author: Murdock : TURNER,

text:
    W. & K. Holding Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent. Herman Knobloch, Petitioner, v. Commissioner of Internal Revenue, Respondent. Wesley E. Knobloch, Petitioner, v. Commissioner of Internal Revenue, Respondent. Harvey W. Peace, Petitioner, v. Commissioner of Internal Revenue, Respondent. David C. Knobloch, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 81216, 87275, 87276, 87277, 87278.
    Promulgated October 12, 1938.

      Milton M. Dmis, Esq., for the petitioners.

      J. B. Johnston, Esq., for the respondent.
   OPINION.

Murdock :

Issue I. — Sale by W. <& K. of Securities Acquired from Its Stockholders in Exchange for Preferred Stock.

The petitioner, W. & K., contends that it is entitled to use as its basis for gain or loss on the disposition of the securities the cost of those securities to its stockholders because the property was acquired in an exchange of the kind described in section 112 (b) (5) of the Eevenue Act of 1932. The statutory provision is as follows:

SEC. 112. RECOGNITION OP GAIN OR LOSS.

(b) Exchanges Solely in Kind.—

* * * * <t * *
(5) Transfer to corporation controlled by transferor.- — No gain or loss shall bo recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior, to the exchange.

Every element necessary under the above provision is present here. See also section 112 (j) as to control.

The Commissioner argues, however, that since this transaction was carried out for the purpose of minimizing taxes, since it had no real business purpose, and since it was followed by a redemption of the preferred stock, it should be treated as a taxable transaction giving the property a new basis in the hands of W. & K., citing Gregory v. Helvering, 293 U. S. 465. The question in the Gregory case was whether or not there was a nontaxable reorganization. No such question is involved in this issue. This was an exchange, not a reorganization. The Gregory case does not support the Commissioner’s contention. Cf. George W. Griffiths, 37 B. T. A. 314.

Here there was an exchange and no substantial change occurred in the beneficial ownership and control of the property beyond the change from individual to corporate ownership. Snead v. Jackson Securities Co., 77 Fed. (2d) 19. The loss of the stockholders was therefore postponed under the statute. The transaction was not a sale with payment deferred. The transferors had no right to any purchase price. Their rights were those of stockholders. Cf. Newman, Saumders & Co. v. United States, 36 Fed. (2d) 1009; certiorari denied, 281 U. S. 760; Osbum California Co. v. Welch, 39 Fed. (2d) 41; certiorari denied, 282 17. S. 850; American Compress & Warehouse Co. v. Bender, 10 Fed. (2d) 655; T. W. Phillips, Jr., Inc., 23 B. T. A. 1272; affd., 63 Fed. (2d) 101. The expectation of redemption is the only new circumstance. But it was a mere expectation, not an agreement. There was no debt due from the corporation to the preferred stockholders and no obligation to retire the preferred stock. The redemption was subject to claims of all creditors. The stock was actually retired in the next fiscal year, but the exchange is not dependent upon what happened that long afterward.

The exchange was within the provisions of section 112 (b) (5). Therefore, 113 (a) (8) applies and the basis for W. & K. was the same as that of the transferors. Section 101 (c) (8) (B) also applies and makes the loss a capital loss. That being so, section 23 (r) does not apply. The Commissioner erred as the petitioner contends.

Issue II. — Redemption of Common Stock "by W. <⅛ K.

. The Commissioner has held, as to each individual petitioner, that the retirement of the common stock was “at such time and in such manner as to make the distribution and * * * redemption in whole * * * essentially equivalent to the distribution of a taxable dividend.” Six hundred and fourteen of the 1,000 shares outstanding were retired at $300 per share. The total amount distributed was $184,200, consisting of $173,100 paid on January 3 and $11,100 paid on October 7,1933.

That these amounts were actually paid from earnings or profits accumulated after February 28, 1913, can not be seriously controverted on this record. The corporation was not formed until long after February 28, 1913. All of its earnings or profits were accumulated after that date. Its books showed an operating surplus of $31,411.52 at August 1,1932. That was increased to $189,374.68 upon the sale of the real estate in November 1932. There was also on the books in January 1933 a “capital surplus” of $30,860.59. The amount of accumulated earnings on January 3, 1933, and on October 7,1933, is not shown. The petitioners had the burden of proof. However, it is clear that the accumulated earnings exceeded the total amounts distributed. The excess was more than sufficient to take care of all uncertainties in this record, as well as all liabilities and losses shown by the record. The loss on the securities allowed under issue I has no effect upon the distribution of January 3, 1933, because the sales were made after that date. Furthermore, that loss and the loss of $12,104.70 involved in issue VI, the date of which is not shown, do not affect earnings available for distribution because they are not, actually and for dividend purposes, losses of the corporation, since they resulted entirely from the fact that the corporation was merely permitted to use a basis in excess of cost to it for the purpose of computing its taxable income. Earnings available for dividends are computed upon actual gains and losses of the corporation as of the date of the distribution. Charles F. Ayer, 12 B. T. A. 284; B. M. Weyerhaeuser, 88 B. T. A. 594; Susan T. Freshman, 33 B. T. A. 394; F. J. Young Corporation, 35 B. T. A. 860.

The petitioners contend that the surplus should be reduced by a reserve of $35,000 for taxes for the fiscal year ended July 31, 1933. The taxes owed for that period were much less than $35,000 and can only be accrued ratably to the distribution date. Commissioner v. James, 49 Fed. (2d) 707, affirming 13 B. T. A. 764. Due allowance has been made for Federal taxes in our finding that earnings were available. Another contention of the petitioners, that the surplus had to be allocated to all of the 1,000 shares outstanding, is contrary to the clear provision of section 115 (b) which requires only the existence of earnings. Some testimony about depreciation in value of two assets was unimportant because, even if it were convincing, ,it would account for a reduction of excess surplus only.

The evidence not only fails to show error in the Commissioner’s determination as to the effect of this distribution but supports his conclusion. The corporation had an extraordinarily large profit which it desired to distribute to its stockholders. It could have declared a dividend for that purpose. Instead, it distributed its excess funds by redeeming a large block of its stock. The distribution was made in that way so that the stockholders might avoid tax. Cf. J. Natwick, 36 B. T. A. 866, as to motive. There was no intention to liquidate. A dividend need not be in direct proportion to stock-holdings. However, the relative stock interests of the principal stockholders were not materially changed by the redemption. It is not essential that there be any connection between the issuance and the retirement of the stock or that the stock be canceled instead of held in the treasury. Annie Watts Hill, 27 B. T. A. 73; affd., 66 Fed. (2d) 45; James D. Robinson, 27 B. T. A. 1018; J. Natwioh, swpra. Since the facts show that this distribution was essentially equivalent to the distribution of a taxable dividend, it follows that the Commissioner did not err.

