author: Hill : Opper,

text:
    William A. Webster Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88700.
    Promulgated May 5, 1938.

      F. E. Hagler, Esq., and Edgar A. Ryerson, G. P. A., for the petitioner.

      Marry R. Morrow, Esq., for the respondent.
   OPINION.

Hill :

This proceeding is for the redetermination of deficiencies in income and excess profits taxes for the fiscal year ended February 28, 1934, in the amounts of $2.34 and $2,357.99, respectively. Petitioner assigned as errors the action of the respondent (a) in failing to allow “certain depreciation on Furniture and Fixtures”, and (b) in failing to allow “the declared value of Capital Stock as stated by the petitioner”, which alleged errors were denied by respondent.

The first issue above indicated apparently was abandoned by petitioner, no evidence being offered thereon. In its brief petitioner states:

There is only one question presented in this appeal. It is: May a taxpayer make a second, amended, or corrected declaration of value for its capital stock tax prior to the expiration of the period provided for making such declaration?

The deficiencies determined by respondent are, therefore, approved in so far as they result- from the adjustment of depreciation, and we will consider here only the second issue.

The facts were stipulated in part, and none is in controversy. Petitioner is a Tennessee corporation, with its principal office at Memphis. On July 29, 1933, petitioner filed on the form provided therefor a return of capital stock tax for the year ended June 30,1933, which return disclosed an original declared value for petitioner’s entire capital stock of $395,157, and on the same date petitioner paid to the collector of internal revenue the capital stock tax shown to be due on such return in the amount of $395.

On September 8, 1933, and within the time for filing capital stock tax returns for the year 1933, as extended by Treasury Decisions 4368 and 4386, petitioner filed on the form provided for capital stock tax returns a return intended by it as an amended return for the year 1933, but which is not admitted by respondent to be an amended return, or any return whatsoever, which disclosed an original declared value of $800,000 for the entire capital stock. On the same date petitioner paid to the collector of internal revenue $405, which is the difference between the amount of capital stock tax shown to be due by the alleged amended return, which was $800, and the amount theretofore paid, which was $395.

Under date of June 12,1934, respondent issued his notice of refund, with which there was enclosed a Treasury check for $423.13, being for the return of the $405 so paid on September 8,1933, together with $18.13 as interest thereon. This check has never been endorsed or cashed by petitioner, who never made claim or demand for same.

Under date of January 18, 1937, respondent issued his notice of deficiency for petitioner’s fiscal year ended February 28, 1934, which notice asserted a deficiency in income tax of $2.34 and a deficiency in excess profits tax of $2,357.99, all of which the parties have stipulated is due and assessable on the basis of a declared value for petitioner’s capital stock of $395,157, but none of which is due or assessable on the basis of the declared value of $800,000.

The question presented here is governed by sections 215 (f) and 216 (a) of the National Industrial Recovery Act, 48 Stat. 195, 208, quoted in the margin. The language used in the pertinent provisions of the statute appears too plain and unambiguous to require interpretation. In construing the words of an act of Congress the purpose is to seek the legislative intent, and we should “give to the words their natural significance unless that leads to an unreasonable result plainly at variance with the evident purpose of the legislation.” Lincoln v. Ricketts, 297 U. S. 373, 376. The plain, obvious, and rational meaning of a statute is always to be preferred. Old Colony Railroad, Co. v. Commissioner, 284 U. S. 552.

The pertinent language used in the quoted statute is that, in valuing the capital stock of a domestic corporation for purposes of the capital stock tax, “the adjusted declared value shall be the value, as declared by the corporation in its first return under this section (which declaration of value can not be amended).” Petitioner filed its first return pursuant to the statute on July 29, 1933, in which it declared the value of its entire capital stock to be $395,157, and paid thereon the tax due in the amount of $395. Later, on September 8, 1933, but within the time as extended for filing capital stock tax returns, petitioner filed its so-called amended return in which it sought to amend its former declaration of value by increasing the amount thereof from $395,157 to $800,000. We think this action was plainly prohibited by the express terms of the statute. No question is raised here that the enactment was unconstitutional.

The legislative intent is not difficult to discover, and strongly indicates that the words used, when given their natural and commonly understood meaning, aptly expresses such intent. Under the capital stock tax provisions of the earlier revenue acts, much administrative difficulty was encountered in determining the value of capital stocks. In order to obviate that situation, a new plan was adopted ip the enactment of the present law. The capital stock tax imposed was to be computed for the first year on the basis of value of the stock as declared by the corporation in its first return, with the proviso that such original declaration of value could not thereafter be amended; and for subsequent years, it was provided that the original declared value, as modified only by changes in the capital structure, should be the basis.

However, in order to assure a reasonable original declaration of value, an excess profits tax was levied upon the net income of the corporation in excess of 121/2 percent of the adjusted declared value of its capital stock. Hence, while a declaration of low value for the capital stock would reduce the capital stock tax, it would tend to increase in a much larger amount the excess profits tax in the event the corporation later had substantial net income. See report of the Senate Committee on Finance, No. 114, p. 6; H. R. 5755 73d Cong., 1st sess.

The obvious purpose of prohibiting amendment of the original declared value was to prevent a corporation from declaring an unreasonably low value for its capital stock in order to reduce the capital stock tax, at a time when it probably could not be determined what its net income subject to the excess profits tax would be, and then later, when such net income could be determined, reducing its excess profits tax by increasing the capital stock valuation through the filing of an amended capital stock tax return. But whatever might be the actual purpose of an attempt to amend the original declared value, the language of the statute is absolute; no exception is provided.

In Scaife & Sons Co. v. Driscoll, 94 Fed. (2d) 664, arising under the Revenue Act of 1935, which, in section 105 (f), contains the same provisions as the statute hereinabove quoted, the court had before it substantially the same question we are considering here and under similar facts. In its opinion the court said:

The statute declares that the declaration of value contained in the first return can not be amended. This language is plain, and it means what it says. Therefore the Collector possesses no power to accept and file an amended return' in lieu of the original return. It follows that no power lies in any court to enjoin the Collector from a refusal to accept a return, when that refusal is in accordance with the law.

A somewhat analogous question was considered by us in Automobile Loan, Inc., 36 B. T. A. 809. That case arose under section 351 of the Revenue Act of 1934, which imposes a surtax upon personal holding companies, but in subdivision (d) provides that the tax shall not apply if all the shareholders of the corporation include, at the, time of filing their returns, in their gross income their entire pro rata shares, whether distributed or not, of the “adjusted net income” of the corporation for the taxable year. In the cited case the shareholders of the petitioner corporation, a personal holding company, filed their first or original returns without reporting in gross income their pro rata shares of the corporation’s adjusted net income, and later, but within the time allowed the corporation for filing its return, they filed “amended returns” including in gross income their pro rata shares of the corporation’s adjusted net income. We held that “the time of filing their returns” was when the first returns were filed, and that the requirements of section 851 (d) were not met by the filing of the “amended returns.”

Petitioner cites and relies upon the decision of the United States District Court for the Western District of Kentucky in Oertel Co. v. Glenn, 13 Fed. Supp. 651, wherein it was held that a taxpayer corporation filing a capital stock tax return, showing total value of its outstanding stock to be an amount which was its book value, could correct the mistake by filing an amended return before the excess profits tax liability had accrued, showing value of capital stock determined by capitalization of earnings and including intangibles not on the books. With all due respect for the court, we are unable to accept its reasoning, or to agree with the conclusions reached.

In accordance with what we have said hereinabove, we hold that the declaration of value contained in petitioner’s first return could not thereafter be amended, and respondent’s determinations are approved.

Reviewed by the Board.

Judgment will he entered for the respondent.

Opper,

dissenting: We regret our inability to concur in the conclusion reached by the majority. But it seems to us that this result is unnecessarily inequitable and harsh, and contrary to the evident if not to the explicit intent of the statute.

Section 215 of the National Industrial Recovery Act “provides for a new tax.” Subdivision (a) of that section imposes the tax “For each year ending June 30” and subdivision (d) requires “Every corporation liable for tax under this section” to “make a return under oath within one month after the close of the year with respect to which such tax is imposed * * It permits the Commissioner to “extend the time for making the returns and paying the taxes imposed by this section under such rules and regulations as he may ■prescribe with the approval of the Secretary, but no such extension shall be for more than 60 days.” (Emphasis supplied.) On June 23¡ 1933, the Commissioner, with the approval of the Acting Secretary, extended this period to August 31 by Treasury Decision 4368. On August 15, Regulations 64 were promulgated, article 55 of which confirmed this extension to August 31. On August 24 a further extension to September 29 was granted and Regulations 64 were amended accordingly.

