author: ÁRNOio:

text:
    Mohawk Petroleum Company, Petitioner, et al.
      v. Commissioner of Internal Revenue, Respondent.

    Docket Nos. 105967, 105968, 105969, 105970, 105971.
    Promulgated October 30, 1942.

      Fred, E. Brown, O. P. A., for the petitioners.

      T. M. Mather, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: Alfred L. Marsten, Jr.; Lewis A. Marsten; Edwin V. McKenzie; and Estate of Alfred L. Marsten, Deceased, Edwin V. McKenzie, Executor.

       Prior to October 22, 1942, this report was approved for promulgation. i

   OPINION.

ÁRNOio:

These consolidated proceedings involve deficiencies in income.taxes determined by the respondent against petitioner Mohawk Petroleum- Co. for the fiscal years ended September 30, 1936 and 1937, in the amounts of $991.84 and $15,603.44, respectively.

The petitioners in Docket Nos. 105968, 105969, 105970, and 105971 are admittedly transferees of the assets of the Mohawk Petroleum Co. and liable, as such transferees, for any deficiencies determined against the Mohawk Petroleum Co. herein, together with interest thereon as provided by law.

T]ie question involved is whether the Mohawk Petroleum Co., hereinafter referred to as petitioner, is entitled to loss deductions in the amounts of $5,044.13 and $35,026.52 claimed to have been sustained by it through the abandonment of oil well equipment in the fiscal years ended September 30,1936, and September 30,1937, respectively.

The facts were stipulated.

The petitioner was in the taxable years a California corporation and filed its returns with the collector of internal revenue for the first district of California. The petitioner has consistently closed its books and filed its income tax returns on the basis of a fiscal year ending September 30.

The petitioner acquired certain oil and gas leases upon lands in the Fruitvale Oil Field in Kern County, California, shortly after its organization in 1928. One of the leases so acquired was called the Red'Ribbon Ranch lease. At the time of the acquisition of this lease there was a producing oil well located thereon. Five additional wells were drilled on the Red Ribbon Ranch lease by petitioner in 1929, 1930, and 1931 and all of the five wells became producing wells. All of the six wells located on the Red Ribbon Ranch lease continued to produce crude oil until during the fiscal year ended September 30, 1934, when one well became nonproductive. This well, petitioner’s Red Ribbon Ranch lease well No. 6, was finally abandoned in the fiscal year ended September 30, 1936. The other five wells located on the Red Ribbon Ranch lease continued to produce crude oil for several years after the year ended September 30,1936.

On December 12, 1932, the petitioner entered into an oil and gas lease with E. E. and Frona McKeehan covering certain lands in the Weedpatch Oil Field in Kern County, California. During the fiscal year ended September 30, 1934, two producing oil wells were drilled on the McKeehan lease and during the‘fiscal year ended September 80,1936, one producing oil well was drilled thereon. During the fiscal year ended September 30, 1937, wells Nos. 1 and 3 on the McKeehan lease became nonproductive and were abandoned. Well No. 2 on such lease continued to produce for several years after the fiscal year ended September 30,1937.

On March 17, 1936, the petitioner entered into an oil and gas lease with the Earl Fruit Co., a corporation, covering certain lands in Kern County, California. During the fiscal year ended September 30,1936, one oil well was completed on the Earl Fruit Co. lease and during the fiscal year ended September 30, 1937, two additional wells were completed on that lease. Earl Fruit Co. lease well No. 1 started production of crude oil in August 1936 and become nonproductive in May 1937 and was abandoned prior to September 30, 1937. Well No. 2 on the Earl Fruit Co. lease was completed in January 1937, but it was not a commercially productive well and was abandoned shortly after completion and the capitalized cost of the well was written off as a dry hole loss and allowed as such by the respondent in the fiscal year ended September 30, 1937. Earl Fruit Co. lease well No. 3 was completed in March 1937 and produced crude oil for several years after its completion. Two additional producing wells were later completed on this lease.

Ever since its organization in 1928 petitioner has consistently deducted intangible development costs in connection with drilling oil wells as expense and has capitalized the cost of tangible oil well equipment. The cost so capitalized of each well was set up separately. in the petitioner’s books. The cost so capitalized applicable to the wells here in question is as follows:

Red Ribbon Ranch lease well No. 6- $9,093.00
McKeehan lease well No. 1- 22,304.17
McKeehan lease well No. 3- 16, 542.36
Earl Fruit Co. lease well No. 1- 15, 735. 91

Ever since its organization in 1928 petitioner has consistently computed depreciation on the so-called unit of production method, that is to say, the annual depreciation applicable to the capitalized cost of oil well equipment located on a particular lease was determined-by dividing the capitalized cost (after a 10 percent reduction for estimated salvage value) of all the wells on a particular lease by the estimated net potential crude oil production of the lease and the unit cost per barrel thus determined was then multiplied by the net number of barrels produced during the year from that particular lease to arrive at the amount of depreciation for the year. Estimated oil reserves and resulting unit cost per barrel were for an entire lease and the estimate was based upon the aggregate potential production of all wells and no separate determination of unit cost as to each separate well was made.

The depreciation reserve account in the petitioner’s general ledger relating to depreciation on the capitalized cost of its oil wells is segregated as between the depreciation applicable to each separate oil lease, but is not segregated as between each separate oil well located on a particular lease.

Ever since its organization in 1928 petitioner has maintained a record of the crude oil production of each separate oil well.

During the fiscal year ended September 30, 1936, petitioner wrote off as a loss consequent to the abandonment of its Red Ribbon well No. 6 in that year an amount of $5,044.13, which said amount was computed as follows:

Total cost of tangible ecjuiimient capitalized- $9,093.60 Less depreciation previously written off:
Net Mils, produced after royalty to Ycar ended bon Well No. 6 Unit depreciation rate applicable to Red Iiililion Iiancli I .ease Well Equipment Amount
Sept. 30, 1930_12,421 $.032063392 $405. 77
Sept. 30, 1931- 22, S70 . 032CGS392 747.32
Sept. 30, 1932- 41,285 ,.032971291 1, 301. 22
Sept. 30, 1933_37, 847 . 032920749 1,245. 95
Sept. 30, 1934- 8, 785 . 032920749 239.21
Sept. 30,1935_ None None
Sept. 30, 1936- None ■ None
Total_ $4,049.47
Abandonment. Loss. $5,044.13

During the fiscal year ended September 30, 1937, petitioner wrote off as losses consequent to the abandonment of its McKeehan wells Nos. 1 and 3 and its Earl Fruit Co. well No. 1 a total amount of $35,026.52, which amount was computed as follows:

