author: James

text:
    Appeals of LOUISE P. V. WHITCOMB, CHARLOTTE A. W. LEPIC, and MARGUERITE T. WHITCOMB.
    Docket Nos. 1946, 1947, 2321, 1948, 1949.
    Submitted April 20, 1925.
    Decided April 23, 1926.
    Taxpayers are life tenants under a trust which includes depreciable assets. The trustee, in returning the net income of the trust, deducted and was allowed the deduction of an allowance for exhaustion, wear and tear. Distributions to the beneficiaries of life interests were made irrespective of such allowances, and the Commissioner, in auditing the returns of the beneficiaries did not permit the said allowance for depreciation to be divided amongst them. Held; that, under section 219 of the Revenue Act of 1918, life beneficiaries are not entitled to allowances which relate to capital transactions and the corpus of the estate. Article 347, Regulations 45, asf amended by T. D. 2987, approved.

      W. W. Spaulding, Esq., for the taxpayers.

      Laurence Graves, Esq., for the Commissioner.
    Before James, Smith, and Teussell.
    These are appeals from determinations of deficiencies as to Louise P. Y. Whitcomb for the years 1917, 1918, 1919, and 1920, in the amounts of $351.17, $3,491.12, $3,196.29, and $3,292.05; as to Charlotte A. W. Lepic for the years 1917, 1918, 1919, and 1920, in the amounts, respectively, of $364.80, $3,443.12, $3,196.29, and $3,433.63; and as to Marguerite T. Whitcomb for the years 1919 and 1920, in the amounts, respectively, of $700.51 and $547.71.
    FINDINGS OE EAOT.
    The taxpayers are nonresident aliens and, during the taxable years here in question, resided in France. Louise P. Y. Whitcomb was, during those years, the widow of A. C. Whitcomb, deceased. Charlotte A. W. Lepic was the daughter of A. C. Whitcomb, and Marguerite T. Whitcomb was the widow of Adolphe Whitcomb, deceased, son of A. C. Whitcomb.
    A. C. Whitcomb, deceased, left a will, the seventh clause of which is as follows:
    I give to my hereinafter named Executor Jerome Lincoln, of said San Francisco, all the rest of my property, real, personal or mixed, except what I may have in France, of every kind and nature, and not hereinbefore disposed of, after the payment of my debts, in Trust, nevertheless, to pay over to my said wife, Louise Palmyre Vion Whitcomb, one third part of the interest thereof or income therefrom for and during her natural life, and the other two-thirds part to my two children born of her; one Adolphe born on or about the 23rd day of February 1880, and the other Charlotte Andree, born on or about the 4th day of December, 1882, with the reversion or remainder of the whole three third parts to the descendants per stirpes of the said two children, if any be alive at the time of the death of the said two children; and if none be alive at that time, to Harvard College in conformity with the provisions named or indicated in Section Six (6) of this will having reference to said Harvard College. * * *.
    The foregoing provision of the will has been judicially construed as providing to the widow, Louise Palmyre Vion Whitcomb, an estate for life in one-third of the income of the trust, an estate for life to each of the two children in one-third of the income of the trust continuing to the death of the survivor and, because of‘the death of Adolphe Whitcomb, an estate for the life of Charlotte A. W. Lepic, in the share of Adolphe to his widow and his two children, share and share alike.
    The net income of the trust estate is distributable periodically .to the beneficiaries and is so distributed.

      In preparing the fiduciary returns of the trust estate for the years 1917 to 1920, inclusive, the trustee included therein the income of the estate for the respective years and deducted therefrom expenses, including interest, taxes, and also the allowance provided by the statute for exhaustion, wear and tear on account of the depreciable assets belonging to the trust. The difference between the gross income and deductions so made was shown on the fiduciary returns as the net income of the trust and as the aggregate distributable net income of the beneficiaries, the share and interest of each beneficiary being stated.
    In preparing the income-tax returns of the beneficiaries of the trust for the years 1917 to 1920, inclusive, the trustee included therein, as the distributive share of the net income of the trust of each of said beneficiaries, that proportion of the net income of the estate as shown by the fiduciary return which the interest of the beneficiary in the income bore to the total income, namely, one-third to Louise P. V. Whitcomb, one-third to Charlotte A. W. Lepic, and one-third of the remaining one-third to Marguerite T. Whitcomb.
    The Commissioner, in auditing the fiduciary returns of the trust, allowed depreciation as a deduction in determining the net income of the trust for each of the years under consideration, but, in auditing the returns for the several years of each of said beneficiaries, determined the distributive net income apjfiicable to each of them as the share of the net income of the trust to which she was entitled, excluding from the said computation the said deductions on account of depreciation, so that, in determining the deficiencies here in issue, the Commissioner increased the net income of the said parties as reported by the trustee for the several years, in the amounts stated below:
    Estate of Louise P. Y. Whitcomb: By $8,153.32 for 1917; by'$15,854.96 for 1918; by $13,779.43 for 1919; by $12,276.40 for 1920.
    Charlotte A. W. Lepic: By $8,158.32 for 1917; by $15,854.96 for 1918; by $13,779.43 for 1919; by $12,276.40 for 1920.
    Marguerite T. Whitcomb: By $4,593.14 for 1919; by $4,092.13 for 1920.
   OPINION.

James

: The- petitioners contend that the net income, the distributive share of which is taxable to these beneficiaries, is the statutory net income of the trust divided into the number of shares provided in the will. The Commissioner agrees that the statutory net income is the starting point of the computation, but contends that the distributive shares of life beneficiaries must be computed with due regard to what they actually receive under the trust as income and that the remainder interests must be given due consideration in the computation of such distributive shares.

The question calls for the construction of section 219 of the Revenue Act of 1918, and more particularly subdivisions (b) and (d) thereof. The pertinent provisions are as follows:

See. 219. (a) That the tax imposed by sections 210 and 211 shall apply to the income of estates or of any hind of property held in trust, including— * * . * * * * *
(4) Income which is to be distributed to the beneficiaries periodically, * * *.
(b) The fiduciary shall be responsible for making the return of ipcome for the estate or trust for which he acts. The net income of the estate or trust shall be computed in the same manner and on the same basis as provided in section 212, * * * and in cases under paragraph (4) of subdivision (a) of this section the fiduciary shall include in the return a statement of each beneficiary’s distributive share of such net income, whether or not distributed before the close of the taxable year for which the return is made.
(d) In cases under paragraph (4) of subdivision (a), * * * the tax shall not be paid by the fiduciary, but there shall be included in computing the net income of each beneficiary his distributive share, whether distributed or not, of the net income of the estate or trust for the taxable year, * * ,f.

Provisions of similar import are contained in tbe Act of 1916, as amended by tbe Act of 1917.

Nowhere in the Act is there contained a specific definition of the term “ distributive share.” Treasury Decision 2987, dated March 1, 1920, forms the basis of the Commissioner’s action in the instant appeal and is so important to an understanding thereof as to warrant its reproduction in full.

Regulations No. 45 are amended by adding thereto article 347 to read as follows:
ART. 347. Estates and trusts toMch can not be treated as a unit. In the case of certain estates and trusts it is recognized that the estate or trust can not be treated as a unit for income-tax purposes and may represent an aggregate of distinct interests, to all of which the fiduciaries are responsible. In such cases the procedure stated in this article should govern. The following are recognized as cases which can not be treated as a unit and must, therefore, be governed by this article: (a) When there is income distributable periodically and also income which is to be accumulated in trust, held for future distribution, or added to the corpus ; (b) when there is income distributable periodically and also income (according to the Federal income-tax statutes and regulations) which is not distributable periodically under State law, e. g., gains from sale of capital assets, stock dividends; (c) when there is income distributable periodically and deductions (according to Federal income-tax statutes and regulations) which are not deductible under State law from the distributable income, e. g., losses from the sale of capital assets, depletion, depreciation.
In ascertaining whether an estate or trust comes within any one of the cases just enumerated, the provisions of the Federal statutes and regulations — rather than the provisions of the will or trust and the provisions of State laws — shall determine what items constitute taxable gross income or allowable deductions; the provisions of the will or trust and of State laws shall determine the allocation of items of gross income or deduction; that is, to which of the different interests making up the whole such items shall be charged or allowed. In cases which are to be treated under this article, the items of gross income and deduction as determined by the Federal income-tax statutes and regulations must be scrutinized and classified in accordance with the provisions of the will or trust or rules of local law into two classes, one subject to the procedure specified in subdivision (e) of section 219, and the other to the procedure specified in subdivision (d) of section 219. The result will be that the beneficiary to whom income is to be distributed periodically must include, in computing his net income, the amount actually distributable to him (except exempt income) even though the aggregate of the distributive shares should’ be larger than the net income of the estate or trust computed as a unit. Any gain, profit, or income which is not periodically distributable must be included in computing the net income of the estate or trust, so that the fiduciary will pay the tax upon any excess of the net income of the estate or trust computed as a unit over the aggregate distributive shares.
For example, a trust is created the income of which is distributable periodically for the life of the beneficiary, the remainder over to others. The trust has the following items of income: Rent, $3,000; interest, $2,000; gain on sale of capital assets, $1,500; cash dividend, $1,000. And deductions: (Jen-eral expenses (all deductible from distributable income), $700; depreciation, $300; loss on sale of capital assets, $3,000. Under the terms of the trust $5,300 will be distributed to the beneficiary, viz, rent, $3,000; plus interest, $2,000; plus dividend, $1,000; less general expenses, $700. The gain and loss on the sale of capital assets will be considered capital items affecting the corpus only, and the items of depreciation will not affect the amount to be • distributed, there being no rule of State law or provision of the trust requiring this deduction from distributable income. In such a case the fiduciary must report on Form 1041, showing a net income for the trust of $3,500, and must show as the distributive share of the beneficiary the $5,300 to which he is entitled. The beneficiary must account for the amount actually distributable to him as income, viz, $5,300, as provided in section 219 (d) and will be entitled to a credit of $1,000 on account of the dividends in computing the normal tax, but not to any deduction on account of depreciation or capital losses.
If there had been no loss on the sale of capital assets so that the net income of the estate or trust was $8,500, Form 1041 should show the distributive share of the beneficiary as $5,300 and the distributive share of the fiduciary as $1,200; and the fiduciary should file a separate return on Form 1040-A, reporting $1,200 for taxation.
Dakibl O. Roper,
Oommissioner of Internal • Revenue.