Petitioner filed its original return for the first year on July 29, which was within the period fixed in terms by the statute; and attempted to file its amended return for the first year on September 8, which was after the original period had expired, but well within the final extension properly granted to September 29 by the amendment to Regulations 64. That the amended return was submitted within the permissible period is apparently conceded by respondent.

In seeking to determine the true meaning of the phrase “its first return”, as applied to this proceeding, resort to the general plan and purpose of the legislation may be of value. Sections 215, which imposes the capital stock tax, and 216, levying the excess profits tax, are closely related. We find that “In order to avoid controversy as to the value of the capital stock, the [capital stock] tax is imposed on the value declared by the corporation. A reasonable value is, however, assured by means of an excess profits tax * * * The primary object of this tax is to induce corporations automatically to declare a fair value for their corporate stock * * *.” (Emphasis supplied.)

To hold, therefore, that a corporation may not increase to its fair value the figure placed by it upon its capital stock is to apply the related provisions of the two sections in such a manner as precisely to defeat their declared “primary purpose.” Unless some inescapable legislative language or plan requires this consequence we feel it should be avoided. It is evident, however, that, as to the plan of the statute, no different result would have been reached had the petitioner refrained from declaring any value until the date when it submitted its amended return. Had it done so, it would concededly have been in position to proceed upon the value so declared. We can not see what harmful result could have been envisaged by Congress in permitting it to accomplish the same purpose by filing its amended return within the same period.

As to the language itself, an examination of section 215 seems to us to make it clear that when the words “first return” were used they were intended to designate the return for the first year, thus distinguishing that return from the one made for the subsequent year, in which the original value could not be amended. So far as we know, no tenable reason for any different meaning has ever been advanced. And that this is the true intent of the provision-is we believe evident from a statement made in connection with the provisions of section 701 of the 1934 Act which is in fañ materia with section 215. The managers on behalf of the House, in submitting the conference report on this section, said: “For the first year the tax is measured by the value of the capital stock as declared by the corporation as of the close of its last taxable year ending on or before June 30, 1934. The value of the capital stock having teen declared for the first year, such value may not be subsequently amended.” (Emphasis supplied.) Construing the critical words as we do to mean “its return for the first year”, no reason of logic or interpretation appears to prevent the acceptance by the Commissioner of an “amended return for the first year” subject only to the requirement that it be filed within the time provided by law.

The case of Scaife & Sons Co. v. Driscoll, 94 Fed. (2d) 664, may seem at first glance to authorize the result reached by the majority. But more careful inquiry reveals that in that case the amended return was filed after the period permitted by law. The same is true of Automobile Loans Inc., 36 B. T. A. 809. We think that distinction from the present proceeding is fundamental and that the principle of Oertel Co. v. Glenn, 13 Fed. Supp. 651, is applicable here and should be followed.

Arundell and Mellott agree with this dissent.

         Sec. 215. (f) For the first year ending June 30 In respect oí which a tax is imposed by this section upon any corporation, the adjusted declared value shall be the value, as declared by the corporation in its first return under this section (which declaration oí value can not be amended), as of the close of its last income-tax taxable year ending at or prior to the close of the year for which the tax is imposed by this section (or as of the date of organization in the case of a corporation having no income-tax taxable year ending at or prior to the close of the year for which the tax is imposed by this section). For any subsequent year ending June 30, the adjusted declared value in the case of a domestic corporation shall be the original declared value plus (1) the cash and fair market value of property paid in for stock or shares, (2) paid-in surplus and contributions to capital, and (3) earnings and profits, and minus (A) the value of property distributed in liquidation to shareholders, (B) distributions of earnings and profits, and (C) deficits, whether operating or nonoperating; each adjustment being made for the period from the date as of which the original declared value was declared to the close of its last income-tax taxable year ending at or prior to the close of the year for which the tax is imposed by this section. * * *
      Sec. 216. (a) There is hereby imposed upon the net income of every corporation, for each income-tax taxable year ending after the dose of the first year in respect of which it is taxable under section 215, an excess-profits tax equivalent to 5 pereentum of such portion of its net income for such income-tax taxable year as is in excess of 12% per-centum of the adjusted declared value of its capital stock * * * as of the close of the preceding income-tax taxable year (or as of the date of organization if it had no preceding income-tax taxable year) determined as provided in section 215. The terms used in this section shall have the same meaning as when used in the Revenue Act of 1932.

       48 Stat. 207.

       S. Rept. No. 114, 73d Cong., 1st sess., p. 6.

       See footnote No. 2, supra.

       Cong. Record, vol. 78, part 7, p. 7827.

       See McIntosh v. Wilkinson, 36 Fed. (2d) 807, 810. Cf. Grant v. Rose, 24 Fed. (2d) 115, 118; Buttolph v. Commissioner, 29 Fed. (2d) 695, 696.


source: Caselaw Access Project

author: Van Fossan :

license: Public Domain

text:
    Anna S. Whitcomb, Petitioner, v. Commissioner of Internal Revenue, Respondent. E. B. Whitcomb, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 80017, 85218, 85219, 87196.
    Promulgated May 5, 1938.

      J. E. Armok, G. P. A., for the petitioners.

      P. A. Bayer, Esq., for the respondent.
   OPINION.

Van Fossan :

These proceedings were brought for the redetermination of deficiencies in income tax as follows:

Many of the issues raised by the pleadings have been settled either by stipulation filed by the parties or abandonment by petitioner raising the issue.

The remaining issues are, first, whether Anna S. Whitcomb should be taxed on certain income derived from a trust, or whether, pursuant to an assignment executed by her, said income should be taxed to her husband, E. B. Whitcomb.

The second issue is whether husband and wife, residents of Michigan, may divide equally losses resulting from rental of realty owned by them as tenants by the entirety. '

The third issue is whether husband and wife, residents of Michigan, may divide and deduct from their respective gross incomes certain taxes paid on bonds jointly owned by them.

The stipulated facts are substantially as follows:

The petitioners, Edgar B. Whitcomb and Anna S. Whitcomb, are, and were throughout the years here under consideration, husband and wife, residents of Grosse Pointe Farms, Michigan. For the years 1932,1933, and 1934 they filed separate Federal income tax returns.

On May 4, 1906, James E. Scripps executed a trust agreement by which he transferred certain shares of stocks to three trustees for a period of 30 years ending May 4, 1936. The agreement provided in part that the trustees should pay all the income from the trust to the grantor during his life and (section (c)) after his death “at least fifty (50) per cent of all of the dividends, earnings or other income or revenue that shall come into their hands as holders of said stocks, in equal shares” to his four children, their heirs, and assigns, and (section (d)) also the remaining 50 percent thereof unless otherwise used for the improvement of the properties of the corporations in which the stock is held, or for reinvestment, or otherwise, in the discretion of the trustees; that (section (e)) at the termination of the trust the trust estate should be distributed as follows: 60 percent in equal parts to his children then surviving, 25 percent in equal parts to his grandchildren then surviving, and 15 percent in equal parts to Ms grandcMldren then surviving “of any children now surviving me”; and that:

(f) I expressly provide that this conveyance is made upon the express condition that no interest in the body or corpus of the estate hereby conveyed shall vest except in my said trustees, or their successors, until the termination of said trust, but as to the income accruing during the period of said trust, that such income shall and does vest subject to the terms of this instrument in my children now surviving me, their heirs, legatees or assigns. My said trustees and their successors are hereby expressly vested with the full and complete legal and equitable title to all of said stocks and properties until the termination of the trust created hereby, subject only to the obligation to execute such trust in accordance with the provisions of this instrument.

The trustees named in said trust instrument have ever since held and/or distributed such stock and the proceeds thereof, pursuant to the authority granted by the instrument.

Petitioner Anna S. Whitcomb is the daughter of said James E. Scripps, and is the same Anna S. Whitcomb mentioned in said trust instrument.

