment, the company by proper corporate act authorized and issued to him common stock of the par value of $20,000, agreeing that his services as engineer and superintendent of construction were worth the amount of par of said stock. The three plants were entered upon the books of the company at' a total capital cost of $48,200.
    The three manufacturing plants at Duluth, Grand Forks, and Sioux Falls with their equipment, upon completion, had cost $35,230.
    On February 3, 1919, the petitioner corporation was organized under the laws of Delaware, with the name of Grelck-Hovey Co., with an authorized capital stock of $30,000, divided into shares of a par value of $100 each. Some time in 1920 petitioner’s name was changed to Grelck Condensed Buttermilk Co., and it is hereafter referred to as the petitioner.
    On February 5, 1919, the petitioner, by proper corporate action, entered into a contract with the Grelck-Hovey Co. of Nebraska to purchase from the latter company all of its property for the sum of $123,200, and to issue stock therefor as provided by the contract. In pursuance of this contract the petitioner acquired all of the property of the Grelck-Hovey Co. of Nebraska, including equipment, machinery, and the plants at Duluth, Grand Forks, and Sioux Falls, and all its rights and licenses to manufacture condensed buttermilk and issued its stock in payment therefor in the amount of $123,200, and set up said assets on its books as follows:
    Plant and equipment-$48,200
    License- 70, 000
    Total_ 123,200
    The stock was issued to the same persons who held the stock of Grelck-Hovey Co. of Nebraska as follows:
    Shares.
    William P. M. Grelck--- 232
    Bertha Grelck_ 750
    E. P. Hovey_ 250
    Total-1, 232

      Upon acquiring the plants and equipment the petitioner immediately began the production of condensed buttermilk. There was an immediate and large demand for this product and today there are several million pounds produced yearly. The petitioner company, however, did not prosper, due to the fact that creameries which produced their own raw buttermilk without cost began generally to infringe upon the patent rights or to produce a similar product by processes sufficiently modified to escape infringement.
    The petitioner, however, prior to August, 1923, acquired three other manufacturing plants, and, on August 1, 1923, was the owner of six plants for the production of condensed buttermilk.
    Prior to July 9, 1918, Grelck produced another related invention, for which on July 9, 1918, he secured United States Patent No. 1272035, and prior to August 1, 1923, the ownership of the two patents herein referred to passed to another corporation known as the Grelck-Hovey Patent Co.
    On August 1, 1923, the last-named company granted to Albert P. Hunt of Chicago, Ill., license to manufacture and sell products specified in each of said patents for the period of one year and renewable from year to year during the life of said patents. The license granted to Hunt was unlimited and exclusive except as to the rights owned by and to be exercised by the petitioner at its then-existing six plants or other plants which might thereafter be substituted therefor, at no time exceeding six in number, and except that the licensor retained the right to manufacture the products described in patent No. 1272035 at any place in the United States. In consideration of this license Hunt agreed to pay to the licensor the s'qm of $30,000 per year so long as the license continued in force. Under his license, Hunt has the right to and does operate many plants, and has granted many sublicenses.
    During the year 1919, while suits for the infringement of patent No. 1230479 were in progress the petitioner advanced the sum of $500 toward defraying the cost of patent litigation. This amount it charged to expense, although it expected that the amount would be repaid to it and in 1924 it received such repayment.
   OPINION.

TRUSsell:

The petitioner corporation, being the successor to and being controlled by the same stockholders as its predecessor the Grelck-Hovey Co. of Nebraska, and having taken over its predecessor’s assets for stock, can not, under the provisions of sections 326 and 331 of the Revenue Act of 1918, claim a larger invested capital on account of such assets than could have been claimed by the predecessor corporation.

Concerning the matter of capital value of the license for the use of a patent acquired by the petitioner, the record contains evidence of value which falls into two classes — (1) the judgment of the men who produced patents and who were the owners of the corporation acquiring the license, and (2) the facts relating to a subsequent license agreement respecting the same patent. Neither of these classes of evidence can be rejected as having no probative value. Men having produced a patent and dealing with a corporation of which they are the owners may, not unnaturally, have entertained a too high opinion of its value, but in the transaction of a later license agreement respecting the same patent these same men were dealing with strangers to the property and with men who were about to pay cash for the rights acquired under a license agreement.

