text:
    Appeal of COMMERCIAL COMPANY OF EGYPT, INC.
    Docket No. 5810.
    Submitted January 12, 1926.
    Decided April 3, 1926.
    The taxpayer corporation was organized June 8, 1920, and elected to close its books upon the basis of a fiscal year ending April 30, 1921. During such period it had sustained a net loss. Held, under the provisions of section 204 of the Revenue Act of 1921, that the corporation is entitled, in its return for the fiscal year ending April 30,1922, to deduct so much of the net loss as the number of days within 1921 bears to the number of days from the date of incorporation to the end of the fiscal year.

      Arthur V. Grimes, G. P. A., for the taxpayer.

      Robert A. Littleton, Esq., for the Commissioner.
    Before Phillips, GbatipneR, and Teammell.
    Taxpayer appeals from the determination of a deficiency of $290.94 in income and profits tax for the fiscal year ended April 30,1922, and alleges that the Commissioner committed error in refusing to permit taxpayer to deduct, from its income for that year, a net loss claimed to have been sustained in the prior taxable year.

      FINDINGS OF FACT.
    The taxpayer is a Massachusetts corporation with its principal office at Boston. A certificate of incorporation was duly issued to the taxpayer by the Secretary of the Commonwealth of Massachusetts on June 8, 1920. Taxpayer elected to keep its books and file its tax returns upon the basis of a fiscal year ending April 30. From June 8, 1920, to May 1, 1921, taxpayer sustained a net loss of $8,891.63, representing the result of its operations during that period. The Commissioner refused to allow taxpayer to deduct any part of such loss from its income for the fiscal year ending April 30, 1922.
   OPINION.

Phillips

: Section 204 of the Revenue Act of 1921, after providing that a net loss for one year may be allowed as a deduction in the following year, provides in paragraph (d) as follows:

(d) If it appears * ⅜ * that a taxpayer having a fiscal year beginning in 1920 and ending in 1921 has sustained a net loss during such fiscal year, such taxpayer shall be entitled to the benefits of this section in respect to the same proportion of such net loss which the portion of such fiscal year falling within the calendar year 1921 is of the entire fiscal year.

The statute defines a fiscal year as an accounting period of 32 months ending on the last day of any month other than December. In the Appeal of Carroll Chain Co., 1 B. T. A. 38, this Board held that a corporation operating its business for a part of its first fiscal year after organization, and sustaining a net loss therefrom, was entitled to deduct such net loss from its income for the succeeding year. This decision was followed in the Appeal of Patapsco Ballast Co., 1 B. T. A. 1081, holding that a corporation organized in 1918 and dissolved in 1919 came within the net loss provisions of the scatute. The decision of the Board in the Appeal of Carroll Chain Co. was sustained by the United States District Court for the Southern District of Ohio, Eastern Division, in a decision rendered orally July 16, 1925, United States v. Carroll Chain Co., 8 Fed. (2d) 529. In the course of its opinion, the court holds that the first taxable year is so much of that fiscal year as falls within the first year of the existence of the corporation. In this case the taxpayer was organized on June 8, 1920, and its first fiscal year ended April 30, 1921. For the purpose of the .statute this period constituted its entire fiscal year. Since the corporation was in existence during 327 days of the fiscal year, of which 120 fell within the calendar year 1921, it is entitled, in its return for the fiscal year ending April 30, 1922, to deduct 120/327ths of the net loss of $6,891.63 sustained in the fiscal year ending April 30, 1921.

Order of redetermination will be entered on 15 days’’ notice, under Rule 50.


source: Caselaw Access Project

license: Public Domain

text:
    Appeal of FIRST NATIONAL BANK, JEROME, IDAHO.
    Docket No. 3726.
    Submitted February 12, 1926.
    Decided April 3, 1926,

      W. Frank Gibbs, Esq., for the Commissioner.
    Before Graupner, TiiáMmele, and Phillips.
    This is an appeal from the determination of deficiencies in income tax for the calendar years 1919 and 1920, in the amounts of $143.58 and $313.37, respectively. By stipulation the taxpayer waived the allegations of error out of which the deficiency for the year 1919 arose. The deficiency for the year 1920 arises out of an alleged error of the Commissioner in refusing to allow a deduction from income for bad debts. The evidence does not establish the existence or worthlessness of the debts.
   FINDINGS OF FACT.

The taxpayer is a banking corporation, organized under the banking laws of the United States, with its principal place of business at Jerome, Idaho.

In the year 1920 it charged off upon its books of account items aggregating $6,495.83 as losses on bad loans.

This amount was not claimed as a deduction upon the taxpayer’s original return, but was claimed on a supplemental return and disallowed by the Commissioner.

The deficiency is $143.58 for the year 1919 and $313.37 for the year 1910. Order will be entered accordingly.


author: Green

text:
    Appeal of H. H. HORNFECK & SON, INC.
    Docket No. 4086.
    Submitted September 1, 1925.
    Decided April 3, 1926.
    A corporation may not include in its invested capital amounts due its stockholders by reason of its purchase of assets therefrom.

      Robert H. Koehler, Esq., for the taxpayer.

      R. P. Smith, Esq., for the Commissioner.
    Before Sternhagen, Green, and Love.
    This appeal arose out of the Commissioner’s determination of a deficiency in income and profits taxes in the sum of $5,758.98 for the fiscal years ending January 31, 1919, and January 31, 1920. The petitioner contends that it is entitled to have included in its invested capital for the years in question certain balances standing on- its books to the credit of its stockholders.

      FINDINGS OF FACT.
    The petitioner is a New York corporation with its principal office in the City of New York. Some time prior to 1890, H. H. Horn-feck and A. C. Hornfeck, his wife, formed a copartnership which continued until the death of H. H. Hornfeck in March, 1909. After the death of H. H. Hornfeck, his son, M. E. Hornfeck, became a partner in the business, and thereafter it was operated by the new partnership until May, 1916, at which time there was organized a corporation under the name of H. H. Hornfeck & Son, Inc., which corporation took over all the business, assets, and property of the partnership, including the good will, which was of considerable value.
    At the time of the organization of the corporation the partners paid $10;000 cash, and received therefor stock of the corporation of the par value of that amount.
    The partners turned over to the corporation net assets of $111,-296.57, good will of $20,000, making in all a total value of the assets of $131,296.57. The contract of sale between the partnership and the corporation expressly provided that $131,296.57 should be placed to the credit of the partners upon the books of the corporation, payable on demand; and that such credit was expressly subject to all of the indebtedness of the said partnership and expressly subject to all present and future indebtedness of the corporation. No cash was paid at the time of the transfer of the assets, and the only consideration received by the partners was the obligation of the corporation to pay the amount named, as evidenced by the contract and by the credits to their individual accounts upon the books of the corporation.
    On the first day of April, 1918, the corporation issued to the former partners its stock of the par value of $90,000, and charged the individual accounts of the partners with $90,000. Between May, 1916, and January 31, 1919, $32,273.09 had been credited to the individual accounts of the former partners as “ accrued officers’ salaries.” This amount is not claimed as invested capital. By January 31, 1919, the individual accounts, by reason of debits and credits, had been reduced to $73,569.66. This amount, reduced by the accrued salaries above referred to, left a balance of $41,296.57, which the taxpayer contends it is entitled to have included in its invested capital.
   OPINION.

Green

: The taxpayer contends that the remainder of the purchase price, $41,296.57, standing to the credit of the stockholders on its books, is in fact a paid-in surplus and as such should be included in its invested capital. The Commissioner contends that such amount should, in the computation of invested capital, be treated as borrowed money. The taxpayer calls our attention to the provision of the contract by which such credit to the stockholders is expressly made subject .to the claims of the general creditors. It cites the case of Eaton v. English & Mersick Co., 7 Fed. (2d) 54, and contends that the rule therein announced is contrary to the rule announced by this Board in the Appeal of Kelly-Buckley Co., 1 B. T. A. 1154. In the English & Mersick case the court said:

These accounts did not bear interest, and were not understood by the stockholders (except for salary items) to be an indebtedness of the corporation to them.

The court held that the crediting of the accounts with their proportionate part of the surplus was not a dividend. It also said:

As the plaintiff employed its surplus in its business, it must have been either as “invested capital” or as “borrowed capital.” The surplus having never been distributed but during the entire period was retained in its own treasury, it could not have constituted “ borrowed capital.” The corporation could not borrow its own funds. And the shareholders could not loan what they at no time owned or had received.

The facts in this appeal are not parallel to those in the Mersiek case. The accounts here were understood to be an indebtedness of the corporation to the stockholders. Upon what other theory could the stock of the par value of $90,000 have been issued to them? There is and can be no question of dividends in this case. Nor do we have an earned surplus. True, as pointed out by the taxpayer, the partnership had a surplus over the original investment, but that did not become, on the transfer of the assets to the corporation, a corporate surplus. The corporation acquired net tangible assets of the value of $111,296.57 and good will of the value of $20,000, a total of $131,296.57, for which it agreed to pay $131,296.57 to the partnership. Such a transaction does not give rise to a corporate surplus, unless the promise to pay meant nothing and the transaction was in fact a gift. This is refuted by the subsequent issue of stock of the par value of $90,000.

This appeal is in its essentials the same as the Appeal of Kelly-Buckley Co., supra, and the rule there announced is controlling here.

The deficiency is $5,758.98. Order will ~be entered accordingly.


author: Phillips

text:
    Appeal of RUSSEL WHEEL & FOUNDRY CO.
    Docket No. 2029.
    Submitted October 1, 1925.
    Decided April 3, 1926.
    1. Where taxpayer claimed certain amounts to be due it from its debtors, the correctness of which claims was disputed by the debtors, and the debtors asserted other claims against taxpayer which were disputed by taxpayer, and taxpayer’s claims were tona fide claims for goods sold or money advanced, held that a deductible loss of the difference between the amounts claimed and the amounts realized was sustained in the year in which compromises were effected.
    2. Where accounts are improperly written off in prior years, they should be restored for the purpose of computing invested capital and determining the amount of the loss upon final settlement of the account.
    3. When a final liquidating dividend is received from a corporation, a closed transaction results, and taxpayer is to account for the profit realized or loss sustained.
    4. Invested capital for 1917, 1918, and 1919 determined under section 1207, Revenue Act of 1926, superseding decision in Appeal of Guarantee Construction Co., 2 B. T. A. 1145.