On January 31, 1933, petitioner Anna S. Whitcomb executed and delivered the following instrument and immediately notified the trustees of the trust estate of such fact:

Know All Men by These Presents, that on this 31st day of January A. D. 1933, I, Anina Scripps Whitcomb, Village of Grosse Pointe Farms, County of Wayne and State of Michigan, for and in consideration of the love and affection which I have and bear towards my husband, Edgar B. Whit-comb, Village of Grosse Pointe Farms, County of Wayne and State of Michigan, do by these presents give, grant, alien, assign, transfer and set over unto the said Edgar B. Whitcomb, and to his heirs and assigns forever, (subject to the following power of revocation), all my right, title and interest in and to one-half of all my interest in and to the income, rents, interest, reversion, remainder and remainders, both corpus and income therefrom, which from time to time may be payable to me or to which I may be hereafter entitled, under a certain Trust Agreement, dated May 4th, 1906, executed and delivered by my father, James E. Scripps, now deceased, to William E. Scripts, George G. Booth and Edgar B. Whitcomb, as trustees, the property comprising said Trust Fund and the Trustees of said fund being located in the said State of Michigan; with full power to demand, sue for and recover said one-half interest, for and in the name of said Edgar B. Whitcomb, and upon payment and receipt of the same or any part thereof to release and receipt for the same in such manner as shall be lawful and proper.
This Indenture of Agreement is executed and delivered upon the express condition that the undersigned reserves a complete power of amendment or revocation of this Indenture; in that the undersigned hereby reserves the right to revoke and/or amend this Indenture of Agreement, and thereby void any right, title or interest of Edgar B. Whitcomb herein or hereunder upon and at the expiration of twelve months and one day after notice of revocation as hereinafter set forth.
Such notice of revocation or amendment of this Indenture of Agreement, shall be in writing, signed by the undersigned, witnessed and acknowledged before a notary public and shall be served upon the said Edgar B. Whitcomb, or upon said Trustees herein above named, or upon both, either in person or by registered mail at least twelve months and one day prior to such revocation or amendment becoming effective.
In Witness Whereof, the said Anna Scripts Whitcomb, has hereunto set her hand and seal the day and year first above written.
Anna S. Whitcomb (L. S.)
Anna Sobipps Whitcomb
Signed in the presence of:
William J. Bees
Thomas J. Joyce, Jr.
State of Michisan
County of Wayne, ss :
On this 81st day of January, A. D., 1933, before me a notary public, in and for said County, personally appeared, Anna Sobipps Whitcomb, to me known to be the person described in and who executed the within instrument, who then acknowledged the same to be her free act and deed.
Martin C. Callahan
Notary Public, Wayne Co. Midi.
My commission expires: Nov. 29, 1935.

No notice of revocation was given by Anna S. Whitcomb prior to May 22, 1934. On May 22, 1934, Anna S. Whitcomb and Edgar B. Whitcomb mutually agreed to an immediate revocation of the aforementioned assignment dated January 31, 1933.

Pursuant to and by virtue of the terms of the instrument referred to above, cash distributions were made to petitioner Edgar B. Whit-comb, during the year 1933 by the trustees (which cash had previously been received by the trustees as dividends from stock of domestic corporations), in the aggregate amount of $94,437.22; likewise there was paid to Edgar B. Whitcomb by the trustees, during the period from January 1, 1934, to and including May 22, 1934, an aggregate amount of $90,750.

Edgar B. Whitcomb deposited these sums of $94,437.22 and $90,750 in a bank to the joint account of himself and petitioner Anna S. Whitcomb.

Respondent has included the $94,437.22 in Anna S. Whitcomb’s taxable income for the year 1933.

In their separate income tax returns filed for the year 1934, Anna S. Whitcomb reported the $90,750 as her income and Edgar B. Whit-comb did not report in his return for that year any of the $90,750 as being his income. The Commissioner of Internal Revenue has made no adjustment to the returns of either Anna S. Whitcomb or Edgar B. Whitcomb on account of said $90,750.

During the years here in question, Edgar B. Whitcomb and Anna S. Whitcomb owned, as tenants by the entirety, various parcels of real estate situate in the State of Michigan. The financial results from the ownership of such real estate for the years 1982, 1988, and 1934 were as follows:

The taxes and interest and other expenses shown above were paid out of a joint bank account of Edgar B. Whitcomb and Anna S. Whit-comb, his wife, and the checks in payment thereof were usually drawn and signed by M. O. Callahan, business manager.

In the Federal income tax returns which they filed for the years 1932, 1933, and 1934, all of the above taxes and expenses (except for some adjustments in amounts) were claimed as deductions by the husband, Edgar B. Whitcomb, and none of the expenses were claimed as deductions by Anna S. Whitcomb; likewise the income rents received for these years, as shown above, were included in the returns of the husband, Edgar B. Whitcomb, and none of the income was included in the returns of Anna S. Whitcomb.

Respondent has allowed no part of the losses shown above as deductions from Anna S. Whitcomb’s gross income, but has allowed Edgar B. Whitcomb to deduct the losses in full from his gross income. Respondent has included no part of the above mentioned income rents received in the gross income of Anna S. Whitcomb, but has included the same as income for the husband, Edgar B. Whitcomb.

During the year 1932, petitioners Edgar B. Whitcomb and Anna S. Whitcomb, owned, jointly, certain bonds. In order to make the bonds exempt from local personal property taxes, there was paid to the Treasurer for Wayne County, Michigan, the sum of $1,695.98 in payment of the so-called “Mortgage Tax”, as provided by Act 91 of the Public Acts (Michigan) of 1911.

Respondent has failed to allow Anna S. Whitcomb to treat any part of this tax payment as a deduction from her gross income.

The respondent contends that the assignment by Anna S. Whitcomb, beneficiary of the trust, of a portion of her distributive share of the income from the trust does not release the assignor from tax liability on that portion of the income paid to the assignee.

Petitioners bottom their argument against this contention upon the cases of Grace Scripps Clark, 16 B. T. A. 453; and Ellen S. Booth, 36 B. T. A. 141 (on appeal C. C. A., 6th Cir.) and in our opinion these cases are dispositive of the issue.

In the Clark case, supra, which deals with the same trust as here involved, Grace Scripps Clark assigned to her husband a “one-half interest in all income, grants, interest, reversion, remainder and remainders” which might thereafter be payable to her from the trust. This assignment was irrevocable. The Board there held that Mrs. Clark’s interest in the trust was an assignable interest and that the legal effect of the assignment was “to vest in the petitioner’s husband all right, title and interest in and to one-half of her interest in the trust fund, including the income therefrom. The distribution to the husband, therefore, was income to him and not income to his wife, the assignor.

The case of Ellen S. Booth, supra, likewise deals with the same trust. The assignment there was of the half interest in the trust and was made to an educational foundation. Express provision was made for the termination of the assignment by the assignor. The Board again upheld the validity of such an assignment, and held that although the assignment was revocable by the petitioner, it was, in effect, an assignment for a term of years, “since it could be revoked only to terminate at the end of the calendar year in which notice of revocation was given.”

See Blair v. Commissioner, 300 U. S. 5, relied upon in Ellen S. Booth, supra.

The instant case and the Booth case, then, to all purposes here pertinent, are identical, save for the distinction between their respective revocation provisions. This we believe to be a distinction without a difference. The conditions of revocation in the present case are substantially similar and are of the same legal effect as those prescribed in the Booth case.

It is true that an immediate revocation of the assignment was effected on May 22, 1934, by mutual agreement of the parties to the assignment, no notice of revocation being given. This action, in our opinion, does not in any way affect the legal tenor of the instrument, which is, of course, controlling here.

We, therefore, hold that by virtue of the assignment, E. B. Whit-comb became a beneficiary of the trust to the extent of the interest assigned, and the amounts paid by the trustees to him under the assignment are not taxable to Anna S. Whitcomb.

The amended petition of Anna S. Whitcomb in Docket No. 80017 alleges that the respondent erred in refusing to allow her as a deduction from gross income the sum of $847.99 “which amount represented a payment of taxes made by petitioner within the taxable year.” The facts relied upon by this petitioner, as set forth in her petition, are that these taxes in a total sum of $1,695.98 were on certain bonds which she and her husband had acquired jointly, and that one-half of such taxes, or $847.99, were taxes applicable to her interest in the bonds.

As heretofore mentioned, these cases were submitted on a stipulation of facts. That part of the stipulation covering this phase of the case merely recites: “In order to make said bonds exempt from local personal property taxes, there was paid * * * the sum of $1,695.98 in payment of the so-called ‘Mortgage Tax’ * * (Italics ours.) No facts are set forth evidencing that Anna S. Whit-comb paid any portion of such taxes. On this record we must hold the respondent did not err in this respect. William R. Tracy, 25 B. T. A. 1055 (reversed on other issues (C. C. A., 6th Cir.), 70 Fed. (2d) 93).

The respondent, in his brief, in effect concedes the remaining issue dealing with the deduction of losses resulting from the rental of real estate held by petitioners as tenants by the entirety. The cases of John H. Hart, 27 B. T. A. 528; affd. (C. C. A., 6th Cir.), 76 Fed. (2d) 864, and Herman Gessner, 32 B. T. A. 1258, are authority for deciding this issue in favor of petitioner.

Respondent raises an affirmative issue in Docket No. 85218 and requests that the income of E. B. Whitcomb for the year 1933, as shown by the notice of deficiency, be increased by any expenses or losses previously allowed as deductions, which the Board holds to be properly deductible by Anna S. Whitcomb. This adjustment should be made.

Reviewed by the Board.

Decision will be entered wider Rule 50.

Steknhagen and Mellott dissent.


author: Hill:

text:
    Thomas M. McIntyre, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 84755, 86853.
    Promulgated May 10, 1938.