The particular situation of these taxpayers is covered in subdivision (c) of the first paragraph of the foregoing, that is, the income in this case is distributable periodically, but there are reductions (in this case depreciation) which do not affect the computation of distributable income of the life beneficiaries but do affect the corpus of the estate. This is illustrated in the third paragraph, wherein is set forth ordinary income subject to distribution, in the total amount of $5,300, and capital losses which reduce the income of the estate for the purpose of the fiduciary return, but relate to the separate entities represented by the estate as a whole, ultimately consisting of the remaindermen.

We are dealing here, then, with a situation in which there are distributive shares of life tenants and distributive shares in effect of remaindermen, which latter have to do with the capital assets and capital transactions of the estate and have nothing to do with the life tenancy and the income distributable thereunder. The situation is perfectly clear in the case of the estate or trust in which a portion of the taxable net income is derived from capital sources. In such a case the ordinary income is distributed to the life beneficiaries and the capital gains are reported by the fiduciary and taxed to him. The situation is not different in the case of capital losses, that is, the ordinary income is distributed to the life tenants and the capital losses are absorbed by the estate or trust as the representative of the remaindermen. True, in the one case the fiduciary must make an income-tax return and pay tax upon the gain derived from capital transactions, whereas, in the case, of losses, no such return is required and of course no such tax is collected, but the distributive share of the life tenant is unchanged in either case. It is the share to which he is entitled of the ordinary net income of the estate, that income which under the will or trust instrument or under the laws of the jurisdiction under which the estate or trust is being administered, is ordinarily distributable to life tenants. The other gains taxable or deductions allowed relate not to such ordinary income, but to capital transactions in which the life tenant has no interest upon which he may be charged for tax as to gains and as to losses which he may not be permitted to use to reduce the distributive share of the income which he receives and upon which he should pay tax. His distributive share remains unchanged whether the capital transactions of the estate or trust show a gain or a loss, and he has no interest in that aspect of the trust, except the natural future interest in the increase of his income in the case of gains or in its decrease in the case of losses.

There is, then, in all of these cases, a taxable entity represented by the estate or trust, in the background of which lie the remain-dermen who will ultimately divide the corpus. These remaindermen are not themselves taxable upon the gains, nor themselves entitled to deduct the losses, but the entity, the trust, which is administering the corpus for the time being, is taxable on such gains and-is entitled to the deduction of such losses. It matters not that in many cases of losses under these circumstances there remains no income from which to deduct them. The estate in such circumstances is in no different position from that of any taxpayer whose losses exceed his gains. He is fortunate only in that he has no tax to pay.

It is not altogether fortunate that Treasury Decision 2981 contains the following language:

The result will be that the beneficiary to whom income is to be distributed periodically must include, in computing his net income, the amount actually distributable to him (except exempt income) even though the aggregate of the distributive shares should be larger than the net income of the estate or trust computed as a unit.

The aggregate of the distributive shares, when clue regard is had for the estate as an entity, is never other than the taxable net income of the estate. The fact merely is that the sum of the plus quantities is, where losses occur, in excess of the net income and is reduced by the minus quantities, namely, capital losses, depletion or depreciation.

There remain to be considered' only certain points made by llie taxpayer having to do particularly with the alleged erroneous reasoning in Baltzell v. Mitchell, 3 Fed. (2d) 428. In that case the court said: “ It is necessary to resort to the instrument containing the terms of the trust to determine her distributive share.” This the taxpayer contrasts with the language of the Supreme Court in Merchants’ Loan & Trust Co. v. Smietanka, 255 U. S. 509, in which the court said: “ The provision of the will may be disregarded. It was not within the power of the testator to render the fund nontaxable.”

As we have pointed out above, the construction of the language “ distributive share ” is entirely consistent with the position taken by the Commissioner, and, in fact, is the only position which possibly can be taken in the case of returns of estates or trusts, where capital transactions and ordinary income are commingled in a single return but must be separated into pai'ts to represent the various interests concerned therein. This, we believe, is all that the court meant in Baltzell v. Mitchell, and, as so interpreted, is certainly entirely correct.

Taxpayer also points out the identical language between sections 218 and 219, wherein “ distributive share ” of partners is contrasted with “ distributive share ” in the case of trusts. There again the question is one of fact as to what the distributive share is. Partnership income is quite commonly distributed in a manner different from the interests of the partners in capital, yet it is not often contended that the partners should be taxed upon shares computed upon the basis of their interest in capital alone, yet that, in a measure, is the contention here, namely, that life beneficiaries who have no interest, except in income, should be affected by the fact that capital transactions relating solely to remainder interests have occurred and affected the trust as an entirety.

Nor do we believe, as the taxpayer claims, that the construction which we have placed upon the statute above is one outside and beyond the statutory language. Certainly such is not our intent, for if the words “ distributive share ” are not subject to the construction given, there is no other place in the statute in which authority can be found for taxing as income the amount by which the Commissioner here seeks to increase the income returned by these taxpayers. That income must be then distributive shares or income taxes can not be imposed thereon. In our opinion, Congress, while using general language, used language peculiarly apt and particularly adapted to the purpose in mind. Any attempt to be specific would have resulted in far greater confusion than that incident to the application of general language to situations which from time to time are necessarily complex in fact, if not in the principles to be applied.

The taxpayers also argue that depreciation, being a matter of annual deduction, is a deduction which is properly allowable to life beneficiaries. We think the answer is clear; depreciation or “ exhaustion, wear and tear,” in the language of the statute, allowed by the Act, relates to capital assets. The depreciation is not in the income but in the capital, and it affects income only in that, if the depreciable assets are not replaced, the income sooner or later will cease. This might result, as the taxpayer points out, in no assets being left for the remaindermen, but this certainly is not a matter in which a life tenant has any particular interest.

We are of the opinion that the Commissioner committed no error in the determinations here under appeal.

The deficiencies are: For the year 1917, Louise P. V. Whitcomb, $351.17; Charlotte A. W. Lepic, $364.80 — total $715.97. For the year 1918, Louise P. V. Whitcomb, $3,491.12; Charlotte A. W. Lepic, $3,443.12 — total $6,934-24- For the year 1919, Louise P. Y. Whitcomb, $3,196£9; Charlotte A. W. Lepic, $3,196.29; Marguerite T. Whitcomb, $700.51— total $7,093.09. For the year 1920, Louise P. V. Whitcomb, $3,292.05; Charlotte A. W. I^epic, $3,f33.68; Marguerite T. Whitcomb, $547.71 — total $7,273.39. Order will be entered accordingly.

On reference to the Board, Steenhagen concurs in the result only.


source: Caselaw Access Project

author: SteRnhagen:

license: Public Domain

text:
    Appeals of ELIZABETH M. ABELL, ELIZABETH M. ABELL, WALTER W. ABELL, MARY ABELL MORGAN, and MARY ABELL MORGAN.
    Docket Nos. 2693-2697.
    Submitted May 25, 1925.
    Decided April 23, 1926.

      Haines II. Ilargrett, Esq., for the taxpayers.