The transaction was not in liquidation, neither was it a sale, as the petitioners contend. Nor was any reasonable business need accomplished by making the distribution in the form of a retirement rather than as a dividend. Section 115(g) is not unconstitutional merely because it incorporates the presumption of section 115(b) that all distributions are made out of earnings to the extent thereof and from those most recently accumulated. The presumption of (b) has been held constitutional, Leland v. Commissioner, 50 Fed. (2d) 523, and (g) adds no unconstitutional effect.

Issue III. — Redemption of Preferred Stock by W. <& K.

The Commissioner gave the preferred shares a basis equal to the fair market value of the property given in exchange for them instead of the cost of that property to the transferors. Since the exchange was a nontaxable one, as held under issue I, it follows that the Commissioner erred. Section 113(a) (6) allows the use of the cost of the property as the basis for the property received in exchange. Even if this gives a double deduction, one to the stockholder and another to the corporation, Congress alone can correct the law.

Issue IV. — Alleged Loss of Sewat from Disposition of Securities and Alleged Loss of Peace from Exchange of his W. <& K. Stack for Flushing Mortgage.

Sewat claims the right to use, as its basis for gain or loss on the securities acquired from Peace on January 10, $51,171.62, the cost of those securities to Peace. It makes this contention on the ground that the exchange was within section 112(b) (5) and, therefore, section 113(a)(8) applies. This argument is unsound, since the exchange was not within section 112 (b)(5). Peace transferred the securities to Sewat as part of an integral plan. Although he momentarily held the stock of Sewat, he was never in control of that corporation. He had to transfer that stock immediately to W. & K. Thus, W. & K., not Peace, was in control of Sewat immediately after the exchange. Control depends upon the situation as it exists upon completion of the plan, not upon the situation existing after one of the intermediate steps. Wilbur F. Burns, 30 B. T. A. 163, 172; affd., 85 Fed. (2d) 8; Charles Hall, 31 B. T. A. 125.

Sewat was not entitled to use cost to Peace as its basis for gain or loss on the securities, but was entitled to use only the value of those securities at the time of the transfer. That value was $11,154.62. Those securities were exchanged by Sewat for the Flushing mortgage. The principal amount of the mortgage was $10,000. Its fair market value is not shown, although Herman Knobloch acquired it and another mortgage as set forth in the findings. It was worth at least $4,000 and the loss of Sewat could not exceed $7,154.62 ($11,154.62— $4,000). The Commissioner has held that this exchange did not result in any deductible loss. He argues that this particular transaction was but a part of a larger one, the consideration for the whole was divided among the various parts to suit the convenience of the parties and to avoid income taxes, and there was other consideration for the transfer by Sewat of assets worth $11,154.62 for a mortgage worth much less. The evidence strongly supports this contention of the Commissioner and it fails to show that Sewat sustained any loss which would entitle it to a deduction for income tax purposes. The statute does not mean that parties may obtain deductions in this way through maneuvering puppets. Sewat held the mortgage only long enough to transfer it pursuant to the general plan. This consideration was not the result of dealing at arm’s length. The loss was not genuine and real. Cf. Seymour H. Knox, 33 B. T. A. 972; Labrot v. Burnet, 57 Fed. (2d) 413, affirming 18 B. T. A. 332; Commissioner v. Ehrhart, 82 Fed. (2d) 338; Shoenberg v. Commissioner, 77 Fed. (2d) 446; certiorari denied, 296 U. S. 586.

Peace claims the right to use $51,154.62, the cost of his securities, as his basis for gain or loss on the 38 shares of W. & K. preferred stock which he received in exchange for those shares. But since the exchange was not within section 112 (b) (5), as previously explained, he can not use that old basis. It follows, however, that he sustained a loss of $40,027.46 on January 10, 1933. He owned on that morning securities which had cost him $51,154.62. He exchanged them and held in their place at the end of the day 38 shares of preferred stock of W. & K-, redeemable for $11,127.16. A part of that loss was a capital loss. Proper adjustment may be made under Rule 50.

The 38 shares of W. & K. preferred then had a basis in his hands of $11,127.16. Peace exchanged them, together with 12 shares of common which had cost him $1,550, for the Flushing mortgage, which he valued at $10,000. The Commissioner has held that that transaction was not entered into for profit. The obvious inadequacy of the consideration supports the determination. An individual is allowed such a loss only in case the transaction was entered into for profit. Sec. 23 (e). The "Commissioner contends, in addition, that this transaction was only a part of the larger transaction and here, again, there was no real loss. We agree with the Commissioner. Peace had to reduce the bank loan. He could have sold his W. & K. stock, but the Knoblochs did not want outsiders to get that stock and they wanted Sewat to have a loss. The plan was then formed whereby the Knoblochs would satisfy the bank and Peace would transfer his W. & K. stock to Sewat, which was in turn owned by W. & K. Herman Knobloch transferred the Flushing mortgage to Archie Peace without any stated consideration. Archie transferred it to Sewat for assets worth much more than the mortgage. These were family transactions and invite careful scrutiny. The net result was that each family, the Knoblochs and the Peaces, received assets worth substantially the same as those surrendered. No real loss resulted to either, and on this record the action of the Commissioner can not be changed except as already stated. Cf. Shoenberg v. Commissioner, supra; Commissioner v. Ehrhart, supra.

Issue V. — Loss on Sale of Amsterdam Avenue Mortgage by W. & K.

The parties have stipulated that the cost of this mortgage to the stockholders was $13,104.70. The stockholders donated the mortgage to W. & K. in November 1932. The mortgage then had a basis for gain or loss to W. & K. of $13,104.70. Sec. 113 (a) (2). The evidence is reasonably clear that the fair market value of the mortgage thereafter was about $1,000. It was sold by W. & K. to Archie Peace, a minority stockholder, for $1,000 during the fiscal year ended July 81, 1933. The evidence indicates that the sale was absolute and an isolated transaction. There is no suggestion that W. & K. ever reacquired the mortgage. W. & K. is entitled to deduct a loss of $12,104.70 on the sale.

Issue VI. — Constitutionality of Excess Profits Tax.

W. & K. alleges that “the law under which the respondent attempts to impose an excess profits tax amounting to $3,764.37 is unconstitutional.” Sections 215 (a) and (f) and 216 (a), National Industrial Recovery Act of June 16, 1933, 48 Stat. 195, impose a capital stock tax and an excess profits tax on domestic corporations. The capital stock provisions apply only to the year ended June 30, 1933. The profits tax provisions do not apply to any year ending after June 30, 1934. Sec. 703, Revenue Act of 1934. Substantially the same provisions (except as to years) were reenacted in sections 701 and 702 of the Revenue Act of 1934, effective beginning with the year ending June 30, 1934.