      William F. Carpenter, Esq., for the petitioner.

      Hoary B. Horrow, Esq., for the respondent.
   OPINION.

Hill:

These are consolidated proceedings for. the redetermination of deficiencies in petitioner’s income tax for the taxable years 1933 and 1934 in the amounts of $600.91 and $44.08, respectively. Petitioner assigns as errors relating to each year the action of the respondent (a) in “treating the entire partnership income of McIntyre and Associates as income taxable to petitioner”, and (b) in “treating dividends on stocks owned jointly by petitioner and his wife as income taxable wholly to petitioner.” Respondent denies the errors alleged.

The second issue apparently has been abandoned by petitioner. It is not mentioned in his brief, and no evidence was offered thereon. Accordingly, on the second issue, we hold for respondent.

The first issue presents for decision the question whether or not during the taxable years a bona fide partnership for the conduct of a public accounting business existed between petitioner and his wife. Respondent computed the deficiencies on the basis of taxing to petitioner all of the net income derived from an accounting business conducted under the name of “McIntyre and Associates”, whereas petitioner reported in his return only one-half of such net income, and contends that his wife was a partner in the business, subject to tax on her distributive share of one-half of the net income.

Petitioner is an individual, residing at Nashville, Tennessee, and since 1925 has been engaged in the business of auditing books and doing tax work. Petitioner was a partner in the firm of McIntyre & Short from 1925 to June 1,1931, and was a partner in C. G. Robinson & Co. from September 1, 1931, to August 1, 1932. Thereafter, petitioner engaged in practice individually as a certified public accountant.

From time to time during the year 1932 petitioner borrowed money from his wife. The total amount so borrowed was $1,000. The money was not used by petitioner in his accounting business, but for personal and household expenses. In October or November 1932 petitioner and his wife discussed the matter of the formation of a partnership, and petitioner consulted an attorney as to the legality of a partnership in Tennessee between a husband and wife. About that time a penciled draft of a partnership agreement was drawn up, and was typed sometime around the first of January 1933. The instrument was not dated, but about a week or so after January 1,1933, it was signed by petitioner and his wife. The agreement recited the formation of a partnership, to be known as “McIntyre and Associates”, and in paragraph (4) stated that petitioner agreed to contribute his office furniture and fixtures, valued at $1,000, as his share of the partnership capital, and that his wife agreed to cancel her claim against petitioner for $1,000, representing funds advanced to him, as her share of partnership capital. It was further provided that the partnership should begin J anuary 1, 1933, and continue for a term of two years, unless dissolved by mutual consent of the parties.

In the 1932 Year Book of the American Institute of Accountancy petitioner was listed as a partner in “McIntyre and Associates.” This book was published about November or December 1932, or shortly after the annual meeting of the Institute on October 18-19, 1932.

Petitioner’s wife is not an accountant; she has no knowledge of accounting; she has never performed any services whatsoever in connection with “McIntyre and Associates”; and it was not understood in connection with the partnership agreement that she should perform any such services. Petitioner never represented to any of his clients that his wife was one of his “associates.” All accounting work done by petitioner during the taxable years was in behalf of “McIntyre and Associates.”

Petitioner’s bank account was not changed subsequent to execution of the partnership agreement, other than the printing of checks after J anuary 28, 1933, with the name of “McIntyre and Associates.” The bank account used in his accounting business during the taxable years was a continuation of the account he had been using for many years. Petitioner’s wife had no authority to draw checks on that account during the taxable years.

Prior to January 1, 1933, petitioner did not maintain any books of account in connection with the operation of his accounting business, and his receipts and disbursements were shown only by his check book stubs. After execution of the partnership agreement, no books of account were opened, the only records kept being check stubs. No books of account were kept by “McIntyre and Associates” until after a revenue agent made an investigation of petitioner’s 1933 return about the first of April 1935. No records were kept during the taxable years of the earnings of the so-called partnership. No accounting was made with respect to the so-called partnership interests during the taxable years. The only record showing withdrawal of funds by petitioner and his wife during the taxable years was made just prior to the hearing of this case in preparation for trial.

In 1933 petitioner opened a brokerage account for the purchase and sale of securities on margin. The account was in petitioner’s individual name and the funds used in that connection were obtained from the accounting business.

In the light of the foregoing facts, we think an extended discussion of the question presented is unnecessary. Aside from the execution of a more or less formal agreement of partnership, we are unable to find in the record any evidence of the existence during the taxable years of a bona fide partnership relation between petitioner and his wife. The device of a partnership between husband and wife or members of the same family is often resorted to solely for the purpose of avoiding or reducing tax liability by means of a division of the taxable income. While the formation of a partnership for legitimate business purposes between such persons is not to be denied recognition merely because of its effect on tax liability, the situation always justifies a close scrutiny of the surrounding facts and circumstances where the bona fides of the transaction is called in question. In Harry C. Fisher, 29 B. T. A. 1041, 1048; affd., 14 Fed. (2d) 1014, we said:

Arrangements within families for the diversion of income, while not necessarily subject to condemnation because of the close relationship of the parties, are always subject to careful scrutiny and clear and convincing evidence is required to establish their bona fides.

In the circumstances disclosed here the mere execution of the alleged partnership agreement is not alone sufficient to establish the formation of a bona fide partnership. As we pointed out in W. M. Buchanan, 20 B. T. A. 210, 212:

There must be credible evidence of acts, conduct, facts and circumstances demonstrating the alleged partner’s actual participation in the business and assumption of its responsibilities to those with whom the business is transacted. While husband and wife and other members of a family may be recognized as eligible to conduct themselves as a partnership, it is not lightly to be assumed or established that they do. When, in addition to the close family relation, by reason of which the statute gives them a peculiar election to file either joint or separate returns, they seek to establish a business relation as partners and thus to augment the peculiar advantage of such election, it is in our opinion no more than justice and good sense to require substantial circumstantial evidence to support the statements which they make in their own behalf. This is particularly true since the legal recognition of a partnership has in general litigation ever been affected by the course of conduct of the parties concerned as manifesting the partnership contract and not alone by the statements, prospective or retrospective, of understanding or intention.

Aside from the execution of the so-called partnership agreement, what primary facts and circumstances are disclosed in the instant case which demonstrate that the parties were in fact and in good faith associated together as partners in carrying on a public accounting business? Petitioner’s wife contributed no capital to the enterprise. The agreement recited that her contribution of capital consisted of the cancellation of the indebtedness of $1,000 owing to her by petitioner, but that did not constitute a contribution to partnership capital. The alleged partnership received nothing thereby. The claim was not transferred to the partnership, nor did petitioner pay into the partnership as capital the amount thereof. Neither did petitioner’s wife contribute services. She is not an accountant, and so far as shown she did not participate in any manner in the conduct of the business. No accounting was' made to her of any portion of the profits or earnings. She was not held out to the clients as a partner. In all material respects petitioner conducted his public accounting business subsequent to January 1, 1933, in substantially the same manner as theretofore. Even the proprietary name was not changed. Prior to 1933 petitioner carried on his business under the name of “McIntyre and Associates.” Subsequent to the formation of the alleged partnership the business was operated under the same name. One of the essential elements of a partnership is the contribution by each member of either property or services. See George M. Cohan, 11 B. T. A. 743, 757, and authorities cited. Petitioner’s wife contributed neither.

Humphreys v. Commissioner, 88 Fed. (2d) 430, cited and relied on by petitioner, is distinguishable in our opinion from the case at bar. There, the wives of both Humphreys and Day contributed substantial cash capital for the operation of the accounting business, and at the beginning contributed all of the capital so used. Because of its character and extent it appears that a large amount of capital was required for the successful conduct of the business. Respondent conceded that a bona fide partnership was formed, and the acts and conduct of the parties, aside from the written agreement.of partnership, demonstrated that this was true. The wives had separate bank accounts, and the distributive share of the net earnings of each member, including the wives, was accounted for and paid over.

From a careful consideration of all the evidence before us in the instant case, we can only conclude that the partnership agreement executed by petitioner 'and his wife was such in form only; that their subsequent acts indicate it was wholly without substance during the taxable years. It follows that no legal eifect can be attributed to it in the determination of tax liability. Cf. Gregory v. Helvering, 293 U. S. 465.

Judgment will he entered for the respondent.


author: Murdock: Oppee,

text:
    Amalgamated Housing Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent. Amalgamated Dwellings, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 80686, 80780.
    Promulgated May 10, 1938.