      Edward McCarthy, Jr., 'Esq., and E. M. StroAley, O. P. A., for the taxpayer.

      Robert A. Littleton, Esq., for the Commissioner.
    Before GRaupneR, Tkammell, and Phillips.
    Taxpayer appeals from the determination of deficiencies in income and profits taxes for the fiscal years ending April 30, 1917, 1918, and 1919, in the sum of $13,630.40.
    FINDINGS OF FACT.
    In 1912 taxpayer entered into a contract to deliver to the Washington-Detroit Theatre Co. all necessary steel for the erection of a theatre, such steel to be delivered within a specified time. Subsequently, changes were made in the building plans and differences arose between the parties in which each claimed that the other had violated the contract.
    On April 7, 1913, taxpayer had upon its books of account charges against the Theatre Co. of $13,438.62, claimed by it to be due for materials delivered or prepared for delivery in connection with the construction of a building for the Theatre Co. The Theatre Co. disputed the correctness of the account and also asserted a claim against taxpayer for $50,000 for failure to perform the contract. In March or April, 1913, suit was brought by each of these parties upon their respective claims.' On April 30, 1915, the taxpayer charged off on its books $4,438.62 of this account. On April 29, 1916, it charged off $8,000, and on April 30, 1918, the remaining $1,000. At each of such dates the Theatre Co. was solvent and the amounts were charged off because taxpayer doubted whether judgment could be recovered against that company in view of the disputes between them. The amounts so written off were determined arbitrarily. In October, 1918, these two suits were settled by agreement between the parties, the taxpayer receiving $4,250, from which it paid attorney’s fees of $150.
    Upon its income-tax return for the fiscal year ending April 30, 1919, taxpayer claimed $9,938.62 (the difference between $13,438.62 and $3,500) as a deduction from its net income. In computing invested capital for the taxable years ending in 1917, 1918, and 1919, taxpayer did not deduct the sum of $13,438.62 or any part thereof. In computing the deficiency the Commissioner has disallowed the deduction claimed, and in computing the invested capital he has reduced'the earned surplus in each year by $12,438.62, the portion of the account charged off prior to the beginning of the first fiscal year in dispute.
    On April 30, 1918, the taxpayer had upon its books charges against the Nisqually-Nussel Car & Locomotive Works in the amount of $16,099.49. This account had been open and active for about five years, during which time there had not been a settlement or account stated. The amounts so charged included money loaned, goods sold, goods shipped on consignment, and interest. The account was charged with further interest of $205.28 in October, 1918. Early in the history of the account differences had arisen between the parties as to the correctness of the balances, and at no time were they in accord or able to reconcile their differences.
    On April 30, 1918, taxpayer charged off $4,024.87, being 25 per cent of the balance. At that time the debtor was solvent. In October, 1918, the Nisqually-Nussel Car & Locomotive Works sold the major part of its assets to the Government, and in November it tendered to the taxpayer a check for $6,889.03 as full payment of its account. Issue was taken between the taxpayer and the Locomotive Works as to the amount due, which resulted in a further payment of $5,728.57 to the taxpayer in January, 1919. This amount was received as a compromise in full settlement of the account. From this taxpayer paid attorney’s fees of $526.96, and on its books it charged off the balance, which it claimed as a deduction in its income-tax returns. This deduction was disallowed by the Commissioner.
    In 1915 taxpayer acquired $5,000 par value of the capital stock of the Nisqually-Nussel Car & Locomotive Works at a cost of $4,992.0®. During the fiscal year ending April 30, 1919, taxpayer received a liquidating dividend of $2,500. On April 30, 1919, there were no prospects that any further dividends would be paid, and taxpayer thereupon wrote off as a loss $2,492.06, which it claimed as a deduction upon its income-tax return. This loss was disallowed by the Commissioner. No further liquidating dividends were paid.
    In computing invested capital for the fiscal year ending April 30, 1918, under the Revenue Act of 1917, the Commissioner deducted from earned surplus existing at the beginning of the year the amount of $25,176.27, and under the Revenue Act of 1918, the amount of $25,082.21, representing income and profits tax for the fiscal year ending April 30, 1917. The amount so deducted was computed by prorating the entire tax for 1917 from the date when it became due and payable. In a similar manner $35,826.21, a prorated portion of the income and profits tax for the fiscal year ending April 30, 1918, was deducted in computing invested capital for the fiscal year ending April 30,1919.
   OPINION.

Phillips

: It appears that in 1912 taxpayer entered into a contract to furnish steel for the erection of a theatre building. The plans for the building were changed, making unavailable for use certain steel fabricated by the taxpayer. Differences arose between the parties and each claimed a violation of the contract by the other. Suits were brought by the Theatre Co. for damages for delay in delivery and by the taxpayer for the amount claimed by it to be due. It appears that a part, at least, of taxpayer’s claim was for steel not actually delivered but prepared for delivery prior to the change in plans. We are satisfied from the evidence that the claim asserted by the taxpayer was bona fide and that the compromise was the result of the suit for damages for failure to perform. It is' our opinion that, in these circumstances, the taxpayer sustained a loss at the time of the compromise of the two suits in the amount of the account as carried upon its books. The amounts written off in prior years were, so far as the income-tax law is concerned, improperly written off and were not proper deductions from income in those years, either as losses sustained or debts ascertained to be worthless. The amount of the Washington-Detroit Theatre Co. account written off the books of the taxpayer prior to May 1, 1917, should be restored to invested capital and $9,938.62 allowed as a deduction from income for the taxable year ending April 30, 1919. Appeal of George C. Peterson Co., 1 B. T. A. 690.

The situation with reference to the account with the Nisqually-Russel Car & Locomotive Works is similar to the Theatre Co. account and should be treated in the same manner. The taxpayer had advanced money and sold and consigned goods to that company and had charged interest on the account. Taxpayer’s books were kept on an accrual basis, and presumably each of these items had entered into the computation of the income of the taxpayer in previous years. The debtor disputed the correctness of the charges and also claimed to be entitled to commissions upon goods sold on consignment. There was also the question as to whether certain goods sold by the Nisqually-Russel Co. were the property of that company or of the taxpayer. It was not until final adjustment of the account was made that the taxpayer could ascertain what would be realized from the account.

The taxpayer should also be allowed as a deduction for 1919 the loss of $2,492.06 sustained on the liquidation of its stockholdings in the Nisqually-Russel Car & Locomotive Works.

The taxpayer further alleges that the Commissioner committed error in reducing its invested capital for 1918 and 1919 by deducting from the invested capital at the beginning of the year the income and profits taxes for the preceding year, prorated from the date when each installment became payable. In the Appeal of Guarantee Construction Co., 2 B. T. A. 1145, the Board decided that such a reduction of invested capital was not justified by the law. Since that appeal was decided, the Revenue Act of 1926 has become effective. That Act provides in section 1207 as follows:

See. 1207. The computation of invested capital for any taxable year under the Revenue Act of 1917, the Revenue Act of 1918, and the Revenue Act of 1921, shall be considered as having been correctly made, so far as relating to the inclusion in invested capital for such year of income, war-profits, or éxcess-profits taxes for the preceding year, if made in accordance with the regulations in force in respect of such taxable year applicable to the relationship between invested capital of one year and taxes for the preceding year.

The regulations which were in force at the time the Revenue Act of 1926 became effective, in respect of the taxable years here involved, provide:

For the purpose of computing invested capital federal income and war profits and excess profits taxes are deemed to have been paid out of the net income of the taxable year for which they are levied. * * * Amounts payable on account of such taxes for the preceding year may be included in the computation of invested capital only until such taxes become due and payable. A deduction from the invested capital as of the beginning of the taxable year must therefore be made for such taxes or any installment thereof, averaged for the proportionate part of the taxable year, after the date when the tax or the installment is due and payable. (Art. 845, Regulations 45, Revised January 28, 1921.)

The adjustment of invested capital made by the Commissioner by reason of the income and profits taxes for the preceding years was made in accordance with this regulation and must be approved, except as the amount of the deduction may be affected by a redeter-mination of these taxes in accordance with this opinion.

Order of redetermination will Toe entered on 15 days' notice, under Rule 50.


text:
    Appeal of SALINA BELL, Executrix of the Estate of JAMES W. BELL, Deceased.
    Docket No. 1070.
    Submitted September 22, 1925.
    Decided April 3, 1926.

      W. Frank Gibbs, Esq., for the Commissioner.
    Before Marquette, Green, and Love.
    This appeal is from the determination of a deficiency in estate tax of $127 under the Bevenue Act of 1921.
    The taxpayer offered no evidence at the hearing, and agreed to submit the appeal on the pleadings.
   FINDINGS OF FACT.

James W. Bell died in February, 1923.

In the estate-tax return, a deduction of $2,500 attorney’s fee was taken, which was disallowed by the Commissioner, on the ground that it appeared that it had not been paid. This amount was paid by the estate.

Order of redetermination will be entered on 15 days' notice, under Rule 50.


author: Tbussell

text:
    Appeal of F. A. HALL CO., INC.
    Docket No. 4612.
    Submitted November 9, 1925.
    Decided April 3, 1926.
    Statute of limitations. — The consolidated income and profits-tax return for the year 1918, made on behalf of taxpayer and its associated company and containing the facts respecting gross income and allowable deductions required by section 239 of the Revenue Act of 1918, it appearing that said return was neither false nor fraudulent, was the return of each of said corporations required by the then existing law, and the statute of limitations, section 277 (a) (2) of the Revenue Act -of 1924, began to run on April 14, 1919, the day following the day on which said return was filed with the collector of the district within which each of said corporations maintained its principal office. On and after April 8, 1925, the Commissioner was without authority under the law to then assess taxes for 1918 against the taxpayer.