Loss on McKeehan Wall No. 1
Total cost of tangible equipment capitalized_ Less depreciation previously written off: $22,304.17
Unit fleprpeia-Net bills. tion rate nppll-S reduced after cable to Mc-o.valty to I.es- Keelian Reuse _ , , sor-JIeKeelian Well Equip-Year ended Weil No. l ment Amount
Sept. 30, 1934_ 105, 420 $. 043550770 $4, 592. 02
Sept. 30, 1935_ 114,161 .063458951 7, 244. 54
Sept. SO, 1930- 40,122 .003458951 2, 540.10
Sjpt. 30, 1937- 8,309 1 .003458951 526. 71
Total- $14, 909. 37
Loss on McKeehan Well No. 1_ $7,394. 80
Loss on McKeehan Well No. S.
Total cost of tangible equipment capitalized- $16,542.36
Less salvage value of tangible equipment removed from well_ 1,479.75
Balance of equipment abandoned Less depreciation previously written off: $15, 062. 61
Year ended Net bills, produced after royalty to Lessor-McKeelian Well No. 3 Unit depreciation rate applicable to Mc-Keelian Lease Well Equipment Amount
Sept. 30, 1935_ 9, 218 $. 063458951 $584. 96
Sept. 30, 1936_ 5,938 . 063458951 376.92
Sept. 30, 1937_ None
Total___ $961. 88
Loss on McKeehan Well No. 3_ $14,100. 73
Loss on Karl Fruit Company Well No. 1.
Total cost of tangible equipment capitalized_ $15, 735.91
Less salvage value of tangible equipment removed from well_ 2,204.92
Balance_ $13, 530.99
Depreciation previously written off_ None

Petitioner did not adjust tlie cost of well equipment on account of depreciation in its computation of loss on tlie abandonment of the Earl Fruit Co. lease well No. 1 because at the time of closing its boobs for the fiscal year ended September 80, 1936, it had no reliable engineering reports as to the possible potential crude oil production from this lease and accordingly had insufficient data to compute depreciation with respect to the lease for the year and did not compute any depreciation in its books nor claim any depreciation in its income tax return with respect to the lease for the year. Respondent computed and allowed depreciation applicable to the well equipment located on the Earl Fruit Co. lease for the year ended September 30,. 1936, as follows:

In his final determination of tax for the fiscal year ended September 30, 1936, the respondent disallowed the claimed deduction of $5,044.13 consequent to the abandonment of petitioner’s Red Ribbon Ranch lease well No. 6 and similarly disallowed during the fiscal year ended September 30,1937, claimed deductions totaling $35,026.52 consequent to the abandonment of petitioner’s McKeehan lease wells Nos. 1 and ■3 and Earl Fruit Co. lease well No. 1, for the following reasons:

■(b) On your return your claimed the deduction of $5,044.13 in the fiscal year ended September 30, 1936 (and $35,026.52 in the fiscal year ended September 30, 1937) as a loss sustained through the abandonment of oil well equipment at oil wells shut down during the taxable year although other wells on the same leaseholds continued to operate.
You elected and have continued to deduct depreciation on your oil well equipment on your income tax returns on a unit of production basis based’ upon the total estimated production of oil to be obtained from an entire leasehold.
Since your tangible oil well equipment installations on each leasehold in question consist of more than one installation and depreciation has been based upon the average lives of all such installations, losses claimed on the normal retirements of such assets are not allowable inasmuch as an average rate contemplates a normal retirement of assets both before and after the average life has been reached and there is therefore, no possibility of ascertaining any actual loss under such circumstances until all assets contained in the group have been retired or disposed of.
Therefore the losses claimed in the respective years are disallowed as de-deductions. See Article 23 (e)-3, Regulations 94 and 101.

Article 23 (e)-3 of Regulations 94 and 101, in so far as pertinent herein, is set forth in the margin.

The petitioner contends that the unit of production method used by it in determining depreciation on its oil well equipment contemplated that the lives of the oil wells on a particular lease would be the same, i. e., as long as the lease on which such wells are located was -commercially productive, and that the abandonment of any well and the retirement of its equipment prior to the time the lease becomes commercially nonproductive are premature and hence abnormal. The petitioner also contends that, since the method used by it vas not based upon the average life of the individual veil upon a given lease but upon the life of the lease, which is coextensive with the longest life of any well located on such lease, the losses claimed are allowable under the provisions of the last paragraph of article 28 (e)-3.. (See note 1.)

The fallacy of petitioner’s argument lies in the fact that it presupposes the life of the tangible equipment of a well to be coextensive with the life of the lease or so long as the lease on Avhich the-wells are located is productive. It is common knowledge that some wells produce salt Avater and other deleterious substances that eat out the casing, tubing, rods, lead lines, and other equipment, necessitating replacements of tangible equipment during the productive life of such wells. On the other hand equipment in some Avells may still have considerable useful life after a Avell becomes nonproductive. The fact that a well becomes nonproducth’e and is abandoned does not necessarily result in the complete loss of usefulness of the equipment thereon or accelerate its depreciation or constitute abnormal retirement of the equipment. Such equipment may be and often is used at other wells. The stipulation shows that the wells involved were abandoned, but there is no evidence showing that the equipment thereon Avas also abandoned because it had lost its usefulness or that the abandonment of the Avells caused depreciation of the equipment in excess of that normally sustained. Except that the stipulation shoAA’s that petitioner “wrote off” the amounts of $5,044.13 and $35,020.52 “as losses consequent to the abandonment of its” Avells and claimed losses in its income tax returns in such amounts, there is no evidence that the equipment Avas actually retired or abandoned because it had lost its economic usefulness and had no more than scrap or salvage \ralue or no value.

The method used by petitioner contemplates the recovery of the entire cost of the equipment over the productive life of the lease. This method contemplates a normal retirement of the equipme2it, both before and after the average life has been reached. In the absence of a sale of the equipment for Avhich the loss is claimed, or unusual or abnormal circumstances which result in its destruction, obsolescence, or accelerated depreciation, no retirement loss is alloAvable so long as the lease continues to produce and other equipment on the same lease is in use.

What Avas said in U. S. Industrial Alcohol Co., 42 B. T. A. 1323, 1378-1379 (appeal pending, C. C. A., 2d Cir.), is equally applicable herein:

The principle to be applied to a composite rate in such a case as this, therefore, is that assets which are retired at the end of their normal life can not be permitted to furnish further compensation by way of a deduction for loss on retirement, even though they may be retired in advance of the average life of the entire group. Their early retirement will be compensated for by depreciation taken after the average period has passed.
What has been said, however, applies only to normal retirements; and the converse of the statement is also true. If assets are removed from the group as a result of abnormal retirements resulting from unanticipated causes occurring before the end of the normal life attributed to such assets in arriving at the composite rate, the resulting.loss is the proper ground for a deduction. Such losses are not to be compensated for by way of depreciation. Southland Coal Co., 16 B. T. A. 50, and if not permitted as deductions will prevent the final recovery of the entire original cost.