      I. Herman Sher, Esq., for the petitioners.

      I. M. Tullar, Esq., for the respondent.
   OPINION.

Murdock:

These petitioners claim that they are instrumentalities of the State of New York, performing an essential governmental function, and, therefore, are not subject to Federal income tax. They cite authorities to show that the housing board was an instrumentality of the state. They were private corporations conducting their own separate businesses and paying taxes to a political subdivision of the State of New York on the land which they owned. They were no part of the government of the State of Yew York and they may not escape Federal income tax upon the theory that they are instrumentalities of a state performing essential govermnental functions.

They also contend that they are exempt from tax under the provisions of section 103 (8) of the Revenue Acts of 1928 and 1932, because they are “civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare.” The statute does not define the term “civic league.” A league ordinarily implies an unincorporated association of persons who have associated themselves together for some common purpose, a covenant between two or more parties for the accomplishment of some purpose by their cooperation. Hughes v. State, 160 S. W. 209; Crooks v. Kansas City Hay Dealers’ Assn., 37 Fed. (2d) 83. “League” is defined in Funk & Wagnalls Yew Standard Dictionary, 1935, as “an alliance of persons, parties, states, etc., voluntarily maintained, for mutual support in the attainment of a common end.” The same authority defines “civic” as “of or pertaining to a city, a citizen, or citizenship.” A civic enterprise is a project in which citizens cooperate to promote in some way the common good and general welfare of the people of the community. It may be doubtful whether either of these corporations would come within the ordinarily understood meaning of the term “civic league.” See, however, Garden Homes Co. v. Commissioner, 64 Fed. (2d) 593, reversing 26 B. T. A. 441. But decision of that question is unnecessary because in any event each was an “organization.”

The case turns upon whether or not these corporations were “not organized for profit but operated exclusively for the promotion of social welfare.” They call attention to the fact that in section 103 various organizations are exempt from income tax, provided they are not organized and operated for profit, and provided further that no part of their net earnings “inures to the benefit of any private shareholder or individual”, while in the case of civic leagues, the last condition is omitted. Therefore, they argue that Congress intended to exempt civic organizations which are not organized for profit and are operated exclusively for the promotion of social welfare, even if a part of their earnings inures to the benefit of private shareholders or individuals. The petitioners discuss two cases in their brief after making the above contention. Neither case supports the contention made. They are cases like the case of Trinidad v. Sagrada Orden de Predicadores, 263 U. S. 578, also cited by the petitioners. The Court in the latter case held that a religious organization was not subject to tax where, as a mere incident to its religious work, it carried on a profitable business, but used the gain derived therefrom entirely to further the religious work that it was doing. The other cases cited by the petitioner, including Unity School of Christianity, 4 B. T. A. 61, and Hanover Improvement Society, Inc. v. Gagne, 92 Fed. (2d) 888, are similar cases. But in the present case the profits of these corporations did not have to be used to further the work which they were doing. Instead, those profits were used, at least in part, to compensate the private capital which the corporations needed and had to have in order to begin their operations.

The case of Garden Homes Co. v. Commissioner, supra, is probably more like the present case than any of the others cited. The mayor of Milwaukee, believing that a shortage of housing facilities existed in the city, appointed a housing commission in 1918. That commission, in November of the same year, reported that wage earners should be aided in acquiring homes, and suggested legislation to stimulate the erection of homes for them. A law was enacted in 1918 which granted to housing corporations the general powers of other corporations. They were also given the power to erect dwellings and lease them exclusively to stockholders of the corporation. The tenants were not permitted to hold stock in excess of the value of the premises occupied. No dividends were to be declared upon the stock of the corporation to anyone not a tenant in excess of 5 percent of the par value of the stock. Ten percent of the profits had to be set aside to retire the preferred stock. Both common and preferred stock had voting powers. The mayor had the Garden Homes Co. organized under that law. It issued over 2,700 shares of preferred stock, a number of which were purchased by the city and county.- The remainder was purchased by numerous firms and individuals who were appealed to on the ground that the project was a civic enterprise and not a money making scheme. Dividends were paid on the preferred stock. The corporation secured substantial loans from banks, on which it paid 6 percent. It constructed 105 houses. Much of the work necessary for the accomplishment of the project was contributed by various city employees, without compensation. The corporation had only three salaried employees, whose total salaries were small. The occupants of the houses were required to pay rent. Later, pursuant to an amendment to the law, houses were sold to certain of the tenant stockholders. The directors passed resolutions providing that any excess amounts held by the corporation should be refunded to the property owners at the time of final dissolution. The court held that the owners of preferred stock certificates were in fact creditors and not stockholders. It further held that the monthly payments were not rentals, and, since the excess of those payments over the amount necessary to pay expenses and fixed charges, including dividends on and retirement of the preferred stock, had to be applied in payment for tenant stockholders’ common stock, it constituted capital contributions and was not profit to the petitioner. The following quotations are from the opinion of the court:

In the instant case, however, there was no return whatever to petitioner in excess of the expenses, except the amounts which it was bound to apply upon the common and preferred stock, and in this respect it was acting as a mere conduit, without remuneration except its expenses, in performing the promise it had made to the tenant stockholders.
* * * * * * *
If the so-called dividends upon the preferred stock and the payments upon the common stock are to be considered as profits to the taxpayer, then the intention of the parties and the object of the organization will be defeated. We are convinced that under the facts here presented petitioner was not organized for profit and that none accrued to it.

It might be said with equal force in the present proceedings that the petitioners were mere conduits which could not retain any of the income as their own. But with all due respect to the Seventh Circuit, we do not think that the conduit theory is a sound one upon which to hold that the present petitioners were not organized for profit. This question is not entirely dependent upon whether they were engaged in social service. Suppose that a corporation existed which was like this one except that its tenant stockholders were in higher income groups, so that the social welfare feature would be eliminated. Would anyone contend that the corporation was not organized for profit or that it did not have any income merely because that income had to be used to pay off a mortgage, to retire the preferred stock, to pay dividends on preferred stock, to pay expenses of the corporation, or to make a refund to the tenants ? Most corporations exist only to earn profits and to distribute those profits to their stockholders. These two petitioners earned profits and those profits can not be distinguished from the profits earned by any other corporation. The statute contains no provision that all corporations which return their earnings to their stockholders are exempt from tax. Unless there is some specific exemption in tlie statute, tliey must pay taxes on tlieir earnings even though they exist only to immediately turn those earnings over to their stockholders. Since it can not be said that these petitioners were “not organized for profit”, they must be treated like any other corporation for the purpose of computing their income tax liability. Cleveland Railway Co. v. Commissioner, 36 Fed. (2d) 347, affirming on this point 10 B. T. A. 310; certiorari denied, 281 U. S. 743. Cf. Citizens’ Water Co., 32 B. T. A. 750; Citizens Water Works, Inc., 33 B. T. A. 201.

We are mindful of the fact that these corporations were organized under a special law of the State of New York, which was enacted for the purpose of relieving unsatisfactory housing conditions for residents of the state whose earnings were small, that their surplus could not exceed 12 percent of their capital stock and any excess earning's would either have to be distributed to tenants or turned over to the State of New York upon final dissolution. The state, in limiting the dividends to 6 percent, and in otherwise restricting the projects, did not intend or desire to discourage entirely the use of private capital, which could be interested only by prospects of a profit. The framers of the act sought merely to eliminate the speculative features of a purely commercial enterprise, but they intended to have the projects present a sound investment. The provision for 6 percent on the stock was deliberately designed to encourage the use of private capital in projects which might develop under the act. The private limited dividend corporations organized under the act were permitted to sell their common and preferred stock to any investor who would buy. The purchasers did not have to be tenants. Some of the companies organized under the law were financed by private capital through the sale of common and preferred stock to any investor who would buy. It seems clear that those corporations were organized for profit and were not operated exclusively for the promotion of social welfare. Housing chose to sell its common stock to tenants only, but that Avas not true of its preferred stock. Although the preferred was rather closely held, the record does not indicate that the purchasers were not prompted to make their investments because of the prospects of financial profits. Each corporation was in position to permit the sale of its common stock to outsiders. The corporations during the taxable years here in question were operated in such a way as to permit the payment of dividends on the preferred shares. Those preferred stockholders were just as much stockholders as are preferred stockholders of any other corporation. Neither of these organizations comes within the provisions of section 103 (8). Each was organized in part for profit, even though the profit was limited, and neither was operated exclusively for the promotion of social welfare.