Section 215 (a) imposes for each year ending June 30 an excise tax of $1 for each $1,000 of the adjusted declared value of the capital stock. Section 215 (f) provides that for the first year ending June 30 “the adjusted declared value shall be the value, as declared by the corporation in its first return under this section (which declaration of value can not be amended), as of the close of its last income tax taxable year ending at or prior to the close of the year for which the tax is imposed by this section (or as of the date of organization in the case of a corporation having no income tax taxable year purling at or prior to the close of the year for which the tax is imposed by this section.)” There are provisions for increases and reductions of the original declared value for subsequent years, on account of additions and reductions of capital, earnings, distributions, etc., which are similar to the old invested capital provisions of earlier acts, not here material.

Section 216 (a) imposes “upon the net income of every corporation, for each income-tax taxable year ending after the close of the first year in respect of which it is taxable under section 215, an excess-profits tax equivalent to 5 per centum of such portion of its net income for such income-tax taxable year as is in excess of 12⅜ per centum of the adjusted declared value of its capital stock * * * as of the close of the preceding income-tax taxable year * * * determined as provided in section 215. * * * ” The tax imposed by section 216 (a) is subject to the same provisions of law as taxes imposed by Title I, Eevenue Act of 1932. The plan of the statute is to permit the taxpayer to declare the value of the capital stock, and, if it makes a low valuation and thereby pays a small capital stock tax, the 12½ percent credited against its net income will be smaller and will result in an increase of the excess profits tax. A high valuation will operate conversely. The statute was designed to avoid administrative difficulty and controversy in valuing the stock. The profits tax permits a reasonable valuation, and the primary purpose was to induce corporations to declare a fair value. William A. Webster Co., 37 B. T. A. 800; Senate Eeport 114, 73d Cong., 1st sess. p. 6.

Wesley Knobloch testified that the income tax return was made up first, and, as he knew the amount of net income to be $48,244.22, he arbitrarily declared the value of the capital stock of W. & K. at $386,000, so as to escape the profits tax. In other words, he declared it at 8 times the net income. He was familar with the assets and liabilities and the market value of the assets, and expressed the opinion that the fair market value of the stock was $115,000. He does not state how he arrived at this figure.

The amended petition alleges that the profits tax is based upon $397,154.62, an arbitrary and unsound value which petitioners were compelled by section 215 to place on their stock; that amount did not reflect the actual value on June 30, 1933; the law denied to them the right to file an amended return correcting that value; the law does not provide any method by which the value may be computed but delegates to the taxpayer the right arbitrarily to fix it without any basis in fact, an invalid delegation of the lawmaking power; and the law requires doing an act in terms so vague that men must guess at its meaning and differ as to its application, all in violation of the Fifth Amendment. The petitioner argues that section 215 is invalid under the Fifth and Fourteenth Amendments in that it compels payment of a tax based upon an arbitrary and unreasonable amount not easily or accurately ascertainable nor defined within the law itself, not based upon actual facts, but upon a basis prejudicial to taxpayers by reason of its effect upon the tax imposed under section 216. The petitioner relies on Oertel Co. v. Glenn, 13 Fed. Supp. 651, wherein the United States District Court of Western Kentucky sustained the right to file an amended return. The Commissioner contends that this case supports the validity of the statute, since the right of amendment is not here involved.

Since the briefs were filed, tbe Board, the Court of Claims, and the Circuit Court for the Sixth Circuit have considered these provisions. The cases are: Glenn v. Oertel Co., 97 Fed. (2d) 495; Chicago Telephone Supply Co. v. United States (Ct. Cls.), 23 Fed. Supp. 471; William A. Webster Co., 37 B. T. A. 800.

It is to be noted that the Commissioner determined an excess profits tax and we are not here concerned with the validity of, nor have we jurisdiction over, capital stock taxes. The Court of Claims in the Ghicago Telephone case sustained the statute, but stated its validity is not free from doubt. In the Oertel case, the District Court held that where the original declared value is understated the taxpayer may file an amended capital stock tax return before the liability for the profits tax accrues. The reasoning of the court is that the capital stock tax is based on the value of the stock, the value must be determined according to the underlying facts, and declared value means actual value. The court further observed that if the tax were levied on a value declared by the taxpayer regardless of actual value, it would be void for uncertainty and would offend the Fifth Amendment. The latter statement is pure dicta, since the court held that the statute was not to be so construed. The case is, therefore, no authority for holding the statute invalid. The Circuit Court of Appeals on June 8, 1938, affirmed the District Court. In construing the statute it held that Congress did not intend that an incorrect invalid return springing from an honest mistake could not be corrected, particularly where the correction was sought within the period for which an extension had been granted. It reasoned that to lay a tax upon the taxpayer’s error rather than its income was inconsistent with the purpose to induce declaration of fair and reasonable values. It did not pass on the validity of the law.

The Board in the Webster case reached an opposite conclusion from the District Court in the Oertel case. The original capital stock tax return was filed and, within the time for filing as extended by the Treasury, the taxpayer sought to file an amended return increasing the value from $395,000 to $800,000. The Board held the statute prohibited amendment in plain terms and refused to accept the reasoning of the Oertel case. There is nothing in the facts there to show the reason for the change or that the first return was due to mistake. The constitutionality of the law was not raised.

The Chicago Telephone case is the only one in which the constitutional question was decided. The court followed the Board in holding that the statute does not permit amendment. The decision of the court is that the real value was known to and was readily ascertainable by the taxpayer, and the resulting profits tax was not due to arbitrary features of the law, but to the taxpayer’s fault in electing to state a fictitious value which it had full opportunity to avoid. ^Referring to the statement in the Oertel case that the statute, if construed to deny amendment to show real value, would raise a conclusive presumption that an incorrect value shall be used as a measure of the tax, the court held that for the first year the declaration is made, no question of presumption arises, as the taxpayer has an opportunity to ascertain the value and can not be said to have fixed it without evidence or an opportunity to be heard. The court further held that the statute did not involve a delegation by Congress of its lawmaking authority, since a declaration of value is a mere statement of fact; and it answered the objection, that no guide or method was prescribed for making the declaration of value, by saying that there is no necessity for a guide in making a statement of fact. The court seemed to think that, if a declaration for a previous year were used in a later year, it might be arbitrary to make the declaration conclusive, but that case, like the present one, involved use of the declaration only in the first year.

