author: Murdock:

text:
    The Savings Feature of the Relief Department of the Baltimore and Ohio Railroad Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 59486, 61166.
    Promulgated March 29, 1935.

      Hugh G. Bickford, Esq., George Dobbin Penniman, Esq., and B. Kemp Slaughter, Esq., for the petitioner.

      ATlin H. Pierce, Esq., and Irving M. Tuller, Esq., for the respondent.
   OPINION.

Murdock:

The petitioner makes but one contention before the Board. That contention is that it is exempt from tax. No other issue or question will be decided. The Commissioner has determined that the petitioner is an association within the meaning of that term as used in the statutory definition of the word “ corporation.” See section 1 of the 1918 Act, section 2 (a) (2) of the 1924 and 1926 Acts, and section 701 (a) (2) of the 1928 Act. He cites in this connection A-C Investment Association, 24 B.T.A. 582 (reversed by the Court of Appeals of the District of Columbia, 68 Fed. (2d) 386, on the exemption question), and Sears, Roebuck & Co. Employees' Savings (& Profit Sharing Pension Fund v. Commissioner, 45 Fed. (2d) 506 (reversing 17 B.T.A. 22). “The petitioner concedes that under recent decisions of the Board of Tax Appeals and the courts, the association is probably the technical equivalent of a corporation for tax purposes ”; it nowhere argues that it is not an association within the meaning of the applicable statutes; and, consequently, the Board expresses no view upon this point. Neither party makes any contention that the petitioner is not properly before the Board. The petitioner once suggested, but did not plead or argue, that it might be exempt as a labor organization. Its pleadings raise the issue of whether or not it is exempt as a cooperative bank without capital stock organized and operated for mutual purposes and without profit, but this point was not argued. The parties have stipulated that if the petitioner is not exempt from tax, then the Commissioner has correctly determined the deficiencies and penalties. It is quite clear from the record and the briefs that the only question submitted for discussion and decision is the question of whether or not the petitioner is exempt from tax, either because it is a mutual savings bank not having a capital stock represented by shares, or because it is a domestic building and loan association substantially all of the business of which is confined to making loans to members. If it appears that the petitioner is exempt under one of the provisions mentioned, of course, discussion of the other becomes unnecessary.

The Commissioner made a brief oral argument at the hearing in lieu of filing a brief. In support of his holding that the petitioner is not exempt as a mutual savings bank, he first said that there were consistent rulings of the Bureau contrary to the contention of this petitioner which were controlling in view of the reenactments of Congress. He next relied rather strongly upon the decision of the Board in A-C Investment Association, 24 B. T. A. 582, and also quoted section 40, article 11 of the Maryland Code as having some application. Thereafter, the decision of the Board in the A-G Investment Association case was reversed by the Court of Appeals for the District of Columbia, A-C Investment Association v. Helvering, 68 Fed. (2d) 386. The court in that case reviewed the departmental rulings. It showed that the early construction had been to exempt the petitioner in that case, but later a contrary ruling was made. It then held that, since there was this inconsistency in the departmental rulings, the decision must turn upon some other point. Immediately after that decision the departmental rulings were again reversed and the decision of the court in the A-G Investment Association case was followed. See G. C. M. 13602, Internal Revenue Bulletin No. 46, vol. XIII, p. 2, which revoked prior rulings of the Bureau (discussed by the court in its opinion) “ in so far as they hold that mutual savings banks (which otherwise meet the requirements of the Federal exemption statute) should be denied exemption because they are not organized under a State law and/or do not operate subject to State supervision, notwithstanding the State of their domicile imposes no such restrictions on mutual savings banks ” and held that “mutual savings banks not organized or operated under State laws and supervision in a State which recognizes the right of individuals to carry on a banking business and makes no provisions for supervising such organizations are exempt from Federal income tax.” See also Regulations 86, art. 101(2)-1.

After the decision of the Board in the A-G Investment Association case had been reversed, the Commissioner filed a short brief in which he unsuccessfully attempted to point out that the court’s decision would not apply to the present case because the laws of Maryland differed from the laws of Texas, under which the A-C Investment Association operated. The facts in the present case differ somewhat from the facts in the A-G Investment Association case and from the facts discussed in G.C.M. 13602. But the differences strengthen this petitioner’s case and do not make the reasoning in those two decisions inapplicable here. Attention is called in that brief to additional sections of the Maryland Code to show, apparently, that the petitioner is not a savings bank.within the meaning of the Maryland statutes quoted, sections 31, 36, 38-41, article 11, Bagby’s Annotated Code of 1924. The petitioner does not confine its operations to the State of Maryland. It operates in all of the territory along the lines of the Railroad from New York to Chicago and St. Louis. Maryland is but a relatively small part of that area. However, since the respondent relies entirely upon the laws of Maryland, we have examined the statutes of that state to which he has called our attention. Those statutes provide methods for forming mutual savings banks and contain a number of provisions for state supervision of savings institutions. The provisions for state supervision refer principally to corporations. The petitioner was not incorporated. It was not organized under any of the provisions of the statutes to which the respondent refers. Most of those provisions have no application whatever to the petitioner. Section 40, already referred to, provides that certain associations, not authorized to conduct a business of a savings bank, shall not advertise or put forth a sign as a savings bank or savings institution. We need not decide whether this provision applies to the petitioner, for, in any event, the petitioner did not advertise or put forth a sign as a savings bank or savings institution. It was able to carry on its activities without such sign or advertisement. The petitioner does not rely upon any of the provisions quoted for authority to conduct its business. Those statutes seem to recognize that there may be unincorporated savings banks which are subject to no state supervision. Cf. Weer v. Page, 155 Md. 86; 141 Atl. 518. The petitioner has operated for many years without being called to account for violation of any of the laws of the State of Maryland or of any other state in which it operated so far as this record shows. None of the provisions referred to seems to interfere in any way with the conduct of the petitioner’s business or require it to submit to state supervision. The right to engage in the banking-business was open to all under the common law. State v. Scougal, 3 S. D. 55; 51 N. W. 858. There is, in the statutes referred to, no justification for denying the petitioner the exemption which it claims.

Thus the principal arguments advanced by the respondent in support of his determination have failed him. Furthermore, the facts show that the petitioner actually carried on a very extensive business of the kind which Congress must have intended to exempt from tax under the provisions of subdivision 2 of section 231 of earlier acts and of subdivision 2 of section 103 of the Act of 1928. A-C Investment Association v. Helvering, supra. Thousands of persons scattered all along the lines of the Railroad were depositors. Their separate deposits were relatively small in amount. These depositors were thus assisted in saving. The deposits were generally subject to withdrawal upon demand. They bore interest. Passbooks were used in which deposits, interest, and dividends were credited and withdrawals debited. None but the depositors benefited from the earnings of the petitioner. They alone were entitled to the current earnings and surplus assets accumulated. The organization did not lack mutuality. The deposits and accumulated surplus were invested by those in charge of the petitioner much in the same way that any savings bank would invest its funds. A large part was invested in well secured mortgage loans, another part was invested in bonds, and a part was in the form of a cash deposit with the Railroad. Some investments were made in stock of corporations. If such an investment was not a proper one for a savings institution, no point has been made of that circumstance. The court in A-C Investment Association v. Helvering, supra, has discussed the history and purpose of the provisions exempting mutual savings banks from tax and has reviewed a number of authorities. Nothing would be accomplished by further discussion or review here. The court has held, and we think rightly so, that it is immaterial in the decision of such cases that only certain classes could become depositors. The Commissioner has followed this interpretation by the court in promulgating regulations under the Revenue Act of 1934. See Regulations 86, art. 101 (2)-1. Thus the petitioner was in fact a mutual savings bank not having a capital stock represented by shares within the meaning and intent of the applicable statute and is, therefore, entitled to the exemption.