In 1923, when the basic patent still had approximately only 11 years to run and the subsequent related patent had approximately 12 years of life, Hunt undertook to pay $30,000 per year for the rights which he acquired under his license agreement. Applying well known formulae of reducing future payments to present value, it may be found that the capital value of the license agreement acquired by Hunt was approximately $200,000. And, while this agreement covered not only the basic patent in which the petitioner has an interest but also a later related patent, we believe the valuation here suggested for the Hunt license can be taken as furnishing the basis for estimating the value of the license obtained by the petitioner at an earlier date. And, considering all the facts disclosed by the record, especially the fact that when the petitioner obtained its rights the same were unlimited, although not exclusive, and that such rights had a period of more than 15 years of the remaining life of the patent, we have arrived at the conclusion that the license rights acquired by the petitioner and paid for by the issuance of stock had a value on June 28, 1917, of $30,000, and that the petitioner is entitled to have the same included in its invested capital at that value, subject to statutory limitations, and to the right to an annual deduction for the exhaustion of that capital value over the remaining life of the patent.

Concerning the property and plant acquired by the petitioner, it appears that said property cost the predecessor corporation $28,200 in cash disbursements plus the value of the services of Grelck rendered in connection with the construction and equipment of the three plants originally built. It appears from the record that these plants were constructed under the personal supervision of Grelck as an expert in the line of business to which the plants were to be dedicated; that in such construction the predecessor corporation by reason of the employment of Grelck, saved construction costs equivalent to a contractor’s profit, which ordinarily is not less than 15 per cent of the cash cost of th'e construction. It also saved.architect’s fees for plans and superintendence, which for properties of the size and cost of the properties here under consideration may have been equal to not less than 10 per cent of cash disbursed in the erection of said plants. A contractor’s profit at the rate of 15 per cent would have amounted to $1,230 and an architect’s fees at 10 per cent would have been $2,820. It appears that it is for these things that the predecessor corporation issued $20,000 of its common capital stock. We are, therefore, of the opinion that these buildings and equipment should be included in invested capital at a total of $35,250, and that the petitioner may claim an annual exhaustion deduction upon that cost.

The $500 paid by petitioner in 1919 was advanced to the owners of the patent here in question to help defray litigation expenses. We regard this as in the nature of a loan and, in view of the fact that it was later repaid, we are of the opinion that it should not have been allowed as an expense deduction in the year 1919.

The deficiency may be redetermined in accordance with the foregoing findings of fact and opinion upon 15 days’ notice, pursuant to Rule 50, and judgment will be entered in due course.


author: Trussell:

text:
    First National Bank of Sleepy Eye, Minn., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 2334.
    Promulgated May 25, 1927.
    Income. — Fees and commissions earned by officers of a national bank, acting as agents for insurance companies in the placing of insurance, are not income of the bank.

      Albert Hauser, Esq., for the petitioner.

      W. IT. Lawder, Esq., for the respondent.
    The deficiencies are for the calendar years 1919, 1920, and 1921 and aggregate $2,370.87. They are the result of the Commissioner’s adding to the bank’s income the fees and commissions earned by officers of the bank, who, acting in their individual capacity represented a number of insurance companies.
    FINDINGS OF FACT.
    Prior to August, 1902, C. D. Griffith and W. W. Smith had been partners engaged in the business of private bankers and insurance agents. In August, 1902, they caused to be procured a charter for the First National Bank of Sleepy Eye, Minn., with an authorized capital of $25,000, of the par value of $100 each. Griffith subscribed for 110 shares, Smith for 110 shares, and three of their employees for 10 shares each. The First National Bank so organized took, over and succeeded to the private banking business, and Griffith and Smith retained and continued the insurance agency business. The relative stock ownership of the bank as above shown has continued without change to the present time.
    Prior to 19Ó6, the stockholders of the bank agreed that of each dividend declared by the bank á portion thereof should be returned to the bank and, on January 23, 1906, the amount of $4,000 had been so returned. On that date the bank started an account known on its books as a stockholders’ reserve account. Continuing the same practice from year to year, as dividends were declared and paid stockholders returned portions of the same to the bank where they were credited to the stockholders’ reserve account. On July 15, 1915, the balance in this reserve account was $25,869.53, and on that date $20,000 was by proper corporate action transferred to the bank’s regular surplus account. The practice of returning portions of dividends declared was thereafter continued, and on June 30, 1920, the balance in this reserve account was $20,750.
    During the calendar year 1918 Griffith and Smith, .in their insurance agency business, earned fees and commissions in the amount of $1,943.46, and during the year 1919 such fees and commissions amounted to $2,545.86. The amounts of these fees and commissions were deposited in the bank and certificates of deposit payable to Griffith and Smith were issued therefor. On December 31, 1919, these certificates of deposit amounted to $4,489.32.
    In the spring of 1920 the stockholders of the bank determined to increase its capital from $25,000 to $50,000, and by proper corporate action directed that $20,750, the then existing balance in the stockholders’ reserve account, was available for the issue of the stock dividend. In order that such stock dividend might be issued for the whole amount of $25,000, Griffith and Smith donated to the said stockholders’ reserve account the amount of $4,250 from the total then represented by the certificates of deposit issued to them for insurance fees and commissions to the said stockholders’ reserve account, increasing the same to the amount of $25,000, and that amount was then by proper corporate action distributed pro rata to the stockholders of the bank in the form of a stock dividend.
    During the calendar year 1920, Griffith and Smith earned fees and commissions in the amount of $2,758.14, and during the year 1921 in the amount of $1,209.24. These amounts were deposited in the bank and certificates of deposit were issued therefor payable to Griffith and Smith.