      William A. Graham, Esq., for tbe taxpayer.

      P. S. Grewe, Esq., for the Commissioner.
    Before James, Littleton, Smith, and Teussell.
    This is an appeal from the determination of a deficiency in income and profits taxes for the period from January 1 to July 31, 1918, amounting to $3,385.30, as disclosed by a deficiency notice mailed April 8, 1925. The taxpayer pleads the statute of limitations as a complete defense to the deficiency determined by the Commissioner.
    findings of fact.
    The taxpayer was a Rhode Island corporation with its office at 35 Pine Street, Providence. The company is no longer doing business and was formally dissolved February 11, 1925. Prior to August 1, 1918, taxpayer and the Universal Optical Corporation were in no way connected or affiliated. On that date the entire capital stock of the taxpayer was purchased by the Universal Optical Corporation, both corporations then existing under the laws o'f the State of Rhode Island and doing business in the City of Providence.
    The taxpayer was a tool-manufacturing company in Providence, and the Universal Optical Corporation was selected by the Government to manufacture telescopic sights for tanks. These were very intricate and complicated instruments. The telescopic sights for the tanks had not been built or made up until the tanks were practically completed, and these telescopic sights were necessary. The taxpayer was the only available company in Providence that had any equipment which was adaptable for the manufacture of these sights. To fill the Government orders the taxpayer company was taken over •by the Universal Optical Corporation on August 1, 1918.
    For the purpose of complying with the requirements of the Revenue Act of 1918, in respect to the making of income and profits-tax returns for the calendar year 1918, the taxpayer and the Universal Optical Corporation caused to be prepared, on the form prescribed and furnished by the Commissioner, a consolidated return for said corporations for the calendar year 1918. On a typed schedule attached to the official form there were set up, in parallel columns and ■on lines numbered 1 to 25, inclusive, following the numbering of lines on Schedule A of said official form, items of gross income and ■deductions allowed by law of both Universal Optical Corporation, F. A. Hall, Inc., and a consolidation of each item separately, in words and figures as follows:

    The consolidated items were transferred to the identical numbered lines of Schedule A of the official form. There was also attached, to the said official form other typed schedules showing:
    (1) Reconciliation of net profits per books with taxable income and consolidation of tbe same.
    (2) A tabulated statement showing tbe cost of goods sold.
    (3) Statement of interest deduction.
    (4) Description of items of other income.
    (5) Tabulated statement of ordinary and necessary expenses of each corporation in parallel columns.
    (6) Statement of salaries paid by each company during tbe years 1916 to-1918, inclusive.
    (7) Statement of depreciable assets and amount written off during tbe year for each company.
    (8) Statement and description of claim for amortization of equipment purchased for use in manufacturing war material.
    (9) Computation of Universal Optical Corporation’s loss on purchase of IT. A. Hall, Inc.
    (10) Balance sheets of both companies for the year ended December 31, 1918, and consolidation of items in parallel columns.
    (11) Balance sheets of both companies at the end of the year 1917 and* consolidation of items in parallel columns.
    (12) Statement showing credits and charges to surplus of Universal Optical Corporation during the year 1918.

      (13) Statement showing credits and charges to surplus of P. A. Hall, Ine., during the year 1918.
    In the tabulated statements numbered 9 and 13, as above described, it is clearly set forth and shown that “net gain F. A. Hall, Inc., January 1, 1918, to July 31, 1918, [was] $7,746.34 [and that the] net loss August 1, 1918, to December 31, 1918, [was] $21,337.61.”
    E. J. B. Beattey was treasurer of the Universal Optical Corporation throughout the year 1918. At the time the above-described consolidated return was made, he was treasurer of both the Universal Optical Corporation and F. A. Hall, Inc., and as such treasurer of both corporations he executed and acknowledged the foregoing described return. Said return was filed in the ofiice of the collector of the district of Connecticut, within which the principal office of the taxpayer corporation was then located, on the 13th day of April, 1919, which day was prior to the end of the extended time within which corporations were permitted to file income and profits-tax returns for the calendar year 1918.
   OPINION.

Tbussell

: There is presented to us for consideration only the question of whether, on April 8, 1925, the Commissioner was barred by the statute of limitations from asserting and proposing to assess income and profits taxes against this taxpayer for the calendar year 1918, or for any part of that year. Section 277 (a) (2) of the Keve-nue Act of 1924 is the statute of limitations governing the issue here presented and reads as follows:

The amount of income, excess-profits, and war-profits taxes imposed by the Act entitled “An Act to provide revenue, equalize duties, and encourage the industries of the United States, and for other purposes,” approved August 5, 1909, the Act entitled “ An Act to reduce tariff duties and to provide revenue for the Government, and for other purposes,” approved October 3, 1913, the Revenue Act of 1910, the Revenue Act of 1917, the Revenue Act of 1918, and by any such Act as amended, shall he assessed within five years after the return was filed, and no proceeding in court for the collection of such taxes shall be begun after the expiration of such period.

The position of the Commissioner is set forth in the deficiency letter in the following language:

As no separate return was filed by you for the above-mentioned period the statute of limitations upon the assessment of the above deficiency for the period involved, as outlined in section 277 (a) (2) of the Revenue Act of 1924 does not apply.

When it became the duty of the corporate taxpayer to make income and profits-tax returns for the calendar year 1918, the Eevenue Act of 1918 was in force, and its provisions defined the duties of corporate taxpayers in respect to the making of income and profits-tax returns. Section 239 of that Act provided:

That every corporation subject to- taxation under this title and every personal service corporation shall make a return, stating specifically the items of its gross income and the deductions and credits allowed by this title. The return shall be sworn to by the president,- vice president, or other principal officer and by the treasurer or assistant treasurer.

And section 240 (a) contained this provision:

That corporations which are affiliated within the meaning of this section shall, under regulations to be prescribed by the Commissioner with the approval of the Secretary, make a consolidated return of net income and invested capital for the purposes of this title and Title III, and the taxes thereunder shall be computed and determined upon the basis of such return.

Internal Eevenue Eegulations No. 45, published as T. D. 2831 under date of April 16, 1919, and purporting to be the authorized regulations of the Treasury Department respecting the administration of the provisions of the Eevenue Act of 1918, contained, in Article 634, the following provision:

Change in ownership during taxable year. — -When one corporation owns substantially all the stock of another corporation at the beginning of any taxable year, but during the taxable year sells all or a majority of such stock to outside interests not affiliated with it, or when one corporation during any taxable year acquires substantially all the capital stock of another corporation with which it was not previously affiliated, a full disclosure of the circumstances of such changes in ownership shall be submitted to the Commissioner. In accordance with the peculiar circumstances in each case the Commissioner may require separate or consolidated returns to be filed, to the end that the tax may be equitably assessed.

For the purposes of this appeal it is admitted that the only return made by F. A. Hall, Inc., for the year 1918 was the consolidated return described in the foregoing findings of fact, and, therefore, the issue here resolves itself into a determination of whether such consolidated return was the return required by section 239 of the Eevenue Act of 1918.

No substantial change was made in the language of this paragraph during the years when the Eevenue Act of 1918 and Eegulations 45 were in force. The first specific reference in the Department regulations calling for separate returns from affiliated corporations for any portion of a taxable year during which the affiliation did not exist, appeared in the following language:

In either case the subsidiary or subordinate corporation whose status is changed during the taxable year should make a separate return for that part of the taxable year during which it was outside of the affiliated group.

which was added to article 634 of Regulations 62, prepared under the Revenue Act of 1921 and published under the approval date of February 15, 1922.

An examination of the form of income-tax return made and filed on April 13, 1919, as a consolidated return for the Universal Optical Corporation and F. A. Hall, Inc., shows conclusively that that return stated “ specifically ” the items of gross income and the items of deductions of F. A. Hall, Inc., for the calendar year 1918, as required by section 239 above quoted. The testimony shows that said form was signed and sworn to by E. J. R. Beattey, who was the then treasurer of said company, and thus was in substantial compliance with the statutory provisions respecting the making of income and profits-tax returns. The said form also complied with article 634 of Regulations 45 in respect to furnishing “ a full disclosure of the circumstances of such changes in ownership ” of taxpayer’s stock which had occurred during the year. The typed Schedule A-19 recites:

The F. A. Hall, Inc., #36 Garnet Street, Providence, Rhode Island, was purchased and taken over by the Universal Optical Corporation on August 1, 1918.

In typed Schedule A-23 it is said:

Net gain F. A. Hall, Inc., January 1, 1918 to July 31, 1918 [was] $7,746.34.

The same schedule recites:

The stock of the F. A. Hall, Inc., was purchased by the Universal Optical Company at an amount much in excess of its then book value on the strength of government contracts which later proved a loss largely through cancellation.

When the consolidated return on behalf of this taxpayer and its associated company was made and received by the Commissioner, there was then in effect a statute of limitations contained in the Revenue Act of 1918, section 250 (d), in the following language:

* * * the amount of tax due under any- return shall be determined and assessed by the Commissioner within five years after the return was due or was made.

So far as the record of this appeal shows, no steps were taken by the Commissioner to inquire concerning, or to investigate, the tax liability under the return as filed until on or about April 8, 1925, when the deficiency notice was mailed to the taxpayer — nearly six years after the filing of the return. There is nothing in the record which indicates that at any time during that six years the Commissioner either advised the taxpayer or called upon it in any manner to furnish a separate return for that part of the year 1918 during which affiliation did not exist. The statutes of limitation exist only by virtue of legislative enactments, and the times when they begin to run and the conditions of their running must also be governed wholly by legislative enactments.

We have therefore arrived at the conclusion that, as to this taxpayer, in respect to its income and profits-tax return for the calendar year 1918, or any part thereof, the statute of limitations began to run on the day following the filing of the consolidated return, and that on April 8,1925, the Commissioner was barred by the provisions of section 277 (a) (2) of the Revenue Act of 1924 from assessing any deficiency in tax against said corporation for the year 1918.

There is no deficiency and it wfll be so ordered.