The decision of the Court of Claims is a complete answer to the petitioner’s contentions. The petitioner here is in a less favorable position than the taxpayer in that case. Here, with full knowledge of the facts as to value and of its net income, the petitioner made what is now claimed to be a grossly excessive declaration expressly intended to wipe out any profits tax. The effect of its action is that it has secured the benefit of a lower tax than it would have had to pay if it had made a lower valuation. Its claim is not now directed to the right to amend to show the actual value, but it seeks to strike down the whole taxing statute as void for failure to set a guide for the declaration of value.

There is nothing in the statute which prohibits a taxpayer from declaring the actual value. Congress did not intend that a corporation should declare a value sufficiently high to wipe out all profits taxes, for the purpose is to tax profits in excess of the credit of 12½ percent. One of the objects is to tax at higher rates abnormal profits which are out of proportion to the capital. In the case of the Sewat Co., the declared value was based on the value of assets acquired for stock.

If the District and Circuit Court in the Oertel case are right in holding that the statute contemplates a tax only on actual value of the capital stock, that construction gives taxpayers a standard or guide. It would then follow in this case that if the capital stock tax was invalid as being based on an excessive value (it is not here involved), the profits tax was less than what it would have been if computed on actual value. Hence, the petitioner suffered no injury or damage when the Government applied the tax on the basis of its excessive valuation. The petitioner in such case could not attack the constitutionality of the profits tax. The rule is that “one who invokes the power to declare a statute unconstitutional must show not only that the statute is invalid but that he has sustained or is immediately in danger of sustaining some direct injury as the result of its enforcement, and not merely that he suffers in some indefinite way in common with people generally.” Massachusetts v. Mellon, 262 U. S. 447, 488. See also Heald v. District of Columbia, 259 U. S. 114, 124.

On the facts in this case a claim of the right to file an amended return would avail the petitioner nothing. The petitioner’s contention is without merit.

Beviewed by the Board.

Decision will be entered wider Bule 50.

TURNER,

dissenting: It is true, as the majority opinion points out, that the question in Gregory v. Helvering, 298 U. S. 465, was whether the transfer by one corporation of a part of its assets to another corporation for all of the stock of the latter was a reorganization within the meaning of section 112 (i) of the Bevenue Act of 1928 and the question in issue I of the instant case is whether the transfer of securities by three individuals to a corporation for preferred stock was a transfer within the meaning of section 112 (b) (5) of that act, but the distinction drawn is in my opinion a distinction without a difference in so far as the application of the statute is concerned. The only concern or purpose in applying any provision of the statute is to determine the tax effect, and the tax effect of compliance in any transaction with either of the above provisions of the statute is obviously a point of similarity and not of distinction and is that the gain or loss realized or sustained in the particular transaction is not to be recognized until the subsequent disposition of the stock acquired. Accordingly, the distinction that may be drawn between the exchange in Gregory v. Helvering and the exchange in the instant case, which is a distinction as to the form of the transactions and not as to tax effect, is of no significance because admittedly in both transactions there was literal compliance with the statute.

A provision corresponding to section 112 (b) (5) first appeared in the Bevenue Act of 1921. The Committee on Ways and Means, in reporting the bill which was later enacted as the Bevenue Act of 1921, said that the provision “if adopted, will by removing a source of grave uncertainty, not only permit business to go forward with the adjustments required by existing conditions but will also considerably increase the revenue by preventing taxpayers from taking colorable losses in wash sales and other fictitious exchanges.” It is thus apparent that Congress had in mind only actual and real business transactions when it inserted the provisions under consideration in the income tax statutes. Furthermore, it anticipated that taxpayers indulging in fictitious exchanges would not be given the benefit of the statute.

In the Revenue Act of 1924 Congress, for the first time, separated and grouped in one section the provisions of the statute dealing with the recognition of gain or loss realized or sustained on exchanges of property. That part of the definition of the term “reorganization” construed in Gregory v. Helvering made its first appearance in that act. Keporting the measure to the House of Representatives, the Committee on Ways and Means stated: “It appears best to provide generally that gain or loss is recognized from all exchanges and then except specifically and in definite terms those cases of exchange in which it is not desired to tax the gain or allow the loss.” In a later paragraph of the report the Committee stated that Congress had theretofore “adopted the policy of exempting from tax the gain from exchanges made in connection with a reorganization in order that ordinary business transactions will not be prevented on account of the provisions of the tax law.” Among the exceptions to the general rule that gain or loss from all exchanges should be recognized and stated in identical terms were the exceptions stated in section 112 (b) (5) of the 1928 Act, with which we are here concerned, and in that part of section 112 (i), which was construed by the Supreme Court in Gregory v. Helvering. The exceptions are all on a basis of equality and certainly nothing is apparent to indicate that Congress had any thought or intention that literal compliance with one of the excepted provisions was sufficient to prevent recognition of gain while in the other it should be necessary that the exchange meet the requirements of the statute not only as to form, but also that it should have an actual and real business purpose. In applying section 112 (i) the Supreme Court, in Gregory v. Helvering, held that it was not enough that a transaction fall literally within the terms of the statute, and concluded that a transfer of assets by one corporation to another in pursuance of a plan having no relation to the business of either corporation was “outside the plain intent of the statute.”

I am unable to find any basis for holding that Congress actually did or intended to deal less strictly with taxpayers who seek to bring their transactions within the terms of section 112 (b) (5) than with those who seek to apply the terms of section 112 (i). Such, however, is the effect of the distinction drawn between Gregory v. Helvering and the instant case. To so hold is to say to taxpayers that gain realized on an exchange which meets the literal requirements of section 112 (b) (5) is not to be recognized even though the transfer has no relation to the business of either the transferor or transferee. But if the gain realized in a transaction described in section 112 (i) is to escape recognition, the transaction must not only satisfy that section as to formalities but must also serve a real business purpose. In my opinion Congress made no such distinction and the presence of a real business purpose is a prerequisite to the applicability of section 112 (b) (5) just as it is with section 112 (i).

As I read the facts, the transaction in this case, as in Gregory v. Helvering, served a tax purpose and not a business purpose. The securities were transferred to W. & K. for the sole purpose of permitting that corporation to apply the loss, which would result from their sale, against gain which it was known the corporation would realize during the taxable year in the course of its regular business. The retirement of the preferred stock was provided for at the time of the exchange and the retirement price was fixed at $292.82, an amount which was to the penny equivalent to the prorated fair market value of the securities transferred. The final sale of securities occurred on July 28, 1933, and on October 6, 1933, The preferred stock was retired with the proceeds of the sale. The facts and circumstances in my opinion indicate that there was no intention that the corporation would use the securities in its business or retain the proceeds for such use after the securities were sold and show that the transfer of the securities by the three petitioners to the W. & K. Holding Corporation was “not a transfer of assets * * * in pursuance of a plan having relation to the business” of either the transferors or the transferee. “The transaction upon its face lies outside the plain intent of the statute.”