The respondent in his brief sets forth figures representing the income which the petitioner derived from the printing plant during each of the years 1919 to 1926, inclusive, and, in a parallel column, figures which he said represented the petitioner’s entire net income for each of those years. He then argued from a comparison of the two columns that the chief source of income earned by the petitioner during that period was not from the operation of a savings bank business but rather from the operation of a printing plant, and Congress did not intend to exempt such income from tax. However, the respondent is mistaken as to the facts. The figures for total net income upon which he bases this argument are entirely incorrect. They represent not net income, but the balance which the petitioner carried to surplus in each of the years after paying interest and dividends to its depositors. The amounts were but a small part of the net income of the petitioner for each of the years. Although it is true that the conduct of a printing plant is not a usual or incidental function of an ordinary savings bank, nevertheless, the petitioner need not lose its exempt character during the years 1919 to 1926, inclusive, merely because it operated this printing plant. Cf. Trinidad v. Sagrada Orden de Predicadores, 263 U. S. 578. The Railroad was the petitioner’s only customer for printing and obviously adopted this plan as an indirect means of reimbursing the petitioner for its expenses. The earnings from the printing plant never equaled the petitioner’s expenses of operation. In 1926 this indirect plan was abandoned and thereafter the Railroad paid directly all of the expenses of operation which the petitioner otherwise would have had to pay itself. The fact that the Railroad thus voluntarily aided and encouraged the petitioner in no way interferes with the petitioner’s right to receive the exemption by which Congress also intended to encourage its activities.

The respondent further contends that exemption must be denied the petitioner because it failed to comply with the provisions of his regulations entitled “ Proof of exemption.” The contention of the respondent suggests a number of questions, including what the effect is of the provisions of his regulations entitled “ Proof of exemption”; whether the provisions are merely directory, or are mandatory, so that the filing of proof of exemption with the Commissioner is thus made a condition precedent to the right of exemption; the extent, if any, to which the petitioner has complied with the regulations; and what the effect is of what it has done. Although some subdivisions of the revenue acts specifically authorize the Commissioner to make regulations on the subject therein dealt with, yet there is no specific authorization for regulations relating to exemption of mutual savings banks. Cf. William W. Vaughan, 31 B.T.A. 548. Authority for the provisions of the regulations relating to “ Proof of exemption ” must be found in the general authority granted in each revenue act to the Commissioner to make all needful rules and regulations for the enforcement of the provisions of the act. The revenue acts did not confine the exemption to those banks which might file proof of exemption with the Commissioner. The exemption was intended to encourage savings banks. A-C Investment Association v. Helvering, supra. The words of article 511, to one having these things in mind, do not seem to make the filing of “ proof of exemption ” a condition precedent to the right of exemption. The provisions of this article are directory rather than mandatory in this respect. They require those claiming exemption from tax to supply the Commissioner with information showing their exempt character so that he may be satisfied that they are actually exempt. The article indicates in a general way the kind of proof which should be submitted, but no certain form is specified. No time for filing it is mentioned. No special emphasis is placed upon any particular annual period. There is recognition that changes in the character of such organizations will not be frequent. The Commissioner, in effect, says in these articles, that each organization claiming exemption, if it wants him to agree that it is exempt, must file proof of its exemption with him. The penalty for failure to comply seems to be that the Commissioner, if he has doubts of the exempt character of any organization, may assess the tax and put that organization to the trouble of proving elsewhere its right to exemption. That is what has happened in the case of the present petitioner, but the latter has now proved its right to exemption. The question of whether the Commissioner had the right to make the filing of proof of exemption a condition precedent to the right of exemption, need not be decided in this case. Even if the words of article 511 are to be interpreted as making the filing of proof of exemption a condition precedent to the right of exemption, still decision in this case must be for the petitioner. The petitioner, in March 1923 gave the Commissioner certain proof of its exempt character which complied at least in part with the regulations. Thereafter, more than eight years elapsed before the Commissioner made any move to assess a tax against the petitioner. Under such circumstances, a holding that the petitioner had forever forfeited its right to exemption would not be justified. Thus, whatever the correct interpretation of article 511 may be, the provisions of that article and its later counterparts afford no proper basis for denying exemption to the present petitioner.

Be vie wed by the Board.

Decision will be entered for the petitioner.

       The applicable provisions of the revenue acts are found in subdivisions 2 and 4 of section 231 of the Acts of 1918, 1921, 1924, and 1926 and of section 103 of the Act of 1928. The language, which is as follows, is the same in all of these acts except that the words “ substantially all the business of which is confined to making loans to members ” do not appear in the 1918 Act: “ The following organizations shall be exempt from taxation under this title * * * (2) Mutual savings banks not having a capital stock represented by shares; * * * (4) Domestic building and loan associations substantially all the business of which is confined to making loans to members; * * * ”

       This provision is contained in article 511 of Regulations 45, 62, 65, and 69, and in article 521 of Regulations 74. These articles, in so far as they related to mutual savings banks are substantially identical. Article 511 of Regulations 45 is in part as follows:

        “Proof of exemption. — In order to establish its exemption, and thus be relieved of the duty of filing returns of income and paying the ¿ax, it is necessary that every organization claiming exemption * * * file an affidavit with the collector of the district in which it is located, showing the character of the organization, the purpose for which it was organized, the sources of its income and its disposition, whether or not any of its income is credited to surplus or may inure to the benefit of any private stockholder or individual, and in general all facts relating to its operations which affect its right to exemption. To such affidavit should be attached a copy of the charter or articles of incorporation and by-laws of the organization. Upon receipt of the affidavit and other papers by the collector, he will inform the organization whether or not it is exempt. If, however, the collector is in doubt as to the taxable status of the organization, he will refer the affidavit and accompanying papers to the Commissioner for decision. When an organization has established its right to exemption, it need not thereafter make a return of income or any further showing with respect to its status under the law, unless it changes the character of its organization or operations or the purpose for which it was originally created. Collectors will keep a list of all exempt corporations, to the end that they may occasionally inquire into their status and ascertain whether or not they are observing the conditions upon which their exemption is predicated. * * * **


source: Caselaw Access Project

author: Arundell:

license: Public Domain

text:
    Rogers, Brown & Crocker Bros., Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 67581.
    Promulgated March 29, 1935.

      Adrian, G. Humphreys, Esq., and Newton K. Fox, Esq., for the petitioner.

      8. B. Anderson, Esq., for the respondent.
   OPINION.

Arundell:

Respondent determined a deficiency of $7,345.21 in petitioner’s 1929 income tax. Petitioner alleges that the determination is erroneous, in that respondent (1) overstated gross profit from trading, and (2) disallowed a deduction of $41,744.63 for salaries incurred within the year.

Petitioner, a Delaware corporation, was organized on June 8, 1925, succeeding to the businesses of two partnerships. At first its principal business was selling pig iron and other metals on a commission basis. In 1929 its commission sales amounted to $3,447,-051.80 and its sales for its own account amounted to $17,254,791.81.

Petitioner keeps its books on an accrual basis.

In its 1929 return petitioner reported gross income from “ commissions earned ” in the sum of $872,548.01, of which $69,449.76 represented commissions earned on sales of pig iron and other metals, $139,748.51 represented profits from dealings on tbe rubber exchange, and $663,348.74 represented gross profit from sales for its own account of pig iron and other metals ($400,457.22), crude rubber ($215,727.58), and export merchandise ($47,164.94). The only one of those- items now in dispute is the gross profit of $215,727.58 from sales of crude rubber, and the controversy as to that item arises out of petitioner’s challenge of the accuracy of its own return. The return included deductions, among others, of $41,774.63 for “ Eeserve for additional compensation ” and $98,558.95 for 1928 net loss, and showed a net income of $209,488.88. Petitioner sustained a statutory net loss of $73,558.95. in 1928. Eespondent disallowed the deduction taken for reserve for additional compensation, reduced the deduction for 1928 net loss to the amount now agreed to be the correct figure, and, accepting the return as otherwise correct, determined a net income of $276,263.51.