      For each of the years 1919 to 1921, inclusive, the Commissioner added to the bank’s gross income the amounts of Griffith’s and Smith’s certificates of deposit representing insurance fees and commissions.
   OPINION.

Trussell:

The record of this case is convincing that the First National Bank of Sleepy Eye, Minn., never carried on any insurance agency business, and that it never represented any insurance companies. Prior to the organization of the bank Griffith and Smith had been engaged in the insurance agency business and continued in that business. Individually and personally they were the representatives of insurance companies and the fees and commissions on insurance policies and contracts written were the individual earnings of Griffith and Smith. That they, in 1920, donated a portion of the moneys so earned by them individually to the surplus account of the bank and allowed the three minority stockholders to share in a stock dividend, distributing such reserve, shows only that Griffith and Smith, owning twenty-three twenty-fifths of the stock of the bank were willing and did share with the three minority stockholders two twenty-fifths of a portion of the earnings of their insurance business. We are of the opinion that the moneys earned by Griffith and Smith as insurance agents were erroneously added to the gross income of the bank.

The deficiencies may he redetermined in accordance with the foregoing findings of fact and opinion upon 15 days’ notice,, pwrsuanb to Rule 50, and judgment will he entered accordingly.


author: TRtjssell:

text:
    Lord & Bushnell Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 10597, 12124.
    Promulgated May 25, 1927.
    1. Amendment of Petition. — The petition in Docket No. 10597 stated that it was an appeal from the determination of deficiencies for the years 1917 and 1918. It plainly referred to a deficiency letter dated November 10, 1925, which asserted deficiencies for the years 1918 and 1919, recited the amounts of such deficiencies, and the whole context was such that no one was likely to be misled and, in fact, the respondent was not misled by the recital of the year 1917 in place of the year 1919. Held, that the motion to amend the petition was properly granted as a matter of course and that the Board acquired jurisdiction of the deficiency for the year 1919.

      2. Invested Capital.' — The cost of petitioner’s plant and equipment as shown by the evidence determined for the purposes of in-vésted capital.
    3. Depreciation. — Petitioner’s plant and equipment was situated upon land held under an indeterminate lease from 1911 to August 1, 1917, and thereafter, under the terms of a lease expiring on April 30, 1932. The deduction for exhaustion, wear and tear of those portions of the plant and equipment having a probable useful life running beyond April 30, 1932, should be computed on the basis of such probable life up to August 1, 1917, and upon the unextinguished balance the depreciation deduction should be computed upon the basis of the term of the lease. Other items of plant and equipment having a probable useful life ending prior to the term of the lease, should be the basis of an exhaustion deduction in proportion to the period of their useful life.

      William W. Thompson, G. P. A., O. E. Burrows, Esq., and D. J. Greenburg, Esq., for the petitioner.