Teammell dissents.


author: ■ GRAupneR:

text:
    Appeal of ILLINOIS RURAL CREDIT ASSOCIATION.
    Docket No. 5058.
    Submitted December 11, 1925.
    Decided April 3, 1926.
    Subscribers to capital stock, after making partial payment on tbeir subscriptions, defaulted in meeting tbe remaining payments due. Tbe stock so subscribed for, together with payments then made, was declared forfeited to tbe corporation, but with tbe privilege to tbe subscribers to re-subscribe and thereby receive. credit for tbe payments declared forfeited. Helé, tbe payments declared forfeited are not income to tbe corporation.

      R. O. De Mange, Esq., for the taxpayer.

      M. N. Fisher, Esq., for the Commissioner.
    Before Graupner, Trammell, and Phillips.
    This is an appeal from the determination of a deficiency in income and profits taxes for the calendar year 1918 in the amount of $9,507.29. . The question involved is whether payments made by subscribers to capital stock, which were forfeited to the corporation upon default in payment of installments due, constitute taxable income.
    FINDINGS OF FACT.
    The taxpayer is a Delaware corporation with its principal office at Bloomington, Ill. It was organized in March, 1916, with an authorized capital of $1,000,000, divided into 20,000 shares of-a par value of $50 each.
    By written contract dated March 25, 1916, the taxpayer employed two- agents to obtain subscriptions to its capital stock at $100 per share. Under this contract the agent's were authorized to sell and accept subscriptions to the stock on the basis of cash payment in full, less a discount, or 25 per cent cash payment and three notes of the subscriber's each representing 25 per cent of the amount of the subscription, payable in three, six, and nine months from date. The agents were to receive, as commission and full compensation for their services, 25 per cent of the gross amount realized from the sale of stock, which commission the taxpayer agreed to pay from each sale upon receipt of each subscription contract with the cash payment and the notes for deferred payments. Out of the commissions received the agents agreed to pay all expenses, including office rent, telephone, stationery, etc., incurred in starting the business of the taxpayer and in the selling of its stock. They also agreed to reimburse the taxpayer for the salaries paid by it to its president and secretary to and including June, 1916.
    The agents had no connection with the taxpayer except their employment under contract.
    In accordance with the terms of their contract of employment, the agents during 1916, 1917, and the early part of 1918, secured a number of subscriptions to the capital stock of the taxpayer.
    Some of the subscribers failed to meet their notes when due and were advised by the taxpayer, by letter, that, unless payment was made by a specified date, the stock subscribed for would be offered for sale, and if no outside bidder could be had the stock might either be purchased by the taxpayer or forfeited to it together with any payments that had been made.
    On December 1, 1917, a meeting of the board of directors was held at which 1,319½ shares of stock, for which payments on subscriptions were in default, were offered for sale, but no bids being made therefor, on motion duly carried, a resolution was adopted that the stock should be forfeited to the taxpayer. A similar meeting was held on January 7, 1918, at which 121 shares of stock were declared forfeited to the taxpayer. In addition to the stock forfeited- at the latter meeting, subscriptions to 218 shares had been released by agreement between the taxpayer and the subscribers., making a total of 334 shares forfeited or released in 1918.
    Prior to the meeting of December 1, 1917, subscribers to the stock which was declared forfeited on that date had paid on account of their subscriptions $34,150, of which the selling agents had received as their commissions $32,987.50 and the taxpayer had received $1,162.50. With respect to the stock forfeited at the meeting of January 7,1918, and the stock released in 1918, subscribers had paid $8,800, of which the selling agents had received $8,350 and the taxpayer had received $450. The total amount paid by subscribers on the stock so declared forfeited was $42,950.

      After the stock subscribed for and the payments on the subscriptions of delinquent subscribers had been declared forfeited, the taxpayer notified such subscribers by letter that they might re-subscribe for the forfeited shares, in which event they would be given credit for the payments they had theretofore made and which had been declared forfeited and would be reinstated as members and entitled to all the privileges and benefits of the association. Subsequently, two of the subscribers whose stock had been declared forfeited for delinquency in meeting payments on their subscriptions took advantage of this offer of the taxpayer and became stockholders.
    In its income-tax return for 1918 the taxpayer did not include the sum of $42,950 as income, but did add that amount to its average invested capital for the year. The return filed showed a loss for the year and consequently no tax due. The Commissioner added the amount of $42,950 to income for the year, which resulted in a net taxable income of $34,225.21 and gave rise to the deficiency from which the taxpayer appeals.
   OPINION.

■ GRAupneR:

The issue in this appeal is whether the sum of $42,-950, or any part of it, which was paid by subscribers on account of their subscriptions to capital stock of the taxpayer, was income to the taxpayer.

The payments on account of the stock subscriptions, at the time they were made, were undoubtedly capital payments, being made to provide capital for the corporation, and were in its hands capital receipts as distinguished from income. The fact that payments were made in installments and stock was never issued for such payments, because they were not made to the full amount of the subscriptions, does not alter their character.

There is no deficiency and it will be so ordered.


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    Appeals of O. B. BARKER, RICHARD A. NOELL, J. T. JENNINGS, W. L. EVANS, and EDWARD E. YODER.
    Docket Nos. 3583, 3223, 3222, 3221, 3220.
    Submitted October 21, 1925.
    Decided April 8, 1926.
    1. March 1, 1913, value of capital stock determined.
    2. In determining profit or loss arising from the declaration and payment of liquidating dividends, a stockholder is entitled to set off, against the amount received in liquidation of a corporation, the portion thereof which he has subsequently been required to refund by way of payment of taxes of the corporation.

      H. H. Shelton, Esq., and O. H. Tufts, O. P. A., íor the taxpayers.

      A. H. Murray, Esq., for the Commissioner.
    Before Graupner and Phillips.
    Taxpayers appeal from the determination of deficiencies for the calendar years 1918, 1919, 1920, and 1921, as follows:

    In each of these cases the greater portion of the deficiency arises by reason of the liquidation of the Barker-Jennings Hardware Co., and the principal question involved is the March 1,1913, value of the three classes of stock of that corporation.
    BINDINGS OP PACT.
    During the years 1918, 1919, 1920, and 1921 the taxpayers owned stock of the Barker-Jennings Hardware Co., as follows:

    During the years in question the affairs of “the corporation were liquidated and liquidating dividends were paid as follows: $100 per share on the first preferred stock in 1918, $100 per share on the second preferred stock in 1918, $555 per share on the common stock in 1918, $5 per share on the common stock in 1919, $5 per share on the common stock in 1920, and $6 per share on the common stock in 1921. All of such stock was owned by the respective taxpayers prior to March 1, 1913. The Commissioner determined the March 1,1913, value of the two classes of preferred stock to be $100 per share and the March 1, 1913, value of the common stock to be $400 per share, and computed the gain from the liquidation on that basis. The taxpayers claim the March 1, 1913, value of the common stock to be $666.66 per share, of the first preferred stock to be $100 per share, and of the second preferred stock to be $122.66 per share.

      The Barker-Jennings Hardware Co. was incorporated in 1894 ,and took over and operated a wholesale hardware business which had been in continuous operation in Lynchburg, Va., since prior to the Civil War. Upon organization the corporation issued $75,000 par value of its common stock. In 1905 it issued 5 per cent preferred stock which it sold at par and which was retired at par in 1909. In 1912 it issued $75,000 par value of its first preferred 6 per cent nonvoting capital stock and $75,000 par value of its second preferred nonvoting stock. The second preferred stock was to receive dividends at the rate of 6 per cent per annum and an additional 2 per cent per annum whenever dividends of 10 per cent per annum or more were declared and paid on the common stock. The second preferred stock paid dividends at the rate of 8 per cent per annum from the date of its issue.-
    From its organization the business of the corporation was successful. For six years prior to March 1, 1913, the dividends upon the common stock averaged 40 per cent per annum. Shortly after 1913 the dividends were increased to 46 per cent and later to 48 per cent per annum. Both before and after March 1, 1913, the corporation, in addition to paying such dividends, increased its surplus account. On March 1, 1913, the earned surplus of the corporation as shown by its books was $145,483.22.
    On December 2, 1917, the place of business of the taxpayer was destroyed by fire. The principal stockholders of the taxpayer were well along in years and not in good health, and they determined to liquidate the affairs of the corporation rather than to continue the business.
    On March 1, 1913, the fair market value of the first preferred stock was $100, of the second preferred stock $120, and of the common stock $500 per share.
    In 1923, after the liquidation of the corporation had been completed, additional income and profits tax for 1917 was assessed against the corporation by the Commissioner. This tax was compromised by the payment of $2,000 on May 31, 1923. Of this amount, $1,520 was paid by O. B. Barker and the balance by others whose common stockholdings in the. corporation had been liquidated.
    In 1912 the husband of the sister of the taxpayer Bichard A. Noéll died. The widow was without funds, and during the years in question the widow and her three children were supported by the taxpayer Bichard A. Noell. All of the children were under 18 years of age and the services of the mother were devoted to the maintenance and care of a home for the children.
   OPINION.

Phillips

: The principal issue involved is the March 1, 1913, value of the various classes of stock of the Barker-Jennings Plardware Co. The stock was closely held by the persons actively engaged in the business, and, except for the sale of a few shares of second preferred stock, there appear to have been no dealings. The parties agree upon $100 as the March 1, 1913, value of the first preferred stock. The evidence shows sales of the second preferred stock within six months of March 1, 1913, at from $120 to $135 per share. This stock was, in effect, an 8 per cent stock in an established corporation, the annual earnings of which were more than five times the amount necessary to pay the dividend. The testimony of prominent bankers and brokers of Lynchburg, where the corporation oper- . ated, and which would be the natural market for such stock, was that such stock would sell on a 6 per cent basis in March, 1913. In view of this testimony and the testimony concerning the few actual sales which took place, we believe that a value of $120 on March 1, 1913, is proper.