The petitioner asserts that the result of its trading in crude rubber was a loss of $176,360.93 and not a gross profit of $215,727.58, as reported in the return. The reported gross profit was computed by deducting from the total of crude rubber sales ($7,788,415.24) the total actual invoice cost ($7,572,687.66) to petitioner of the crude rubber sold. The petitioner contends that cost should be represented not by actual invoice cost, but by a figure that reflects the sum of the opening inventory at cost or market, whichever is lower ($178,668.77), plus total cost of purchases during the year ($9,685,359.38), less closing inventory at cost or market, whichever is lower ($1,899,251.98), or $7,964,776.17. Taking the latter figure as cost, a loss from crude rubber sales in the amount asserted by the petitioner would be reflected. The parties agree that this $7,964,776.17 is the correct cost of goods sold figure if petitioner is entitled to use inventories valued on the basis of cost or market, whichever is lower, in computing net income. The respondent concedes petitioner’s right to use inventories for that purpose, but contends that a previous election by petitioner, to value inventories on the basis of cost, is binding upon the petitioner for the taxable year. If that be the case, the result of the year’s trading in crude rubber has been correctly reported in the return; for the arithmetical result of a computation of cost, when based upon cost of purchases and inventories valued at cost — there being no evidence of actual loss, through shrinkage, spoilage, or other cause, of otherwise inventoriable crude rubber — would be the same figure as that representing actual invoice cost. Thus the question resolves itself into one of whether petitioner is entitled to value its current inventories of crude rubber on the basis of cost or market, whichever is lower, or is limited to a valuation at cost.

By section 22(c) of the Eevenue Act of 1928 taxpayers are required, whenever in the opinion of the Commissioner inventories are necessary in order clearly to determine tbe income, “ to take inventories upon such basis as the Commissioner * * * may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.” Article 102 of Regulations 74, promulgated under that act, provides in respect of the valuation of inventories, as follows:

Section 22(c) provides two tests to which each inventory must conform:
(1) It must conform as nearly as may he to the best accounting practice in the trade or business, and
(2) It must clearly reflect the income.
It follows, therefore, that inventory rules can not be uniform but must give effect to trade customs which come within the scope of the best accounting practice in the particular trade or business. In order to clearly reflect income, the inventory practice of a taxpayer should be consistent from year to year, and greater weight is to be given to consistency than to any particular method of inventorying or basis of valuation so long as the method or basis used is substantially in accord with these regulations. An inventory that can be used under the best accounting practice in a balance sheet showing the financial position of the taxpayer can, as a general rule, be regarded as clearly reflecting his income.
The bases of valuation most commonly used by business concerns and which meet the requirements of section 22(c) are (a) cost and (b) cost or market, whichever is lower. * * *
* * * Taxpayers were given an option to adopt the basis of either (a) cost or (b) cost or market, whichever is lower, for their 1920 inventories. The basis adopted for that year is controlling, and a change can now be made only after permission is secured from the Commissioner. Application for permission to change the basis of valuing inventories shall be made at least 30 days prior to the close of the taxable year for which the change is to be effective. * * *

Also, article 101 of Regulations 74 provides that “ In order to reflect the net income correctly, inventories at the beginning and end of each year are necessary in every case in' which the production, purchase, or sale of merchandise is an income-producing factor.” The foregoing provisions of the 1928 Act and Regulations 74 have their counterpart in section 205 of the Revenue Act of 1926 and articles 1611 and 1612 of Regulations 69, which governed the years 1925 (petitioner’s first taxable year) to 1927, inclusive. By these statutory and regulatory provisions, it was mandatory upon the petitioner to elect an acceptable basis for valuing the inventory of the year in which purchases and sales became income-producing factors, and such election was thereafter binding upon it unless and until it secured the permission of the respondent to change to another basis.

While the stipulated facts and other evidence are not entirely clear about the matter, we gather from those sources that purchases and sales of crude rubber and other commodities have been income-producing factors in petitioner’s business from the beginning of its corporate existence and that inventoriable commodities, though perhaps not in large quantities in the first two years, have been carried forward from year to year. The petitioner’s 1928 return shows an opening (1927 closing) inventory of $568,700.48, so that it is clear that as early as 1927 petitioner was carrying a substantial inventory. What the petitioner’s election may have been in the matter of valuing its earliest inventory does not specifically appear. Its claim of right to value its inventories at cost or market, whichever is lower, is based on a statement in the 1928 return that the opening and closing inventories were valued on that basis, which statement, petitioner contends, was an exercise of an election that is binding for the taxable year in question. But the petitioner must have filed returns for 1925, 1926, and 1927, and, as already indicated, it was carrying a substantial inventory as early, at least, as 1927; and it is clear, as will hereinafter more fully appear, that the 1927 closing (1928 opening) inventory was valued at cost. The burden of showing an election to value its inventories at cost or market, whichever is lower, that is binding as to the taxable year in question is upon the petitioner, and that burden is not met by merely proving what was said in the 1928 return about valuing the inventories of that year, especially when the petitioner is known to have carried an inventory in an earlier year and the statement in the 1928 return can be shown to be without factual basis.

In the 1928 return petitioner, in answer to a specific interrogation about the matter, stated that its opening inventory of $568,-700.48 and its closing inventory of $203,290.93 were valued “At cost or market whichever is lower.” In the 1929 return petitioner answered that its opening (1928 closing) inventory of $203,290.93 and its closing inventory of $2,526,019.69 were valued at “ Cost.” Now it is obvious that both of these statements as to the 1928 closing (1929 opening) inventory cannot be correct; for the inventory valuation could not be the same on both bases, unless cost was lower than market at the close of 1928, and that clearly was not the case, because the parties have agreed that the cost of crude rubber (but not of the other commodities) then on hand was higher than its then market value, and that the value of the 1928 closing (1929 opening) inventory at cost or market, whichever is lower, was $189,635.15. That that inventory was actually valued at cost, and not the lower of cost or market, not only in the 1929 return but in the 1928 return as well, is clear from the following computation:

Invoice cost of goods in 1929 closing inventory as shown in 1929 return-$2, 526, 019. 69
Add: Invoice cost of goods sold in 1929_ 16, 593,442. 07
Total_i_19,119,461. 76
Deduct: Invoice cost of all purchases in 1929_18,916,170. 83
Invoice cost of goods sold in 1929 opening (1928 closing) inventory as shown in the 1928 and 1929 returns-- 203,290.93

That the 1928 opening inventory was also valued at cost is deducible from the following: The record shows that the gross profit from commodity sales included in the 1928 return was computed in the same manner as in the 1929 return, that is, on the basis of selling price less actual invoice, cost; and since that gross profit is reflected in the year’s net loss that exactly fits in in a reconciliation of the year’s net change in surplus, the unmistakable inference is that the opening inventory reflected in surplus at the beginning of the year and the closing inventory reflected in surplus at the end of the year are, in both instances, valued at cost.

In view of the foregoing, we hold that the record does not show an election by the petitioner in 1928, or at any previous time, to value its inventories on the basis of cost or market, whichever is lower, but that, notwithstanding the statement in the 1928 return, it has consistently valued its inventories, at least from and including 1927, at cost.

The petitioner argues, however’, that the best accounting practice in “ the rubber business ” is to use inventories valued at cost or market, whichever is lower; and that income is distorted by the use of inventories otherwise valued, because of daily price fluctuations in the rubber market and the narrow margin of profit in dealings in that commodity. The argument is supported, to some extent, by the opinions of petitioner’s witnesses. But petitioner’s inventories were made up, not only of crude rubber, but of many other commodities — pig iron, mica, shellac, coke, fluorspar, alloys, etc., and so-called “export merchandise.” True, crude rubber was the principal single item in and made up the greatest part of the 1929 inventories, but that commodity represented no such an important part of previous inventories. Whatever the best accounting practice as to inventories in “ the rubber business ” may be, it is no more a criterion of the best accounting practice in a jobbing business dealing in a large group of unrelated commodities than would be the practice in a business dealing exclusively in pig iron, or mica, or fluorspar, or any one of the other commodities which made up petitioner’s gross sales. This is not a case where dealings in each separate commodity constituted a separate business, but rather where the business was made up of several departments, each engaged in dealing in a different commodity.