It was stipulated that well No. 6, Red Ribbon Ranch lease, was abandoned in the year ended September 30,1936, and that wells Nos. 1 and 3, McKeelian lease, and well No. 1, Earl Fruit Co. lease, were abandoned in the year ended September 30, 1937, for the reason that such wells became nonproductive and that the petitioner wrote off as losses the respective amounts herein claimed. It is not the well which is subject to depreciation, but it is the equipment used in connection with the production of oil which is the subject of depreciation. The life of the well does not determine the life of the equipment. There is no evidence that the equipment had outlived its usefulness or that the retirement of the equipment was necessitated by unusual or abnormal circumstances. The evidence shows that well No. 6 produced a total of 123,214 barrels of oil. This is less than the average estimated oil reserve of the Red Ribbon Ranch lease. Such a showing, however, does not entitle petitioner to the deduction of a retirement loss under the circumstances shown herein. See Acme Manifolding Co., 24 B. T. A. 429, and U. S. Industrial Alcohol Co., supra.

The petitioner argues that it ought to be permitted to deduct the losses claimed because it kept records of the capitalized 'cost of equipment and the production of each well. However, in determining the depreciation allowable in years prior to the abandonment of the well for the purpose of computing the loss sustained the petitioner multiplied the annual production by the rate used in determining the depreciation allowance on the lease on which the well was located. As heretofore stated, such rate was based on the estimated oil reserve of the entire lease and the capitalized cost of all the oil well equipment on such lease, less 10 percent for salvage. The evidence fails to show the estimated oil reserve for any of the wells abandoned. Not having the estimated oil reserve of the individual wells, it is impossible to determine the rate of depreciation applicable to the equipment of each well on the unit of production basis, even though the cost of the equipment and production of each well is shown.

Respondent in his determination allowed the loss claimed on well No. 2, Earl Fruit Co. lease, and there is no dispute as to that item. Well No. 1 on that lease produced oil, and although for a comparatively short time, under petitioner’s unit of production method for determining depreciation on well equipment there is no reason why the equipment in connection with this well should be treated differently from that of wells' abandoned on leases while other wells on the same lease continued to produce, since the Earl Fruit lease continued to produce after well No. 1 thereon was abandoned. The fact that petitioner had not determined the estimated oil reserve of such lease at the time of closing its books for the fiscal year ended September 30, 1936, and did not deduct any depreciation is immaterial. From the stipulation it appears that the oil reserve was later determined and in computing petitioner’s tax liability for the year ended September 30, 1936, the respondent allowed depreciation on the unit of production basis employed by petitioner.

The petitioner relies in particular upon the case of Witherspoon Oil Co., 34 B. T. A. 1130, claiming that the precise question here involved was presented therein. A reference to the record of that case discloses that the issues raised involved only an alleged partnership loss and disallowance of “undepleted cost.” The Board approved the action of the respondent as to these two issues. The decision entered therein was for the amounts of the deficiencies in taxes claimed by the respondent, no allowance being made upon recomputation of the deficiency under Rule 50 for any undepreciated costs of physical assets. Apparently the depreciation deductions allowed by the respondent in that case were not questioned.

Decisions will he entered for the respondent.

       Art. 26 (e)-3. Loss of useful value.— * * *
      If the depreciable assets of a taxpayer consist of more than one item and depreciation, whether in respect of items or groups of items, is based upon the average lives of such assets, losses claimed on the normal retirement of such assets are not allowable inasmuch as the use of an average rate contemplates a normal retirement of assets both before and ■after the average life has been reached and there is, therefore, no possibility of ascertaining any actual loss under such circumstances until all assets contained in the group have been retired. In order to account properly for such retirement the entire cost or otiier basis of assets retired, adjusted for salvage, will be charged to the depreciation reserve account, which will enable the full cost or other basis of the property to be recovered.
      In cases in which depreciable property is disposed of due to causes other than exhaustion, wear and tear, and normal obsolescence, such as casualty, obsolescence other than normal, ■or sale, a deduction for the difference between the basis of the property (adjusted as provided in section 113 (b) and articles 113 (a) (14)-1, 113 (b) — 1, 113 (b)-2, and 113 (b)-3) and its salvage value and/or amount realized upon its disposition may be allowed subject to the limitations provided in the Act upon deduction for losses, but only if it is clearly ■evident that such disposition was not contemplated in the rate of depreciation.
      In the case of classified accounts, if it is the consistent practice of the taxpayer to base the rate of depreciation on the expected life of the longest lived asset contained in the account, or in the case of single item accounts if the rate of depreciation is based on the maximum expected life of the asset, a deduction for the basis of the asset (adjusted as provided in section 113 (b) and articles 113 (a) (14)-1, 113 (b)-l, .113 (b)-2, and 113 (b)-3) less its salvage value is allowable upon its retirement. * * *


source: Caselaw Access Project

author: Leech:

license: Public Domain

text:
    United Life Insurance Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.

    Docket No. 106059.
    Promulgated October 30, 1942.

      Walter E. Barton, Esq., for the petitioner.

      J. Marvin Kelley, Esq., for the respondent.

       Prior to October 22, 1942, this report was approved for promulgation.

   OPINION.

Leech:

The principal issue is whether the reserves maintained by the petitioner are of the character required by sections 201 (a) and 203 (a) (2) of the Revenue Acts of 1934 and 1936, so that it may be taxed as a life insurance company. The Florida statute which controlled the petitioner required it to set aside as a reserve an amount “not less than three percent of the gross collections from policyholders during the current year.”

The petitioner contends that it complied with that provision and that this compliance is enough to bring it within the meaning of “reserves required by law” as used in the Federal revenue acts. Respondent argues that it is not sufficient and has computed its income under section 204 as insurance company other than a life or mutual.

We agree with the respondent. Reserves as used in the revenue acts have a technical meaning. Compliance with a state statute is not enough. See Helvering v. Inter-Mountain Life Insurance Co., 294 U. S. 686; Helvering v. Illinois Life Insurance Co., 299 U. S. 88. We think reserves as used in the statute mean actuarial reserves computed with reference to a standard table of mortality. Independent Life & Accident Insurance Co., 47 B. T. A. 894; Mothe Burial Benefit Life Insurance Co. v. Fontenot, 46 Fed. Supp. 978. See Commissiner v. Oregon Mutual Life Insurance Co., 112 Fed. (2d) 468; affd., Helvering v. Oregon Mutual Life Insurance Co., 311 U. S. 267; Commissioner v. Monarch Life Insurance Co., 114 Fed. (2d) 314; Continental Assurance Co. v. United States (Ct. Cls.), 8 Fed. Supp. 474; Old Line Insurance Co., 18 B. T. A. 758.