For the reasons outlined, I respectfully express my dissent.

ArNold, Disnex, and Oppek agree with this dissent.


source: Caselaw Access Project

author: Black:

license: Public Domain

text:
    Charles Weyl and Edward S. Weyl, Executors and Trustees of Estate of Maurice N. Weyl, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88527.
    Promulgated October 12, 1938.

      Gilbert J. Kraus, Esq., for the petitioners.

      T. F. Callahan, Esq., for the respondent.
   OPINION.

Black:

The only issue in this proceeding is whether or not the income tax return of Maurice N. Weyl for the year 1930, filed March 10, 1931, was false and fraudulent with intent to evade tax. If it was not, then the statute of limitations has run and bars the assessment and collection of the deficiency. If it was filed with a false and fraudulent intent to evade tax, then the statute of limitations has not run. See sec. 276 (a), Revenue Act of 1928.

The burden of proof to sustain fraud is upon the Commissioner, and he assumed that burden at the hearing and offered evidence to sustain it. Counsel for respondent argues in Ms brief that the decedent, Maurice N. Weyl, did not make a bona fide sale of the securities in question in December 1930 and therefore Ms claim for losses on sales wMch were not really made amounts to fraud and deceit and establishes that decedent’s income tax return was false and fradu-lent with intent to evade tax.

Although we have found in our findings of fact that the income tax return of Maurice N. Weyl was false and fraudulent with intent to evade tax, we do not agree with respondent that decedent did not make sales of the stocks in question in December 1930. He unquestionably did make these sales on the dates set out in our findings, but on the very same days that the stocks were sold decedent purchased like quantities of the same stocks through the use of the name of his secretary, Margaret M. Halbert.

This fact decedent did not disclose in his income tax return filed March 10, 1931. If he had done so, it would immediately have brought into play section 118 of the Eevenue Act of 1928, which reads as follows:

In the ease of any loss claimed to have been sustained in any sale or other disposition of shares of stock or securities where it appears that within thirty days before or after the date of such sale or other disposition the taxpayer has acquired (otherwise than by bequest or inheritance) or has entered into a contract or option to acquire substantially identical property, and the property so acquired is held by the taxpayer for any period after such sale or other disposition, no deduction for the loss shall be allowed under section 23 (e) (2) of this title; nor shall such deduction be allowed under Section 23 (f) unless the claim is made by a corporation, a dealer in stocks or securities, and with respect to a transaction made in the ordinary course of its business. If such acquisition or the contract or option to acquire is to the extent of part only of substantially identical property, then only a proportionate part of the loss shall be disallowed.

Now of course it is perfectly true that if Margaret M. Halbert had been the real purchaser of these stocks for her own beneficial ownership on the dates in December 1930 detailed in our findings, decedent Maurice N. Weyl would have been entitled to take the losses claimed on Ms return and certainly he would not have been guilty of any fraud, because, as we have already pointed out, he made bona fide sales of these stocks through the New York and Philadelphia stock exchanges to purchasers who are unknown to us.

But Margaret M. Halbert was not the real purchaser of the stocks which were purchased in her name. She was a witness at the hearing and the substance of her testimony is that, at or about the time decedent made the sales of the stocks in question, he told her that he was wanting to make some sales to reduce his taxes and asked her for the use of her name in helping to put through the transactions. To tbis she gave her consent. She testified that she did not put up any of her own money; that Weyl provided the money with which the stocks were purchased; and that when the same stocks were sold for her account, on January 22, 1931, the check for $32,011.50 which was received from the brokers in settlement of the proceeds from the sale was immediately endorsed over by her to Maurice N. Weyl. That check is in evidence and corroborates Miss Halbert’s testimony. Unfortunately Weyl is dead and we do not have the benefit of his version of the transactions. Cf. L. Schepp Go., 25 B. T. A. 419. We are convinced however that Miss Halbert’s testimony was truthful and that, notwithstanding that the shares of stock were purchased in her name, she was not the real beneficial owner thereof; that the real purchaser was Maurice N. Weyl, himself, and this fact he did not disclose to the Commissioner in his income tax return for 1930.

Counsel for petitioners concedes that under the facts established at the hearing, section 118 of the Revenue Act of 1928, known as the wash sales' provision, would prevent petitioners’ decedent from taking a deduction for any loss on the sales in question, but he contends that is a technical provision of the law with which respondent has not proved decedent was familiar and that bad faith should not be imputed to decedent because he did not disclose on his income tax return the complete facts, citing in support of his contention a memorandum opinion of the Board which was based upon James Nicholson, 82 B. T. A. 977, and Arthur M. Godwin, 34 B. T. A. 485.

We are not impressed by this, argument, in view of all the facts which are before us. The facts show that on January 22, 1931, shortly after the 30-day period prescribed in section 118 had expired, the transactions of December 5, 8, and 10, 1930, were reversed and the stocks were sold in the name of Margaret M. Halbert and the same number of shares in the same corporations were acquired by Maurice N. Weyl. This indicates to our satisfaction that Maurice N. Weyl was well aware of the provisions of section 118 of the Revenue Act of 1928. As we have already stated, if the purchases made in the name of Margaret M. Halbert had been purchases for her own individual ownership, then section 118 of the Revenue Act of 1928 would not apply and decedent would be entitled to the loss deduction claimed. But on the facts we hold that Margaret M. Halbert’s so-called purchases in December of 1930, engineered and put through by Weyl himself, were not what they purported to be and Weyl was the real purchaser of the stocks and not Margaret M. Halbert, and therein the taxpayer runs afoul of the fraud provisions of the statute.

A taxpayer has the right to minimize his taxes by every legitimate means open to him, but he must not endeavor to do it by transactions which are not what they purport to be. In Drawoh, Inc., 28 B. T. A. 666, we said:

While it is of course lawful for taxpayers to use means and methods which are legal and not tainted with fraud to avoid taxes, cf. Brillon v. State of Wisconsin, 240 U. S. 625; Isham v. United States, 17 Wall 496, it is never lawful for taxpayers to use methods of concealment and deception to evade taxes. It is on the use of the latter methods that taxpayers run afoul of the fraud penalties * * *.

On the evidence, we must conclude that the reason for the decedent’s acquiring the same number of shares in the same corporations as the ones he sold, in the name of his secretary, Margaret M. Halbert, instead of his own name, was to evade the application of section 118 of the Revenue Act of 1928, the wash sales provision of the act. This action on his part, we think, amounts to fraud, and his failure to disclose the complete facts in his income tax return for 1930 amounted to the filing of a false and fraudulent return, with intent to evade tax. Cf. Robert Wilson Carter, 36 B. T. A. 598; Sol H. Goldberg, 36 B. T. A. 44; affd., 100 Fed. (2d) 601; L. Schepp Co., 25 B. T. A. 419.