In general, the business may be likened to departmental merchandising. In a business of that character the inventory method must be uniformly applied throughout all departments and to all commodities or merchandise, irrespective of what the best accounting practice may be in a trade or business of dealing in any one of the separate commodities represented in the inventory. Moreover, it is inconceivable that petitioner’s income is distorted by the use of inventories valued at cost. Certainly there is nothing in the record, apart from the opinions of petitioner’s witnesses, that would justify a conclusion to that effect; and the basic facts upon which the witnesses formed their opinions are not a matter of record. Cost, as a basis of inventory valuation, has been consistently recognized since the first income tax law as generally applicable to all businesses. It may be that, because of the narrow margin of profit, in dealings in crude rubber, the price fluctuations of a day might result in the disposition of some part or all of the crude rubber inventory in the following year at less than inventory value; but that might happen whether inventor}? value be cost or market. And that possibility is not peculiar to crude rubber alone; it might happen in the case of any of the staple commodities that are dealt in on commodity exchanges on narrow profit margins. Certainly the possibility is no sound reason for holding that the cost method of valuing inventories is not a proper method in this case.

We would not pass unnoticed petitioner’s argument on the brief that it is not seeking a change in inventory method, because it “ never took physical inventories or used inventories in computing the income shown on the returns filed.” The inference is, of course, that, never having taken or used inventoried to determine income, the cost method of valuing inventories has not heretofore been adopted or used. But the premise is only a half truth born of sheer expediency.

In the first place, a physical count of goods in the 1928 and 1929 inventories must have been available to the petitioner and the respondent, otherwise they would not have been able to agree upon and stipulate, as they have done, the value of the goods in those inventories, at cost or market, whichever is lower. Secondly, while petitioner has not in the taxable year or previously computed cost of goods sold by the formula of “ opening inventory, plus purchase, less closing inventory ”, such a procedure was wholly unnecessary; for, as already pointed out, the arithmetical result of that formula, when the inventories are valued at cost, assuming that there have been no inventory losses through shrinkage, spoilage, or other similar causes, is the same figure as the actual invoice cost of the goods sold, which petitioner used for computing gross profit from sales. That there were no inventory losses is evident from the same reasoning and computations by which we determined that the inventories shown in the 1928 and 1929 returns were valued at cost; for had there been such inventory losses, the computations and reasoning would have yielded entirely different results. The parties have stipulated that: “ The result of the method employed by the petitioner in computing taxable net income on the income tax return filed for the years 1929 and prior years was to disregard all purchases of goods in each year which were still on hand at the end of each of such years.” We understand this stipulation to mean that petitioner did not use the formula of “ opening inventory, plus purchases, less closing inventory.” The important thing is, however, not that petitioner did not use that formula for determining cost of goods sold and income, but that as shown by the balance sheets, which are a part of the returns and intended to support and substantiate the reported net income, or net loss, as the case may be, inventories were valued at cost. Again, had those inventories been used in the suggested formula, the resulting cost figure would have been the same as the figure used by the petitioner for computing gross profit from sales. It did then, both in fact and in theory, use inventories valued at cost in computing income.

In view of the foregoing, we hold there is no error in the amount of gross profit from sales of crude rubber reported in the return for the taxable year in question.

The final question for consideration is whether respondent erred in disallowing the deduction of $41,114.63 representing a so-called “ Keserve for additional compensation.” The facts in respect of this matter have all been stipulated and, being brief, we quote that part of the stipulation below:

As a liability under an officers and employees bonus and profit sharing plan based on a percentage of the annual net earnings of the petitioner, an account was accrued and set up on the books of the petitioner during the year 1929 styled “ Reserve for Additional Compensation ” in the sum of $57,000. This represented the estimated amount of additional compensation due under the Bonus Plan. During the year 1929 advances had been made and paid out under the Bonus Plan in the sum of $15,225.37, leaving an estimated balance due as of December 31, 1929 of $41,774.63 for the year 1929. When the final computation of the amount due officers and employees under the Bonus Plan was determined for the year 1929, the so-called Reserve for Additional Compensation was found to be underestimated in the sum of $851.18. In addition to the advances made during the year 1929, payment of the additional compensation for the year 1929 was made under the plan in the total sum of $42,625.81 — $36,532.82 being paid in January, 1930 and $6,092.22 in February, 1930.

The petitioner now claims not only the $41,774.63 disallowed by the respondent, but an additional $85,1.18 representing the amount by which its liability for additional compensation was understated in the return, a total of $42,625.81.

There is no dispute as to the reasonableness of the deduction claimed. The respondent disallowed $41,774.63 of the deduction on the ground that the applicable statute does not provide for the deduction of amounts credited to a “ reserve for salaries.” His position in the matter is further stated on the brief as follows: “ In closing the books for 1929 the petitioner could have accrued as a definite ascertained liability the amount of $57,851.18 as of December 31, 1929. Being on the accrual basis it is obvious that the deduction would then be allowable. But the fact is that this was not done.” Thus it appears that while respondent concedes that the amount in question was an actual liability at the close of the taxable year, as well he may under the stipulated facts, he. has made the disallowance because the petitioner chose to designate its liability a “ reserve ” rather than by some other name that might have better indicated its true character. But such is not the test of deductibility. True reserves representing mere appropriations of surplus are not proper deductions from income, unless specifically provided for by statute; but when an item is without question within the realm of ordinary and necessary business expenses, it may be deducted, in the case of a taxpayer on an accrual basis, in the year in which incurred, regardless of the style or accounting nomenclature by which it may be called. The statute specifically includes within the category of ordinary and necessary business expenses “ a reasonable allowance for salaries or other compensation for personal services actually rendered.” That petitioner incurred liability for additional compensation of $42,625.81 during the taxable year not only appears from the stipulated facts, but is conceded; and since petitioner computed net income on an accrual basis, and there is no question as to the reasonableness of the deduction claimed, the whole amount is properly deductible for the taxable year in controversy.

Decision will 5e entered, wider Rule 50.


author: McMahoN :

text:
    National Adjusting Association, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 53464.
    Promulgated March 29, 1935.

      David Levinson, Esq., for the petitioner.

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

McMahoN :

The respondent, upon an audit of petitioner’s. returns covering a period of years, determined that the petitioner’s method of estimating earned commissions failed to reflect the commissions to which petitioner was entitled on payments made by debtors to clients, particularly in view of the fact that petitioner retained collections made by it until clients reported on payments received from debtors. The respondent, therefore, pursuant to section 212 (b) of the Revenue Act of 1926, recomputed the earned commissions by using an average percentage based upon total collections and remittances for a period of five preceding years.

The petitioner contends that the total of collections received by it in each year, in excess of its commissions thereon, is a liability and remains a liability until settlement is made, or until the expiration of the statute of limitations; and that, therefore, no part thereof, until settlement or expiration of the statutory period, can possibly be included in its gross income.

Thei practice of the petitioner of examining the master cards did not aid in determining the commissions to which petitioner was entitled on both collections made by it and on all payments made by debtors to clients. .While payments made by debtors to clients were entered on the cards, such payments and the commissions thereon were entered only if and when the clients reported such payments to the petitioner. Hence, the cards did not disclose the commissions on unreported payments to clients to which the petitioner was entitled. The practice of checking up the master cards, therefore, does not disclose the actual amount of commissions to which petitioner is entitled under its contracts because it fails to disclose the commissions to which the petitioner is entitled on unreported payments made to clients, and discloses merely' (1) the commissions to which it is entitled on collections made by it, and (2) commissions to which it is entitled on reported payments made by debtors to clients.

The petitioner does not make settlements with its clients until the amount of its offsetting claims against the clients for commissions on payments made by debtors to clients has been ascertained. Hence collections made by petitioner, less its commission thereon, which ordinarily would be due and payable to clients, are retained by the petitioner until clients make reports of payments received.