The petitioner then takes the position, raising the alternative issue, that, if it is not a life insurance company within the meaning of the revenue acts but is taxable under section 204 as an insurance company other than life or mutual, as respondent we think properly determined, then advance premiums received on outstanding policies during the respective taxable years and additions to reserves made in those years are deductible as “unearned” premiums in computing its “earned” premiums for such years. Section 204 (b)(5). Respondent opposes this position generally, without giving reasons therefor.

Our finding of fact as to the amounts of advance premiums petitioner received in the taxable years, we think disposes of their de-ductibility. The advance premiums here are certainly “unearned” premiums. See Massachusetts Protective Association v. United States, 114 Fed. (2d) 304; Travelers Equitable Insurance Co., 22 B. T. A. 784.

The petitioner increased its reserves in each year by an amount at least equal to 3 percent of its gross premiums collected in that year. This amount was added to such reserve of earlier years so that in any year the reserve aggregated an amount at least equal to 3 percent of gross premiums collected to and including those of the current year.

Respondent’s argument opposing the deduction of the contested additions to reserves as “unearned” premiums is apparently limited to the position that these additions exceed the reserve required by the Florida statute in that each such annual addition was computed on the basis of the gross premiums collected in each of the several taxable years instead of upon the basis of the excess of the premiums collected in such years over those collected in the respective prior years. He argues, therefore, that their deduction as “unearned” premiums should be denied. The petitioner argues that the provisions of the state law are immaterial. Its contention is that the deductibility of the contested item under section 204 (b) (5), supra, depends upon whether, in fact, it was an unearned premium and that this item was such.

Generally, the premiums received on such policy contracts as are here involved, in each year by insurance companies, are more than the actual cost of meeting the risks of those contracts and the expenses of the business, in that year. That surplus is set aside in a reserve account and helps to defray the costs of those risks in future years, increasing as the policyholders grow older. The amount of this reserve is ordinarily computed from mortality and other similar tables establishing the probable risks to the insurer as to the respective varying ages of its policyholders. Because this reserve is not used by the insurer in the tax year but is set aside for future years, it has been held to be “unearned premiums” within the meaning of section 204 (b) (5), supra. Massachusetts Protective Association v. United, States, supra; Travelers Equitable Insurance Co., supra.

The reserve of petitioner performed the same functions as those computed upon such tables. The only difference is that the addition made by petitioner in each year was less in amount than it would have been if computed upon those tables. We think that difference is without significance here, and hold for petitioner on this issue. However, because of the fact that, in computing the taxable income of petitioner for the respective taxable years under section 204 (b)(5), we have already held that advance premiums received in each such year are deductible as “unearned premiums,” the amounts of those premiums will be eliminated from the “gross premiums” upon which the additions to reserves at the end of such years are computed.

There is no merit in respondent’s argument that the petitioner exceeded the requirements of the state law in pyramiding these additions to its reserve each year — if that point is material here. The Florida statute, supra, is concerned with annual additions to reserves and not the aggregate of those reserves.

Decision will be entered under Bule 50,

       Sec. 6264. Compiled General Laws of Florida. 1027:
      “Percentage for reserve. — On December 31, 1025, and annually thereafter, each association. corporation or company transacting the business of sick and funeral benefit insurance in this State, shall set aside as a reserve for the protection of all such policyholders, an amount not less than three percent of the gross collections from policyholders during the current year. Associations, corporations or companies organized under the laws of this State shall maintain with the Treasurer of Florida for the protection of all policyholders of this class an amount equal to said reserve * * *. The State Treasurer shall require life‘insurance companies to set aside such reserves on life and industrial business as shall be in nccoi dance with any accepted and recognized standards, and shall require companies writing insurance against loss by fire and other hazards, fidelity and surety bonding arid indemnity coverage, to set aside the unearned portion of premiums in force, computed according to the usual methods, for the protection of their policyholders. * * *”

       SEC. 204. INSURANCE COMPANIES OTITER TITAN LIFE OR MUTUAL.
      (b) Definition of Income, etc. — In the case of an insurance company subject to the tax imposed by this section—
      *******
      (!>) Premiums earned. — “Premiums earned on insurance contracts during the taxable year" means an amount computed ns follows :
      From tile amount of gross premiums written on insurance contracts during the taxable year, deduct return premiums and premiums paid for reinsurance. To tiie result so obtained add unearned premiums on outstanding business at tile end of the preceding taxable year and deduct unearned premiums on outstanding business at the end of the taxable year.


author: Disney:

text:
    Scaife Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.

    Docket No. 106794.
    Promulgated October 30, 1942.

      Samuel Kaufman, Esq., for the petitioner.

      J. Hcm-ison Miller, Esq., for the respondent.

       Prior to October 22, 1042, this report was approved for promulgation.

   OPINION.

Disney:

This proceeding involves excess profits tax and income tax for the taxable year 1937. The return was filed with the collector for the twenty-third district of Pennsylvania. The case was submitted ¡upon the pleadings. Respondent determined a deficiency in excess profits tax of $1,221.66 and an overassessment in income tax of $85.58. Both the deficiency and the overassessment arose out of a reduction of the declared value of capital stock. The petitioner filed this proceeding before the Board, alleging as error only the Commissioner’s refusal •to allow a declared value of $1,000,000 as the basis of computation of excess profits taxes. No allegations were made in the petition with reference to the overassessment. The petitioner now admits the deficiency in excess profits tax in the amount of $1,221.66 and does not contest the deficiency. However, at the hearing, by permission given, the petitioner filed an amendment to its petition to allege error in the refusal of the Commissioner to determine the entire deficiency for the taxable year in one net amount rather than two separate amounts, alleging as ground therefor as follows:

Petitioner is informed, believes and avers that because of the dependency on each other of the normal income tax, the surtax on undistributed profits and the excess profits tax, the liabilities therefor constitute an aggregate or net ¿mount rather than separable amounts.