      Ellis W. Manning, Esq., for the Commissioner.
    Before Stbknhacen, Lansdon, Geeen, and Love.
    These appeals involve deficiencies in income taxes for the years 1919 and 1920 in the following respective amounts: Elizabeth M. Abell, for the year 1920, $1,774.14; Elizabeth M. Abell, for the year 1919, $1,629.86; Walter W. Abell, for the years 1919 and 1920, $3,330.46; Mary Abell Morgan, for the year 1919, $1,877.21; and Mary Abell Morgan, for the year 1920, $1,919.98.
    The deficiencies arose from the refusal of the Commissioner to permit the taxpayers to deduct their proportionate share of losses sustained by a trust upon the sale of capital assets and deducted by the trustee from the taxable income of the trust. The facts are not in dispute and have been stipulated, and the same question of law is involved in all of the appeals.
    BINDINGS OP FACT.
    Edwin F. Abell died in the year 1904, while domiciled in the State of Maryland, leaving a last will and testament in words and figures as follows:
    This is the last will and testament of Edwin E. Abell, of Baltimore, State of Maryland.
    I give, devise and bequeath to my two sons, Arunah S. Abell and Walter W. Abell, and the survivor of them, and his heirs, personal representatives and assigns, all of the property, real and personal, joint or several, in possession or expectancy, legal or equitable, of which I may die seized or possessed, or to which I may be in any way entitled, at the time of my death.
    In trust, nevertheless, for the following uses and purposes and for no other uses or purposes whatsoever:
    I. To collect the rents, issues, income and profits thereof, and after paying the expenses.of administering and managing said property, and a reasonable commission to themselves as trustees, to divide into four equal parts the net proceeds therefrom and pay the same to the following persons:
    One of the said four equal parts is to be paid to my wife, Elizabeth Maxwell Abell, for and during her life in quarter-yearly installments.
    One of the said four equal parts is to be paid to my daughter, Mary Abell Morgan, wife of James Dudley Morgan, to her sole and separate use, free from the control of her present husband or of any husband she may hereafter have, for and during the life of my said wife in quarter-yearly installments.
    One' of the said four equal parts is to be paid to my son, Arunah S. Abell, for and during the life of my said wife, Elizabeth Maxwell Abell, in quarter-yearly installments.
    One of the said four equal parts is to be paid to my son, Walter W. Abell, for and during the life of my said wife, Elizabeth Maxwell Abell, in quarter-yearly installments.
    Should any of my children die during the life of my said wife leaving issue living at the time of his or her death, the part or portion of said income directed to be paid to such child so dying is to be paid to the issue per stirpes of the child of mine so dying.
    Should any child of mine die during the life of my said wife leaving no issue living at the time of his or her death, or leaving such issue and it should become extinct during the life of my wife, then the part or proportion of the said income theretofore paid to such child so dying, or to such issue so becoming extinct, is thereafter to be divided, share and share alike, between my said wife and any surviving children or child of mine, and issue then living o£ any child of mine, then dead, such then living issue to take per stirpes a share equal to that to be paid to my wife or to any child of mine then living.
    II. On the death of my said wife the said trustees or the survivors of them are to set apart or divide all of the property of every kind then held by them, subject to the trust hereby created, except such stock in the A. R. Abell Company of Baltimore City as my said sons, or the survivor of them then living may then hold in trust, into equal parts, and shall convey one of said equal parts to each of my children living at the time of the death of my wife, and one of said parts to the issue per stirpes then living of any child of mine who shall have died leaving issue which shall be living at the time of the death of my said wife, free and discharged of any trust.
    But if my said daughter, Mary Abell Morgan, shall be living at the time of the death of my said wife, the part set apart for her is to be held by said trustees and the survivor of them, and his successor, and the rents and profits thereof are to be collected and paid over to her sole and separate use, free from the control of her present husband and of any husband she may hereafter have, during her life; and on her death I devise and bequeath such part or share to her issue living at the time of her death in such parts or proportions as my said daughter may by last will and testament, and in no other way appoint; and in default of such appointment, I devise and bequeath such share to her issue living at the time of her death, per stirpes.
    III. On the death of my said wife leaving either of my said sons surviving her, I will and direct that any stock of the A. S. Abell Company of Ballimore City then held by the said trustees or the survivor of them, be held in trust until the death of the survivor of my said sons, trustees as aforesaid, and the income therefrom after paying the expense of administering the trusts, and a reasonable commission is to be paid over to my issue per stirpes, and on the death of such surviving trustee, sons of mine, the said stock is to go and pass free of any trust to my issue then living per stirpes.
    IV. And I hereby authorize my said trustees or the survivor of them, or the successors in said trust, to sell and convey absolutely or by way of lease or otherwise dispose of said trust property or any part or parts thereof held by them or him at any time, and the proceeds thereof to invest in any other property or estate as they or he may deem expedient and proper; and with full power likewise to the said trustees, or survivor or successor to change such reinvestment or new investments from time to time to make; and such reinvestments or new investments are to be held subject to the same trusts hereunder as applied to the property sold or disposed of.
    V. I constitute and appoint my said sons Arunah S. Abell and Walter W. Abell and the survivor of them executors of this my last will and testament; and I will and direct that my said sons and the survivors of them shall not be required to give bond either as exeeutors or executor, trustees or trustee under this will.
    I hereby revoke all other wills or codicils by me heretofore made.
    The will was admitted to probate and, at all times hereinafter mentioned, the estate of Edwin F. Abell has been administered according to its provisions.
    Under the provisions of said will, each of the taxpayers, in the years 1919 and 1920, was entitled to receive and did actually receive in “ quarter-yearly installments ” one-fourth of the “ net proceeds ” of “ the rents, issues, income and profits ” of said estate, after “paying the expenses of administering and managing said property ” and after deduction of “ a reasonable commission ” for the trustees. Another son, Arunah S. Abell, who under the provisions of the will was entitled to receive one-fourth, died prior to the years in controversy and is not involved in these appeals.
    During the year 1919 the trust estate received income from many different sources, but it also sustained a loss of $49,914.95 upon the sale of securities theretofore owned and held by the trust as capital assets. Likewise, during the year 1920, the trust estate received income from many different sources, but it also sustained a loss of $59,756.16 from the sale of securities theretofore owned and held by the trust as capital assets.
    The surviving trustee filed a fiduciary return, upon which he reported the gross income of the trust and deducted therefrom the aforesaid loss of $49,914.95 for the year 1919 and the loss of $59,756.16 for 1920.
    In said returns he stated the net income of the trust, reported the taxpayers1 names, and stated their proportionate share of such income. The amount so reported by the trustee as being the taxpayers’ part of the net income and shown upon the return was less than the amount actually distributed to the taxpayers by the trustee in the respective years, for the reason that, under the provisions of said will and under the laws of the State of Maryland, the “ net proceeds of rents, issues, income and profits ” of the said estate were required to be and were distributed to the taxpayers and other beneficiaries of said trust without reduction for or on account of the estate’s loss of capital.
    The taxpayers filed their individual income-tax returns for the years 1919 and 1920 and reported for taxation one-fourth of the net taxable income of the trust, as computed and reported by the trustee upon his aforesaid fiduciary returns, and omitted the remainder of the amounts actually received from the trust.
    Thereafter, the Commissioner made an audit of the aforesaid returns and, after examination thereof and over the protest and objection of the taxpayers, held that to the gross income reported by them upon their returns for the years 1919 and 1920 there should be added the sum representing one-fourth of the loss sustained by the trust upon its sale of capital assets in the years 1919 and 1920, respectively, and deducted by the trustee from the taxable income of the trust in making his aforesaid fiduciary return for that year, and asserted deficiencies as hereinbefore set forth.
   OPINION.

SteRnhagen:

The issue upon which the determination of these appeals rests is the same in all respects as that decided by the Board in the Appeals of Louise P. V. Whitcomb et al., 4 B. T. A. 80, and, upon the authority of that decision, the Commissioner’s position in respect of the right of beneficiaries to take deductions for capital losses is sustained. The deficiencies of the present petitioners should therefore be computed in accordance with the rule announced in that decision.

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


author: Trammell

text:
    Appeal of RICHMOND LIGHT & RAILROAD CO. and NEW JERSEY & STATEN ISLAND FERRY CO.
    Docket No. 5060.
    Submitted December 29, 1925.
    Decided April 23, 1926.
    Reserves for damages and casualties are not allowable deductions.

      Francis J. Sweeney, Esq., for the taxpayer.

      John D. Foley, Esq., for the Commissioner.
    Before Phillips and Trammell.
    This is an appeal from the determination of a deficiency in income and profits taxes for the fiscal years ended June 30, 1920, and June 30,1921, amounting to $29,597.36. The deficiency arises (a) from the disallowance by the Commissioner of $5,178.53 for 1920 and $5,149.90 for 1921, claimed by the taxpayer on account of the exhaustion, wear and tear of tangible assets; (b) on account of the disallowance by the Commissioner of a deduction claimed for reserves for casualties and damages in the amount of $33,460.29 for the fiscal year ended June 30, 1920, and $49,822.88 for the fiscal year ended June 30, 1921, the Commissioner having allowed a deduction on account of damages and casualties which had actually been paid during the taxable years; (c) the disallowance by the Commissioner from invested capital for each of the years involved of $969,477.34. The taxpayer alleges that this amount was excluded on account of an erroneous and arbitrary segregation of fixed capital, while the Commissioner sets forth that it was excluded because no value of assets acquired for stock was shown; (d) the Commissioner also deducted $45,322.47 for 1920 and $41,378.92 for 1921 from invested capital, on account of assets which the taxpayer contends were erroneously determined by the Commissioner to be inadmissible assets. The other errors assigned in the petition of the taxpayer were conceded by the Commissioner in his answer.
    FINDINGS OP PACT.
    The taxpayer, the Richmond Light & Railroad Co., is a corporation organized under the laws of New York, and was engaged in generating and selling electric energy and operating a street railway. The New Jersey & Staten Island Ferry Co. is a corporation organized under the laws of New Jersey, and is engaged in operating a ferry between Elizabethport, N. J., and Holland Hook, Staten Island, N. T. The two corporations, during the years involved, were affiliated and filed consolidated returns.
    Pursuant to the order of the Public Service Commission of New York, the Richmond Light & Railroad Co. in December, 1910, made a segregation of its capital account as of December 31, 1908, into certain subaccounts, among which were franchises. This was done for the purpose of dividing the property account into subaccounts as classified by the Public Service Commission. The Commissioner deducted from the invested capital as set up by the taxpayer $969,471.34, representing the par value of its stock issued for franchises acquired by the Richmond Light & Power Co., and $45,000, representing the par value of its stock issued for franchises acquired by the New Jersey & Staten Island Ferry Co., upon the ground that no value of such assets was satisfactorily established.
    The Richmond Light & Railroad Co. set up a reserve on its books for casualties and damages for the fiscal year ended June 30, 1920, amounting to $33,460.29, and for the fiscal year ended June 30. 1921, amounting to $49,822.88. The actual disbursements on account of casualties and damages for the claim department, medical and adjustment expenses, for the fiscal year ended' June 30, 1920, amounted to $28,783.39, and for the fiscal year ended June 30, 1921, to $5,759.61. The balance in the reserve for casualties and damages at June 30, 1921, amounted to $48,740.17. Judgments settled and paid subsequent to June 30, 1921, and applicable to years prior thereto, amounted to $49,396.31.
   OPINION.

Trammell

: The taxpayer alleges that the Commissioner excluded $969,477.34 from invested capital on account of an arbitrary segregation of accounts, but the allegation that the accounts were arbitrarily segregated, even if conceded to be true, would not be sufficient to overcome the presumption of correctness of the determination of the Commissioner on this point. The amount was disallowed by the Commissioner, according to his determination set forth in his 60-day letter, on account of the fact that “ no value of the intangible assets having been proven, the total book value has been eliminated from your invested capital.”

The taxpayer introduced no evidence as to values of any intangible assets acquired for stock or to sustain its claim for additional depreciation, nor has the taxpayer introduced any evidence which would enable the Board to determine what the inadmissible assets were or any evidence with respect thereto in order that we may determine whether the Commissioner correctly excluded the amount thereof from invested capital.

The only facts material to the consideration of this appeal which the Board has before it are .those which were stipulated by counsel. They relate entirely to the reserves which were set up for casualties and damages.