The earned commission reported by petitioner on its return was estimated by using the following percentages for 1924 to 1927, inclusive: 71.48, 75, 75, and 70 percent, respectively, while the respondent used the following percentages: 84.373, 85.493, 86.519, and 85.313 percent, respectively. There is no evidence to show how, or the method by which, the percentages used by the petitioner were determined or arrived at, except that the first percentage used was based on some figures submitted by petitioner’s president and that changes in the percentages were made when the annual check up of the master cards indicated to petitioner that a change should be made. On the other hand, the percentages used by respondent are based upon the total collections from debtors of clients and remittances from petitioner to clients over a period of five years. They are based on known and actual figures resulting from petitioner’s own business experience covering a period of five years.

The petitioner adduced no evidence pertaining to the collections ordinarily due clients which petitioner retained each year awaiting reports from clients as to payments received by them. There is no evidence as to the amounts of collections so retained by petitioner, if any, which were never remitted to clients. There is no evidence as to the amount of commissions earned each year by the petitioner on collections made by it, or the amount of commissions earned each year on reported payments made by the debtors directly to clients, both of which were ascertainable from its own records.

The petitioner contends that the entire amount collected by it in excess of its commission thereon is a liability and remains a liability until settlement is made or until the expiration of the statutory period of limitations. No doubt there were some clients who failed to make reports to petitioner and as to these, according to petitioner’s practice, no settlements have been made. Hence, some of these retained collections were probably never remitted to clients. The petitioner has been in existence since 1918. In the meantime claims of clients for collections retained by petitioner have probably been outlawed, but there is no evidence that petitioner included such items in income at any time.

The petitioner contends that the respondent’s method is inconsistent and erroneous because, while he based his computation of the petitioner’s liability to its clients on the amount of $109,620.07, the amount which petitioner estimated to be due to its clients as of December 31, 1923, he assumes that there is no further liability to clients for each succeeding year. The petitioner is in error in this respect. The respondent in determining the amount due to clients as of December 31 each year recognized the fact that petitioner is continually incurring and reducing its liability to its clients. Commencing with the amount of $109,620.07, as the amount of liabilities due clients as of January 1, 1924, he deducted each year the amount remitted to clients and added each year the difference between the amount collected and the amount determined to be earned commissions, or 15.627 percent of the collections in 1924,14.507 percent of collections in 1925,13.481 percent of collections in 1926, and 14.687 percent of collections in 1927, with the result that at the end of 1927 the amount due to clients was estimated to be $68,252.64.

In our opinion the petitioner has failed to show that respondent’s method of computation of petitioner’s earned commissions is erroneous.

Furthermore, we are convinced, from the evidence presented, that the method of accounting employed by the petitioner and its method of estimating its earned commissions do not clearly reflect its annual income. We must, therefore, approve the respondent’s determination.

Decision will he entered for the respondent.

       (b) The net income shall be computed upon the basis of the taxpayer’s annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. If the taxpayer’s annual accounting period is other than a fiscal year as defined in section 200 or if the taxpayer has no annual accounting period or does not keep Books, the uet income shall be computed on the basis of the calendar year.


author: McMahon:

text:
    Edward C. Simmons II and St. Louis Union Trust Company, as Executors of the Estate of Wallace D. Simmons, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent. Edward H. Simmons, Petitioner, v. Commissioner of Internal Revenue, Respondent. Richard W. Simmons, Virginia W. Simmons and St. Louis Union Trust Company, as Executors of the Estate of George W. Simmons, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 47210-47212.
    Promulgated April 3, 1935.

      Hal G. Bangs, Esq., for the petitioners.

      T. M. 'Mather, Esq., for the respondent.
   OPINION.

McMahon:

At the hearing counsel for the respondent conceded error in holding that George W. Simmons transferred 155,500 Associated Simmons Hardware Cos. common shares to the Winchester-Siijtmons Co., since prior to that time he had transferred 40,000 shares to his wife and 40,000 shares to his wife as trustee for his children. George W. Simmons transferred 75,500 shares to the Winchester-Simmons Co. The respondent held that Edward H Simmons transferred 175,500 Associated Simmons Hardware Cos. common shares to the Winchester-Simmons Co. However, the evidence shows that this was error on the part of the respondent. Prior to that time Edward H. Simmons had delivered to his wife, Mabel F. Simmons, and his daughter, Dorothy L. Simmons, each, a certificate for 50,000 common shares or interim receipts representing such shares, and he transferred to the Winchester-Simmons Co. 75,500 common shares in the transaction in question.

The respondent held that the transfers of Associated Simmons Hardware Cos. common shares by Wallace D. Simmons, Edward H. Simmons, and George W. Simmons to the Winchester-Simmons Co. in exchange for preferred stock of such company, “marketable securities ” of other companies, and cash are governed by section 202 (c) (2) and (e) of the Revenue Act of 1921. He held that the three individuals had the right to exchange each share for preferred stock in the Winchester-Simmons Co. and $3.75 in cash, or, at their option, an equivalent amount of any marketable securities acceptable to them. He held that under these circumstances the fair market value of the securities received for each Associated Simmons Hardware Cos. common share in lieu of cash was equivalent to $3.75, the amount which, respondent held, was paid for such securities by the depositary, and held that gain was derived upon'the transfer of each Associated Simmons Hardware Cos. common share in the amount of the excess of $3.75 over the basis. Respondent held that the basis was $2.0747 for each Associated Simmons Hardware Cos. common share, and it has been stipulated that this is the proper basis. Respondent, in his computation of gain derived, included no value for the preferred stock of the Winchester-Simmons Co. received by each of the individuals, but stated in the notice of deficiency that, upon the later sale or other disposition of such preferred stock, the full amount should be reported for income tax purposes. The petitioners contend that the exchanges come within the provisions of section 202 (c) (1) of the Revenue Act of 1921. They claim that both the preferred stock of the Winchester-Simmons Co. and the common and preferred stock of other companies, which they received on the exchange, are of a like kind or use to the shares exchanged within the meaning of that section, and that the exchange to this extent is nontaxable. They admit that the cash received, less cash commissions paid therefrom, would be taxable if in excess of the basis, under the provisions of the second clause of section 202 (e), but point out that cash was not received in excess of the basis. There is set forth in the margin section 202 (c) (1), (2) and (e) of the Revenue Act of 1921.

It should be pointed out that certain amendments made to section 202 (c) (1) and (e) of the Revenue Act of 1921 by an act of Congress approved March 4,1923, are not applicable in the instant proceeding, since the act specifically provides that it should take effect January 3, 1928.

The respondent held that the depositary paid cash for these securities of other companies and, in effect, treated the transaction as one in which the individuals received cash and then purchased stocks of the other companies, rather than an exchange, in part, of the common participation shares for stock of the other companies. There is some evidence to indicate that it was contemplated that, the depositary should buy stock of other companies suitable to the individuals. The letter of September 15, 1922, setting forth the proposal to the shareholders of the Associated Simmons Hardware Cos. stated that in addition to the preferred stock of the Winchester-Simmons Co. there should be received for each Associated Simmons Hardware Cos. common share $3.75 in cash, or, at the option of the holder, marketable securities acceptable to the holder. However, it is apparent that this plan was not carried out. On the other hand, on September 26,1922, the Winchester-Simmons Co. made separate written offers to each of the individuals, setting forth a list of the “ marketable securities ” of other companies which it offered to each such shareholder of the Associated Simmons Hardware Cos., together with cash and preferred stock of the Winchester-Simmons Co. The offer last made was accepted in each instance. In our opinion, it can not be said, in view of these circumstances, that the shareholders of the Associated Simmons Hardware Cos. received cash and then, with a portion of such cash, purchased stock of other companies. We, therefore, hold that there was an exchange of common shares of the Associated Simmons Hardware Cos. for preferred stock of the Winchester-Simmons Co. and preferred and common stock of other companies, together with cash.