Upon brief the petitioner, in substance, argues that there is no dispute about the amount either of the $1,221.66 deficiency in excess profits tax, or the overassessment of $85.58 in income tax, but that, •since both arose as to the same year and out of the same fact, to wit, the reduction of the declared value of capital stock, the Board has jurisdiction to enter and should “enter judgment in the net amount of income and excess profits taxes due”; that petitioner is not seeking a redetermination of the liability for either income or excess profits tax, but is “rather in need of application of the doctrine of recoupment out of the excess profits tax of the overassessment of the income tax, both determinations by the respondent being based upon the same transaction.” It is admitted that there is no authority precisely in point and that the petitioner’s only argument is based upon the argument of doing equity under the particular circumstances of this case. The brief points out that at the date of the filing of the petition herein it was too late to make a claim for refund and that the respondent omitted in the deficiency notice to follow his usual procedure of inviting a timely claim for refund of the overassessment. It is admitted, however, that petitioner had sufficient time after the receipt of the notice of deficiency within which to make a claim for refund, but it is suggested, in effect, that the situation would be the same had the respondent deferred mailing the notice of deficiency until the time to file claim for refund had expired.

The respondent on his part argues that the Commissioner determined no deficiency in income tax liability and that the Board is without jurisdiction “to redetermine the said income tax liability on the basis of a petition filed against the determination of a deficiency in the excess-profits tax for that year,” and says that the Board has no jurisdiction under Will County Title Co., 38 B. T. A. 1396, and Superheater Co. v. Commissioner, 125 Fed. (2d) 514.

We do not find either of these cases exactly in point. In the Will County Title Co. case income taxes and excess profits taxes for 1934 were involved, and the Commissioner determined as to income tax a deficiency of $529.25 and as to excess profits tax an overassessment of $745.04. The only assignment of error contained in the petition was the failure of the Commissioner to allow as a deduction certain obsolescence, and apparently both determinations, of deficiency and over-assessment, arose therefrom. The Board held that there was no jurisdiction, in so far as the petition was based upon the Commissioner’s determination of an overassessment of excess profits tax, stating that “The two taxes are imposed by entirely separate provisions of the statute.” The case indicates no contention by the petitioner that overassessment should be offset against deficiency, but rather that the petitioner’s view was that there was jurisdiction because of net overassessment, considering both the income and the excess profits taxes. Here the petitioner does not so urge, but contends that it is not asking redetermination of income tax, as to which there was no deficiency, but only for equitable treatment in the nature of recoupment. Do we have jurisdiction to grant such relief ?

In the absence of statutory provisions extending its jurisdiction a court may entertain a counterclaim, set-off, or reeonvention only where it would have jurisdiction to entertain the claim originally; and the cross demand must be within the jurisdiction of the court as to subject matter, amount, or territorial limitations * * *. [57 C. J. 374.]

Among the citations for the above statement is In re Patterson-Maa-Donald Shipbuilding Co., 284 Fed. 281. There a bankruptcy court was held to be without jurisdiction to render a judgment on a cross petition against a creditor’s claim. To the same effect are In re T. M. Lesher & Son, 176 Fed. 650, and Pennsylvania R. Co. v. Musante-Phillips, Inc., 42 Fed. Supp. 310. Petitioner does not argue that we have jurisdiction as to the overassessment of income tax, and under the above authority we think it clear that we have no jurisdiction to give effect to a cross demand founded thereon. To hold otherwise and to deduct from the amount of the admitted deficiency the amount of the overassessment would be to exercise authority over a refund, which authority Congress has not given. It would also be to disregard the statute of limitations as to refunds which had run at the time of the filing of the petition. We hold that we have no jurisdiction, equitable or otherwise, to grant such relief.

Decision will he entered for the respondent.


author: Hill :

text:
    The Celina Manufacturing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.

    Docket No. 109281.
    Promulgated October 30, 1942.

      Robert D. Towoelle, Esq., for the petitioner.

      Lawrence R. Bloomenthal, Esq., for the respondent.

         Prior to October 22, 1942, this report was approved for promulgation.

   OPINION.

Hill :

The sole issue of this proceeding is whether or not petitioner is to be allowed a deduction for salaries accrued but not paid in cash within the taxable year or 2½ months thereafter.

Respondent disallowed for each taxable year that part of the salaries which petitioner did not so pay in cash. The disallowance was made under the provisions of section 24 (c) of the Revenue Act of 1936 as amended by section 301 of the Revenue Act of 1937, the Revenue Act of 1938, and the Internal Revenue Code. He contends that the notes were not payment but merely represented a change in the name of the liability accounts.

The petitioner contends that, since the officers accepted the notes in full payment of the accrued but unpaid salaries, petitioner paid within 2½ months after the close of the taxable years all salaries due.

Petitioner rests its case solely on the contention that section 24 (c) (1) does not apply to the facts here. It makes no claim that 24 (c) (2) or (3) does not apply. From this we may reasonably assume that petitioner acknowledges that section 24 (c) (2) and (3) are applicable. Unquestionably subdivision (3) of such section so applies. The record is silent as to whether the officers of petitioner are on an accrual or cash basis of accounting. We, therefore, resolve the question of whether subdivision (2) of such section is applicable to the facts here against the petitioner and hold that it is so applicable.

We have then for determination only the question whether the issuance and acceptance of the notes here involved constitute payment within the meaning of section 24 (c) (1). On the authority of the principle announced in Helvering v. Price, 309 U. S. 409, and Eckert v. Burnet, 283 U. S. 140, we hold that the issuance and acceptance of the notes here involved do not constitute payment within the meaning of such statute. We hold, further, that subdivisions (1), (2), and (3) of section 24 (c) coexist under the facts of this proceeding and that, therefore, the determination of the respondent herein should in all respects be sustained.

Decision will be entered for the respondent.

       SEC. 24. ITEMS NOT DEDUCTIBLE.
      ******
      (e) Unpaid Expenses and Interest. — In computing net income no deduction shall be allowed under section 23 (a), relating to expenses incurred, or under section 23 (b), relating to interest accrued—
      (1) If such expenses or interest are not paid within the taxable year or within two and one-half months after the close thereof; and
      (2) If, by reason of the method of accounting of the person to whom the payment is to be made, the amount thereof is not, unless paid, includible in the gross income of such person for the taxable year in which or with which the taxable year of the taxpayer ends; and
      (3) If, at the close of the taxable year of the taxpayer or at any time within two and one-half months thereafter, both the taxpayer and the person to whom the payment is to-be made are persons between Whom losses would be disallowed under section 24 (b).


text:
    Estate of Joseph H. Scobell, Leola K. Scobell, Executrix, Petitioner, v. Commissioner of Internal Revenue, Respondent.

    Docket No. 108476.
    Promulgated November 5, 1942.

      Henry S. Gottfried, Esq., for the petitioner.

      Lawrence B. Bktmenthal, Esq., for the respondent.

       Prior to October 22. 1942, this report was approved for promulgation.

   OPINION.