The taxpayer contends that reserves set up by it at the end of each of the years involved to pay damages subsequently to be determined to be due by it on account of accidents and casualties happening during the respective years are deductible. With this contention we can not agree. Reserves for such purposes are not deductible in determining net income. Appeal of William J. Ostheimer, 1 B. T. A. 18; Appeal of Pan-American Hide Co., 1 B. T. A. 1249; Appeal of Morrison-Ricker Mfg. Co., 2 B. T. A. 1008; Appeal of Stokes Milling Co., 2 B. T. A. 1284. If the actual amount of damages so determined in subsequent years be held to relate back to the years when the accidents or casualties on which they are based occurred, we have no evidence as to the amounts attributable to each of such years, and it is not necessary to decide such principle.

The taxpayer contended that the invested capital should also be adjusted in accordance with the opinion of the Board in the Appeal of Guarantee Construction Co., 2 B. T. A. 1145. The Revenue Act of 1926, in section 1207, makes specific provision relating to this question which is retroactive and governs this case. The adjustment made by the Commissioner is in accordance with the statute. Appeal of Russel Wheel & Foundry Co., 3 B. T. A. 1168.

In his answer the Commissioner admitted various errors which will be corrected in computing the deficiency.

Order of redetermination will he entered on 10 days’ notice, under Rule 50.


author: Geeen:

text:
    Appeal of CLEVELAND & WESTERN COAL CO.
    Docket No. 2341.
    Submitted August 20, 1925.
    Decided April 23, 1926.
    1. Where income is derived in part from trading as a principal and in part from contracts with coal producers, involving the use of capital in financing such producers and marketing their coal, and three stockholders collectively holding a substantial amount of stock devote none of their time to tho business, and other stockholders devote only a part of their timo thereto, personal service classification will be denied.
    2. Where a corporation has a large amount of capital stock fully paid in and, through credit extended to it, it is enabled to own large business facilities, finance customers, and maintain large inventories, and derives its entire income from trading as a principal, personal service classification will be denied.

      3. A corporation issued stock to an individual at par, fully paid and nonassessable, in part as bonus for purchase of preferred stock, and in part in consideration of good will and patronage wbicb such individual brought to its business and of services rendered in promoting and financing the corporation. Held, that the stock was not issued solely for good will and that evidence of sales to customers procured by such individuals was insufficient to establish that good will had any cash value.
    4. Amounts paid to an individual for his influence in bringing about the dissolution of a receivership of a corporation with which taxpayer desired to enter into a contract, and to one of the receivers for consenting to the dissolution, may not be included in invested capital, since they were not expended for any asset used in the business and were not proper capital expenditures.
    5. The fact that taxpayer considers its tax too high and that taxes of other corporations are lower than that proposed against taxpayer is insufficient to prove that exceptional hardship had been worked or that a gross disproportion exists owing to abnormal conditions.
    6. Efficient operation of a business resulting in a greater than average rate of turnover of capital does not produce abnormality warranting special assessment.

      O. F. Taplin, Esq., J. L. Steinbugler, Esq., and E. A. Mihills, G. P. A., for the taxpayer.

      Edward Q. Lake, Esq., for the Commissioner.
    Before Geeen, Lansdon, and Love.
    The taxpayer, the Cleveland & Western Coal Co., as the parent company, and the Wisconsin Coal & Dock Co., as the subsidiary company, filed consolidated returns for the years 1918 and 1919 as a personal service corporation. The Commissioner determined a deficiency in the income and profits taxes on the consolidated net income amounting to $304,667.38 for the year 1918 and $46,669.76 for the year 1919. The deficiency results from denial to both companies of classification as a personal service corporation; from the disallowance as part of invested capital of an item of good wifi in the amount of $87,300 and an additional item of $15,300, and from the denial of affiliation with two subsidiaries.
    FINDINGS OF FACT.
    The Cleveland & Western Coal Co. is an Ohio corporation organized during the month of February, 1913,"with its principal place of business in Cleveland. At its organization the taxpayer had an authorized capital of $250,000, divided into $100,000 of preferred and $150,000 of common stock. The preferred stock was all issued for cash on the basis of $100 per share. Common stock of the pai value of $50,000 was issued to F. E. Taplin at the time of incorporation in consideration of the good will and patronage which he brought to the company and of his services rendered and to be rendered in the promotion and financing of the company. Common stock of the par value of $37,300 was issued as a bonus to the purchasers of preferred stock at the rate of one-half share of common for each share of preferred. Up to March 31, 1915, there had been issued $80,000 par value of preferred stock and $87,300 par value of common stock.
    Some time prior to January 1, 1918, the authorized capital stock of the Cleveland & Western was increased. There was outstanding on that date $500,000 common capital stock, all of the preferred stock having been theretofore retired by conversion into common stock-On October 1, 1918, the capital stock was increased from $500,000 to $1,000,000, all of the increase being issued for cash or tangible property.
    The Wisconsin Coal & Dock Co. was organized in December, 1916, and had during the years 1918 and 1919 outstanding capital stock of the par value of $100,000, all of which was issued for cash or tangible property. The Cleveland & Western owned all the outstanding stock of the Wisconsin Coal & Dock Co. during the years in question.
    The stockholders of the Cleveland & Western owned and controlled considerable capital stock of three other corporations — the Meadow Lands Coal Co., the Standard Island Creek Coal Co., and the A. J. Morgan Coal Co. The Cleveland & Western alleged in its petition that these three corporations were affiliated with it during the years 1918 and 1919, but at the hearing it was conceded that it was not affiliated with these corporations during such years.
    The capital stock of the Cleveland & Western was held, on the dates shown, by the following individuals:

    C. G. Taplin was a director but did not devote any time to the business and received no salary. C. F. Taplin was a practicing attorney and maintained an office in which he conducted his profession; he devoted part of his time to the business of the company. A. P. King devoted his entire time to the business of the Wisconsin Coal & Dock Co. and was not engaged in the business of the Cleveland & Western. Edith S. Taplin did not devote any time to the business of the company and was paid no salary. The other stockholders owned stock in other corporations which were engaged in mining coal and they devoted only a portion of their time to the conduct of the business of the Cleveland & Western.
    The balance sheets of the Cleveland & Western Coal Co., at the beginning of each of the years 1918, 1919, and 1920, are as follows:

      The capital, invested and borrowed, that was available in the business of the Cleveland & Western Coal Co. at various dates is shown in the following schedule:

    The Cleveland & Western, .in order to obtain coal for its customers, financed many of the companies for which it sold coal by loaning such companies.large sums of money for indefinite periods and also by advancing funds in contemplation of future shipments of coal.
    The Cleveland & Western had entered into written contracts with various mining corporations to sell coal in accordance with the terms of said contracts and to guarantee the payment to the companies for all coal shipped under said contracts. The business of the Cleveland & Western consisted in part, and the business of the Wisconsin Coal & Dock Co. consisted almost entirely, of buying and selling coal as a principal.
    In nearly all of the transactions in the purchase and sale of coal, the Cleveland & Western and the Wisconsin Coal & Dock ordered, sold, billed, collected and paid for coal in their respective names.
    On the coal shipped by the Cleveland & Western Coal Co. to the lake front it paid the freight charges from its own funds and included such charges in its bills to the purchasers. The freight charges so paid amounted to $2,413,547.21 and $2,208,195.82 for 1918 and 1919, respectively.
    Subsequent to the organization of the Cleveland & Western Coal Co., and at the first meeting of the stockholders held February 27, 1913, the following resolution was adopted:
    The preferred stock is to be sold only for cask, and at no less than par, and each share of preferred stock is to carry with it one-half share of the common stock as a bonus; which common stock, so far as the company is concerned, is to be regarded as fully paid and non-assessable.
    To E. E. Taplin are to be issued live hundred (500) shares of the common stock, already subscribed for by him, as fully paid and non-assessable; said stock is issued to him in consideration of his good will and patronage which he brings to this company, and of his services rendered and to be rendered in the promotion and financing of the company; in consideration of which he is relieved of any cash payment for said five hundred (500) shares of common stock so subscribed for by him.
    Pursuant to the resolution, common stock of the par value of $87,300 was issued and good will in the amount of the par value of the capital stock so issued was set up on the books of the Cleveland & Western. During the years 1914, 1915, and 1916, the good will account was entirely written off by charging profits and crediting the good will account. The amounts so taken from the account were restored on January 1, 1920, and the surplus account was credited witli the amount thereof.
    Prior to the acquisition by the taxpayer of the Meadow Lands Coal Co., A. S. McQueen, of Pittsburgh, Pa., was in close touch with the receivers and the stockholders of that company. In 1915 the Cleveland & Western informed McQueen that it was desired to obtain the right to sell the coal of the Meadow Lands Coal Co., and thereafter it secured from the receivers a contract for one year beginning April 1, 1916, for the right to sell the coal produced by that company. While this contract was in force the stockholders of the Cleveland & Western secured sufficient stock of the Meadow Lands Coal Co. to exercise a control over it. In order to secure a renewal of the contract with the Meadow Lands Coal Co., the Cleveland & Western obtained, through the influence of McQueen, the consent of the receivers ■ to the dissolution of the receivership. After securing the contract with the Meadow Lands Coal Co., and after the stockholders of the Cleveland & Western had secured sufficient capital stock to control said corporation, and after the receivership had been dissolved, the Cleveland & Western paid McQueen $10,000. James S. Boggs, one of the receivers of the Meadow Lands Coal Co., was paid the sum of $5,800 in 1917 for consenting to the dissolution of the receivership of said corporation.
    Taxpayer seeks special assessment under the provisions of sections 327 and 328 of the Revenue Act of 1918 and predicates its claim of abnormalities upon (1) good will of considerable but undetermined value not reflected in invested capital, (2) F. E. Taplin’s guarantee of accounts payable for coal purchased, (3) a line of credit established through F. E. Taplin’s acquaintance with hank officials, (4) investments of large sums in Liberty bonds and non-income producing stock of mining companies, and (5) expenditures amounting to $15,300 resulting in the obtaining of the Meadow Lands contract, which amount was neither capitalized nor allowed as expense. The taxpayer further claims that the same abnormalities existed in 1918 which were found by the Department to justify special assessment in 1917, and it submitted as comparatives the following-named corporations for the year 1918:

      The Commissioner denied special assessment to the taxpayer for the year 1918, upon the ground that the taxpayer has failed to prove that it meets the provisions of section 327 and that no abnormalities existed in 1918 which would justify special assessment.
   OPINION.