The evidence shows to our satisfaction that the individuals held all their Associated Simmons Hardware Cos. common shares for investment, and that such individuals were not dealers in securities; and the question to be determined is whether the preferred stock of the Winchester-Simmons Co. and common and preferred stocks of the other companies received by the individuals from the Winchester-Simmons Co. were property of a like kind or use as compared with the common shares of the Associated Simmons Hardware Cos. which they exchanged therefor, within the meaning of section 202 (c) (1), or whether it was “other property” within the meaning of the second clause of section 202 (e). In Richard T. Greene et al., Trustees, 15 B. T. A. 401; affd., Commissioner v. Greene, 42 Fed. (2d) 852, we stated in part:

* * * We see no justification; for saying as a matter of law that for the purpose of this statute stocks and bonds are per se not property of like kind or use. The words can not fairly he regarded as importing distinctions which have no relation to the purpose of the statute. Stocks and bonds are both commonly regarded as investment property, and if in any case they are not so in fact it must be because the evidence so indicates. * * *
If the test lies in an identity of legal rights inherent in the property, the provision could be practically nullified. * * *

In Edson v. Lucas, 40 Fed. (2d) 398, reversing Margaret M. Edson, 11 B. T. A. 621, the court stated:

* * * It seems reasonably clear that Congress intended that paper profits or paper losses resulting from the exchange of securities held for investment purposes, whether stocks or bonds, commonly known as “wash sales,” should not be reflected in taxable income. It was evidently not intended that such profits or losses, if resulting from an exchange of common stock for bonds, preferred stock, bonds with conversion privileges, profit-sharing certificates, debentures, beneficial certificates in common-law trusts, or other evidences of the obligations of or rights of participation in the profits or property of corporate or other entities which are known to the modern financial world and generally sold to the public as “ investment securities ”, should stand on any different basis than exchanges of stock for stock or bonds for bonds.
*******

To the same effect is Girard Trust Co. et al., Executors, 16 B. T. A. 308, petition for review dismissed on stipulation of the parties July 23, 1931, by the United States Circuit Court of Appeals for the Third Circuit in Commissioner v. Girard Trust Co. et al., Executors, See also Ralph Andrew Applegate, Executor, 10 B. T. A. 705; Frank Filer, 14 B. T. A. 1084; and G. T. Wofford, 15 B. T. A. 1225; petition for review dismissed by the United States Circuit Court of Appeals for the Fifth Circuit in Lucas v. Wofford, 49 Fed. (2d) 1027.

It will thus be seen that the words “like kind or use ” employed in section 202 (c) (1) with regard to property held for investment have received liberal interpretation. Upon the authorities cited we hold that both the preferred stock of the Winchester-Simmons Co. and the preferred and common stocks of the other companies were property of a like kind or use as compared with the common shares of the Associated Simmons Hardware Cos. which were exchanged within the meaning of this section and that such stock was not “ other property ” within the meaning of the second clause of section 202 (e).

In so holding we have not overlooked the fact that the Associated Simmons Hardware Cos. is not and was not a true corporation, but a trust. At the hearing and on brief counsel for petitioners stated that the Associated Simmons Hardware Cos. is and was a so-called Massachusetts trust, and this statement was not challenged by the counsel for the respondent. The petitioners state on brief that it is and was an association taxable as a corporation; and no contention has been raised by the respondent that its shares are not property of a like kind or use as compared with stock of a true corporation, upon the grounds that its shares are in reality participation shares in a trust. On the contrary, the respondent, in his determination, has treated it as a true corporation, inasmuch as he held that these transactions amounted to a reorganization of a corporation under section'202 (c) (2). In any event, we consider the words “ like kind or use ”, as interpreted by the above cited authorities, as broad enóugh to cover the transactions in question in these proceedings.

In the deficiency notices the respondent stated that the stock of the outside corporations received by the individuals in exchange must be treated as “other property” because it was not “stock or securities in a corporation a party to or resulting from such reorganization” within the language of section 202- (c) (2). The respondent thus determined that these transactions constituted a reorganization within the meaning of such section, but he has not favored us with any brief in support of his determination.

The petitioners contend that there was no reorganization, but that even if there were, the securities of the other companies which were received would not be taxable. We find it unnecessary to decide whether such securities of other companies would be taxable if there had been a reorganization, since, in our opinion, it is clear that there was no reorganization within the meaning of the statute.

Here the transactions between the Winchester-Simmons Co., on the one hand, and the stockholders of the Winchester 'Co. and the shareholders of the Associated Simmons Hardware Cos., on the other hand, did not constitute a true merger or consolidation, nor did they result in anything of the nature of a merger or consolidation. There was apparently no intention of accomplishing a merger or consolidation. We find it unnecessary to predicate these conclusions upon the facts that neither of the old companies was to go out of existence and that neither did. The Winchester-Simmons Co. did not acquire any of the preferred shares of the Associated Simmons Hardware Cos., nor did it acquire any of its assets. It appears that the-Winchester-Simmons Co. was nothing more than a holding company, holding a large percentage of the common stock of the Winchester Co., and the common shares of the Associated Simmons Hardware Cos. Both the Winchester Co. and the Associated Simmons Hardware Cos. retained the assets which they had always held. There was no recapitalization, or mere change in identity, form, or place of organization of the Associated Simmons Hardware Cos. Upon principles enunciated in the following cases, we hold that there was here no reorganization within the meaning of section 202 (c) (2) of the Revenue Act of 1921: Thomas W. White et al., 29 B. T. A. 1272, affirmed on this point Feb. 18, 1985, in Fordyce v. Helvering, 76 Fed. (2d) 431; Thomas H. Redington, 25 B. T. A. 707. See Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462, and Wilbur F. Burns, 30 B. T. A. 163; and see discussion in Alfred R. L. Dohme, 31 B. T. A. 671.

Under section 202 (c) (1) and the last part of section 202 (e) none of the stock received in exchange is taxable, and, since the cash received (not exceeding 25 cents per share) was not in excess of the basis of the common shares of the Associated Simmons Hardware Cos., there was no taxable gain derived upon the transactions by any of the individuals with whom we are concerned. Edwin Eisendrath et al., Executors, 28 B. T. A. 744.

It is alleged in Docket No. 47210 that the respondent erred in twice including the cash- received by Wallace D. Simmons in connection with the transfer of his Associated Simmons Hardware Cos. common shares to the Winchester-Simmons Co. An examination of the notice of deficiency discloses that the respondent did commit such an error. In view of our holding, however, that the cash received did not exceed the basis of the shares exchanged and that Wallace D. Simmons did not derive any taxable gain upon the transaction, this error of the respondent becomes of no consequence here.

Decision will be entered wider Bule 50.

       (c) For the purposes of this title, on an exchange of property, real, personal or mixed, for any other such property, no gain or loss shall be recognized unless the property received in exchange has a readily realizable market value; but even if the property received in exchange has a readily realizable market value, no gain or loss shall be recognized—
      (1) When any such property held for investment, or for productive use in trade or business (not Including stock-in-trade or other property held primarily for sale), is exchanged for property of a like kind or use;
      (2) When in the reorganization of one or more corporations a person receives in place of any stock or securities owned by him, stock or securities in a corporation a party to or resulting from such reorganization. The word “ reorganization,” as used in this paragraph, includes a merger or consolidation (including the acquisition by one cor-poraton of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or of substantially all the properties of another corporation), recapitalization, or mere change in identity, form, or place of organization of a corporation, (however effected) ; or
      *******
      (e) Where property is exchanged for other property which has no readily realizable market value, together with money or other property which has a readily realizable market value, then the money or the fair market value of the property having such readily realizable market value received in exchange shall be applied against and reduce the basis, provided in this section, of the property exchanged, and if in excess of such basis, shall be taxable to the extent of the excess; but when property is exchanged for property specified in paragraphs (1), (2), and (3) of subdivision (c) as received in exchange, together with money or other property of a readily realizable market value other than that specified in such paragraphs, the money or fair market value of such other property received in exchange shall be applied against and reduce the basis, provided in this section, of the property exchanged, and if in excess of such basis, shall be taxable to the extent of the excess.


author: Moekis :

text:
    Frank L. Martinelli, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 61884.
    Promulgated April 3, 1935.

      Jefferson E. Peyser, Esq., for the petitioner.