Hill :

The issues presented to us for decision are whether or not deductions for $5,150 paid to attorneys and $1,190 paid to employees are alloAvable as ordinary and necessary expenses of decedent’s business.

Respondent disallowed the attorneys’ fees for the reason that he claimed they were paid for political influence. This position is maintained in his brief. However, we have found as a fact that this payment was an ordinary and necessary business expense. We have also found that the amount was reasonable and that no part was paid for political influence. There is ample evidence to support the latter finding, whereas there is no evidence which would support the position of the respondent. Therefore, petitioner is entitled to a deduction for this amount in decedent’s return for the period January 1 to November 3, 1939. Sec. 23 (a), Internal Revenue Code.

Sections 42 and 43 of the Internal Revenue Code place the last return of a taxpayer who dies upon the accrual basis. The income which had accrued but had not been paid to decedent was properly reported in his income tax return for that period.

The only question is whether or not petitioner is entitled to accrue as an expense the item of $1,190 paid as bonuses to the decedent’s employees. We think not. Decedent determined the amount of the bonuses, but he did not actually pay them before his death. There was no legal obligation by contract, express or implied, or otherwise, upon decedent to make such bonus payments. Hence, no accrual of such payments as an expense of decedent was proper. In order for an item to be accruable as an expense all events fixing the liability must have occurred. United States v. Anderson, 269 U. S. 422. The disallowance by the respondent of this deduction is approved.

Decision will loe entered under Rule 50.


author: Disney :

text:
    E. T. Weir, Petitioner, v. Commissioner of Internal Revenue, Respondent.

    Docket No. 106058.
    Promulgated November 10, 1942.

      John E. Laughlin, Jr., Esq., for the petitioner.

      Orris Bennett, Esq., for the respondent.

      Prior to October 22,1942, this report was approved for promulgation.

   OPINION.

Disney :

This proceeding involves income taxes for the years 1934, 1935, 1936, and 1937, as to which the respondent determined deficiencies in the respective amounts of $57,727.55, $11,321.03, $20,936.45, and $19,953.66. One issue as to automobile expense and depreciation has been settled by stipulation, reducing the amounts now involved to some extent, as will be reflected in decision under Rule 50. The petitioner is a resident of Pennsylvania and his income tax returns for the periods here -involved were filed with the collector for the twenty-third collection district of Pennsylvania. The facts have all been stipulated and we adopt the stipulation of facts as our findings herein. The facts will be set forth herein only in so far as necessary to an examination of the issues involved. They may be summarized as follows:

In 1924 the petitioner placed in trust with a trust company 2,500 shares of the capital stock of the Weirton Steel Co. under a trust agreement providing in substance that the income was to be paid by the trust company to his then wife for her life in approximately equal monthly installments to the extent only of $18,000 per year; that if the income should exceed that amount, it should be held until $50,000 was accumulated, which amount should be treated as reserve fund and used to make up any deficiency thereafter occurring in any year in the income, and if not so used, should be invested and become a part of the principal fund; but that, if the trust income in any year should not equal $18,000, the petitioner would pay to the wife directly at the end of each year any amount necessary, in addition to the trust income, to make the sum of $18,000; that the stock dividends received by the trustee should be treated as corpus and not as income; that the stock placed in trust should not be sold or converted into cash or other securities or property without the consent of the petitioner, his wife, and the trustee; that as long as the petitioner was an officer or director of the Weirton Steel Co., the stock of that company held by the trustee should be voted at stockholders’ meetings by the petitioner, if the trustee should be satisfied that to do so would not impair the security of the wife under the trust agreement; that in case of the failure of the income from the trust property to equal $18,000 in any year and the failure of the petitioner to make up the deficiency, the trustee was directed and authorized to use trust corpus for that purpose, the petitioner however forthwith to restore the same to the principal; that at any time while the shares of stock placed in trust remained in possession of the trustee, petitioner should have the right to substitute other security therefor of a value not less than the securities previously held and in all respects satisfactory to the wife and the trustee, the securities so substituted to be held by the trustee, subject to the terms of the trust agreement; that petitioner might at any time relieve himself of the personal obligation to make up any deficiency in the income of $18,000 per year by transferring to the trustee in substitution for the securities held, United States bonds, the income on which should be at least $18,000 per year, or other property equal as, a security, to such bonds, and satisfactory to the wife and to the trustee, and thereupon the securities previously held should be transferred to the petitioner and he be relieved of all personal obligation; that upon the death of the wife, the trust should cease and the trust corpus be conveyed to the three children of the petitioner and his wife, or to the survivor or survivors of such children; that in consideration of the creation of the trust, the wife released petitioner from all claims for dower or other interest in his property or estate and the petitioner released the wife from all claims on his part to curtesy or other claim to her property or estate.

The husband and wife were at the time of the trust agreement residents of Pennsylvania, and two days after the execution of the trust agreement the wife filed a libel for divorce in a court in Pennsylvania. Upon December 23, 1924, the court entered a decree granting her an absolute divorce, without any provision for property settlement, support and maintenance, or alimony.

At the time of the execution of the trust agreement the petitioner was president and a director of the Weirton Steel Co., and he continued to hold those offices until 1929, at which time the National Steel Corporation was organized, in connection with which organization all the shareholders of the Weirton Steel Co., including the trustee, exchanged their stock in the Weirton Steel Co. for stock in the National Steel Corporation, which, as a part of the reorganization, acquired all of the stock of the Weirton Steel Co. and of three other corporations. Thereafter and during the taxable years petitioner was a director and chairman of the board of directors of the National Steel Corporation.

The net income of the trust estate for the taxable years was as follows:

On December 31, 1933, the trustee held undistributed ordinary income of $114.67. During the taxable years it paid petitioner’s former wife as follows:

1934_. $14,400
1935-23,300
1936-18, 000
1937-21,600

The petitioner supplied $3,115.08 of the $14,400 paid to his former wife in 1934, but did not supply any part of the amounts paid to her in the other taxable years. The trustee at no time paid the former wife more than the accumulated ordinary income, plus the $3,115.08 above referred to.

The parties and the trust agreement involved herein are the same as in the case of E. T. Weir, 39 B. T. A. 400; affirmed on the point of taxability of trust income, 109 Fed. (2d) 996. Certiorari has been denied and the Board’s decision therein has become final.

On December 29, 1937, petitioner’s former wife executed and delivered to the petitioner an instrument releasing him forever from any and all obligation or liability to pay her any deficiencies of income from the said trust estate.