The testimony of these same bankers and brokers as to the fair market value of the common stock on March 1, 1913, varied from $450 to $700 per share. The corporation had back of it a long and successful career. It was paying dividends of 40 per cent, and had been paying such dividends for many years, and at the same time had built up a surplus. In 1905 it had floated preferred stock at 5 per cent and in 1912 at 6 per cent. Considering the record of the company, its earnings, its dividends, and the testimony of persons familiar with market conditions for local stocks in Lynch-burg in 1913, we believe that the fair market value on March 1, 1913, as nearly as that value can be determined at the present time, was $500.

The petitions of the taxpayers allege that such taxpayers owned both first and second preferred stocks. These allegations of the petitions are denied and there is no proof of the ownership of any such stock, except in the case of .O. B. Barker. The ownership of the common stock is conceded in the deficiency letters. For these reasons the findings set out the holdings of these taxpayers of common stock, but no findings are made as to the ownership of any preferred stock, except that owned by Barker.

It appears that in 1923, after the liquidation of the corporation, Barker was required to pay out $1,520 on account of a compromise of additional income and profits taxes for 1917 assessed against the corporation. In some respects this situation resembles that presented in the Appeal of Clarence Le Bus, 1 B. T. A. 733. In that appeal, however, it appeared that the amount retained by the trustees in liquidation was sufficient to meet all of the obligations of the corporation, and the only question involved ivas whether the liquidating dividends were to be accounted for in the year in which received by the stockholder or in the year in which the affairs of the corporation were finally wound up by final payment of its liabilities. Here the situation is different, for the stockholders were paid in liquidation sums in excess of their equity in the corporation, and Barker was required to make repayment.

There can be no question that it was the duty of the corporation to pay all taxes lawfully imposed upon it. Taxes can be imposed retroactively and the duty of payment can not be escaped by dissolution. Brushaber v. Union Pacific R. R. Co., 240 U. S. 1; 36 Sup. Ct. 236; 3 Am. Fed. Tax Rep. 2926; United States v. General Inspection & Loading Co., 192 Fed. 223; 1 Am. Fed. Tax Rep. 182; United States v. Boss & Peake Automobile Co., 285 Fed. 410; 2 Am. Fed. Tax Rep. 1796; aff'd. 290 Fed. 167; 2 Am. Fed. Tax Rep. 1973; Brady v. Anderson, 153 C. C. A. 463; 240 Fed. 665; 1 Am. Fed. Tax Rep. 778; certiorari denied, 244 U. S. 654; 37 Sup. Ct. 652. By reason of the receipt of liquidating dividends, in excess of their equity in the corporation, the stockholders became liable to repay so much thereof as was necessary to pay taxes and debts of the corporation.

In Sawyer v. Hoag, 17 Wall. 610, the court said:

Though it be a doctrine of modern date, we think it now well established that the capital stock of a corporation ⅜ * ⅝ is a trust fund for the benefit of the general creditors of the corporation.

In Wood v. Dummer, 30 Fed. Cases, 435, Case No. 17,944, where assets of a bank had been distributed to the stockholders in excess of their equity therein and the action was by creditors against the stockholders, Justice Story said:

The doctrine of following trust funds into the hands of any persons, who are not innocent purchasers, or do not otherwise possess superior equities, has long been established. * * *
The capital stock is a trust fund for creditors, and the stockholders, upon the division, take it subject to all equities attached to it. They are, to all intents and purposes, privies to the trust, and receive it cum onere.

The stockholders were held to be liable to the creditors to the extent of the amount distributed to them.

In Updike v. United States, 8 Fed. (2d) 913, in an action by the United States to recover taxes of a dissolved corporation from stockholders who had received liquidating dividends, the United States Circuit Court of Appeals for the Eighth Circuit held the stockholders liable to contribute pro rata for such tax to the extent of the amounts distributed to them, and in the course of its opinion says:

Its property then [upon dissolution] becomes a trust fund for the benefit of creditors and those sustaining a like position under the law; and, if that property has been distributed to stockholders, it remains impressed with the same trust.

The trust fund doctrine comes into effect with reference to distributions upon dissolution only when creditors or third parties are affected, United States v. Boss & Peake Automobile Co., supra; and then only to the extent to which the stockholder has received distributions in excess of his equity in the corporation’s assets.

In 7 N. C. L. 199, the rule, amply supported ‘by citations, is stated as follows:

The capital of a corporation is its own property, which it may use and dispose of, if not prohibited by its charter, the same as a natural person. It is not held in trust for creditors; except in the sense that there can be no distribution of it among stockholders without provision being first made for the payment of corporate debts, and that, as in the case of a natural person, any disposition of it in fraud of creditors is void. ⅜ ⅜ * The stockholders are conclusively charged with notice of the trust character which attaches to the capital stock; as to it they cannot occupy the status of innocent purchasers, and when they have in their hands any of this .trust fund they hold it cum onere, subject to all equities which attach to it.

In 14 Corpus Juris, 970, it is stated as follows:

If the officers or stockholders of a corporation divide its capital or property among the stockholders leaving any debts unpaid, the stockholders are liable for the debts out of the funds or property so received, up to the value of the proceeds of the property each has received or so much thereof as is necessary to satisfy the claims of creditors.

In Curran v. Arkansas, 15 How. 304, the court said:

The plaintiff is a creditor of an insolvent banking corporation. The assets of such a corporation are a fund for the payment of its debts. If they are held by the corporation itself, and so invested as to be subject to legal process, they may be levied on by such process. If they have been distributed among stockholders, or gone into the hands of others than hona fide creditors ■or purchasers, leaving debts of the corporation unpaid, such holders take the property charged with the trust in favor of creditors, which a court of equity will enforce, and compel the application of the property to the satisfaction of their debts.

The court cites, with approval, 2 Story’s Eq. Jur., sec. 1252, as follows:

If the capital stock should be divided, leaving any debts unpaid, every stockholder, receiving his share of the capital stock, would, in equity, be held liable pro rata to contribute to the discharge of such debts out of the fund in his own hands.

To the same effect, see Mumma v. Potomac Co., 8 Pet. 281, and Hastings v. Drew, 76 N. Y. 9. These and many others are to the effect that the liability of the stockholder arises from the receipt by him of corporate funds subject to a trust to pay the corporate debts, and that the nature of the action is to set aside the delivery of the assets and recover either such assets or their value.

The payment made by Barker in 1923 on account of the corporate taxes was not an obligation incurred or a loss sustained by him in 1923, but was a repayment by him of corporate assets paid to him to which he had no equitable title. It was in the nature of a repayment of money received under a mistake of fact upon which a trust had been impressed and, to the extent to which the amount received was subject to the trust, was not income. Appeal of Carey Van Fleet, 2 B. T. A. 825. The amounts received by him in liquidation of the corporation should be reduced by the amount returned in payment of taxes of the corporation, the amount so returned being set off against the latest distributions received by the taxpayer.

In the case of the taxpayer Bichard A. Noell, it appears that he was the sole support of the three children of his widowed sister. He maintained a home for them in charge of his sister. It is not necessary, in order to obtain the exemption for dependents, that such dependents be supported in the home of the taxpayer. During the-years in question taxpayer should be allowed the credit provided bylaw for the support of three persons under the age of 18 years dependent upon him for their support.

The answers filed by the Commissioner in the appeal of each taxpayer other than O. B. Barker question the jurisdiction of the Board. Without reciting the facts in detail, it is sufficient to say that these appeals come squarely within the decisions of this Board in the Appeals of Ormsby McKnight Mitchel, 1 B. T. A. 143, and Buffalo Slag Co., 1 B. T. A. 749, and the jurisdiction conferred by section 283 (f) of the Kevenue Act of 1926. The plea of the Commissioner to the jurisdiction of the Board is overruled.

Orders denying the motions of the Commissioner to dismiss cmd, redetermining the deficiencies will be entered on 15 days' notice,, under Bule 50.


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    Appeal of RETAILERS FIRE INSURANCE CO.
    Docket No. 3733.
    Submitted October 12, 1925.
    Decided April 8, 1926.
    1. Taxpayer, a fire insurance company, was under contract obligation to refund to its policyholders 50 per cent of its net income for the year. Held, that such liability is an expense incurred during the taxable year and a proper deduction from income.

      2. Held, f urther, that an amount paid in settlement of fire losses occurring and reported in the taxable year, but adjusted after the close of the taxable year, is deductible from income of the taxable year.

      G liarles F. Miller, Esq., for the taxpayer.