      E. L. Corbin, Esq., for the respondent.
   OPINION.

Moekis :

The applicable provisions of the Kevenue Act of 1928 are as follows:

SEC. 275. PERIOD OE LIMITATION UPON ASSESSMENT AND COLLECTION.
(a) General rule. — The amount of income taxes imposed by this title shall be assessed within two years after the return was filed, and no proceeding in court without assessment for the collection of such taxes shall be begun after the expiration of such period.

Section 2, H. J. Ees. 340, passed by the Seventy-First Congress, vol. 72, Congressional Eecord No. 142, p. 10923, approved June 16, 1930, provides as follows:

Seo. 2. The 2-year period of limitation provided in section 275 of the revenue act of 1928 upon the assessment of income taxes imposed by Title I of that act for the taxable year 1928, and the 2-year period of limitation provided in section 322 of the revenue act of 1928 in respect of refunds and credits of income taxes imposed by that act for the taxable year 1928 shall be extended for a period of one year in the case of any married individual where such individual or his or her spouse filed a separate income-tax return for such taxable year and included therein income which under the laws of the State upon receipt became community property.

Our determination rests upon the applicability of the foregoing resolution. If it is applicable the respondent’s determination must be approved.

The petitioner contends that the errors upon which the disputed deficiency is based were those of accounting1 only and do not raise the community property issue and that the aforesaid joint resolution was not intended to operate where the community property issue is not questioned.

We are referred to the discussion before the House upon the proposed resolution (Congressional Eecord, vol. 72, No. 136, pp. 10392-10393), particularly, to certain language of the Acting Secretary of the Treasury in a communication to the Chairman of the Committee on Ways and Means of the House (Congressional Eecord, vol. 72, No. 142, p. 10924), which, he contends, evidences an intention on the part of the Congress to extend the period of limitations “ only in those cases in which the community property income issue is involved for the taxable years 1927 and 1928 ”, therefore, since that issue has not been raised'in this proceeding, the resolution is inapplicable. He lays particular stress upon the following language in that communication:

* * * xhe proposed legislation does not extend the periods of limitation in respect of assessments, refunds, and credits generally, but only in those cases in which the community property income issue is involved for the taxable years 1927 and 1928 * * *.

Though satisfied that the resolution of the Congress is entirely clear and unambiguous, needing no extrinsic aids in its construction, we have carefully considered the brief legislative discussions, the Committee Eeport and the communication of the Acting Secretary of the Treasury, and we find nothing therein casting the slightest doubt upon its intendment.

The resolution provides for the extension of the period of limitation for one year “ in the case of any married individual where such individual or his or her spouse filed a separate income-tax return for such taxable year and included therein income which under the laws of the State upon receipt became community property.” The petitioner was married during the taxable year and he and his wdfe filed separate individual returns for that year upon the community property basis. Thus, without more, the petitioner is brought within the scope of the resolution. Sivly v. Commissioner, 75 Fed. (2d) 916.

But, even assuming the petitioner’s premise to be correct, we would still be unable to agree with the conclusion he reaches. Merely because the petitioner does not choose to contest the division of his income upon the community property basis does not, in our opinion, except him from the clearly intended purpose of that resolution. The test is not whether that issue is before this Board, but whether or not returns have been filed upon the basis of community property, which, in itself, injects, potentially at least, the community property issue. Until the statute has tolled or until the parties have concluded their disputes by statutory agreement, the community property issue is always present, though latent, wherever husband and wife have chosen to adopt that basis for the computation of their respective taxable incomes.

Judgment will be entered for the respondent.


author: Leech :

text:
    First Citizens Bank and Trust Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 71599.
    Promulgated April 3, 1935.

      F. Morse Hubbard, Esq., for the petitioner.

      S. B. Anderson, Esq., for the respondent.
   OPINION.

Leech :

On the hearing of this proceeding no evidence was introduced upon issue (a), the disallowance by respondent of the amounts claimed as business expense. Accordingly, on this issue, respondent is sustained.

This leaves for consideration the deductibility of certain debts alleged to have been ascertained to be partially worthless in the taxable year. The controlling provision is section 23 (j) of the Revenue Act of 1928, which provides:

(j) Bad debts. — Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts); and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part.

Certain debts, listed in our findings in an aggregate amount of $578,608, are established by the evidence to have been ascertained and determined to have been worthless and uncollectible in an aggregate amount of $197,290. This ascertainment and determination was by an examiner for the New York State Banking Department and the vice president and treasurer of petitioner. On the hearing, evidence was presented with respect to each one of the loans in question which, in our opinion, amply ¡sustains the determination made in each instance. The events in connection with these loans, transpiring subsequent to the taxable year, confirm the accuracy of the several determinations. We have, in a number of cases, considered subsequent events in testing the accuracy of determinations of worthlessness of debts, Imperial Furniture Co., 9 B. T. A. 713; H. H. Brown Co., 8 B. T. A. 112, as well as determinations of value, James Couzens, 11 B. T. A. 1040.

In Liberty Insurance Bank, 14 B. T. A. 1428, this Board held that the requirement of section 234 (a) (5) of the Revenue Act of 1921, which is identical with section 23 (j) of the Revenue Act of 1928, required that debts determined to be worthless in part must be charged off to that extent within the taxable year, to entitle the taxpayer to the deduction. No distinction was' drawn between debts determined to be wholly worthless and those worthless in part.

On appeal, the Circuit Court of Appeals for the Sixth Circuit, Commissioner v. Liberty Bank & Trust Co., 59 Fed. (2d) 320, reversed that decision, holding that there was no necessity for the taxpayer to charge off, in the taxable year, that portion of a debt determined to be worthless. The court there said;

This statute deals with two classes of debts: Those that have become wholly worthless, and those recoverable only in part. It makes provision for the deduction of each from gross income, providing as to the first that, when “ ascertained to be worthless and charged off,” a deduction therefor “ shall be allowed ”; and as to the second, that, when “ satisfied that a debt is recoverable only in part the Commissioner may allow such debt to be charged off in part.'’ The allowance as to each class depends on the performance of a precedent act or acts. Those in - the first are the ascertainment of worthlessness and the charging off, which must be done by the taxpayer, subject, of course, to the review of the Commissioner as to the reasonableness of the ascertainment. Sherman & Bryan v. Blair, Comm. (C. C. A.) 35 Fed. (2d) 713; Deeds v. Commissioner, 47 Fed. (2d) 695 (6 C. C. A.). In the other class the precedent act must be performed by the Commissioner. Pie must be “ satisfied that a debt is recoverable only in part,” and, until he is, there can be no charge off, and then only with his permission. The taxpayer being under no duty to make the charge off in this class until the Commissioner permits it to be done, it is sufficient to give him a right to have the Commissioner’s ruling reviewed that his claim to a charge off was made and rejected. In this case claims were presented and disallowed. Whether the disallowances by the Commissioner were because of the failure of the taxpayer to charge off the debts in part or were made in the exercise of the discretion which the Commissioner has does not appear. See Stranahan v. Commissioner, 42 Fed. (2d) 727 (6 C. C. A.) as to the extent of discretion. The Board of •Tax Appeals, as we have said, based its decision upon the failure of the taxpayer to charge off the debts in part. We think it should have considered and determined whether the Commissioner abused his discretion in not allowing the charge offs to be made.

In Allie M. Turbeville, 31 B. T. A. 283, in considering the same question here presented, we followed the decision of the Circuit Court in Commissioner v. Liberty Bank & Trust Co., supra, and applied the rule there announced. This Board then said:

As to debts claimed in their entirety, the taxpayer must ascertain them to be worthless and must charge them off. As to debts claimed only in part the Commissioner “ must be satisfied that the debt is recoverable only in part and until he is there can be no charge off and then only with his permission ”. But this ruling may be reviewed and reversed if it appears that in disallowing the charge off to be made he abused his discretion.