      John W. Fisher, Esq., for the respondent.
    These two proceedings, consolidated for the purpose of hearing and redetermination, are from the Commissioner’s statutory deficiency notices dated November 10, 1925, and January 14, 1926, asserting deficiencies in income and profits taxes in the amounts of $52,517.80 for the years 1918 and 1919, and $410.62 for the year 1921, respectively.
    The petitioner alleges that the Commissioner erred in his determination (1) of the March 3, 1913, value of the petitioner’s lumberyard and equipment for the purpose of depreciation and as to the rates of depreciation; (2) of the petitioner’s invested capital for the years 1918 and 1919, and (3) in not allowing as to the years 1918 and 1919 special assessment under sections 327 and 328 of the Revenue Act of 1918.
    The Commissioner asserts that the Board is without jurisdiction as to the year 1919 for the reason that no appeal as to that year has been taken within 60 days from the date of mailing of the statutory deficiency notice.
    FINDINGS OF FACT.
    The petitioner is an Illinois corporation having its principal place of business at Chicago. It was incorporated in 1883, and since that time has been engaged in buying and selling lumber.
    The Commissioner’s deficiency letter dated November 10, 1925, asserts a deficiency in income and profits taxes for the years 1918 and 1919 in the amount of $52,517.80. On January 4, 1926, the petitioner filed an appeal, Docket No. 10597, from that determination by the Commissioner and alleged that the deficiency letter was dated November 10, 1925, and asserted a deficiency of $52,517.80, and that the years involved were 1917 and 1918.
    The Commissioner’s answer, filed on February 12, 1926, admits and denies the allegations of the petition as to the years 1918 and 1919, and denies as irrelevant and immaterial what action the Commissioner took as to the year 1917. On April 3, 1926, the petitioner submitted to the Board an amended petition not complete in itself but merely a correction of its original petition so that the years involved would be 1918 and 1919. No action was taken on this amended petition until the hearing on the merits was had, at which time leave was granted the petitioner to file the said amended petition. The Commissioner objected to the filing of the amended petition on the ground that as to the year 1919 no appeal has been filed within 60 days from the mailing of the deficiency letter and that the Board is without jurisdiction as to that year.
    ' Prior to the year 1912 the petitioner’s lumberyard had been located at Twenty-second and Center Avenue, Chicago, but its lease for those premises having expired, it was necessary for the petitioner to vacate.
    During the years 1911 and 1912 the petitioner constructed a new lumberyard at 2424- Baffin Street, Chicago, its present place of business. An entire new plant was erected and was completed in the spring of 1912. In constructing the new lumberyard the swampy ground upon which it was built was filled in and graded, about three-quarters of a mile of railroad track was laid, and there was erected one inclosed and one open dock; a reenforced concrete 2y2-story mill building, 66 by 158 feet; a brick-and-reenforced-concrete two-story-and-basement office building, 33 by 56 feet, with modern improvements; a brick-and-concrete barn, 31 by 47 feet; a brick- and-concrete garage, 22 by 29 feet; a brick lunch-room building, 33 by 45 feet; 4 one-story lumber sheds respectively 99 by 233 feet, 52 by 233 feet, 76 by 168 feet, and 19 by 92 feet, each constructed of wood, with tar-and-gravel roofing and plank siding, and upon a foundation of concrete piers. All of the buildings had tar-and-gravel roofing; concrete paving, and plank roads. In 1912 new machinery was installed and some new equipment. One small machine and some equipment was removed from the old lumberyard.
    The petitioner used its own labor and materials for filling and grading the yard, grading and laying the railroad track, building a portion of the docks and building the plank roads. The docks, buildings, and concrete paving were constructed by contractors, but the petitioner supplied all lumber used at wholesale cost.
    The plank roads were constructed by filling with cinders, laying down oak and maple stringers covered with 3-inch maple planks. A total of 1,136,000 board feet of lumber, at an average cost of $20 per thousand feet, was used in constructing the plank roads, representing a cost of $22,720 exclusive of labor, but only $11,116.58 was charged to capital account on petitioner’s books. Upon examination of petitioner’s accounts kept during the years 1911 and 1912 it was found that the cost to the petitioner of the quantity of lumber used in constructing these plank roads, and the labor employed in such construction, was $25,800.75.
    The docks were constructed by the Great Lakes Dredge & Dock Co. under a contract which specified that the petitioner deliver at the dock sites a certain quantity of lumber at cost to it at its yard. The petitioner supplied all the lumber used in the docks except the piles, supplied much heavier battens than were called for by the contract, and billed the dock company for only that amount of lumber called for by the contract, although much additional lumber was used. The lumber which the petitioner supplied for the docks cost it approximately $27 per thousand feet, whereas the retail price was approximately 50 per cent more. The contract price for the construction of the docks was $28,105.88, which was entered upon the capital account of the petitioner’s books as the cost of the docks, although the dock company did only a part of the actual construction work, the balance having been done by (he petitioner with its own labor and materials. Upon examination of petitioner’s books kept during the years 1911 and 1912, it was found that labor and material furnished by the petitioner in the construction of these docks over and above the amount billed to the contractor had cost the petitioner $13,045.33, and that the total cost of the docks as completed in 1912 was $41,151.21.
    The buildings, lumber sheds and the concrete paving were constructed by contractors and the petitioner billed to the contractors, at cost to it, only that amount of lumber called for by the contracts, although additional lumber was used. The petitioner charged $40,741.48, the contract price, to capital account as the total cost of the construction of the buildings. Upon examination of the petitioner’s books kept during the years 1911 and 1912, it was found that the petitioner had furnished toward the construction of these buildings labor and material costing $4,286.42 which .had not been billed to the contractor, and that the total cost of these buildings when completed in 1912 was $45,027.90.
    In ascertaining the additional capital cost of each of the foregoing classes of construction the petitioner used the same labor and material costs as shown by its books of account kept during the years 1911 and 1912.
    When, in 1912, the petitioner had completed its new yards, it charged to capital account for machinery, equipment, and properties not hereinabove mentioned, the total sum of $38,891.06. Upon examination of its books of account kept during 1911 and 1912, it was found that there had been charged to expense capital items with respect to properties, machinery and equipment in an aggregate of $10,529.39, making a total of machinery, equipment, and miscellaneous property with an aggregate cost in 1912 of $49,420.45.
    The ground upon which the new lumberyard was erected was, and is now, owned by Frederick B. Bolles, who was until 1917 the principal stockholder and the active manager of the petitioner. The petitioner had no lease to the property at any time prior to August, 1917. In the fall of 1917 Bolles sold his stock to John Claney and Claney’s brothers and retired from the business. On August 1, 1917, Bolles entered into a lease with the petitioner which provides, among other things not material to this proceeding, that upon the termination of the lease on April 30, 1932, all the buildings and permanent improvements on the premises shall be a part of the freehold and the property of the lessor. There is no provision for a renewal of the lease.
    The cost of petitioner’s plant, properties, and equipment, itemized in accordance with the evidence, the normal rates of depreciation applicable to each item, and the rates of depreciation applicable to those items having a normal life running beyond the termination of the lease, are as follows:

      There is no dispute as to the additions and improvements made to the petitioner’s assets subsequent to March 1, 1913.
    The Commissioner used the book value of the capital assets for the purposes of invested capital and depreciation and has applied, during the years here in question, rates of depreciation without regard to the lease for the premises occupied by the petitioner.
    The Commissioner found that a computation of excess and war-profits taxes under the provisions of section 328 -of the Revenue Act of 1918 would afford the petitioner no relief.
   OPINION.

TRtjssell:

The original petition in Docket No. 10597 recited that the years under consideration were 1917 and 1918. The context in which these figures were used with references to the deficiency letter, and a copy of the deficiency letter attached to the petition, all made it plain that the years for which the petitioner was appealing to this Board were the years 1918 and 1919. This is so apparent that to our mind no one reading the petition and the deficiency letter could have been misled on account of the recital of the years in question. It is plain from the respondent’s answer that the respondent was in no way misled by the erroneous recital. We are, therefore, of the opinion and have held, that the petitioner’s request to amend the petition should have been, as it was at the trial, granted as a matter of course, and that the Board acquired jurisdiction of the deficiency for the year 1919 by virtue of the original petition.

The record of this case contains convincing evidence that the petitioner’s capital accounts so far as they involved the construction of its new lumberyards and properties in the years 1911 and 1912, were incomplete and that much of the material and labor which then went into permanent improvements was incorrectly charged to expense. In so far as the evidence has identified these charges to expense they have been restored to capital account as recited in the findings of fact.

The record contains much testimony offered to prove a March 1, 1913, value of plant and equipment. A retrospective appraisal showing a detailed and valued inventory was received and the testimony of four capable men having experience as builders and appraisers was also received. This testimony varied according to the witnesses in total valuations ranging from $250,000 to more than $270,000, and, while we may not doubt that all of this testimony was offered in good faith, we can not overlook the fact that these properties were acquired one and two years prior to March 1, 1913, and that the spread between the proven cost and the values testified to by the witnesses is so great that it relieves the opinion testimony of much of the weight that it might otherwise have had. We are of the opinion that the corrected costs as set forth in the findings of fact are the substantial equivalent of the March 1, 1913, value.

No testimony was introduced in support of petitioner’s claim for relief under section 328 of the Revenue Act of 1918. The deficiencies must therefore be determined without resort to the provisions of that section.

The deficiencies may be redetermined in accordance with the foregoing fundings of fact and opinion on 15 days’ notice, pursuant to Rule 50, and judgment will be entered accordingly.


author: Trammell:

text:
    John G. Paxton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5911.
    Promulgated May 25, 1927.
    Assessments on stock paid by individual stockholders under the facts of this case represent additional cost of the stock and are not deductible as losses until the stock is sold or becomes worthless.

      John G. Paxton pro se.