In United States v. Anderson, 269 U. S. 422, the Court said that the departmental regulation permitting returns to be made in accordance with books kept on an accrual system of accounting was to permit expenses which are incurred in and properly attributable to the process of earning income to be charged against the income thus earned. It permitted a tax to be accrued in advance of the assessment of the tax where all of the events had occurred which fixed the amount of the tax and determined the liability of the taxpayer to pay it. These-taxpayers were required to renovate their apartments at least every so many months. The need for the renovating was obviously occasioned by the occupancy and use of the apartments during the preceding period of months, and the petitioners set up a reserve from the rent received during that period sufficient to pay, for the renovating at the end of the period. Although that method may have been good accounting, nevertheless, until the end of the period the events had not occurred which determined the liability of the taxpayers to pay for the renovating represented by the additions to their reserves. They did not have to wait until they had actually paid for the renovating before they could accrue their liabilities to pay for that renovating, but, on the other hand, they could not properly accrue as an expense the estimated cost of the renovating prior to the end of the period of months, and prior to the time that the painter rendered some services. Yost Auto Co., 26 B. T. A. 685; Hallack & Howard Lumber Co., 18 B. T. A. 954; Quality Roofing Co., 16 B. T. A. 1371; Jahncke Shipbuilding Co., 11 B. T. A. 479; McCauley-Ward Motor Supply Co., 10 B. T. A. 394; Amigo Coal Co., 8 B. T. A. 598. Although the petitioners were obligated to renovate, they had no liability to pay anyone anything until someone had performed some services. The accrual is for services in renovating, not of the duty to renovate. The accrual method does not permit the anticipation of future expenses prior to the rendition of the services for which the payment is due.

Reviewed by the Board.

Decision %oiTl be entered for the respondent.

Oppee,

dissenting: We are with deference compelled to depart from the majority opinion, since it seems to us this proceeding should have been decided in favor of petitioners on the authority of Garden Homes Co. v. Commissioner, 64 Fed. (2d) 593, which we are unable to distinguish. Discussion of the first point decided by the majority would then have been unnecessary. In view of the explicit legislative findings not only of the State of New York, but more recently of the United States (U. S. Housing Act of 1937, sec. 1, 50 Stat. 888), and of the underlying factual basis which is a matter of public record, we prefer not to treat the first part of the majority opinion as concluding that the construction and operation of housing for families of low income is not a governmental function. There may well be grounds for disposing of the constitutional issue not apparent in the majority opinion, and proceedings arising in the future will perhaps require their consideration. But, in view of our belief that the proceeding before us should have been determined as a matter of statutory construction, we are of the opinion that discussion of the constitutional question was superfluous.

Keen agrees with this dissent.


author: Hill :

text:
    Edward J. Miller, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 85083.
    Promulgated May 10, 1938.

      Robert Ash, Esq., for the petitioner.

      Jonas M. Smith, Esq., for the respondent.
   OPINION.

Hill :

This proceeding is for the redetermination of a deficiency in petitioner’s income tax as determined by respondent for the year 1933 in the amount of $3,857.85. The amended pleadings raise the following issues: (1) Whether or not respondent erred in holding that petitioner’s salary of $5,000 as president of the board of water works of the city of Louisville is not exempt from Federal taxation; (2) whether or not respondent erred in not allowing as a deduction from income interest paid on borrowed money in the amount of $242.91; (3), (4), and (5), whether or not respondent erred in not allowing as deductions from income the amounts of $5,917.69, $1,901.38, and $1,744.34, of which the first represents expenditures by petitioner on account of loss claims for insurance placed by him, the second represents unearned commissions which had been accrued as income, and the third represents prepaid premiums on canceled insurance policies.

Respondent now concedes issues (1) and (2). Accordingly, on those issues we hold for petitioner.

Issues (3), (4), and (5), relating to deductions claimed by petitioner from gross income, will be considered together.

Petitioner is an individual, residing at Louisville, Kentucky. He is an insurance agent, and in 1933 represented about 12 insurance companies, selling all kinds of insurance, except life insurance. From 1919 to January 6,1933, with the exception of an intervening period of about six months, petitioner represented the Union Indemnity Co. of New Orleans, as general and local agent.

Petitioner did not send out any advertisements of insurance companies, or advise his customers of the companies in which their insurance would be placed, because he wished to create business for himself and not for any particular insurance company he might happen to represent at the time. His customers first knew what companies had their insurance when the policies were delivered to them. They were not primarily concerned with the companies in which they were insured, but placed their insurance with petitioner because of their confidence in him.

On January 6, 1933, petitioner received a telegram from the home office of the Union Indemnity Co. advising that it had failed. On the same date the Massachusetts Bonding & Insurance Co. agreed to accept all policies of petitioner’s customers in the Union Co. for their unexpired terms at pro rata rates. Thereupon all such policies in the Union Co. were canceled and rewritten in the Massachusetts Co.

When the Union Co. failed, certain of petitioner’s customers had matured claims against the company under their policies, and petitioner personally paid such claims. In 1933 the claims so paid amounted to $5,917.69. Petitioner paid the claims in order to retain his customers. It had long been petitioner’s policy to pay small claims, sometimes when not specifically covered by a policy, rather than to lose the customer’s business. Pursuant to such policy petitioner has retained the insurance business of all the customers whose claims he paid, and has since received substantial additional commissions thereon.

Petitioner procured assignments of his customers’ claims against the Union Co., and filed them with the receiver. The total amount paid on claims matured under policies and claims for prepaid insurance was $375.78, which petitioner received on August 1, 1936, and reported as income in his tax return for that year.

When petitioner wrote policies of insurance for his customers in. the Union Co., he accrued his commissions as income on his books and reported the full amounts as income in his tax return. When the policies were canceled because of failure of the Union Co., $1,901.38 of such commissions had not been earned. When the policies were rewritten at pro rata rates in the Massachusetts Co. and the premiums paid by petitioner, he again accrued as income his full commissions on sucli premiums. Due to an oversight, the amount of $1,901.38 was not claimed as a deduction by petitioner in -his return for the taxable year 1933.

Under petitioner’s arrangement with the Union Co., he was required to pay premiums on the first day of the second month following the month in which the policies were written, whether or not petitioner had collected from his customers. When the Union Co. failed and the policies were canceled, petitioner had prepaid premiums in the amount of $1,744.34. He procured assignments from his customers and filed claims with the receiver for the company, but recovered in that connection only the amount of $375.78 before referred to. Because of an oversight the prepaid premiums were not claimed as a deduction in petitioner’s income tax return for 1933.

Substantially the same question is presented here respecting at least two of the deductions claimed by petitioner, and respondent argues that the same question is involved as to the other deduction.

What constitutes an allowable deduction for ordinary and necessary business expense often raises a difficult question under the facts, and quite as often requires a border-line decision. However, it is well settled -that expenditures made to protect or to promote a taxpayer’s business, and which do not result in the acquisition of a capital asset, are deductible. The difficulty sometimes lies in determining whether the acts done were motivated by a purpose to protect or to promote the business. For a comprehensive discussion of this point, and citation of authorities, see First National Bank of Skowhegan, Maine, 35 B. T. A. 876, 884.

During the taxable year, when the Union Indemnity Co. became insolvent and went into receivership, petitioner paid claims of his customers in the total amount of $5,917.69, which had matured under policies written by that company. Petitioner also immediately canceled all policies held by his customers in the Union Co., and rein-sured them in the Massachusetts Co. at a cost to himself of $1,744.34. He was under no legal or moral obligation to make such expenditures, but he considered it good business judgment to do so. Such had been his long-established policy, and subsequent events demonstrated the wisdom of his action. He thereby retained the insurance business of all his customers who were affected by the failure of the Union Co. One of those same customers has continued to pay petitioner premiums of approximately $19,000, on which he receives an additional commission of 12 percent gross; and another has continued to place insurance with petitioner amounting to a maximum of approximately one million dollars. The additional commissions which petitioner’s action has enabled him to earn are largely in excess of the aggregate of his expenditures. Obviously petitioner’s purpose was to protect and promote his business. Petitioner so testified, and we think his testimony is not incredible. It is supported by the surrounding facts and circumstances, and there is no evidence of any other motive.

Respondent lays stress upon the fact that petitioner was under no legal obligation in the premise, but made the expenditures voluntarily. This, we think, is immaterial. Many expenditures made without legal compulsion are deductible, such as insurance premiums on business property, bonuses to a taxpayer’s employees, donations resulting in business benefits, and numerous others. In Louisiana Jockey Club, Inc., 13 B. T. A. 752, the petitioner, without legal obligation, paid a note which had been assumed by the city of New Orleans as a part of the purchase price of land. The payment was made by the taxpayer in order to obtain immunity from interference by city authorities with the conduct of its business, and thus was made to protect and promote its business. This Board held that the amount so paid was a legal deduction from gross income as an ordinary and necessary business expense.

Respondent further contends that the amounts in controversy were expended by petitioner in order to retain the good will of his customers; that good will is a capital asset and expenses incurred because of it are not deductible, citing Washburn v. National Wall Paper Co., 81 Fed. 17. We are unable to accept the premise of respondent’s argument. By the expenditures in question, petitioner acquired no capital asset in the form of good will beyond the extent, if any, by which his good will incidentally was thereby benefited. And we think an expense deduction otherwise allowable is not to be denied merely because incidentally it affects good will. Furthermore, if the expenditures were made to retain good will, as respondent contends, then the purpose was to protect — that is, to prevent the destruction of — a capital asset, and so come within the allowable class.