      Geo. G. Witter, Esq., for the Commissioner.
    Before Geeen and Phillips.
    This is an appeal from the determination of a deficiency of $10,895.22 income and excess-profits taxes for 1919 and 1920. Three errors are alleged, as follows:
    (1) An increase in net income of $1,007.50;
    (2) The failure to allow as a deduction $3,292.50, reserve for unpaid losses; and
    (3) The refusal to permit taxpayer to deduct amounts alleged to have been incurred during the taxable years as liabilities to refund to policyholders a portion of the premiums paid.
    FINDINGS OP PACT.
    Taxpayer is a corporation organized under the laws of Oklahoma, with its principal place of business at Oklahoma City. During 1918, 1919, and 1920, the company was engaged in writing one-year fire and tornado insurance policies in the States of Oklahoma, Kansas, and Nebraska. The taxpayer is organized with capital stock upon which dividends are paid, but during the years in question had made provision for participation by its policyholders in its profits.
    In 1912 taxpayer adopted a by-law reading as follows:
    That on the first day of November in each and every calendar year, the books of the company shall be closed and the profits of the company ascertained. After the payment of all return premiums, losses, expense of adjustment, deduction of standard reserves and other expenses of the conduct of the company’s business having been deducted, the net profits shall be divided into two equal parts: To-wit:
    One-half of the net profits shall be applied to the company’s surplus account. One-half to be applied to the policyholder’s participating account, to be payable to each and every policyholder pro rata and in proportion to the earned premium paid by such policyholder, and such profits to be paid to the policyholder on or before Sixty (60) days next after such November 1st, of each and every calendar year.
    On January 16, 1918, this by-law was amended to read as follows:
    On the last day of December in each and every calendar year, the books of the company shall be closed and the profits of the company ascertained. After the payment of all return premiums, losses, expense of adjustment and all other expenses in conducting the company’s business shall have been deducted, the net profits shall be ascertained and at the annual meeting of the Directors on the 3d Wednesday of January of each year the Directors shall determine the amount to be applied to the policyholder’s participating account out of the net profits, and to be paid to each and every policyholder pro-rata and in proportion to the earned premium paid by each policyholder, and each policyholder to be paid his share of said policyholder’s participating account, as determined by the Directors, on the expiration of his policy, and each policyholder shall share in the above profits for the year in which his policy takes effect; provided, he carries same until date of expiration. After determining the amount to be applied to the policyholder’s participating account, the Directors shall have full power to apply the balance of the net profits to the company’s surplus account, out of which dividends to the stockholders may be declared by the Directors.
    Prior to and. during the years 1918, 1919, and 1920, the executive committee of the taxpayer was authorized to take such steps'to advertise the taxpayer’s business as might be for the best interests of the company. Pursuant to such authorization the business of the taxpayer was extensively advertised throughout the States in which it did business, in magazines and newspaper's, by pamphlets, circulars, and personal letters, and otherwise. These advertisements were to the general effect that the company employed no solicitors and that the savings thus effected were returned to the policyholders, and contained such statements as:
    “ the net profits of the company are divided half and half between the policyholders and the stockholders, and the policyholders’ half is applied to the reduction of premiums”, “ it divides its annual profits 50-50 between the policyholders and the stockholders”, “ these profits are divided between, the policyholders and the stockholders, and each policyholder receives his due proportion of the profits, either in cash or in a reduction in the price of his insurance”, “ the Company divides its net earnings between its policyholders and its stockholders. You share in proportion to the size of your policy”, “ it costs you about 25 per cent less, for the reason that instead of turning ALL the profits over to the stockholders of the company, we divide the profits into equal parts, and pay half to the stockholders and half to the policyholders. If you do not take out your share in the form of a reduced premium, you are entitled to receive it in good, hard cash,” “ the vital point of difference between The Retailers Fire and other companies is this :■ We refund, to our policyholders one-half of all the money we make each year; ”
    and further statements to the effect that the refunds amounted to from 25 to 33½ per cent of the premiums paid.
    The policies issued by taxpayer in the State of Kansas contained a rider, reading as follows:
    It is hereby understood and agreed that at the end of the each and every calendar year, after the payment of all return premiums, losses, expense of adjustment and all other expenses in connection with the transaction of the company’s business shall have been deducted, the net profits shall be divided into two equal parts; one-half of which shall be applied to the company’s surplus account and one-half to he applied to the policyholder’s participating account, same to be paid to each and every policyholder and each policyholder to be paid his share of such policyholder’s participating account on the expiration of his policy, said account to be based on the profits for the year in which his policy takes effect.
    The taxpayer employed no agents to solicit business and its business was obtained mainly because of such undertaking to refund a portion of the premiums.
    The amount to be distributed to policyholders in any year was never fixed at exactly 50 per cent of the earnings. After determining the amount of the earnings, the directors would fix a percentage of the premiums paid as the amount to be returned. The percentage so fixed was approximately 50 per cent of such profits and was applied in each case to the premiums paid during the year in which the profits were made. Such returned premium was payable only on the expiration of the policy by its terms, and no refund was made in the event of cancellation of the policy prior to its expiration.
    Upon policies written in 1918, prior to July 1, the refund was fixed at 30 per cent of the premium paid, and on policies written after June, at 20 per cent. Twenty per cent of the premium on policies written in 1919, and 25 per cent on the policies written in 1920, was returned. During 1919 taxpayer refunded to policyholders, on premiums paid during the year 1918, $30,830.93. Net earnings for 1918, before such refunds, were $58,830.93. In 1920 taxpayer refunded to policyholders, on premiums paid during 1919, $44,864.82. Net earnings for 1919, before such refunds, were $93,-142.68. In 1921 taxpayer refunded to policyholders, on premiums paid during 1920, $62,296.52. Net earnings for 1920, before such refunds, were $92,048.17. In computing net income for 1919 the Commissioner allowed as a deduction $30,830.93, and for 1920 $44,-864.82.
    Shortly prior to December 31, 1920, there had been reported to taxpayer two claims for policy losses by fire in the respective amounts of $4,200 and $100, against the first of which taxpayer had reinsurance to the extent of $1,007.50. Taxpayer set up on its books reserves for such unpaid losses of $3,292.50, and claimed such amounts as deductions upon its income-tax return. Such reserve was reasonable in amount. The losses were paid in January, 1921, in the amount of $3,225.58. In computing the deficiency the amount of the reserve was disallowed by the Commissioner, who also added to taxpayer’s income the reinsurance in the sum of $1,007.50. The Commissioner in his answer admits error in adding said $1,007.50 to taxpayer’s income.
   OPINION.

Phillips

Under the decision of the Supreme Court in United States v. Boston Insurance Co., 269 U. S. 197, it is clear that the reserve for unpaid losses claimed as a deduction by the taxpayer is not such a reserve as is contemplated by section 234 (a) (10) of the Revenue Act of 1918, and can not be deducted as a reserve. The question remains, however, whether the amount of the policy loss by fire is to be taken as a deduction in 1920, when the fife occurred and liability under the policy arose, or in 1921, when the amount of the loss was adjusted and paid. Section 234 (a) (10) of’ the Revenue Act of 1918 allows as a deduction in the case of insurance companies “ (b) the sums other than dividends paid within the taxable year on policy and annuity contracts.” Section 200 provides:

The term “ paid ”, for the purposes of the deductions and credits under this title, means “ paid or accrued ” or “ paid or incurred ”, and the terms “ paid or incurred ” and “ paid or accrued ” shall be construed according to the method of accounting upon the basis of which the net income is computed under section 212.

In the case of United States v. Boston Insurance Co., supra, the Supreme Court had before it only the question whether a net addition to a reserve for unpaid policy losses could be deducted, decided that this was not such a reserve as was contemplated by the law, and held that the addition could not be deducted. In the course of its opinion the court indicates that such losses are accrued liabilities to be cared for as such and not as reserves. Referring to McCoach v. Insurance Co., 244 U. S. 585, the court says:

There a fire and marine insurance company sought to recover the tax assessed upon the addition during the year to “ reserve funds ” held against accrued but unpaid losses. (Italics ours.)

The court quotes with approval from that portion of the McGoacJi decision which points out that the insurance commissioner of Pennsylvania required the plaintiff there “to return each year, as an item among their [its] liabilities, the net amount of unpaid losses and claims, whether actually adjusted, in process of adjustment, or resisted.” Commenting on the decision in that case, the court said:

We there distinctly ruled that the “ reserve fund ” of the Federal Act did not include something held by a fire and marine insurance company to cover accrued but unsettled, claims for losses. We adhere to and reaffirm that doctrine. (Italics ours.)

The court was not called upon to determine whether losses occurring during the year but settled thereafter were “ losses accrued,” so as to constitute a deduction from income; and we do not conceive the expressions used by the court in the course of its opinion, and italicized above, to be determinative of that question. These expressions, however, are in substantial accord with the decision and opinion rendered soon thereafter in United States v. Yale & Towne Manufacturing Co., 269 U. S. 422, where the court held that a munitions tax for 1916, imposed by tbe United States on the profits on munitions manufactured by that company and sold during that year, which tax became due and payable in 1917, was properly to be deducted from 1916 income. Commenting upon the provisions of the 1916 Act and the regulations which provided for a return upon an accrual basis, the court says:

* * * It was to enable taxpayers to keep tbeir books and make their returns according to scientific accounting principles, by charging against income earned during the taxable period, the expenses incurred in and properly attributable to the process of earning income during that period; and indeed, to require the tax return to be made on that basis, if the taxpayer failed or was unable to make the return on a strict receipts and disbursement basis.
The appellee’s true income for the year 1916 could not have been determined without deducting from its gross income for the year the total cost and expenses attributable to the production of that income during the year. The reserve for munitions taxes set up on its books for 1916 must have been deducted from receivables for munitions sold in that year before the net results of the operations for the year could be ascertained. * * *
Only a word need be said with reference to the contention that the tax upon munitions manufactured and sold in 1916 did not accrue until 1917. In a technical legal sense it may be argued that a tax does not accrue until it has been assessed and becomes due; but it is also true that in advance of the assessment of a tax, all the events may occur which fix the amount of the tax and determine the liability of the taxpayer to pay it. In this respect, for purposes of accounting and of ascertaining true income for a given accounting period, the munitions tax here in question did not stand on any different footing than other accrued expenses appearing on appellee’s books. In the economic and bookkeeping sense with which the statute and Treasury decision were concerned, the taxes had accrued.

The taxpayer here became liable in 1920 to pay for the loss covered by its policy to the same extent that the Yale & Towne Manufacturing Co. became liable in 1916 for the payment of the munitions tax upon the profits of that year, and the true income of the taxpayer for 1920 could not have been determined without giving effect to that liability. The liability to pay a policy loss arising and reported in 1920 but adjusted in 1921 was as much an expense of taxpayer’s business for 1920 as was the munitions tax upon 1916 income, the amount of which tax could not be fixed until 1917, an expense of the munitions manufacturer for 1916.

The same construction appears to have been placed upon the law by the Bureau of Internal Bevenue, for in Law Opinion 1056, 4 C. B. 297, the Solicitor of Internal Bevenue, after reaching the conclusion that, under the decisions of the Supreme Court in McCoach v. Insurance Co., supra, and Maryland, Casualty Co. v. United States, 251 U. S. 342, additions to reserves for unpaid losses could not be deducted by insurance companies, points to the provision allowing the deduction of losses sustained during the taxable year and not compensated for by insurance or otherwise, and states:

Under the law they are entitled to deduct the several items included in unpaid losses as “losses,” and to allow them also to include these items in reserves the net additions to which may he deducted from gross income in determining the taxable income of such companies, would be in effect to permit them a double deduction, a result which can not be presumed to have been intended by Congress.