      J. Arthur Adams, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income tax for 1922 in the amount of $86.54 The deficiency arises from the action of the Commissioner in disallowing as deductions two amounts of $1,000 each paid by the petitioner as assessments upon his stock in the First National Bank of Independence, Mo. The case was submitted upon the pleadings, all of the material allegations of fact in the petition being admitted in the answer.
    FINDINGS OF FACT.
    The petitioner during the year involved was a stockholder in the First National Bank of Independence, Mo. The petitioner had been an officer of this bank since its organization. Prior to the year involved it had made loans upon paper negotiated by a partnership known as Smith & Ricker.
    Smith & Ricker, a partnership, had been for a long time dealing in cattle paper in the Kansas City stock yards. The business and financial standing of the partners was good. Smith was the president of the Commonwealth National Bank of Kansas City. As an adjunct to their business they obtained control of a number of banks adjacent to Kansas City. About 1907 they obtained control of the First National Bank of Independence, which had been in business since 1889. Upon getting control of the bank, Smith and Ricker permitted the former officers to remain in office. The bank greatly needed loans, and Smith and Ricker furnished the bank cattle paper negotiated by them. As the amount of this paper greatly increased the officers of the bank required the personal guarantee of Smith and Ricker for all of the loans negotiated by them. The connection seemed profitable to the bank, interest was paid promptly on the Smith and Ricker loans and the bank declared dividends of 14 per cent per annum after adding something to its surplus each year.
    In December of 1921 rumors were heard affecting the standing of Smith and Ricker. On January 3, 1922, the officers of the bank learned that Smith and Ricker were insolvent. They still believed that the personal guarantee of Smith was worth something, but it soon developed that this, too, was of no value. The total liabilities of Smith and Ricker were about $12,000,000, the bank having in round numbers about one-half million of Smith and Ricker paper.
    The bank’s capital was $100,000, and its surplus and profits about $100,000.
    The officers of the bank decided to avoid a bank failure with a consequent loss to its depositors. It was manifest on the first examination of the Smith and Ricker paper that there was a loss of $200,000. By charging off this amount the surplus and undivided profits were wiped out as well as the amount of its capital.
    An assessment of $100 per share was levied upon all of the stock of the bank. The Smith and Ricker stock in the bank was held by persons who could pay no assessment, and their stock was offered without price to anyone who would pay the assessment of $100 per share.. So great was the confidence of Willian T. Kemper and other bankers of Kansas City in B. Zick, Jr., president of the bank, and its good reputation in the past, that they agreed to take -the Smith and Ricker stock and pay therefor the proposed assessment of $100 per share. The other stockholders in the bank, including the petitioner, paid the assessments upon their stock. There was then charged off $200,000 of the Smith and Ricker paper.
    Later in 1922 the comptroller, after a thorough examination of the condition of the bank made an order that an additional assessment of $100 per share should be paid with the alternative that if it were not paid the comptroller would close the bank. The petitioner’s part of that additional assessment was $1,000, which he paid. The comptroller upon examination decided that not less than $300,000 of the Smith and Bicker paper should be charged off as worthless.
    Since the failure of Smith and Bicker in 1922 the bank has never declared a dividend and all earnings have been appropriated to additional charge-offs ordered by the comptroller of certain Smith and Bicker paper held by the bank. In 1925, for the first time, some of the stock of the First National Bank of Independence was sold at the price of $105 per share.
   OPINION.

Trammell:

The question involved is whether the amount of $2,000, which is the total of the two assessments made on the stock owned by the petitioner in the First National Bank of Independence, Mo., in 1922, is deductible from the gross income of the petitioner in determining his net income for that year. The petitioner contends that the amount should be deducted from his income, while the respondent contends that the amount constituted additional expenditure which must be added to the original cost of the stock and that no gain or loss resulted therefrom during 1922, since the stock was not sold during that year.

The facts in this case are very similar to the facts in the Appeal of Harry E. Lutz, 2 B. T. A. 484, and we think that our decision there is applicable and controlling here. The additional assessments levied upon stock in a corporation constitute additional capital outlay by the stockholders in the acquisition of their stock. No deductible loss results from the transaction until the stock is sold or is shown to have become worthless. In this case it is not shown that the stock was sold, nor is there any evidence that the stock became worthless during the taxable year involved. The likelihood that the total capital investment could never be recovered and the probability that a loss would be realized on the sale of the stock is not sufficient to warrant a deduction prior to the happening of that event.

Judgment will be entered for the respondent.


author: TRAmmell:

text:
    De Van & Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8630.
    Promulgated May 26, 1927.

      E. J. Goodrich, Esq., for the petitioner.

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

This proceeding is for the redetermination of a deficiency of $454.04 in income and profits taxes for the calendar year 1920. In its amended petition petitioner assigns as errors: (1) The failure of respondent to deduct from its income for 1920 the sum of $3,267.64, which amount was alleged to be individual income of its president earned during 1919, included by mistake in the income of petitioner for that year and which was refunded to its president in 1920 as additional salary for 1919, and (2) the erroneous inclusion by the petitioner in its income for the year 1920 of the amount of $5,896.09, being commissions on sales of life insurance policies earned by its president and belonging to him personally, but erroneously included in petitioner’s income for 1920. These issues were raised by petitioner for the first time in this proceeding.