Geeen:

The issues involved in this case are: (1) Were the Cleveland & Western Coal Co. and the Wisconsin Coal & Dock Co. during the years 1918 and 1919 personal service corporations, within the meaning of section 200 of the Revenue Act of 1918? (2) Is the Cleveland & Western Coal Co. entitled, under the provisions of section 326 of the Revenue Act of 1918, to include in its invested capital for the years 1918 and 1919 the sum of $87,300, representing capital stock issued for alleged good will? (3) Is the Cleveland & Western Coal Co. entitled, under the provisions of section 326 of the Revenue Act of 1918, to include in its invested capital for the years in question the sum of $15,300, representing the amount paid during 1917 to A. S. McQueen and James S. Boggs? (4) Are the Cleveland & Western Coal Co. and the Wisconsin Coal & Dock Co, entitled to a determination of their profits taxes under the provisions of section 328 of the Revenue Act of 1918? The issues will be disposed of in the order above given, and, in considering whether either or both the Cleveland & Western Coal Co. and the Wisconsin Coal & Dock Co. were personal service corporations, each will be considered separately.

The balance sheets of the Cleveland & Western show that the total of the items making up invested and borrowed capital amounted to $1,800,962.87 at January 1, 1918; $2,307,778.77 at January 1, 1919, and $2,929,747.75 at January 1, 1920. Capital is shown to have been used in financing a number of mining companies and the business of the Wisconsin Coal & Dock Co. This contributed to the successful operation of its business. Part of the business of the Cleveland & Western consisted of the sale of coal under contracts in which the Cleveland & Western agreed, among other things, to sell all the coal produced by certain mining companies, to guarantee the payment for all coal sold and, under some of the contracts, to make advances of funds. The balance of the business consisted largely of the purchase and sale of coal as a principal. It paid interest amounting to $35,235.51 during the year 1918 and $31,447.90 during the year 1919. From these facts it is evident that capital, invested and borrowed, was a material income-producing factor. Appeal of C. N. Merritt & Brother, Inc., 1 B. T. A. 927.

The evidence shows that a large part of the sales of this corporation was made by it as a principal. There is serious doubt whether taxpayer has proved that less than 50 per cent of the gross income consisted of income earned through trading as a principal, but, since our opinion will turn on another point, further discussion of this one is unnecessary.

One of the requirements of section 200 of the Revenue Act of 1918 is that the principal stockholders must be regularly engaged in the active conduct of the business of the taxpayer. Three of the stockholders collectively holding a substantial amount of stock devoted- no time to the conduct of the business, while the other stockholders had other important business connections and interests to which they devoted some of their time. This corporation fails to meet this test. Appeal of J. J. Harrington, 1 B. T. A. 11; Appeal of C. W. Simpson Co., 1 B. T. A. 995.

The capital stock of the Wisconsin Coal & Dock Co. was all owned by the Cleveland & Western Coal Co. during the years in question. The fully paid capital stock of $100,000 and the large credit extended to this corporation by the Cleveland & Western Coal Co. permitted the taxpayer to own large dock properties, carry customers, and maintain large inventories of coai as shown by the balance sheet. For this reason it can not be said of this corporation that its income was “ ascribed primarily to the activities of its principal stockholders who were regularly engaged in the active conduct of its business.” It is also very apparent that capital, invested and borrowed, was a material income-producing factor. Appeal of Hanley-Ried & Co., 2 B. T. A. 315:

The second issue involved in this appeal is whether the Cleveland & Western Coal Co. is entitled, under the provisions of section 326 of the Revenue Act of 1918, to include in its invested capital the sum of $81,300, representing capital stock alleged to have been issued for good will.

During the years 1913, 1914, and 1915, the Cleveland & Western Coal Co. issued common stock of the par value of $87,800 to F. E. Taplin, J. M. Todd, F. E. Danielson, and C. F. Taplin, who, it is claimed, brought good will to the business. The minutes of the first meeting of the stockholders indicate that there were two conditions under which this stock would be issued. Each share of preferred stock was to carry with it one-half share of common stock as a bonus. The par value of the stock issued as a bonus was $37,300 and the only consideration required by the corporation was the purchase of preferred stock. Fifty thousand dollars of the common stock is indicated in the minutes to have been issued to F. E. Taplin in consideration of the good will and the patronage which he brought to this company and of services rendered and to be rendered in the promotion and financing of the company. These facts indicate that the corporation did not consider that the stock was being issued solely for good will, although F. E. Taplin was paid a substantial salary for the services rendered by him to the corporation. The corporation endeavored to prove a value for the good will of $87,300 by furnishing a list of customers to F. E. Taplin to whom coal was sold subsequent to incorporation. In the opinion of the Board, the evidence is insufficient to establish that the good will had any actual cash value. Appeals of Saenger Amusement Co., 1 B. T. A. 96; W. E. Marshall & Co., 1 B. T. A. 175; Wright's Automatic Tobacco Packing Machine Co., 1 B. T. A. 1260; and Providence Mill Supply Co., 2 B. T. A. 791.

The third issue involved in this appeal is whether the Cleveland & Western Coal Co. is entitled, under the provisions of section 326 of the Revenue Act of 1918, to include in its invested capital the sum of $15,300, representing the amount paid during 1917 to A. S. McQueen and James S. Boggs.

The Meadow Lands Coa.l Co. was in the hands of receivers until March 20, 1917, and had been for some time prior thereto. During the year 1915 the Cleveland & Western, through one of its officers, informed McQueen that it desired a contract for the coal produced by that company and asked McQueen if he would use his influence with the receivers in aiding the Cleveland & Western in obtaining such contract. The Cleveland & Western did secure said contract for one year, beginning April 1, 1916. During the life of this contract the stockholders of the Cleveland & Western purchased sufficient capital stock of the Meadow Lands Coal Co. to control it, provided the receivership was dissolved. In order to obtain a new contract when the old contract expired April 1, 1917, the Cleveland & Western desired termination of the receivership, and through the influence of McQueen the receivership was terminated. Alter the receivers had agreed to the termination of the receivership, the taxpayer, during the year 1917, paid $10,000 to McQueen and $5,300 to James S. Boggs, the latter being one of the receivers of the Meadow Lands Coal Co. The question is whether the two payments totaling $15,300 are properly allowable as invested capital, during 1918 and 1919, to the Cleveland & Western Coal Co.

The evidence as to the purpose of the payment to McQueen and the circumstances surrounding that payment is wholly insufficient to enable the Board to determine whether it was an ordinary and necessary expense or a capital expenditure. The amount paid to Boggs, one of the receivers of the coal company, is neither a capital expenditure nor an ordinary and necessary business expense. A receiver is an officer of the court and is paid for his services by court decree. For an outside party to pay or agree to pay him for his services as a receiver is contrary to public policy. The amounts paid to McQueen and Boggs, amounting to $15,300, are not allowable as invested capital during 1918 and 1919, because the amounts so paid were not expended for any asset used in the business during the years under consideration, nor were the amounts so expended proper capital expenditures.

The fourth issue involved in this appeal is whether the Cleveland & Western and the Wisconsin Coal & Dock Co. are entitled, under the provisions of section 327 of the Revenue Act of 1918, to a determination by the Commissioner of their profits taxes under the provisions of section 328. A taxpayer must come within the provisions of section 327 in order to be entitled to computation of its profits taxes under the provisions of section 328. Section 327 contains four conditions, one of which must be met before the taxpayer is entitled to consideration under the provisions of section 328. From the evidence submitted it is clear that the taxpayer does not meet any one of the first three conditions, and unless it meets the fourth condition it is not entitled to a computation of its taxes under section 328. The fourth condition, above referred to, provides as follows:

Where upon application by the corporation the Commissioner finds and so declares of record that the tax if determined without benefit of this section would, owing to abnormal conditions affecting the capital or income of the corporation, work upon the corporation an exceptional hardship evidenced by gross disproportion between the tax computed without benefit of this section and the tax computed by reference to the representative corporations specified in section 328. This subdivision shall not apply to any case (1) in which the tax (computed without benefit of this section) is high merely because the corporation earned within the taxable year a high rate of profit upon a normal invested capital, nor (2) in which 50 per centum or more of the gross income of the corporation for the taxable year (computed under section 233 of Title II) consists of gains, profits, commissions, or other income, derived on a cost-plus basis from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive.

Section 327 (d) provides that an “ exceptional hardship ” must be evident and that a “ gross disproportion ” exists owing to abnormal conditions,” and, until this is shown, taxpayer is not entitled to the benefits of this act. The act also provides that this subdivision shall not apply to any case in which the tax (computed without benefit of this section) is high merely because the corporation earned within the taxable year a high rate of profit upon a normal invested capital. The record in this case indicates that the taxpayer did earn a larger net income during the period of the war than during prior years. It was from such excess war profits that Congress apparently intended to derive revenue when it enacted the Revenue Act of 1918.

The fact that the taxpayer considers its tax too high and that the taxes of a few other corporations are lower than the tax proposed against the taxpayer, is not sufficient to prove that an “ exceptional hardship ” had been worked or that a “ gross disproportion ” exists “ owing to abnormal conditions.” The efficient operation of the corporation resulting in a rate of turnover of its capital in excess of the average rate of turnover does not produce an abnormal condition affecting capital or income which warrants the computation of the tax under section 328 of the Revenue Act of 1918. Appeal of United Shoe Stores Co., 2 B. T. A. 73.

The deficiency is $30//.,667.38 for 1918, and $f.6,669.76 for 1919. Order will he entered accordingly.


author: MoRRis:

text:
    Appeal of ILLINOIS MERCHANTS TRUST CO., Executor of the Estate of WILLIAM R. MANIERRE, Deceased.
    Docket No. 3106.
    Submitted August 3, 1925.
    Decided May 28, 1926.
    1. In 1919 the water level in tbe Chicago Kiver suddenly and unexpectedly receded and thus exposed part of the foundation piles under the decedent’s building. These piles immediately started to rot, which caused the wall on the river side to settle to such extent that the collapse of the building- threatened. The cost of shoring up the wall and repairing the foundation was a proper deduction from gross income under section 214 (a) (1), Kevenue Act of 1918.
    2. The decedent’s business had no good will value on March 1, 1913.