It has uniformly been held by the Bureau that a loss from fire results in the year in which the fire occurs. In T. B. B. 55, 1 C. B. 123, the Advisory Tax Board had under consideration the case of a fire which occurred in one year, the loss being partially covered by insurance and not settled until a future year. The decision reached was as follows:

The Advisory Tax Board, therefore, recommends that in those eases in which a loss occurs in one taxable year, the taxpayer should compute his loss by deducting from the total loss the estimated amount of the recoverable insurance. The loss so determined should be deducted from the taxpayer’s income of the year in which the loss was sustained. If subsequent events demonstrate that this estimate was substantially inaccurate, an amended return should be filed correcting the mistake.

To, the same effect is the decision of the Bureau in I. T. 2150, IV-1, C. B. 147, where the Bureau had under consideration the deductibility of a fire loss which occurred in 1920. After determining that a loss was sustained, the ruling continues:

There remains the question, During what period was the loss sustained? In cases of claims for unliquidated damages and in cases of indeterminable or contingent liability, it is held that the loss is sustained when the claim is paid or put in judgment, or when a definite liability is incurred. The instant case is distinguishable. Upon the destruction of the building the extent of the M Company’s liability which measured its loss was immediately ■determinable, being controlled by the replacement cost of the buildings at that time. The liability to replace the buildings rested upon a definite, contractual obligation, was clear and undisputed, became fixed at the time of the fire, and was thereafter promptly satisfied. Also the M Company returned its income on an' accrual basis, both items of gross income and all deductions being treated uniformly on that basis. Under such circumstances, it is logical to say that the loss was sustained by the M Company at the time of the fire, when the liability was incurred.

The Board has given the same construction to the law. Appeal of International Boiler Works Co., 3 B. T. A. 283.

Considerable light as to what deductions were intended to be allowed to insurance companies may be gained from the legislative history of the provisions governing insurance companies. McCoach v. Insurance Co., supra, holding that the addition to a reserve for unpaid losses could not be deducted by an insurance company and indicating that the losses were to be deducted when incurred, was decided by the Supreme Court in 1911. Thereafter, the Revenue Act of 1918 was passed continuing the provisions of the 1916 Act. The decision of the Supreme Court in the Maryland Casualty Co. case, supra, which appeared to overrule the decision in the McCoach case, was rendered in 1920. The following year the Revenue Act of 1921 was adopted and contained the following definition of losses deductible by insurance companies (sec. 246 (b) (6)) :

The term “losses incurred” means losses incurred during the taxable year on insurance contracts, computed as follows:
To losses paid during the taxable year, add salvage and reinsurance recoverable outstanding at the end of the preceding taxable year, and deduct salvage and reinsurance recoverable outstanding at the end of the taxable year. To the results so obtained add all unpaid losses outstanding at the end of the taxable year and deduct unpaid losses outstanding at the end of the preceding taxable year.

This provision of the law appears to have been inserted for the purpose of clearing up the uncertainty which existed after the decision in the Maryland Casualty Co. case and of restating and affirming the law and regulations as they existed under the decision in the McCoach case and prior to the decision of the Maryland Casualty. Co. case.

After careful consideration of the decisions of the Supreme Court, the rulings of the Bureau of Internal Revenue, and the legislative history of the tax statutes as they affect this deduction, we are of the opinion that the taxpayer is entitled to deduct in 1920 the amount of $3,226.58 paid by. it in January, 1921, in settlement of the fire losses which occurred in December, • 1920, liability for which it appears to have recognized when it set up reserves on its books in December, 1920.

The taxpayer claims that it became liable to refund to its policyholders 50 per cent of its net earnings for each taxable year; and that such amount is deductible from the income of the year in which such earnings were made. It does not appear to be questioned that such refunds are in the nature of ordinary and necessary expenses, analogous to commissions to agents, advertising, or other expenses of securing business, and are deductible. The Commissioner and taxpayer differ only as to the year in which the amount is deductible. Such expenses, in the case of a taxpayer keeping its accounts on an accrual basis, are to be deducted when “ incurred.” The Commissioner contends that, under the by-laws of the company, the amount to be refunded to policyholders was within the discretion of the directors of the taxpayer and that no liability was incurred until the annual meeting took place some time after the end of the year. The taxpayer contends that a contract was created between the corporation and its policyholders by which the corporation became bound to refund 50 per cent of its net earnings to the policyholders,, and that this contract is not affected by any provision of the by-laws which are made for the internal regulation of the company and are not binding on strangers without notice.

The company informed the public by way of advertisements, circulars, letters, and otherwise, that 50 per cent of the net earnings of each year would be distributed to those taking out policies in the company during such year. The law is well established that an offer may be made to the general public and that acceptance thereof will result in a contract. The statements made by the insurance company were more than statements of a future intention; they were statements of what the company would do if insurance were written. The statements are definite and fix with exactness the agreement for a refund which is to exist between the company and the policyholder. If any ambiguity exist, and we see none, it is made clear in the rider which was attached to the policies issued in Kansas, setting out the terms of the agreement in the form of an express, written contract. We must also consider the fact that such a refund had been the established policy of the company for many years and that many of its policyholders had been such in the past and had received such refunds.

In our opinion the taxpayer was obligated by contract to distribute one-half of its profits for each of the taxable years among its policyholders. This contractual liability can not be impaired by any limitations contained in the .by-laws, for these were not communicated to the policyholders, and it is well established that such by-laws are made for the internal regulation of the corporation and are not binding on strangers without notice where the officers of the corporation act within their ostensible authority. The amount of the refund constitutes a part of the cost of transacting the business of the year in which the policies were written, to the extent of the liability incurred to refund 50 per cent of the net earnings of that year.

It is to be noted that in practice the taxpayer based its refund upon a percentage of the premiums paid, the total refund approximating or exceeding 50 per cent of its earnings. To the extent that the distribution voted was in excess of 50 per cent of its earnings, it was not in discharge of any contractual liability incurred during the year in which the policies were written. If the taxpayer saw fit to distribute more than 50 per cent of its earnings for the purpose of creating new business, or for any other purpose, this was a voluntary act upon its part creating a liability in the year of distribution. To the extent, however, of 50 per cent of its net earnings, there was a liability to its policyholders incurred during the year and existing at the close of the year which the taxpayer is entitled to deduct in determining its net income for such year. United States v. Yale & Towne Manufacturing Co., supra. Any refund to policyholders in excess of such amount, voted and paid during the succeeding year, would be deductible as an expense of such succeeding year. Upon this basis the taxpayer is entitled to deduct for 1919, $47,986.81, and for 1920, $44,317.86.

The Commissioner admitted error in overstating taxpayer’s income for 1920 by $1,007.50, and proper adjustments should be made.

Order of redeterminaüon will be entered on 15 days’ notice, under .Rule 50.


author: Trammell:

text:
    Appeal of TONAWANDA POWER CO.
    Docket Nos. 2889, 3870, 6506.
    Submitted October 8, 1926.
    Decided April 8, 1926.
    Where two corporations are consolidated under tbe laws relating to statutory consolidation in New York and the consolidated corporation issues its stock to the stockholders of the two old corporations, it thereby acquires the assets of such corporations, and the invested capital of the new corporation is determined by the actual cash value of the assets, tangible and intangible, at the time of the consolidation.

      Charles P. Franchote Esq., for the taxpayer.

      Edward O. Lake, Esq., for the Commissioner.
    Before Graupner, Trammell, and Phillips.
    These appeals are from determinations of deficiencies in income and profits taxes for the years 1918 to 1921, inclusive, in the respective amounts of $18,071.90, $9,841.18, $15,645.34, and $2,130.86. •Only so much of the deficiencies is in controversy as arises from the exclusion by the Commissioner from the taxpayer’s invested capital, for each of the years involved, of the amount of $212,746.32, carried -on its books as “ other intangible electrical capital.”
    FINDINGS OP PACT.
    The taxpayer is a .corporation organized under the laws of the State of New York in the year 1899, with a capital stock of $250,000, divided into 2,500 shares of the par value of $100 each. Its principal office and place of business are at North Tonawanda, N. Y., and it is engaged in the business of producing and distributing electricity for light, heat, and power.
    The taxpayer was created by the consolidation of the Tonawanda Lighting & Power Co. and the Tonawanda Cataract Power Co., two ’New York corporations..