We are not advised as to the position taken by respondent upon the application of this rule to the present proceeding. He has not filed a brief nor did his counsel argue the question at the hearing. It does appear, however, that the claim for the deduction of this partially worthless indebtedness satisfies the requirements of the applicable regulation, except, in the one particular, that there was no charge-off during the taxable year. It is assumed that it was for this reason the disputed deduction was denied. However, since the hearing in this proceeding, we note the publication of G. C. M. 13114, C. B. XIII-1, p. 116, reading as follows:

Advice is requested whether the decision of the Circuit Court of Appeals (Sixth Circuit) in Liberty Bank & Trust Co. v. Commissioner (59 Fed. (2d), 320) should be followed generally in determining the deductibility of partially worthless debts under the Revenue Acts of 1921, 1924, 1926 and 1928.
$**#$**
It is the opinion of this office that in order to have the benefit of such a deduction, there must have been an ascertainment by the taxpayer of partial worthlessness withm the taxable year. The charge-off in such a ease, being a technical requirement, may be made after the taxable year. The allowability of the deduction is, of course, subject to the discretion of the Commissioner. This conclusion is applicable to all cases involving the deductibility of partially worthless debts under the Revenue Acts of 1921, 1924, 1926 and 1928.

It would seem that petitioner’s claim to the deduction of the uncol-lectible items, appearing in our findings, satisfies the requirement of the controlling statute as now construed and applied by respondent. We hold that, in computing its taxable income for the calendar year 1930, petitioner is entitled to the deduction of those amounts of the several debts, properly ascertained to be worthless in that year, as set out in our findings of fact.

Judgment will be entered under Rule 50.

       Art. 191, Regulations 74. Bad debts. * * * where' banks or other corporations which are subject to supervision by Federal authorities (or by State authorities maintaining substantially equivalent standards) in obedience to the specific orders, or in accordance with the general policy of such supervisory officers, charge off debts in whole or in part, such debts shall, in the absence of affirmative evidence clearly establishing the contrary, be presumed, for income tax purposes, to be worthless or recoverable only in part, as the case may be.

       It may be noted that, a definite limitation upon the deductibility of partially worthless debts, to amounts charged o£E during the taxable year, appears in sections 23 (J) and 23 (k) of the Revenue Acts of 1932 and 1934, respectively.


author: Sea well :

text:
    Motion Pictures Capital Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent. Investors Equity Company, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 60564, 62440.
    Promulgated April 5, 1935.

      Bernhard Knollenberg, Esq., and Harry J. Rudiclc, Esq., for the petitioners.

      Ralph E. Smith, Esq., for the respondent.
   OPINION.

Sea well :

The Motion Pictures Capital Corporation, hereinafter sometimes referred to as the transferor, incurred expenses of $49,-464.83 in connection with its organization in 1923. At various times during the years 1924 to 1929, inclusive, it increased its capital stock and incurred expenses aggregating $10,440.50 in connection therewith.

The transferor’s capital stock was listed on the New York Stock Exchange. In connection with the listing of all or some of its increases of capital stock the transferor paid the New York Stock Exchange listing fees aggregating $3,129.42. The stock was not listed on the. New York Stock Exchange after October 22, 1929.

None of the amounts just referred to were deducted from gross income by the transferor in income tax returns rendered for any period prior to the taxable period.

On October 23, 1929, the transferor was merged with the Investors Equity Co., another Delaware corporation, hereinafter sometimes referred to as the transferee, and incurred legal fees and expenses amounting to $12,811.43 in connection therewith.

As a result of the merger all of the assets and property of the transferor, having a value in excess of the amount of tax and interest thereon involved here, were transferred to the transferee.

In his determination of a deficiency of $8,893.81 in income tax against the transferor for the period January 1 to October 22, 1929, the respondent refused to allow any of the amounts set forth above as deductions from the gross income. The petitioners claim that the organization expenditures, cost of increasing the transferor’s capital stock, and fees paid for listing the additional stock on the New York Stock Exchange are deductible as losses. They also p.1 aim that the expenditure requisite in obtaining the merger is deductible as an ordinary and necessary business expense. The Investors Equity Co. concedes transferee liability for any tax due from the Motion Pictures Capital Corporation.

We have frequently held that organization expenses of a corporation are capital expenditures. The meager stipulated facts, all of which are set forth above, do not itemize the expenditures incurred in connection with increasing the transferor’s capital stock. The parties treat the amounts as capital expenditures, in view of which we find no reason to question the nature of the expenditures.

In Citizens Trust Co., 20 B. T. A. 392, we had the question of whether the petitioner could deduct organization expenditures as a loss in the year of its merger with another corporation. We declined to allow the loss on the ground that under the laws of New York a merged corporation, while losing its separate identity, becomes an integral part of the surviving corporation, carrying into it all of its “ rights, powers, liabilities and assets ” except the “ indicia and attributes of a corporate body distinct from that into which it is merged.”

Mergers are statutory. Alice V. St. Onge, 31 B. T. A. 295. Section 60 of the Corporation Laws of Delaware provides that, when the agreement of the parties to a merger is duly recorded, as provided by section 59:

* * * the separate existence of all of the constituent corporations, or all of such constituent corporations except the one into which such constituent corporations have been merged, as the case may be, shall cease, and the constituent corporations shall become a new corporation or be merged into one of such corporations, as the case may be, in accordance with the said agreement, possessing all the rights, privileges, powers and franchises, as well of a public as of a private nature, and being subject to all the restrictions, disabilities and duties of each of such corporations so consolidated, and all and singular, the rights, privileges, powers and franchises of each of said corporations, and all property, real, personal and mixed, and all debts due to any of such constituent corporations on whatever account, as well for stock subscriptions as all other things in action or belonging to each of such corporations shall be vested in the consolidated corporation; and all property, rights, privileges, powers and franchises and all and every other interest shall be thereafter as effectually the property of the consolidated corporations as they were of the several and respective constituent corporations, and the title to any real estate, whether by deed or otherwise, under the laws of this State, vested in any of such constituent corporations, shall not revert or be in any way impaired by reason of this Chapter; provided, that all rights of creditors and all liens upon the property of any of said constituent corporations shall be preserved unimpaired, and all debts, liabilities and duties of the respective constituent corporations shall thenceforth attach to said consolidated corporation, and may be enforced against it to the same extent as if said debts, liabilities and duties had been incurred or contracted by it.

The Delaware statute is to the same effect as the New York law. With this the petitioners agree. They also concede that the case is on all fours with Citizens Trust Co., supra. The arguments they advance in an effort to convince us that the decision is wrong were fully considered in that case. We adhere to the rule announced therein and decide the issues relating to the deductibility of the items of $49,464.88 and $10,440.50 as losses in favor of the respondent.

Fees paid for listing capital stock on a stock exchange create rights and benefits for an indefinite period and may not be deducted as ordinary and necessary business expenditures. Dome Mines, Ltd., 20 B. T. A. 377; Baltimore & Ohio Railroad Co., 29 B. T. A. 368. The petitioners claim that the expenditures resulted in an asset of a capital nature, the usefulness of which expired with the withdrawal of the stock from the exchange at the time the merger took place. They say that corporations having their stock listed on an exchange find it easier to obtain credit and borrow money. If the fees paid for listing the stock did result in the acquisition of a capital asset, the reasoning of Citizens Trust Co., supra, controls our answer.' If the purpose of listing the stock was to create a market for the sale of the stock or obtain credit, there being nothing in the stipulation to the contrary, clearly no loss was sustained, for such expenditures do “ not result in the acquisition of any asset other than the capital itself.” James I. Van Keuren, 28 B. T. A. 480. On this issue the respondent is sustained.

In the case of Odorono Co., 26 B. T. A. 1355, where the petitioners sold their assets and businesses to another corporation in a sale which, for the purposes of the case, we treated as a reorganization or other nontaxable transaction within the meaning of section 112 of the Revenue Act of 1928, we held that attorney fees paid by the petitioners in connection with the transactions were not deductible as ordinary and necessary business expenses. We think that ruling controls our answer to the remaining issue respecting the deducti-bility of the legal fees and expenditures incurred in the merger of the transferor with the transferee. The case of Welch v. Helvering, 290 U. S. 111, is not regarded as contrary to the result or reasoning of the Odorono Co. case, supra.

Reviewed by the Board.

Decision will be entered for the respondent.