      Richard S. Doyle and L. Dana Latham, Esqs., for the petitioners.

      A. R. Mam, Esq., for the Commissioner.
    Before Makquette and MoRris.
    This appeal is from the determination of deficiencies in income taxes for the years 1918, 1919 and 1920, in the aggregate amount of $7,643.70, being $396.15 for 1918,' $1,398.49 for 1919, and $5,849.06 for 1920. The correctness of the 1918 deficiency is not in controversy.
    Two questions are raised: (1) Whether certain expenditures made in 1919 and 1920 to prevent the collapse of a building were deductible from gross income, or whether they constituted capital expenditures; and (2) whether the amount of $25,000 received in 1920 on a sale of the good will of the business constituted income of that year, or whether the amount represented good will value existing on March 1, 1913.
    FINDINGS OF FACT.
    William R. Manierre, now deceased, was a resident of Chicago, Ill. Subsequent to February 7, 1925, he died at Chicago, and the Illinois Merchants Trust Co. was duly appointed executor of his estate.

      During the years in question Manierre owned a building, known as Central Warehouse, located on the west bank of the south branch of the Chicago River. It was a brick building, having seven stories above the basement, and rested on a so-called floating foundation of wooden piles.
    Prior to 1919 all the foundation piles on the river’s edge were completely submerged. During that year, owing to the sudden and unexpected lowering of the water level, the ends of some of the piles on which the building rested were exposed to the action of the air and the other elements. Dry rot of the exposed portions immediately set in, and in 1919 the wall on the river side of the warehouse settled so materially that the entire building threatened to collapse.
    To prevent its total loss and to arrest further damage to the structure, it was necessary to saw off the rotted piles at a point below the new water level and to insert concrete supports between the ends of the submerged piles and the floor of the building. This work required the removal of a large portion of the ground floor. It was also necessary to shore up and raise, so far as possible, the partially collapsed wall.
    For those repairs the decedent expended during 1919 the sum of $9,000, and during 1920, $31,562.06. The work done did not prolong the original estimated life of the building, nor did it increase its value. In computing his net taxable income the decedent deducted those amounts from his gross income in the respective years.
    During 1920 decedent leased the warehouse to J. L. Kraft & Brothers Co., of Chicago, and received, over and above the agreed rental, the sum of $25,000 in cash. The lease contained the following provision relating to the sale of good will:
    And the lessee hereby covenants and agrees in addition to pay to the said lessor the sum of $25,000.00 in cash on or before the expiration of 30 days from the execution hereof as purchase price for the good will and storage business now in operation in said building.
    The taxpayer duly turned over to the lessee all contracts of storage then in effect and permitted the lessee to use the name “ Central Warehouse.”
    The Commissioner added the entire $25,000 to the decedent’s income for 1920.
    Prior to 1920, Manierre had specialized in the warehousing of tea and coffee. The Central Warehouse, William Manierre, Proprietor, was known throughout the world in the tea and coffee industry. No other warehouse in Chicago had equal facilities for warehousing, blending, grading, polishing and packing tea and coffee. The principal competitor shipped his teas to the Central Warehouse for packing, cutting and polishing.

      The decedent was over 80 years of age at his death, and, in the more recent years prior to his retirement, he had not kept pace with modern warehousing methods. The warehouse was not as profitable from 1914 to 1920 as it might have been, because of the failure to install a sprinkler system and other improvements. The insurance rate on goods stored in the warehouse was $1.05 per hundred pounds; the rate on goods in warehouses having modern sprinkling systems was 40 cents per hundred pounds. Also, owing to decedent’s failure during these years to conduct his business on more modern lines, he was able to charge but 50 per cent of the legal storage rate. Despite the increased cost of doing business between 1913 and 1920, there was no increase in his storage rates during' this time.
    In 1915, one Smith, who for twenty years prior thereto had been decedent’s manager, left his employment and took a similar position with a competing warehouse. Some of the decedent’s customers left him and went to Smith’s new employer.
    In 1919, Manierre was offered $50,000 for the good will of his business.
    His cash book showed:

    The storage warehouse business had no good will value on March 1, 1913.
   OPINION.

MoRRis:

The taxpayer claims the sums expended on the building are deductible, under section 214 (a) (1) of the Revenue Act of 1918, as ordinary and necessary expenses of carrying on business. The Commissioner contends that they are capital expenditures and therefore not deductible. In support of their contrary contentions both parties rely on article 108 of Regulations 45, which reads as follows:

The cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its Ufe, but keep it in an ordinarily efficient operating condition, may be deducted as expense, provided the plant or property account is not increased by the amount of such expenditures. Eepairs in the nature of replacements, to the extent that they arrest deterioration and appreciably prolong the life of the property should be charged against the depreciation reserve.

The taxpayer cites the first sentence, while the Commissioner emphasizes the second. We do not doubt the soundness of the article in question, nor do we think that the two sentences are inconsistent. We are of the opinion, however, that the Commissioner has incorrectly applied it to the facts in this appeal.

It will be noted that the first sentence of the article relates to repairs, while the second sentence deals in effect with replacements. In determining whether an expenditure is a capital one or is chargeable against operating income, it is necessary to bear in mind the purpose for which the expenditure was made. To repair is to restore to a sound state or to mend, while a replacement connotes a substitution. A repair is an expenditure for the purpose of keeping the property in an ordinarily efficient operating condition. It does not add to the value of the property, nor does it appreciably prolong its life. It merely keeps the property in an operating condition over its probable useful life for the uses for which it was acquired. Expenditures for that purpose are distinguishable from those for replacements, alterations, improvements or additions which prolong the life of the property, increase its value, or make it adaptable to a different use. The one is a maintenance charge, while the others are additions to capital investment which should not be applied against current earnings. We have already pointed out this distinction in the Appeal of Simmons & Hammond Manufacturing Co., 1 B. T. A. 803, in which we held that expenses properly chargeable to capital account include those which are incurred in the original construction of the work and in the subsequent enlargement and improvement thereof, and quoted the following from Union Pacific R. R. Co. v. United States, 99 U. S. 402, page 420:

Theoretically, the expenses chargeable to earnings include the general expenses of keeping up the organization of the company, and all expenses incurred in operating the works and keeping them in good condition and repair; whilst expenses chargeable to capital include those which are incurred in the original construction of the works, and in the subsequent enlargement and improvement thereof.

Applying these principles to the facts in the instant appeal, we find that, due to the sudden lowering of the water level in the south branch of the Chicago River, the upper ends of certain piles upon which Manierre’s building rested were exposed to the air, with the result that dry-rot of the exposed parts immediately set in. The wall on the river side settled so materially that the entire building-threatened to collapse. In order to keep it in serviceable condition, it was necessary to saw off the rotted piles at a point below the new water level and to insert concrete supports between the ends of the submerged piles and the floor of the building and raise the river wall. This work obviously did not arrest the normal deterioration. The Commissioner contends, however, that it did appreciably prolong the life of the property, and therefore denies the deduction under the second sentence of the above article. In our opinion the import of that language is plain and does not warrant the construction placed upon it by the Commissioner. The life of the property therein referred to relates to its probable, normal, useful life for the purpose of the allowance for the return of the capital investment. There is no question but that by this expenditure the life of the building was prolonged over what it would have been after the sudden lowering of the water level in the river, but any repair increases the useful life of property over what it would have had without the repair, and hence the Commissioner’s construction would prohibit the deduction of any such expenditure. The evidence is clear that the normal, useful, expected life of this building was not increased. On the contrary, it was shortened because the building was still ruptured and cracked,” even after the work was done. We are therefore of the opinion that the second sentence of article 103 does not bar the deduction of this expenditure.

The Commissioner does not dispute that these were necessary expenses, but he insists they were not ordinary. This word is defined in Webster’s New International Dictionary as follows: “(1) According to established order; methodical; settled; regular; (2) Common; customary; usual.” The work done was in the nature of repairs for the purpose of keeping the property in a serviceable condition. Expenditures of that character are commonly recognized and accepted as ordinary business expenses. We think article 103 of [Regulations 45 correctly interprets section 214 (a) (1) of the Revenue Act of 1918 in providing that repairs which “ neither materially add to the value of the property nor appreciably prolong its life * * * may be deducted as expense, provided the plant or property account is not increased * * * ”. The evidence shows that these expenditures did not add to the value or prolong the expected life of the property over what they were before the event which made the repairs necessary occurred.

The remaining question is the value on March 1, 1913, of the good will of the storage warehouse business which was sold in 1920 for $25,000. The Commissioner claims that it had no value and added the entire $25,000 to income.

We agree with his conclusion. The decedent’s cash book shows that from the year 1907 to 1912, inclusive, the average annual profits were $843.06, and that for the years 1912 and 1913 there were losses of $1,160.75 and $804.42, respectively. The decedent owned the building in which the business was transacted, and although we are not informed of the amount of his investment therein, it was a substantial building of seven stories above the basement. It would therefore appear that the average earnings for the above years were not even a fair return upon his tangible assets. Considering this in connection with the fact that losses were sustained during the years 1912 and 1913, we' are unable to ascribe any value to the good will of the business as of March 1, 1913, and therefore conclude that the $25,000 received for good will in 1920 should be included in the decedent’s gross income.

We do not hold that a value of good will can be evidenced only by the earnings in excess of a reasonable return upon the tangible assets. The taxpayer has introduced no other convincing evidence of such value and none from which such value can be adduced.

Order of redetermination will be entered on 10 days' notice, wnder Bule 50.


text:
    Appeal of EDWIN C. BRANDENBURG, as Executor of the Estate of GEORGE M. OYSTER, Jr.
    Docket No. 7390.
    Submitted May 5, 1926.
    Decided June 17, 1926.
    1. Expenses of exhibiting horses at state fairs, such horses being used to advertise the business of the taxpayer, held to be proper deductions from income.
    2. Bonuses paid to business employees held to be proper deductions from income.