      The Tonawanda Lighting & Power Co. had outstanding capital .stock of the par value of $150,000, divided into shares of $100 each, and a bonded indebtedness of $150,000. The Tonawanda Cataract Power Co. had outstanding capital stock in the amount of $100,000, divided into shares of the par value of $100 each. It had no bonded indebtedness. Upon the consolidation the stockholders of the two old corporations received stock in the new corporation, share for share, and the new corporation took over the assets of the two old corporations and issued to the holders of the bonds of the Tonawanda Lighting & Power Co. its own bonds in an equal amount. The assets taken over by- the taxpayer were set up on its books at the same values at which they were carried on the books of the two old corporations, as follows:
    tonawanda LIGHTING & POWER CO.
    Property, franchises, etc_$300, 000. 00
    Supplies and material_ 500. 00
    Bills and accounts receivable, viz:
    Notes receivable_ 13. 80
    Commercial incandescent_ 724.31
    Commercial arc_ 193.96
    Municipal lighting_ 1, 517. 50
    Sundry earnings_ 197. 87
    Unexpired insurance_ 631.21
    P. M. Gordon, manager, cash_ 300. 00
    Cash- 5, 406. 73
    The item of $300,000 included the steam plant, poles, wires, meters, transformers, a substation, and all the various assets that go to make up a public utility enterprise furnishing light and power.
    TONAWANDA CATARACT POWER CO.
    Property, franchises, etc_$164, 579. 61
    Preliminary expenses_ 1, 755.40
    Cataract Construction Co_ 7, 885.17
    Niagara Palls Power Co_ 332. 41
    174, 552. 59
    The item of $164,579.61 covered a contract with the Niagara Falls, Power Co. for a supply of electric power known as the “Hill contract,” organization expenses, and agreement by the Niagara Falls Power Co. to assign certain franchises in the territory, and its interest in other contracts. The part thereof attributable to the “ Hill contract ” was $134,500.
    Certain liabilities were assumed by the taxpayer so that the net book value of the assets acquired, not taking into consideration the bonded indebtedness, was $466,335.01. The taxpayer’s fixed capital account was therefore set up on its books at that amount,, and there was charged against the account $250,000 of the capital stock, $150,000 of bonds, and surplus in the amount of $66,335.01. The account remained in that condition until the year 1904, all capital expenditures during the interim being charged to operating expenses. During the years 1904 to 1909, some expenditures were charged to the fixed capital account so that at January 1, 1909, it stood at $496,325.34. With the establishment of the Public Service Commission of the State of New York, and the promulgation of regulations covering a uniform system of accounting for public utilities, the taxpayer began to change and allocate its expenditures for capital improvements in accordance with the uniform system so established, but did not until the year 1917 attempt to split up and allocate the amount of $496,325.34 which represented its capital account at January 1,1909.
    The steam plant acquired by the taxpayer from the Tonawanda Lighting & Power Co. was operated by the taxpayer for a short time after the consolidation and was then abandoned and sold. The taxpayer had no intention of continuing the use of the steam plant. It was necessary to operate it until the hydro-electric power was functioning properly and it was the intention to abandon it as soon as possible. The record does not disclose either the original cost of the steam plant or the amount for which it was sold.
    The contract or lease known as the “Hill contract” acquired by the taxpayer from the Tonawanda Cataract Power Co. was secured by the latter company by assignment from Charles B. Hill for all of its capital stock, which, as above stated, was of the par value of $100,000.
    The Hill contract was entered into by Charles B. Hill and the Niagara Falls Power Co. on June 1, 1898, and it provided, among other things, that—
    * * ⅜ the Niagara Falls Power Company has leased, and hereby does lease to Charles B. Hill, or his assigns, 10,000 electrical horse-power to be generated by the turbines of the Niagara Company in and at its Power House situated upon Dots eleven (11) and twelve (12) of the Stedman Farm, situate at Niagara Falls aforesaid, driving dynamos of like unit, generating electrical horse-power for transformation and transmission to the City of North Tonawanda, in the amounts as called for, in blocks of not less than two hundred (200) electrical horse-power each, one thousand (1,000) electrical horse-power of said amount to be delivered by the Niagara Company and taken by the party of the second part, or his assigns, on or before December 1, 1898; and easement in gross in and issuing out of all said property of the Niagara Company for the protection and preservation of this lease of the said electrical power being intended to be and being hereby granted to the party of the second part, or his assigns, for and during the term of this lease; and a right to it and him to enter upon and to make use of such property to' the extent necessary to perform tills agreement whenever and in case Niagara Company refuse or neglect to perform the same.
    The contract also provided that it should continue in force during the corporate existence of the Niagara Falls Power Co.
    On March 6, 1899, Charles B. Hill assigned to the Tonawanda Cataract Power Co. the contract mentioned, and the assignment was confirmed by the Niagara Falls Power Co. In connection with the confirmation of the assignment, the Niagara Falls Power Co. required the Tonawanda Cataract Power Co. to deliver to it, on account of power contracted for but not taken under the contract, shares of stock of the Tonawanda Lighting & Power Co. of the par value of $34,500, which the Tonawanda Cataract Co. at that time had in its treasury.
    On April 1, 1907, the Tonawanda Power Co. executed an instrument releasing its rights to call upon the Niagara Falls Power Co. for electrical power in excess of 7,000 electrical horsepower and all the right of the Tonawanda Power Co. to enter upon and make use of the power plant or other property of the Niagara Falls Power Co. for the protection of its rights to power under the contract of March 6, 1899. On May 1, 1911, the contract of April 1, 1907, was rescinded and the Tonawanda Power Co. was revested with all its rights as originally conferred under the “ Hill contract.” Under the agreement of May 1, 1911, the taxpayer was obligated to pay the Niagara Falls Power Co. an extra 50 cents per electrical horsepower per year for all power received subsequent to April 1, 1907. On June 28, 1917, the contract of May 1, 1911, was amended so as to release the Niagara Falls Power Co. from the easement provided in the original “ Hill contract.”
    In the year 1917, the taxpayer employed a firm of accountants, who were specialists in public utility accounting, to make a reallocation of the various items of the taxpayer’s property. They estimated the cost of construction of all physical property then owned by the taxpayer and such cost was allocated on the taxpayer’s books. The total cost so determined was deducted from the taxpayer’s fixed capital account as it stood before the reallocation, and the difference, amounting to $212,746.32, was carried into an account known as “ Other intangible electrical capital,” and considered as representing the cost to the taxpayer of the “ Hill contract ” and the steam plant heretofore mentioned.
    The Commissioner, upon audit of the taxpayer’s income and profits-tax returns for the years 1918 and 1921, inclusive, excluded from invested capital for each year the amount of $212,746.32, carried in the capital account under the heading of “ Other intangible electrical capital,” and determined that there are deficiencies in tax in the amounts of $18,071.90 for the year 1918, $9,841.18 for the year 1919, $15,645.84 for the year 1920, and $2,130.86 for the year 1921.
   OPINION.

Trammell:

The only question presented by the record in this appeal is the amount, if any, that the taxpayer is entitled to include in its invested capital for the years 1918 to 1921, inclusive, on account of the item of $212,746.32, designated on its books as “ Other intangible electrical capital.” The taxpayer contends that if the item is to be segregated $134,500 of the amount represents the cost to it of the “ Hill contract ” acquired frqm the Tonawanda Cataract Power Co. and that the remainder of the item, to wit, $64,246.32, should be considered as the cost to it of the steam plant acquired from the Tonawanda Lighting & Power Co. One witness considered the “ steam plant ” as an element in the cost of distribution system and franchises of the Tonawanda ■ Lighting & Power Co. and another considered it as an additional cost attributable to the “Hill contract.” It was contended that under either theory the entire amount is properly a part of its invested capital. •

The Board will take judicial notice of the statutes of New York under which the taxpayer corporation was organized. Under the statute in effect at the time of the statutory consolidation of the corporations, all the rights, privileges, franchises, and interests of every kind belonging to or enjoyed by the corporations consolidated, and every kind of property, real, personal, and mixed, are deemed to be transferred and vested in the new corporation without any other deed or transfer.

The effect of these statutory provisions is that the new corporation acquired assets for stock on its organization. It then becomes necessary to determine the actual cash value of the assets in question and whether they, or any of them, were tangible or intangible.

Two questions arise in the determination of the invested capital with respect to the “ Hill contract ” and the steam plant: First, what was their actual cash value at the time received in exchange for stock; and second, whether either or both of the above items were tangible or intangible. If intangible, the amount to be included in invested capital is limited by section 326 (a) (4) of the Revenue Act of 1918.

There is no evidence as to the value of the steam plant further than that it was abandoned soon after it was taken over. It could not be used in competition with hydraulic power and was not intended to be used for a longer time than was necessary to get the plant into operation under the power contract. The taxpayer contended that the cost of the steam plant should be considered as additional cost attributable to the acquisition of the “ Hill contract.” We do not think this contention is well founded, but if correct it would not establish the value of the steam plant. The “Hill contract ” was acquired from one corporation and the steam plant from another, and there is nothing to indicate that the taxpayer was required to purchase the steam plant in order to acquire the “Hill contract.” It might be more logically contended that the cost of the steam plant represented additional cost attributable to the acquisition of the distribution system of the Tonawanda Lighting & Power Co. But, as stated above, we are here concerned with values and not cost, and we have no evidence of value when the asset was acquired. We have no evidence that the distribution system acquired, even considering the steam plant as inseparably connected with it, was worth in excess of .the values allowed by the Commissioner. Even if the steam plant were shown to have had a value when acquired, it should have been charged off against earned surplus when it was abandoned.

With reference to the “ Hill contract,” the evidence shows that it was acquired by the Tonawanda Cataract Power Co. in exchange for its capital stock of the par value of $100,000. The Tonawanda Cataract Power Co. also was required to pay to the Niagara Falls Power Co., when the assignment of the contract by Hill was confirmed by that company, stock of another company of the par value of $34,500, on account of .power that had been contracted for but not taken. Thereafter the contract was carried on the books of the Tonawanda Cataract Power Co. at $134,500, and when taken over by the taxpayer was set up on its books at that figure.

We have then one company with a distribution system but without a power contract to enable it to obtain electric power at such a cost as to enable it profitably to furnish power to its customers, it having only a steam plant, and we have another company with a power contract by which it could secure electric energy produced by hydraulic power at a price less than it could be produced by steam, but without a distribution system.

We have in the record the testimony of persons familiar with conditions at the time and place and who were qualified by training and experience to testify as to values of such a contract as the “ Hill contract” was. The actual intrinsic value is shown by the saving that could be made by obtaining power under it as compared with the cost of generating power by the steam plant. The steam plant could not be operated in competition with hydraulic power.

We have also the evidence of subsequent events supporting the testimony of the witness above referred to. There was testimony to the effect that a similar contract could have been obtained by any reputable person or company of financial responsibility without cost; fet others could not have obtained it for this particular territory when it once was entered into. It is not unusual that valuable exclusive franchises are obtained without consideration, yet, when obtained, can be sold by the grantee of recipient for a large consideration.

From a consideration of all the evidence, we are of the opinion hat the “ Hill contract ” had an actual cash value of $100,000 when required by the taxpayer.

The next question is: Was the “ Hill contract ” a tangible or intangible asset? It is argued by the taxpayer that it was tangible property; that it was in the nature of a lease of tangible property. With this view we do not agree. It was simply a contract to furnish electric energy to be produced in the future and was not a lease of sxisting tangible property. The taxpayer had the right, in case of breach of contract, to the use of the tangible property — that is, the generators and other machinery — but, in the absence of a breach, no right in or use of tangible property was involved. It was in no sense a lease of any property, and we are of the opinion that the contract referred to was intangible property and that it should be ncluded in invested capital subject to the statutory limitation on ntangibles.

Order of redetermination will ~be entered on 15 days’ notice, under Rule 50.