In Welch v. Helvering, 290 U. S. 111, cited in respondent’s brief, the taxpayer paid portions of the claims of former customers of a bankrupt corporation, of which he had been secretary, in order to strengthen his individual standing and credit, and to reestablish business relations with the corporation’s former customers. The Court held that such expenditures were not deductible as ordinary and necessary business expenses. The present proceeding, in our opinion, does not come within the doctrine of the Welch case. There the expenditures were made to acquire, and not to retain or protect and promote the taxpayer’s business. Cf. First National Bank of Skowhegan, Maine, supra, at page 884.

For the reasons indicated, we hold that petitioner is entitled to deduct from gross income for the taxable year the amounts of $5,917.69 and $1,744.34 hereinabove referred to.

The remaining deduction claimed by petitioner would, under respondent’s contention, be controlled by our decision above in respect of the other two deductions. However, we prefer to rest our conclusion upon a slightly different basis. Petitioner accrued on his books and reported in his tax return as income the full amount of commissions due him on all policies written by the Union Co. When those policies were canceled the amount of $1,901.38 represented unearned commissions. The policies wei’e rewritten in the Massachusetts Co., and petitioner again accrued on his books and reported as income the full amount of his commissions thereon. He himself paid the premiums to the latter company, and was unable to collect the refundable premiums from the former company, except a small amount received in 1936 and reported as income in his tax return for that year. Thus, the amount of $1,901.38, representing the same earned commissions, was twice included in petitioner’s taxable income. To that extent his income was overstated, and to correct the error, he is entitled to a deduction in the amount claimed.

Respondent contends that the evidence is insufficient to show that the amount was included in petitioner’s income twice, and says that, because petitioner voluntarily paid the premiums on the new policies in order to retain the good will of his customers, he is not entitled to the deduction. The latter point we have discussed above. As to the first point, from a careful consideration of the evidence of record we think it is clear that petitioner did in fact twice include the amount in his reported income. He so testified, and his testimony is un-contradicted. His explanation of the transaction seems to us to be reasonable.

Judgment will be entered u/nder Bule 50.


author: Smith :

text:
    Harold S. Denniston and Mrs. Florence F. Denniston, Husband and Wife, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91728.
    Promulgated May 12, 1938.

      George E. H. Goodner, Esq., for tlie petitioners.

      Francis S. Gettle, Esq., for the respondent.
   OPINION.

Smith :

The position of the respondent on the issue presented was stated by his counsel at the hearing as follows:

* * * Out position is that the note was worthless when he got it on May 24, 1934, and it was worthless at the end of the year. Really there was no loss sustained on the note. Our contention is that on May 24, 1934, when Mr. Denniston exchanged his mortgage for Home Owners Loan Corporation’s bonds, there was an exchange from one property to another, which resulted in a taxable transaction. Now he got less than the face of the mortgage, If there was any loss, it was sustained at that moment. The evidence shows that the bonds came direct to Mr. Denniston, and never went to the mortgagors. * * *

We think that respondent’s position is untenable. In the first place, we do not agree with respondent that our question here is limited to whether the petitioner sustained a deductible loss upon the exchange of his mortgage for HOLO bonds, cash, and the new note of the Loves.

The statutory grants of deductions of business losses and of bad debts are separate and distinct and, it has been ruled, are mutually exclusive. Lewellyn v. Electric Reduction Co., 275 U. S. 243; Spring City Foundry Co. v. Commissioner, 292 U. S. 182. Money due on a note is a debt within the meaning of the revenue acts. Porter v. United States, 27 Fed. (2d) 882. The amount owing to the petitioner as principal on the Loves’ note, $20,500, and the accrued interest thereon was a debt; and the nature of the debt was not changed by the fact that it was secured by a mortgage.

The distinction required by the statute between deductions of bad debts and business losses does not arise so long as the debt or the asset is passively held by the taxpayer. The distinction becomes operative when the property is disposed of or the debt becomes worthless and the taxpayer seeks to account for the result in the computation of his income tax. For instance, if a debt, whether secured by a mortgage or not, is purchased for investment purposes and is sold thereafter for a lesser amount, the difference is deductible as a business loss, subject to the statutory limitation on capital losses. If, on the other hand, the debt is not sold but becomes worthless in the hands of the purchaser, his investment therein is deductible as a bad debt if he ascertains the debt to be worthless within the taxable year and charges it off in his accounts or in his income tax return. This dual nature of debts, and specifically “mortgages”, was commented on by the Circuit Court of Appeals for the Third Circuit recently in Brown v. United States, 95 Fed. (2d) 487, in the following language:

Incidentally mueli time and space has been devoted in the oral argument and printed Briefs to the question whether the failure of the taxpayer to realize on this mortgage investment resulted in a bad debt or a loss. The truth is that a mortgage is amphibious. When given, as is usual and as here, to secure the payment of a bond, the bond is a debt, and if worthless is a bad debt. On the other hand, a mortgage is a conveyance. It is conditional but none the less a conveyance, which becomes absolute if the grantor does not pay his bond. This right to redeem is called the mortgagor’s equity of redemption which may be foreclosed and in consequence gone. The very purpose of a foreclosure proceeding is to put an end to the right to redeem and thus to make the conveyance to the mortgagee absolute and unconditional. In this view a mortgage is an investment in real estate. It is idle, however to spend time over this question because the Regulations classify cases such as this as “bad debts,” and the District Court so ruled it to be. It is a “bad debt” loss. The sole question is whether it was “ascertained and charged oif” within the taxable year.

The court there held that the uncollectible portion of a foreclosed mortgage which the taxpayer had purchased for investment was deductible as a bad debt.

The respondent is in error, we think, in regarding the transaction by which the petitioner surrendered his mortgage and received the bonds of the HOLO as an exchange of property which finally determined the petitioner’s tax liability in respect of his entire interest in the indebtedness of the purchasers for the unpaid purchase price of the property.

The facts clearly show that the petitioner did not exchange his mortgage for HOLO bonds. A mortgage on real estate is regarded in most jurisdictions merely as a security for the debt. Carpenter v. Longan, 16 Wall. 271; 88 U. S. 271. The dominant attribute of a mortgage is the security for the debt. United States v. Commonwealth Title Insurance & Trust Co., 193 U. S. 651. “A mortgage is always regarded as an accessory to the principal thing.” Barry v. Snowden, 106 Fed. 571. See also First Trust Co. v. Crooked Creek & Coal Co., 243 Fed. 450; Sexton v. Breese, 135 N. Y. 387; 32 N. E. 133; In re Cossitt's Estate, 204 App. Div. 545; 198 N. Y. S. 560.

A mortgage can not be transferred or assigned separate from the debt which it secures. Carpenter v. Longan, supra; In re Pirie, 199 N. Y. 524; 91 N. E. 1144; Goettlicker v. Wille, 156 App. Div. 392; 134 N. Y. S. 977. In Carpenter v. Longan, supra, the Supreme Court said;

The note and mortgage are inseparable; the former as essential, the latter as an incident. An assignment of the note carries the mortgage with it, while an assignment of the latter alone is a nullity. * * *
All the authorities agree that the debt is the principal thing and the mortgage an accessory. * * *' The mortgage can have no separate existence. * * *

Since the petitioner here did not transfer or assign the entire debt of the Loves he did not transfer and could not have transferred the mortgage securing the debt. What he did, actually, was to surrender his mortgage in consideration for a partial payment of the debt in the form of the HOLC bonds and a small amount of cash. The balance of the debt remained unsatisfied, as all of the interested parties understood and agreed, and was evidenced by the new unsecured note which the Loves gave the petitioner. This note was not received in exchange for any other property and we are not concerned with its cost or value at the time of its receipt. It merely represented the unpaid portion of the old indebtedness. If this note or the amount of the indebtedness which it represented was reasonably ascertained to be worthless and charged off by the petitioner within the taxable year, it is deductible as a bad debt in his income tax return.

The respondent relies upon Josephine C. Bowen, 37 B. T. A. 412. It was there held that where a taxpayer mortgagee in 1934 accepted bonds of the Home Owners’ Loan Corporation of less face value than her interest in certain mortgages which she had held for more than five years, but less than ten years, the transaction constituted an exchange of capital assets and that her deductible loss was limited by the provisions of section 117 of the Revenue Act of 1934. The facts here, however, are materially different from those in the Bowen case. There the taxpayer exchanged her mortgage note, that is, the entire indebtedness, for the HOLC bonds. Nothing of the old indebtedness remained after this exchange. It does not appear, either, that the taxpayer there claimed any bad debt loss in respect of the balance of the purchase money mortgage, nor was there any discussion of this question.