The authorities cited by petitioners in their brief, we think, are distinguishable on their facts.

Decision will be entered for the respondent.


author: Opper:

text:
    Peoples State Bank, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91697.
    Promulgated October 13, 1938.

      William P. Smith, Esq., for the petitioner.

      Frank B. Schlosser, Esq., and Elmer O. Holt, Esq., for the respondent.
   OPINION.

Opper:

Petitioner, closed in 1932 because of insolvency, was reopened pursuant to Michigan law by virtue of a judicially approved agreement by the depositors to accept the proceeds of liquidation of certain segregated assets and the earnings of the bank for five years in satisfaction of approximately half of their deposits. These assets, of a book value equal to the allocated deposits, were held in what was designated a “Trust Fund”, but the bank retained full ownership powers over their liquidation and reserved the right with the consent of the state commissioner of banking to substitute for the segregated assets any of the retained assets which might become doubtful or undesirable. Any losses of the bank were to be charged against the so-called trust fund. At the end of the five-year liquidation period the fund was to be paid to the depositors up to the full amount of their deposits, together with 3 percent per annum interest, the excess, if any, to be retained by the bank. As it finally developed in 1938, at the end of the five-year period the depositors were paid less than 50 percent of their allocated deposits. A table summarizing the figures for the taxable year 1935 as given in the stipulation appears in the margin.

We begin with the assumption that the bank and “trust fund” are taxable together as one entity because that position is agreed to by both parties and therefore is not in issue. The dispute arises by reason of the treatment accorded by respondent to the various items of income and deduction. Principally these consist of income earned by the bank, income received from assets held in the trust fund, and losses incurred on bad debts, and from the sale of capital assets, held in the trust fund. Respondent has taxed petitioner on the two income items and refused to allow the deductions. Petitioner contends that it should be given the benefit of the loss deduction or, alternatively, be freed from liability to tax on the income items. In either event there would be no income subject to tax.

Eespondent suggests a third possibility, namely, that current income is taxable on an annual basis whether earned by the bank itself or by the assets in the trust fund, but that capital losses and bad debts of the trust fund must be held in abeyance for treatment as part of the completed transaction in the year when the entire arrangement is concluded. There may be other possible methods of dealing with the petitioner’s tax status, but none occurs to us, except that suggested by respondent, which would have the effect of charging petitioner with any taxable income in the instant proceeding. That being so, we expressly refrain from attempting to determine which treatment is properly applicable, if that advanced by the respondent is not.

Once it is conceded that the trust fund is the property of the bank and is to be taxed along with the bank’s income in the same way as any of its other property, some special circumstance must exist to justify a departure from the statutory direction that capital losses and bad debts may be deducted in the year when they materialize. Revenue Act of 1934, sec. 23 (f) and (k). The only grounds advanced for such an exception here are, first, that petitioner’s loss has been “compensated for” by the depositor’s agreement to accept the assets in settlement of their deposit liabilities and, second, that to permit deductions to this petitioner would result in a failure properly to reflect its income.

As to the first ground urged by respondent, it was not the segregated assets alone which secured petitioner’s relief from liability, but these assets together with its agreement to devote its own income and that from the trust assets to the depositors. Thus, any benefit secured by it from the segregated assets was not the amount of the deposit liabilities forgiven, but this amount less the income it might earn during the operative period. If, as in the instant case, there is in a given year a net capital loss of say $21,000 and net income from bank and trust assets combined of $15,000, the decrease taking place as of the end of the tax year in the amount available to depositors is the difference between the two, namely, $6,000. This is the amount which, if no later change occurs, will represent liability forgiven. If petitioner is charged with this amount in the current year, either as “compensation” for a loss or as income received, and also with its actual income of $15,000, the total is and necessarily must be exactly equal to the capital loss, since petitioner’s cost basis of the assets in the trust fund was the same as the deposit liabilities originally allocated thereto. Even if the “compensation” theory could be applied to such a case as this, a point which we do not decide, it follows that any “compensation” derived by petitioner in the tax year falls short of the loss suffered by it by exactly the amount of its current income, with the consequence that the income is offset by the remaining loss.

Respondent’s second contention is in turn based on the suggestion to which we have already referred, that the results of the liquidation must be known before it can be determined whether or not petitioner has actually suffered a loss. In the first place, it is by no means clear that each annual period can not be considered by itself so that income for each period may be properly computed without regard to the ultimate effect of the liquidation. The petitioner’s current income and the loss on assets sold in the tax year are known. The doubtful item, if there be one, is the amount of indebtedness which will ultimately be forgiven. Whether or not under some other circumstances a bank situated as was petitioner might obtain taxable income from the scaling down of its deposit liability we do not consider it necessary to determine, for in this instance the amount of liabilities forgiven was so indefinite that at most it could be charged to petitioner only to the extent that the transactions concluded prior to the end of the tax year resulted in such forgiveness. And even if we add to petitioner’s income the amount of indebtedness the release of which arises out of the transactions of that year, no income results since, as we have seen, the extent of the forgiveness exactly equals and must, on these facts, always exactly equal the difference between the capital losses and the income received.

On the other hand, the hypothesis that petitioner’s income can not properly be reflected until the liquidation is completed, seems to us to require postponement to the year of final liquidation not only of the capital items but also of current income. Petitioner’s income, the segregated assets, and the release of liability were all the subjects of one executory contract. At the time the agreement was made the amount of future income was “uncertain and indeterminable.” But until the entire transaction was closed that uncertain and indeterminable quantity was, as we have seen, as much a necessary factor in calculating the effect of the entire transaction upon petitioner’s situation as was the amount which would ultimately be realized from the assets themselves, the uncertain and indeterminable character of which causes respondent to urge postponement. Thus when respondent contends that the loss on these assets mnst be deferred until the end of the liquidating period he inferentially, it seems to us, advances the same argument for postponing consideration of current income, in which event, of course, there would still be no taxable income attributable to petitioner for the year before us.

All of this results, perhaps, only by reason of the present facts that the deposit liability equaled the basis of the segregated assets, that there are capital losses on these assets greater than net income, and that all net income goes to the creditors, thereby reducing any amount required to be treated as forgiveness. But we do not purport to be passing upon other cases where the facts may be different. In the light of this disposition of the proceeding it is not necessary to consider petitioner’s alternative argument that the income is not taxable to it because of its assignment to the creditors; nor its further assertion that the Act of March 1, 1879, referring to the taxation of insolvent bants either in its original form or as amended by the Revenue Act of 1988, requires petitioner’s income to be exempted from tax. For the same reason such doubts as may exist of our jurisdiction under that statute, need not now be resolved.