FINDINGS OF FACT.

Petitioner is a West Virginia corporation with its principal office at Charleston, and is engaged in the general insurance business, other than life insurance.

In 1915 R. P. De Van, president of petitioner, personally entered into a contract with the Equitable Life Insurance Co. to represent it as its agent.

During the year 1919, De Van earned total commissions of $3,267.64 on life insurance policies sold for the Equitable Company and the amount of these commissions was erroneously included by the petitioner in its income for 1919. In 1920 the amount was repaid to De Van by petitioner in the form of additional salary for 1919, and as such deducted from income in its 1920 return. Respondent disallowed the deduction for 1920 as additional salary and, by appropriate adjustment, excluded the amount from petitioner’s income for 1919 as not properly being a part of its income.

During the year 1920 De Van earned total commissions of $5,896.09 under his contract with the Equitable Company, which amount was erroneously included by petitioner in the income reported in its tax return for that year.

Judgment will he entered for the petitioner on 15 days' notice, under Bule 50.


author: Tkammelh :

text:
    Cuyahoga Abstract Title & Trust Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 8937.
    Promulgated May 26, 1927.
    It appearing from the evidence that capital was a material income-producing factor in petitioner’s business, it is not entitled to classification as a personal service corporation under section 200 of the Revenue Act of 1918.

      Ben Jenkins, Esq., for the petitioner.

      Geo. G. Witter, Esq., for the respondent.

      This proceeding is for the redetermination of deficiencies in income and profits taxes for the year 1918 in the amount of $3,671.85, for the year 1919 in the amount of $6,849.11, and for the year 1920 in the amount of $252.52, a total of $10,773.48. The only issue presented is whether petitioner was, during the years involved, entitled to classification as a personal service corporation as that term is defined by section 200 of the Revenue Act of 1918.
    PINDINGS OP PACT.
    The petitioner is an Ohio corporation, with its principal office at Cleveland. It was organized in May, 1900, with an authorized capital stock of $20,000, divided into 200 shares of a par value of $100 each. The corporation succeeded a partnership which had been in existence since 1898, and its stock was issued for the partnership assets, consisting principally of records and abstracts of title, which constituted a so-called “ abstract plant.” From the date of its organization and during the years involved herein, petitioner was engaged in the business of preparing abstracts and certificates of title to real estate, for which it made charges to its clients according to the amount of work involved. The number of abstracts furnished was small in comparison with the number of certificates, and about 75 per cent of petitioner’s services were furnished to banks. In the preparation of abstracts and certificates of title, employees searched the records and assembled the necessary data under the supervision of the principal stockholders, one of whom would pass opinion upon the validity of each title and finally approve each abstract or certificate. The principal owners or stockholders of petitioner were during the years in question regularly engaged in the active conduct of its affairs.
    In 1911, the authorized capital stock of petitioner was increased from $20,000 to $200,000. Additional stock in the amount of $180,000 was issued and set up on the books as good will.
    The abstract plant, for which petitioner at organization issued its -capital stock of $20,000, had been built up by the predecessor partnership, and, during the succeeding years, additions and betterments were constantly made to the plant by the petitioner. The larger part of the cost of maintaining, building up, and improving the plant by the petitioner, was paid out of its current earnings and charged to expense. Petitioner expended between $200,000 and $300,000 in maintaining and building up its plant, which now has a replacement value of not less than $500,000.
    Petitioner’s investment in its abstract plant was necessary to enable it to render the services from which it received its income. The nlant was essential to the efficient performance of its functions. Without the plant it would have been necessary to go to the court house to look up the records in each case, and this would have precluded work on a number of titles at the same time. Without the plant, it would have been impracticable for petitioner to have operated its business.
    An important factor in the preparation of abstracts and certificates of title by petitioner was the possession of a complete set of abstract books and records, such as those maintained by it, with employees competent to use them. Petitioner’s abstract plant represented a capital investment, which was a material income-producing factor in its business.
    During the year 1918, petitioner had 33 employees to whom it paid salaries in the aggregate amount of $37,232; during 1919, it iiad 41 employees to whom it paid $57,148; and during 1920, it had 75 employees to whom it paid $113,620. These employees were classified, according to the duties performed by them, as searchers and examiners, indexing and filing clerks, draftsmen, private secretaries, typists and comparers, bookkeepers, general clerks, and office boys.
    As shown by its amended tax returns, petitioner had a net income for the year 1918 of $17,725.48; for 1919 a net income of $69,949.52; and for 1920, a net income of $60,234.64.
   OPINION.