      E. G. Brandenburg, Esq., for the petitioner.

      F. O. Graves, Esq., for the Commissioner.
    Before Phillips.
    Taxpayer appeals from the determination of a deficiency of $2,919.27, income tax for 1920.
   FINDINGS OF FACT.

George M. Oyster, Jr., departed this life on the 21st day of April, 1921, leaving a last will and testament under and pursuant to which the petitioner duly qualified as executor in the Probate Court of the District of Columbia.

Prior to his death, and during the year 1920, George M. Oyster, Jr., was engaged in the dairy business in the District of Columbia under the name of Chestnut Farms Dairy. In connection with the dairy, decedent also operated a farm at Walkersville, Maryland, which was used for breeding pure-bred Percherons and as a place for resting the horses used on trucks and delivery wagons. Thoroughbred colts bred on the farm were sold throughout the country.

During 1920 decedent exhibited pure-bred Percherons and draft horses at horse shows and state fairs at Chicago and Springfield, Illinois, Des Moines, Iowa, and Syracuse, New York. The expenses of such exhibitions amounted to $11,342.03 and the premiums won amounted to $3,653.95. Decedent included such premiums as income and deducted such expenses in computing the income of his business. The Commissioner excluded both items in computing the deficiency.

The horses on exhibition were driven in a four-horse or six-horse hitch attached to wagons on which appeared the words “ Chestnut Farms Dairy, Washington, D. C.” The prize-winning teams were used in Washington for both work and exhibition purposes, advertising the dairy and securing for it considerable publicity in the newspapers and otherwise. The winnings of the dairy exhibits were also advertised in the local papers.

At Christmas the decedent distributed $910 among the employees of his business, in small amounts, as additional compensation, in accordance with a custom inaugurated by him in 1913. In computing net income the Commissioner refused to allow such payments as deductions.

The income■ of the decedent for 1980, as determined by the Commissioner, should be reduced by $8,598.08. Order of redetermination wiTl be entered on 10 days’ notice, under Hule 50.


author: Lansdon:

text:
    Appeal of WISCONSIN NATIONAL BANK.
    Docket No. 2511.
    Submitted June 12, 1925.
    Decided June 21, 1926.
    1. Deduction for exhaustion of leasehold on basis of March 1, 1918, value allowed.
    2. Deduction for obsolescence of building disallowed.

      Douglass Van Dyke, Esq., and Harold C. Anderson, C. P. A. for the petitioner.

      A. H. Fast, Esq., for the Commissioner.

      Before Steeniiagen, LaNSdoN, GreeN, and Love.
    Tbe Commissioner has determined a deficiency in income and profits taxes for the year 1918, in the amount of $79,074.30, of which the amount of $76,558.27 is in controversy. The two issues involved are (1) exhaustion of a leasehold acquired by the taxpayer prior to March 1, 1913; and (2) obsolescence of a building-owned by the taxpayer during the year 1918.
    FINDINGS OF FACT.
    The petitioner was incorporated under the laws of the United States as a national bank in 1892, and was engaged in the banking business in Milwaukee until June 30, 1919, when it was consolidated with the First National Bank of Milwaukee, under the name of the First Wisconsin National Bank of Milwaukee.
    On February 20, 1890, Frederick Pabst leased Lot 6 in Block 2 in the Seventh Ward of the City of Milwaukee, for a term of 99 years from May 1, 1890, on terms and conditions not in controversy in this appeal but which are fully set forth in the record. In 1891 Pabst erected on such leased land a structure known as the Pabst Building. In 1892 the petitioner leased and occupied the main floor of such building as the tenant of Pabst.
    In 1904 the petitioner purchased the building and leasehold from Pabst for a consideration of $432,000. The purchase price was never segregated on its books as to the respective amounts paid for the leasehold and the building, but the parties have stipulated that $315,693.50 represents the cost of the building and $116,806.50 the cost of the leasehold.
    Prior to December 31, 1917, the petitioner had acquired a two-sixths interest in the fee of the building site and, some time during 1918, it acquired an additional two-sixths interest in such fee. Subsequent to 1918, the remaining two-sixths interest in said fee was acquired.
    The parties agree that the fair market value of the Pabst Building on March 1, 1913, was $460,100, and that the depreciated March 1, 1913, value on December 31, 1917, was $371,147.33; that the depreciated cost of the petitioner’s interest in the leasehold in question was $81,086.99 on March 1, 1913, and $65,350.61 on December 31, 1917, and that the fair market value of its interest in the leasehold was $193,130.36 on March 1, 1913, and that the exhausted fair market value of the same on December 31, 1917, was $180,874.73.
    On account of a very substantial growth in volume of business, it became evident in 1918 that the Pabst Building was no longer adequate for tbe purposes of the petitioner, either as to space or arrangement of rooms. On December 12, 1918, the directors of the petitioner decided to demolish such building and erect a new structure on the, same site, especially designed and planned for a bank. In pursuance of such decision an architect was employed, tentative plans for a new building were drawn and considered, and the directors were authorized by the stockholders to proceed with the work of demolition and construction. Resulting from the plans for demolition, the petitioner, December 31, 1918, wrote down the book value of the Pabst Building in the amount of $100,000, which included ordinary depreciation for the year, and a further write-off for obsolescence on account of the proposed demolition of the structure, and deducted such amount from its gross income in its income and profits-tax return for the calendar year 1918.
    Upon the consolidation of the petitioner with the First National Bank of Milwaukee, on June 30, 1919, the plans to demolish the Pabst Building and to erect a new structure were abandoned. The office space theretofore used by the petitioner was let to another bank, and such banking quarters, together with the office rooms on the upper floors of the building, have ever since been continuously occupied by paying tenants.
    In the consolidation of the books of the petitioner and the First National Bank of Milwaukee upon the consolidation of such concerns into the First Wisconsin National Bank of Milwaukee, the Pabst Building was taken into the assets of the new bank at its book value of December 31,1911-, less the amount of $100,000 written off as depreciation and obsolescence in 1918, and the leasehold in question was taken into such assets at its book value at the date of merger, which was the exhausted 1013 value stipulated by the parties to this appeal.
   OPINION.

Lansdon:

Two issues are presented for the consideration of the Board in the determination of this appeal: (1) Whether the depreciated cost at March 1, 1913, or the fair market value as of that date, shall be used as the basis for computing the petitioner’s deduction from gross income for the year 1918 as exhaustion of a certain leasehold on real estate; and (2) ivhether the petitioner may take a deduction for obsolescence of its bank building in its income-tax return for the year 1918 in excess of the amount of ordinary depreciation allowed by the Commissioner.

The parties agree as to the values involved. The petitioner acquired the leasehold in 1904 at a cost of $116,806.50, and the depreciated cost of its interest therein was $81,086.99 on March 1, 1913, at which time the fair market value was $193,130.36. On December 31, 1917, the depreciated cost was $65,350.61 and the value remaining, after ratably exhausting the fair market value at March 1, 1913, for the intervening period was $180,874.73. The petitioner contends that for the year 1918 it is entitled to deduct an aliquot part of the fair market value of the lease as of March 1, 1913, from its gross income in its income and profits-tax return. This contention is denied by the Commissioner, who asserts that the correct basis for the exhaustion of the leasehold is the depreciated cost of March 1, 1913. On this point the Board must hold that the petitioner’s contention is sound. Appeal of Grosvenor Atterbury, 1 B. T. A. 169, and others in which the same principle is involved.

There is, however, an additional element in this controversy which must be considered. Prior to or about March 1, 1913, the petitioner became the owner of two-sixths of the fee of the real estate covered by the leasehold in question, and, some time during the year 1918, it acquired an additional two-sixths interest in such fee. Neither party bases its contentions on the petitioner’s ownership of such fractions of the fee, and the petitioner voluntarily concedes that it is not entitled to exhaustion of that part of the leasehold represented by its two-sixths interest in the fee on March 1, 1913. The Commissioner suggests that there may have been a merger of the lesser with, the greater estate resulting from the petitioner’s ownership of a fraction of the fee, and insists, in any event, that the petitioner is entitled to exhaustion of only two-sixths of whatever value of the leasehold is the proper basis for the computation of exhaustion.

The rule as to the merger of lesser estatés with greater estates is well established:

Whenever a greater estate and a less coincide and meet in one and the same person, without any intermediate estate, the less is immediately annihilated; or, in the law phrase, is said to be merged, that is, sunk or drowned in the greater. Thus, if there be a tenant for years, and the reversion in fee simple descends to or is purchased by him, the term of years is merged in the inheritance and shall never exist any more. But they must come to one and the same person in one and the same right; else, if the freehold be in his own right and he has a term in right of another (en auter droit) there is no merger. Sharswood’s Blackstone, Vol. I, Book II, 177.

Bouvier says, under the caption “ Merger of Estates ”:

• When a greater estate and less coincide and meet in one and the same person, without any intermediate estate, the less is immediately merged, that is, sunk or drowned, in the latter; but they must be in one and the same person, at one and the same time, in one and the same right. Nicholson v. Halsey, 1 Johns. Ch. (N. Y.) 417; Lockwood v. Sturdevant, 6 Conn. 373.
To have the union operate a merger, the estates must unite in one and the same person, having a commensurate and coextensive interest in each, with no intervening interest in another. A legal estate in fee in one who has only a partial equitable interest, or vice versa, would not merge. In re Washburn's Estate, 11 Cal. App. 735; 106 Pac. 415.
Where the lessee of land becomes the owner thereof in fee, the lease is terminated and the lesser estate is merged into the greater. 24 Cyc. 1342. McMahan v. Jacoway, (Ala.) 17 So. 39; Hudson Bros. Com. Co. v. Glencoe Sand & G. Co., (Mo.) 41 S. W. 450; Story v. Ulman (Md.), 41 Atl. 120.
In order that there may be a merger it is essential that there should be at least two distinct estates, a greater and a lesser, meeting in the same person, or class of persons, at the same time and without any intervening estate. 21 Corpus Juris, 1035-36.