While it may be unfortunate that so many open questions should remain after the decision of a proceeding regarded by both parties as a test case, we do not feel justified in attempting to decide controversial issues of law which seem to us immaterial upon the present record.

Decision will be entered for the petitioner.

       Act No. 8, Public Acts of 1932.

       See following table:
      Reorganized bank Segregated assets Combined Gross Income: Interest Received — ,.... Collected on Bad Debts previously charged olf.. Miscellaneous Income.. Capital Gains..... Commr.’s increase in income (not disputed)-____ Commr.’s increase in income — deduction disallowed for insurance paid (disputed). Total. Deductions: Expenses.. Capital Lossos (disallowed). Bad Debts (disallowed).. Total- — .-__ $50,401.66 Net Income (credited to Trust Fund). Commissioner added interest received on segregated assets — ___ Not Income of Bank per 90-Day Letter. 6,851.07 6,107.93 1,459.39 767.28 65,587.33 60,408.87 5,178.46 10,288.03 15,466.49 $10,288.03 407.31 "‘§,"Í5L42 $60,689.69 407.31 6,851.07 9,259.35 1,459.39 767.28 $13,846.76 $79,434.09 3,166.04 21,345.04 60,408.87 3,166.04 21,345.04 24,511.08 84,919.95 (Loss) $10,664.32 (Loss) $5,485.86

       See G. C. M. 12000, XII-2 C. B. 62.

       ⅜ * * The petitioner and the Commissioner regard the “Trust Fund” here involved to be not a separate taxable entity from the hank. * * * (p. 15, respondent’s brief.)
      * * * throughout the liquidation period the bank retained such complete control of the segregated assets, both by its liquidation thereof with “the same authority it would have if such trusteed assets were fully owned by it” (depositors’ agreement, par. 11), and through its power of substitution of its retained assets therefor, that it must be considered as remaining in substance the owner thereof. * * * (P. 6, petitioner’s brief.)

       It may be noted that if the trust fund were taxable as a separate entity there would apparently be no basis for excluding the deductions, in which event the taxable income could be no more than $5,178.46 instead of the $15,46G.49 claimed in the deficiency letter. See footnote 2, supra.

       See footnote 2, supra.

       Revenue Act of 1934, see. 23 (f).

       Respondent’s brief states: “Moreover the facts show (Stip., par. 13) that the hank has heen fully compensated for the segregated assets, they having cost the banlc $939,931.06 and the bank was relieved of liability for deposits of the same amount in consideration of the assets being set aside for liquidation in payment of such deposit.” A similar statement appears in the deficiency letter:
      However, in regard to losses on segregated assets it seems clear that there is involved in connection with the segregated assets but one composite executory transaction, that your bank has been recompensed for losses on the segregated assets to the extent of claims relinquished by depositors, and that as a result thereof there are offsets which would eliminate otherwise allowable deductions.
      This office accordingly holds that as loss or disposition of the segregated assets is so utterly indefinite and indeterminable no loss is allowable in advance of their final liquidation.

       Revenue Act of 1934, sec. 41.

       Sec. 22. That whenever and after any bank has ceased to do business by reason of insolvency or bankruptcy, no tax shall be assessed or collected, or paid into the Treasury of the united States, on account of such bank, which shall diminish the assets thereof necessary for the full payment of all its depositors; and such tax shall be abated from such national banks as are found by the Comptroller of the Currency to be insolvent; and the Commissioner of Internal Revenue, when the facts shall so appear to him, is authorized to remit so much of said tax against insolvent State and savings banks as shall be found to affect the claims of their depositors. * * *

       See west Town State Bank, 32 B. T. A. 531, minority opinion, and cf. sec. 818 (3). Revenue Act of 1938.


author: Mellott : DisNEY,

text:
    Edwin B. Cox, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89292.
    Promulgated October 13, 1938.

      Charles E. Garnett-, Esq., for the petitioner.

      S. B. Anderson, Esq., and Frank T. Horner, Esq., for tbe respondent.
   OPINION.

Mellott :

Tbe Commissioner determined a deficiency in gift tax for the calendar year 1935 in tbe amount of $600.

The proceeding was submitted upon an agreed statement of facts, all of which we find to be as stipulated. Petitioner, a resident of Ardmore, Oklahoma, duly filed a gift tax return for the calendar year 1935, reporting total gifts made during that year of $200,000 and net gifts made during the preceding year of $77,Y91.38. The $200,000 consisted of two gifts of $100,000 each made to trusts. Accordingly petitioner excluded $5,000 from each, under section 504 (b) of the Revenue Act of 1932, or a total of $10,000, and computed a tax of $18,634.05, which he paid. It is stipulated that “The sole question for determination * is whether the petitioner is entitled to the exclusion or exemption of $5,000 from each of said gifts in the computation of his gift tax liability.”

Respondent filed no brief. The deficiency was determined upon the theory that the transfer of $100,000 to the Guaranty Trust Co. of New York in trust was a transfer of a “future interest in property” and hence not excludable under section 504 (b), supra; but in his amended answer the respondent makes the additional contention that only $5,000 may be deducted because of the fact that petitioner’s son was the beneficiary under each of the two trusts. The trust instruments are incorporated in the agreed statement of facts and have been examined by us. For present purposes, however, it will be sufficient to quote the stipulation.

(3) On November 15, 1935, the petitioner made a transfer of $100,000.00 to the Guaranty Trust Company of New York as trustee in trust for the benefit of the beneficiaries named in and subject to the terms, provisions, and conditions of, a declaration of trust executed by him in the making of such transfer. Petitioner’s son, Edwin Loeliridge Cox, was one of the beneficiaries named in the declaration of trust, and upon conditions of survivorship and the attainment of certain ages therein stated, was to receive certain distributions from the income and from the corpus of the trust. * * *
(4) On December 14, 1985, the petitioner made a transfer to Elizabeth L. Cox, his wife, as trustee in trust for his son, Edwin L. Cox, of the sum of $100,000.00. This transfer was made by a declaration of trust in writing and was wholly without any restrictions upon the administration of the trust fund by the trustee, but provided for distributions therefrom at certain specified dates, and the termination of the trust on January 1, 1950. * * *

The transfer to the Guaranty Trust Co. of New York was not one of a future interest in property. The donor “divested himself of all vestige of title, and no future act on his part could modify or abrogate his act.” Commissioner v. Wells, 88 Fed. (2d) 339, affirming Thomas E. Wells, 34 B. T. A. 315. Inasmuch as the statute imposes the tax upon the donor, the quality of the estate conveyed by him is determinative rather than the estate received by any particular beneficiary, Commissioner v. Krebs, 90 Fed. (2d) 880; but even if the gift be considered from the standpoint of the donee, it was one of a present interest in property, the trust being an entity capable of and in fact actually receiving the property transferred. Commissioner v. Wells, supra; cf. Charles W. Deeds, 37 B. T. A. 293,297; Noyes v. Hassett, 20 Fed. Supp. 31.