The simple facts in this case are that at the beginning of the year the Loves owed the petitioner a debt in the amount of $20,500. No part of this debt was ascertained to be worthless and charged off prior to the beginning of the taxable year. If the entire amount of the debt had been ascertained to be worthless and had been charged off during the year there could be no question but that the petitioner would have been entitled to deduct from his gross income of 1934 the full amount of $20,500. By the payment of $11,875 of HOLC bonds and $22.84 cash the debt was reduced to the amount of $8,602.16. This debt was ascertained to be worthless and was charged off the petitioner’s books of account in 1934. We are of the opinion that there can be no question but that the petitioner is entitled to deduct from his gross income of 1934 as a bad debt the amount of $8,602.16.

Since it appears that the deficiency was determined solely upon the ground that the petitioner was not entitled to the deduction of a bad debt in the amount of $8,602.16, and since we have held that he is entitled to such deduction, there is no deficiency due from the petitioner for 1934.

These findings of fact and opinion supersede the memorandum opinion in this proceeding entered March 15, 1938.

Reviewed by the Board.

Judgment of no deficiency will be entered.


author: Sternhagen :

text:
    Ludwig Littauer & Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91349.
    Promulgated May 13, 1938.

      Edgar B. Bronson, Esq., for the petitioner.

      John E. Marshall, Esq., 'and Edward A. Tonjes, Esq., for the respondent.
   OPINION.

Sternhagen :

The Commissioner has filed a motion to dismiss “for lack of jurisdiction in that no final determination of a deficiency has been made by the Commissioner and no notice of a deficiency has been sent by the Commissioner to the petitioner, as provided by section 272 of the Revenue Act of 1936.” Under date of August 21, 1937, he sent to the petitioner by registered mail a notice of his finding that the petitioner intended to hinder and prevent the collection of tax justly due for the period January 1 to August 21, 1937, and that, pursuant to the authority granted by section 146 of the Revenue Act of 1936, he declared immediately due and payable the taxes for such period; that an assessment had been made of a “total deficiency” of $94,435.85, which amount was declared immediately due and payable, and immediate payment thereof was requested upon presentation of notice by the collector. Within ninety days thereafter the petition was filed. The petitioner regards the notice as a notice of deficiency which supports a proceeding for redetermination in the Board.

Since the notice expressly states that it is sent by virtue of section 146, it may properly be regarded as taking its character from that section. The section has been repeatedly enacted in its present form since its first appearance as section 250 (g) of the Revenue Act of 1918. It should not be confused with section 272, prescribing the normal mode for the determination and assessment of a deficiency, nor with section 273, prescribing the system for making and contesting. an ordinary jeopardy assessment. Section 146 supplements these two sections to provide a means of protecting the Government from the loss of tax through the imminent disappearance of the means of payment. Unlike sections 272 and 273, it provides the extraordinary remedy of terminating the taxable year before the year would normally close and estimating the tax, which becomes immediately due and payable. In the body of the subdivision the word jeopardy is not used, but the subdivision is entitled “Tax IN Jeopardy.” Both the substance of the subdivision and its title indicate an intention to supply a remedy in emergency more extreme than that covered by section 273.

It has been consistently held that the Board has no jurisdiction to weigh the circumstances which the Commissioner officially regards as denoting jeopardy sufficient to impel him to safeguard the revenue. California Associated, Raisin Co., 1 B. T.A. 1251; Foundation Co. v. United States, 15 Fed. Sup. 229. After the expiration of a normal tax year the Commissioner, if he believes assessment or collection of a deficiency will be jeopardized by delay, must immediately assess, and may collect. Thus he is empowered in such circumstances to deprive the taxpayer of the normal procedure of contesting the determination of a deficiency before payment. It is only after the taxpayer receives the required notice of deficiency for the tax year that he may contest the jeopardy assessment which has already been made, and it is only by filing a bond that collection may be stayed pending the proceeding.

Since section 146, subdivision (a), presupposes a more exigent situation of jeopardy than that covered by section 273 — a situation so critical as to require immediate protective action rather than to await the close of the normal taxable year and the determination of a statutory deficiency — it can not be supposed that Congress intended to be more lenient, by permitting the taxpayer to avoid payment during litigation, than under the less perilous circumstances denoted by the jeopardy assessment of section 273. In both situations the Commissioner may assure collection without awaiting the Board’s redetermination. Section 273 requires the Commissioner to send a notice of deficiency upon which the taxpayer may institute his proceeding before the Board. There is no provision of the statute which with equal clarity requires a similar notice of deficiency following the use of the procedure of section 146. The notice required by that section is a notice of the finding that collection is in peril and the declaration of the termination of the taxable year. Any statement in such notice which might be made as to the amount of tax liability is but a provisional statement of the amount which must be presently paid as a protection against the impossibility of collection.

In this view of the nature of the notice given under section 146, the Bureau of Internal Revenue has published a ruling (G. C. M. 17195, XV-2 C. B. 107) which contains the following concluding sentence:

* * * After the end of tlie calendar year, the taxpayer may file a complete return for the entire 12-month period in order that a determination may he made by the Commissioner of any deficiency in tax, or any overpayment or overassessment of tax.

Government counsel reiterate this view in the present proceeding. Thus it appears that notwithstanding a finding, declaration, and collection under section 146 covering a tax for a short period, there still remains the proper tax period, whether twelve months or shorter, for the determination of tax liability with any resulting deficiency or overpayment. See Helvering v. Morgans, Inc., 293 U. S. 121. This is supported by the ensuing subdivisions of section 146, wherein it appears that a taxpayer may escape the rigor of immediate payment of the short term tax by giving security that at the proper time a correct annual return will be filed and a correct annual tax will be paid. It is only after such annual period expires that a determination of correct tax liability can be made, and not until then can it be determined whether there is a statutory deficiency or perhaps a refund of all or part of the amount already collected under section 146. In such circumstances, the amount called a “deficiency” in the notice sent to the petitioner here is not an amount finally determined as a deficiency, and the proceeding to contest it is at this stage premature. The Board is without jurisdiction and the proceeding must be dismissed.

Reviewed by the Board.

Dismissed.

       SEC. 146. CLOSING BY COMMISSIONER OE TAXABLE YEAR
      (a) Tax in Jeopardy. — If tlie Commissioner finds that a taxpayer designs quickly to depart from the united States or to remove Ms property therefrom, or to conceal himself or his property therein, or to do any other act tending to prejudice or to render wholly or partly ineffectual proceedings to collect the tax for the taxable year then last past or the taxable year then current unless such proceedings be brought without delay, the Commissioner shall declare the taxable period for such taxpayer immediately terminated and shall cause notice of such finding and declaration to be given the taxpayer, together with a demand for immediate payment of the tax for the taxable period so declared terminated and of the tax for the preceding taxable year or so much of such tax as is unpaid, whether or not the time otherwise allowed by law for filing return and paying the tax has expired; and such taxes shall thereupon become immediately due and payable. In any proceeding in court brought to enforce payment of taxes made due and payable by virtue of the provisions of this section the finding of the Commissioner, made as herein provided, whether made after notice to the taxpayer or not, shall be for all purposes presumptive evidence of the taxpayer’s design.
      (b) Security for Payment. — A taxpayer who is not in default in making any return or paying income, war-profits, or excess-profits tax under any Act of Congress may furnish to the united States, under regulations to be prescribed by the Commissioner, with the approval of the Secretary, security approved by the Commissioner that he will duly make the return next thereafter required to be filed and pay the tax next thereafter required to be paid. The Commissioner may approve and accept in like manner security for return and payment of taxes made due and payable by virtue of the provisions of this section, provided the taxpayer has paid in full all other income, war-profits, or excess-profits taxes due from him under any Act of Congress.
      (c) Same — Exemption from Section. — If security is approved and accepted pursuant to the provisions of this section and such further or other security with respect to the tax or taxes covered thereby is given as the Commissioner shall from time to time find necessary and require, payment- of such taxes shall not be enforced by any proceedings under the provisions of this section prior to the expiration of the time otherwise allowed for paying such respective taxes.
      * * * ♦ * f *

       Sec. 260 (g), Revenue Act of 1918, 40 Stat. 1084; sec. 250 (g), Revenue Act of 1921, 42 Stat. 267; sec. 282, Revenue Act of 1924, 43 Stat. 302; sec. 285, Revenue Act of 1926, 44 Stat. 68 ; see. 147, Revenue Act of 1928, 45 Stat. 836; sec. 146, Revenue Act of 1932, 47 Stat. 217; sec. 146, Revenue Act of 1934, 48 Stat. 725; sec. 146, Revenue Act of 1936, 49 Stat. 1703.