Tkammelh :

The Revenue Act of 1918 exempts personal service corporations from the taxation imposed upon ordinary business corporations, and provides in section 218 (e) that the individual stockholders shall be taxed in the same manner as tlie members of partnerships. In section 200 of the Act a personal service corporation is defined as one (a) whose income is to be ascribed primarily to the activities of the principal owners or stockholders, (b) who are themselves regularly engaged in the active conduct of the affairs of the corporation, and (c) in which capital (whether invested or borrowed) is not a material income-producing factor.

For each of the years 1918,1919, and 1920, petitioner filed an original corporation income and profits-tax return on Form 1120, and for the years 1919 and 1920 later filed amended returns on the same form. Under date of November 15, 1923, petitioner prepared and filed a personal service corporation return of income on Form' 1065, for each of said years, thereby claiming for the first time to be a personal service corporation. Petitioner now contends that it is entitled to classification as a personal service corporation, and as such is exempt from taxation under the provisions of the revenue act above mentioned. No error other than respondent’s refusal to allow such classification is alleged to have been committed in connection with his determination of the deficiencies involved in this proceeding. Respondent avers that petitioner is not entitled to classification as a personal service corporation for the reason that its income can not be ascribed primarily to the activities of its principal stockholders, and because capital was a material income-producing factor in its business. Thus, the sole issue presented is whether petitioner, during the years in question, possessed the qualifications of a personal service corporation as defined in section 200 of the Revenue Act of 1918.

Since petitioner is seeking to overturn the determination of respondent, the burden is upon it clearly to establish by competent and satisfactory evidence that it comes within the class of corporations referred to. As stated by the court in Matteson Co., v. Willcuts, 12 Fed. (2d) 447:

Every corporation has full control of its own activities. * * * If it does not fairly observe and keep within the requirements of the law, it should not claim the benefits which the law confers. To nearly comply with the law or to come within hailing distance thereof, is not enough.
# íjí ífc 9*< * ‘Jfi
There is constant temptation to urge that particular corporations, with no right to such favor, be accorded classification as personal service corporations, and the requirements necessary thereto must be substantially observed.

Has petitioner discharged its burden and shown itself fairly to come within the definition of a personal service corporation? We think it has wholly failed to do this.

The evidence shows that petitioner at the time of its organization in 1900 issued its entire capital stock of the par value of $20,000 for a set of abstract books and records, which were accepted at that valuation, and that during the succeeding years up to 1920, it spent large sums of money amounting to between $200,000 and $300,000 by way of additions and betterments to its abstract plant in order to keep it up to date. It is immaterial that such expenditures were largely made from current earnings and charged to expense. Book entries are not conclusive of the nature of the expenditure. Doyle v. Mitchell Bros. Co., 247 U. S. 179-188. A taxpayer has no option to treat expense items as capital or capital expenditures as expenses. Appeal of Gilliam Mfg. Co., 1 B. T. A. 967. We are not here concerned with the question of what portion of the expenditures might properly be regarded as maintenance and hence be chargeable to expense, and what part represents a capital investment. It is sufficient to say that the expenditures in question raised the value of petitioner’s abstract plant from $20,000 in 1900 to several hundred thousand dollars in 1920, and to a very material extent constituted an investment of capital. The replacement value of the abstract plant is shown to be now approximately $500,000. Without the possession and use of such plant, petitioner could not successfully have conducted its business. On that point, J. V. Chapek, a witness for petitioner, and who has been its president for 26 years, testified at the hearing as follows:

Q. In other words, you think that you have got to have that investment in the business before you could perform that service to the public?
A. Yes.
Q. Before you could perform it efficiently?
A. Absolutely. You have got to have that. You have got to have all that stuff together. If you don’t have it you cannot do the work. Of course we could not do the work that we do, work on ten or fifteen jobs, if we had to go to the Court House and look up the records. That is something that we could not do night and day efficiently.
Q. In other words, that is where you make your money?
A. Yes.

In the light of this and the other evidence before ns, we are unable to agree with the contention of petitioner that the capital represented by its plant was not a material factor in producing its income. On the contrary, the evidence shows that it was the principal, factor. In the Appeal of Record Abstract Co., 2 B. T. A. 628, the facts were strikingly similar to those in the instant case. There we held that the abstract books of the taxpayer corporation represented a capital asset which was a material income-producing factor in its business, and precluded classification as a personal service corporation.

Having decided that capital ivas a material income-producing factor, the petitioner herein does not meet the requirements of a personal service corporation and a discussion of the other elements prescribed by the statute is not necessary.

Judgment will be entered for the respondent.