Four questions are presented for our solution : The extent to which a former decision of the Board of Tax Appeals and of the Circuit Court of Appeals for the Third Circuit is res adjudieata in this proceeding; whether the petitioner is taxable with respect to the trust income in excess of $18,000 per year; whether he is taxable with respect to the capital gains of the trust; and whether the release executed by his wife on December 29, 1937, releasing him from his guarantee of the $18,000 per year, causes the petitioner not to be taxable upon trust income for that year.

The petitioner concedes that under the opinion in E. T. Weir, 39 B. T. A. 400, affirmed as set forth above, he is taxable with the ordinary trust income to the extent of $18,000 per year, since that opinion, involving the years 1932 and 1933, to that extent renders that question res adjudieata herein. The respondent contends, however, that there is res adjudieata above $18,000 per year, that argument being based upon the expression in the former opinion that the promise (to guaranty $18,000 per year) “affords * * * a valid ground for taxing the income of the instant trust to the petitioner.” From this respondent says that the taxability is limited only by the “income of the trust” even above the $18,000 guaranteed. We.do not agree. Res adjudieata extends only to a cause of action common to the case at hand and the former case relied upon and to matters and facts in issue and directly adjudicated or necessarily involved in the former case. In the former Weir case the income was less than $18,000 per year; therefore there was, and could be, no issue as to income above that amount. Moreover, it is very clear from the decisions upon this subject that the sole reason for taxing trust income to the trustor is his personal agreement, in those jurisdictions where, as in Pennsylvania, and therefore in this matter, an absolute divorce ends all of the husband’s obligations to support the wife. The “promise affords the sole * * * ground for taxing the income of the instant trust to the petitioner” — Weir v. Commissioner, 109 Fed. (2d) 996. We decided this point in Halbert P. Gillette, 46 B. T. A. 573, where the liability under the guaranty by the husband-trustor was $3,000 per year and we said:

* * * The trust income which served to discharge petitioner’s guarantee constituted income to the petitioner and he is taxable on such income. * * *
* * * He has received “income” to the extent that his liability has been discharged, but anything paid to the wife from the trust income above $3,000 was not paid in discharge of petitioner’s obligation. Accordingly, petitioner is taxable upon not more than $3,000 of the trust income in the year 1936.

We there relied on Helvering v. Leonard, 310 U. S. 80, which lays down the above principle. We hold that res adjudieata requires no taxation of petitioner on income above $18,000 per year.

It is also apparent from the language quoted above that unless the Gillette case, supra, is distinguishable, petitioner is not taxable upon either ordinary income or capital gains above $18,000.

The respondent urges, however, that in this case the income in excess of $18,000 went, under the provisions of the trust agreement, into a reserve to pay to the former wife any future deficiencies below the annual amount of $18,000, and that therefore there is discharge of “continuing obligation,” and resultant taxability. The language relied upon by the respondent provides only that any excess above $18,000 income in any year “shall be held until the sum of fifty thousand dollars ($50,000.00) is accumulated, which amount shall be treated as a reserve fund and shall be used to make up any deficiency thereafter” occurring in any year in said income. (Italics supplied.) We think the point not well taken, for the reason that the petitioner had in any one taxable year an obligation of no more than $18,000. If the trust income was sufficient to discharge it, he had none left. The trust income of the year is charged to the trustor for the reason that it merely takes the place of his own income which otherwise would be required, and he is thus saved an equal part of his own income. But his income of a given year is not obligated because of a possible and contingent call upon that of some future year, and he is therefore not benefited in any taxable year prior to that in which the reserve fund is actually usable instead of his own income, to pay the former wife. Such a contingency is, we think, no ground for taxing the trustor above the guaranteed amount for the years at hand, upon either ordinary income or taxable gains.

The respondent contends for taxation of income above $18,000 also upon the ground that the petitioner had such dominion and control over the trust and such economic benefit therefrom as to require taxation to him of its income under Helvering v. Clifford, 309 U. S. 331, and the line of decisions to the same general effect. We examine the facts relied upon to demonstrate such control and economic benefit. The alleged powers are, in the main, that the petitioner retained power to direct the voting of the stock placed in trust, to veto sale of the stock or conversion into other securities, to reacquire the stock, and to appropriate to his own use unrealized appreciation of the corpus and realized capital gain by means of substituting for the corpus Government bonds sufficient to provide ,$18,000 annual income; also to reacquire the stock placed in trust by substituting other securities of equal value.

In our opinion, the right to direct the voting of the shares of stock, to veto their sale or conversion, or to substitute other securities therefor, had expired prior to the taxable years and therefore lends no support to the respondent’s view, for the reason that such rights are specifically limited to the stock originally placed in trust, i. e., stock in tbe Weirton Steel Co., and that stock had been disposed of prior to the taxable years. Moreover, the trust instrument provides for power in the petitioner, as long as he is an officer and director of the Weirton Steel Co., to direct the voting of the stock. He continued to be such officer or director only until 1929, when the Weirton Steel Co. stock was exchanged for stock in the National Steel Corporation and he became chairman of its board of directors. Again, the power to vote the stock is only “if the Trustee shall be satisfied that to do so would not impair in any way the security of the party of the second part” (the wife). Obviously, a power to vote the stock, so limited by the power of the trustee, does not confer the dominion alleged by the respondent.

Similarly, the reacquisition of the stock by substitution of other securities is limited: “If at any time hereafter while the shares of stock hereby assigned remain in the possession of the Trustee,” the petitioner might substitute other securities. The Weirton Steel Co. stock “hereby assigned,” in the taxable years no longer remained in the possession of the trustee. We think it clear that it was intended to limit this power to the original stock placed in trust, and that the petitioner could have been prevented from so substituting new securities for those of the National Steel Corporation, held by the trustee in the taxable years. Moreover, the substitution must be “in all respects satisfactory to the party of the second part [the wife] and the Trustee.” Such discretion on the part of the trustee and the wife, a party with an adverse interest, even though perhaps not absolute, is inconsistent with the dominion and control alleged by the respondent.

The alleged power to veto sale or conversion of the securities is also limited to “stock hereby transferred” and it is doubtful whether it applies to the stock held in the taxable years. It arises from a provision that such stock shall not be sold or converted “without the consent in writing of the parties hereto,” so that it is apparent that, though there is to some extent a power in that regard in the petitioner, there was also a limitation upon the power of the petitioner to substitute other securities. Limited to the consent of “the parties hereto,” it falls far short of broad power and dominion such as relied on by the respondent.