In this appeal the parties agree that the lease was not terminated by the acquisition of a fraction of the fee by the petitioner which was the owner of the entire leasehold. Although the lessee purchased portions of the fee at different times, the leasehold, nevertheless, continued to have a legal existence in its entirety and so could have been sold or otherwise transferred as a whole at any time prior to legal merger of the lesser and greater estate through acquisition of the entire fee by such lessee.

The Board is of the opinion that no merger of the lesser with the greater estate involved in this appeal took place until the entire fee was acquired by the petitioner at a date subsequent to the year involved. The petitioner is entitled to deduct four-sixths of an aliquot part of $193,130.96 from its gross income for éxhaustion of the leasehold in question during the calendar year 1918.

In making its income and profits-tax return for the calendar year 1918, the petitioner deducted the amount of $100,000 for ordinary depreciation and obsolescence of the Pabst Building, which it owned at that time. Such deduction was based on the, decision of its directors that such building should be demolished and one more suitable for banking purposes erected as soon as possible after January 1, 1918. The Commissioner has disallowed all this deduction in excess of the normal or ordinary annual depreciation of such building.

The law permits, and, in some instances, the Board has sanctioned, deduction for obsolescence of tangible property. The petitioner argues that it was certain that the building in question would be demolished within three years at the outside, and that it was, therefore, entitled under the law to recover the unextinguished useful value of its property during that period, and so, for the first year of such period, took a deduction equal approximately to one-third of the remaining book value of the building which it had decided to demolish.

The evidence discloses that the demolition and construction plans considered prior to December 31, 1918, were not carried out. ' The petitioner was consolidated with another corporation in the same business that had quarters adequate for the operations of the combined banks. The building in question was not demolished. The space formerly occupied by the petitioner is now used by a large bank, which pays a substantial rental. The office space in the upper parts of the building is all taken by rent-paying tenants. No matter what may have been the plans of the petitioner in December, 1918, those plans were abandoned. Argument that consolidation with another corporation and the use of the business premises of that concern was, in effect, a demolition of the petitioner’s building, since it involved abandonment of offices long used, is not persuasive. The determination of the Commissioner disallowing extraordinary depreciation or obsolescence of the petitioner’s building for the calendar year 1918 is approved.

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


author: SteRnhagen

text:
    Appeal of COMSTOCK-CASTLE STOVE CO.
    Docket No. 3347.
    Submitted November 11, 1925.
    Decided June 21, 1926.

      George W. Govert, Esq., and Clyde Hunter, C. P. A., for the petitioner.

      A. H. Fast, Esq., for the Commissioner.
    Before Sternhagen and Arundell.
    The Commissioner determined deficiencies in income and profits taxes for the fiscal years ended January 31, 1918, 1919, 1920 and 1921, in the amounts of $4,518.64, $5,618.34, $5,126.05, and $2,241.97, respectively, — a total of $17,505.00. The petitioner set out twenty-eight assignments of error, with respect to the four years involved, some of which were disposed of by stipulation.
    FINDINGS OF FACT.
    1. The taxpayer, an Illinois corporation with its principal office at Quincy, is engaged in the manufacture and sale of stoves and ranges.
    2. During the years under consideration some of its accounts were maintained on the accrual basis, and others were maintained on the basis of cash receipts and disbursements. The books do not clearly reflect the income for any of the years under consideration.
    3. During the years in question the taxpayer accounted for taxes and interest at the time of actual disbursement. Obligations for taxes and interest accrued as follows:

    4. During the fiscal year ended January 31, 1918, the taxpayer charged to expense $6,882.06, being items carried in an account called “ Building Repairs and New Machinery.” Of this amount, $4,494.61 was ordinary and necessary expense.
    5. During 1919, 1920 and 1921, the taxpayer charged to expense sundry items of capital additions and betterments. These amounts were not ordinary and necessary expenses: 1919, $2,540; 1920, $2,105.39; 1921, $1,175.46.
    6. During the years in question expenditures made as to automobiles, office equipment and machinery and tools were accounted for in the machinery and tools account.
    7. The following is contained in the minutes of a meeting of the board of directors of February 10, 1885:
    Alter an examination of the report of business and inventory, it' was agreed to declare a dividend of eleven per cent out of surplus over capital stock, it leaving standing to tbe credit of profit and loss $1,945.88, after allowing $2,000 on estimated shrinkages. It was agreed to charge the account of flasks and patterns with ten thousand dollars, and place same as a permanent credit to surplus fund, and only to be used to cover any shrinkages on flasks and patterns.
    The taxpayer’s properties were revalued in or about 1907, new books of account were opened, and the new values were entered therein. The old books are not available.
    8.From 1910 to 1917, inclusive, the taxpayer made the following capital expenditures and charged them to expense:
    Fiscal 1910. $146. 33
    “ 1911. 3, 880. 51
    “ 1912. 1, 000. 84
    “ 1913. 838. 56
    “ 1914. 1,141.60
    “ 1915. 348.02
    “ 1916. 1, 879. 70
    “ 1917. 1, 368. 69
    Total_ 10, 604.25
    9.When the books were opened in' 1907 an entry was made in the patterns and flasks account showing patterns and flasks owned of $67,687.50. This amount has remained on the books ever since. No depreciation has been provided for. No additional expenditures have been added (except an item of $1.52). All subsequent expenditures for patterns and flasks have been charged off as expense and deducted on income-tax returns. Such expenditures are as follows:
    Riscal 1909. $3, 603. 60
    “ 1910. 3, 223.30
    “ 1911. 4, 641. 44
    “ 1912. 4. 375. 69
    “ 1913. 7, 656. 61
    “ 1914. 3, 598. 76
    “ 1915. 8, 032. 83
    “ 1917. 3, 765. 87
    “ 1918. 1, 662.40
    “ 1921. 685. 80
    10. At the close of the fiscal year 1918 the taxpayer set up on its books a reserve for accrued commissions, salaries and accounts payable, in the amount of $5,460.35, to take care of certain liabilities accrued at that date. At the close of the fiscal years 1920 and 1921 additions were made to this reserve, in the amounts of $1,000 and $300, respectively, for like purposes. The amount of the reserve set up on the books in 1918, and the additions thereto in 1920 and 1921, were claimed as deductions in the income-tax returns of the three years affected. These deductions were disallowed by the Commissioner.
    The commissions, salaries and accounts payable, which had actually been incurred at the close of each of the years under consideration, are as follows:

      Fiscal year ended January SI.

    All of the above items were deducted in income-tax returns for the years in which they were actually paid, in each case the year of payment being the next succeeding year to that in which they accrued.
    11. In each of the inventories at the close of the year taxpayer included automobiles, furniture and fixtures, machinery and tools, office equipment and patent and shop rights, at the values shown in the following tabulation:

      In inventory at close of fiscal year ended January 31.

      The Commissioner made no revision of the above items. The net income, as computed by the Commissioner, is predicated upon inventories in which the foregoing items have been included.
   OPINION.

SteRnhagen

: In accordance with the foregoing findings of fact, based in part upon the stipulation of the parties as to some of the items, we are of opinion that adjustments should be made of the taxpayer’s invested capital and net income for the taxable years in question.

For all the years in question the deduction for taxes and interest should be made upon the accrual basis, as set forth in our findings of fact, paragraph numbered three.

In respect of the taxable year 1918 the taxpayer should be allowed • a deduction of $4,494.61 as ordinary and necessary expense, instead of the amount of $6,882.06 shown in the building repairs and new machinery account and erroneously deducted.

In 1919 the taxpayer erroneously deducted as expenses $2,540, which represented capital expenditure. The Commissioner has already disallowed $188.40, and therefore there remains a further disallowance of $2,351.60. For the year 1920 the taxpayer made a similar erroneous deduction of $2,105.39. The Commissioner, however, disallowed the amount of $2,923.89, and the taxpayer is therefore entitled to have the difference of $818.50 deducted and its net income reduced accordingly. For 1921 the taxpayer likewise erroneously deducted $1,175.46, and this amount should be restored to net income.

In accordance with the stipulation the taxpayer is entitled to deduct depreciation on automobiles'computed' at 25 per cent on a basis of $1,137.14 for 1918; on a basis of $1,137.14 for 1919; on a basis of $1,330.29 for 1920; and on a basis of $1,398.31 for 1921. It was also stipulated that the taxpayer may deduct depreciation at the rate of 10 per cent on office equipment and 7% per cent on machinery and tools. The bases for these last-mentioned depreciation rates are not in the record, either by way of stipulation or proof, and the computation must, therefore, be based upon the amounts adopted by the Commissioner.

The evidence in respect of patterns and flasks is not adequate to justify a finding as to the base or the rate. The testimony as to the useful life of the patterns and flasks owned- by this taxpayer was given by two witnesses, neither of whom could testify satisfactorily in respect of the particular property in question. Furthermore, it is not established that the patterns and flasks claimed were on hand at the beginning of the period in question, and for the same reason we are unable to find for the taxpayer in respect of the claim that any amount should be restored to surplus as invested capital in patterns and flasks.

The Commissioner excluded from invested capital an amount of $10,000, which he regarded as an arbitrary appreciation of . value placed upon the books in accordance with the resolution of February 10, 1885. There is nothing to indicate the actual fact in respect of this entry or whether it represented an actual outlay. From the language of the resolution it is reasonable to infer that it represented a mere inflation of value, and since the Commissioner’s determination in this respect has not been disproved we shall not disturb it.

As to the deductions taken by the taxpayer for accrued commissions, salaries and accounts payable, after, considering the evidence we are of opinion that the net income for 1918 should be reduced by $15,884.78; for 1919 should be increased by $8739.13; for 1920 should be reduced by $5718.19; and for 1921 should be increased by $2490.71.

The inventory for the years in question should be adjusted so as to eliminate automobiles, office equipment, machinery and tools, patents and shop fights in the respective amounts set forth in our findings of fact. Upon the remaining .issues the determination of the Commissioner is approved.

Order of redetermi/nation will be entered on 15 days' notice, wnder Rule 50.