With respect to the power to substitute United States bonds bearing income of $18,000 per annum, there seems no such limitation; and this, the respondent says, conferred absolute power to appropriate to his own use unrealized appreciation of the corpus, as well as realized capital gains, in effect making the trust revocable as to all assets in excess of the substituted bonds, and enabling' the petitioner to recapture capital gains and gain control of the trust corpus to the extent of the excess over the value of the United States bonds substituted, even though such trust corpus had become of far greater value. We think, however, that such a right did not amount to revocation of the trust. In Carlton H. Palmer, 40 B. T. A. 1002; affd., 115 Fed. (2d) 368, we held that a trustor’s retention of power to reacquire the trust res by purchase at a fair price to be fixed by a specified formula prescribed in the trust instrument and over which he had no control after the execution of the instrument “did not constitute a reservation by him of a power of revocation in whole or in part. Cf. Shanley v. Bowers, 81 Fed. (2d) 13,” and “would have no effect upon the continued existence of the trust, but would result merely in a change in character of the trust corpus * * We think that language applicable here. We do not consider the substitution of trust corpus, under the restrictions placed, as in effect power to revoke.

Nor do we consider that there appears here the complexion as to intimate family relationship or temporary reallocation of family income which colors and in effect controls Helvering v. Clifford, supra, and cases of like import; indeed, the family here was breaking up, hostile interests appear, and, instead of temporary change, there is permanent provision for the wife. The trust was irrevocable, with no reversion either to petitioner or his estate, distinguishing the Oliford case, Irving T. Bush, 45 B. T. A. 609 (622). Under all of the circumstances and trust powers discussed above, we conclude that the petitioner is not taxable under section 22 (a), 166, or 167 of the Kevenue Acts of 1934 and 1936, either upon ordinary income or capital gains, above $18,000 per year.

We next consider whether the release of petitioner’s personal guaranty on December 29, 1937, relieved him from taxation on the trust income for that year. The record does not indicate as to whether the trust income was received or paid to the former wife, before or after December 29, 1937. If the $18,000, or any part thereof, Avas income received by the trust after December 29,1937, we consider that to that extent the petitioner would have no tax liability for 1937, since the only ground upon which liability is based,, that is, the personal guaranty, upon that date ceased to exist. The petitioner, however, has not shown that the trust income was received after the release and, the burden being upon him to overcome the effect of the determination by the respondent that petitioner is taxable upon the income for that year, we can not base any conclusion upon any receipt of trust income after that date, but assume, the contrary not being shown, that it was received prior to the release.

The question then arises as to whether the petitioner received such benefit as to cause taxation to him of the amounts of trust income received. The petitioner argues that there was no obligation until the end of the year and that prior to that date such obligation had been wiped out by the release. We think, however, that the release could not be effective upon payments already made. In other words, the former wife did not release an obligation that had already disappeared because already discharged under the terms of the trust agreement, by the trust income, and upon the date of the release the petitioner had no obligation remaining, except to the extent of the difference, if any, between $18,000 and the amounts of trust income received by the former wife. That obligation, and only that, was still extant and subject to release, and, inasmuch as the trust income had served to reduce in such manner the obligation which otherwise would have fallen upon the petitioner at the end of the year, logic impels the conclusion that he received the benefit of trust income to the extent thereof, and is, therefore, taxable thereon. It is as if trust income had been endorsed upon his promissory note due and payable on December 31, and he should not be heard to say that there was release by the former wife, on December 29, of the entire obligation for the year. The release recites that “in recent years, the income from the trust estate has been more than sufficient to provide the sum of Eighteen Thousand Dollars ($18,000.00) a year to the undersigned,” and the trust instrument provides that the wife shall be paid the trust income “in approximately equal monthly installments.” This indicates that the income of the trust had been used “to provide the sum of Eighteen Thousand Dollars ($18,000.00) ” during 1937, prior to the execution of such release. Absent proof to the contrary, we hold that the respondent did not err in taxing the petitioner to the extent of $18,000 for the year 1937.

In 1934 the ordinary income was less than $18,000 and capital gains were approximately $79,000. Is petitioner for that year taxable upon the capital gains, above ordinary gains, but below $18,000 ? If the instrument provided for the distribution of capital gains to the wife, he obviously is so taxable, since he guaranteed distribution to her of $18,000 per year. The Commissioner in the deficiency notice particularly determined liability for capital gains. In 1934 the wife received only $14,400, and income other than capital gains exceeded that amount, so that all income actually received by her is taxable to the husband without reference to taxable gains. The query remains, however, whether, above the amount received by her, and above the amount of ordinary interest and dividend income, and up to the $18,000 receivable, the petitioner may properly be taxed with capital gains. (The question occurs only as to 1934.) Res ad-judicóla from the former Weir case does not assist, since neither the question nor the facts are found therein and it was not necessarily there involved.

The trust instrument is somewhat indefinite as to whether income shall include capital gains as such, but examination of the instrument reveals, in our opinion, plain intent that they are subjected to the payment of the petitioner’s obligation, for it is provided in section 10 that, if the petitioner fails to make up the deficiency, “a part of the principal of the trust funds may be used for the purpose, and the Trustee is hereby directed and authorized to so use the same; but, if so used, the party of the first part [the petitioner] shall, and he hereby agrees to forthwith, replace the same so that the whole of the principal shall be restored * * If, therefore, we assume that, as the petitioner contends, capital gains are corpus, nevertheless by the above language they are subjected to the discharge of the petitioner’s liability for the deficiency. By the above language the petitioner has established a fund to take the place of his own income. There is in this regard no essential difference between ordinary income and capital gains, for both are liable for the discharge of the obligation, even assuming the capital gains to be so subjected only as they become principal. They are then immediately available for use to discharge the deficiency liability. To hold that merely because they become corpus, there is no taxability thereon to the petitioner, would, in the light of the above provision, be to deny the soundness of the essential and often stated reason for taxing the grantor on income of a trust to pay his obligations.

That the petitioner agreed to replace any corpus used to pay to the wife any deficiency below $18,000 is, in our opinion, immaterial. He might or might not comply with such agreement to restore principal, and we think that, since it is seen that his obligation to pay up to $18,000 per year is dischargeable by capital gains as principal, in the same manner as ordinary income, taxation to the husband because of the benefit and credit thus receivable upon his obligation should not be prevented by a mere ancillary agreement on his part to restore the principal used. To so hold would permit him to escape taxation by the mere expedient of violating his agreement to restore. He might be unable to comply with such agreement and no collateral or other security for such compliance is suggested by the trust agreement.

In Reginald B. Parsons, 44 B. T. A. 1142 (1154), we held the trustor taxable upon capital gains trust income, because the trustor had the power to dispose of the trust dorpus; here he has already disposed of it, including capital gains, by subjecting all corpus to payment of his obligation to his former wife.

We therefore hold that, to the extent of the difference between ordinary income and $18,000 per annum, the income from capital gains is taxable to the petitioner.

Decision will be entered under Rule 50.