Bespondent’s contention that the petitioner’s son was the beneficiary under each trust, if important, is only partially true. Under the transfer made to petitioner’s wife the son, Edwin L. Cox, was the sole beneficiary; but not so under the other trust. The instrument creating it provided that the son should receive the income for his life if he attained the age of 21 years. If he attained the age of 32 years then he was to receive 25 percent of the corpus. If he attained the age of 45 years then he was to receive 33⅛ percent of the corpus then on hand. It will be noted that the maximum amount of corpus which he could ever receive was only 50 percent of the amount transferred to the trust company by petitioner. Petitioner’s wife had a possibility of becoming a beneficiary if she outlived the son, but if not then the son’s lineal descendants, if any, were to receive the remainder, otherwise it was to go to Bussell Eugene Cox. So while it is true that the son was a beneficiary under each trust, it can not be said that he was the sole beneficiary.

But even if the son were the sole beneficiary under each trust, we are of the opinion that the $5,000 exclusion should be allowed as to each. The trusts were separate entities. As the court pointed out in Commissioner v. Wells, supra, “They were no different from persons, for the Act so states.” Sec. 1111 (a) (1). In Seymour H. Know, 36 B. T. A. 630, we held that the fact that two beneficiaries were in existence at the time the transfer in trust was made did not entitle the donor to two exclusions of $5,000 each. This was on the theory that the trust was the donee. To the same effect also see Katherine S. Rheinstrom, 37 B. T. A. 308 (on appeal, 8th C. C. A.). The District Court reached a different conclusion in Davidson v. Welch, 22 Fed. Supp. 726; but inasmuch as trusts, though abstractions, long have been, and usually are, treated for income tax purposes as entities having separate existence, cf. Anderson v. Wilson, 289 U. S. 20, and inasmuch as we were affirmed in Commissioner v. Wells, swpra, we prefer to follow our earlier decisions rather than Davidson v. Welch, sufra.

While the precise question now being considered has not been decided, it seems to be a necessary corollary to our earlier decisions that a $5,000 exclusion may be made from each transfer in trust, though the beneficiary be the same. Congress anticipated this holding — though the fact that it did so has comparatively little significance — when it amended section 504 (b) in 1938 and provided that the exclusion should not apply to gifts in trust. See Report No. 1567, Committee on Finance, 75th Cong., 3d sess. The reports of the Congressional Committees in connection with the enactment of the Gift Tax Law in 1932 have also been examined; but, as the court pointed out in Commissioner v. Wells, sufra, “the enactment is neither ambiguous nor doubtful in its expressions,” so the reports furnish little aid.

The respondent erred in denying the exclusion of $5,000 from the transfer in trust made by petitioner to the Guaranty Trust Co. of New York. It follows that the deficiency determined by him can not be approved.

Reviewed by the Board.

Judgment will be entered for the petitioner.

DisNEY,

dissenting: I can not concur in the finding that Edwin Loehridge Cox was only one of the beneficiaries under the trust set up on November 15, 1935. The trust instrument provided, in short, that he should have the income throughout his life and by the age of 45 one-half of the corpus, and that at his death and that of his mother, the trust should cease and the remainder of the corpus should be paid to his lineal descendants, if any, per stirpes; that if no lineal descendants survive him, or if any survive him and die before his mother, the trust should continue through her lifetime to pay her the income and that then the trust should cease, the corpus to be vested in Russell Eugene Cox or his distributees. Under this state of facts, the mother, in any event, would take only the income for her life, perhaps only a portion thereof, and only in the contingency of surviving Edwin Lochridge Cox and any lineal descendants surviving him. Such remote contingency does not, in my opinion, make her a beneficiary under the trust within the intent of the statute, and I conclude that he was beneficiary in two successive trusts.

Moreover, in so far as the majority opinion assumes two successive trusts to the same beneficiary and holds, nevertheless, that there should be allowed two deductions of $5,000 each, I can not concur. The object intended by the statute is too plain, I think, to allow it to be stultified by a plurality of trustees under which arrangement, with trusts of $5,000 each, the gift for tax purposes could be diminished to zero. I do not think that Commissioner v. Krebs, 90 Fed. (2d) 880, or Noyes v. Hassett, 20 Fed. Supp. 31, furnish authority herein, for in both cases the question as to who was donee was not met. In Commissioner v. Wells, 88 Fed. (2d) 339, quoting section 1111 of the Revenue Act of 1932, defining “person” as including “trust,” the statement is made that the donees were trusts. The question was as to future interest, and taken as a whole the case is to the effect that there was transfer, taxable under the statute, because the tax is on transfer and not receipt. Definitions based upon inductive reasoning are often pitfalls for unwary thought when applied to particular situations. I think this is a situation where “A word * * * may vary greatly in color and content according to the circumstances and the time in which it is used.” Towne v. Eisner, 245 U. S. 418, 419. It is well recognized that definitions “are to be understood by looking at the subject-matter * * * and the object of the Legislature * * Edinburgh St. Tramways Co. v. Torbain, 3 App. Cas. 58, 68. In spite of the definition of the word “person” as including “trust” in section 1111, the statute as a whole shows that the definition can not be consistently applied. Thus section 142, requiring specially a return by a fiduciary for a trust, and section 161, providing a particular imposition of a tax upon trusts, seem unnecessary, if the word person is in every instance to include “trust.”

Commonwealth v. Welosky (Mass.), 177 N. E. 656, says:

⅜ * * The word “person” like any other words, has no fixed and rigid signification, but has different meanings dependent upon contemporary conditions, the connection in which it is used, and the result intended to be accomplished. * * *

It has been held, in a consideration of perpetuities, that beneficiary, and not trustee, is donee and first taker. Henry v. Henderson, 58 So. 354, (357). The word trustee itself discloses that another is the person primarily involved. I believe that section 504 (b) requires a construction of the word person in its usual sense. Old Colony Railroad Co. v. Commissioner, 284 U. S. 552. The fact that in Commissioner v. Wells, supra, as well as other cases the tax was based upon the transfer to the trust is justified by the words of the statute, which imposes the tax upon the transfer, with emphasis upon that fact. There was transfer, and not in futuro. As said in Davidson v. Welch, 22 Fed. Supp. 726, the same conclusion could have been reached in Commissioner v. Wells, supra, by finding that the donees were the cestuis que trust. Davidson v. Welch, supra, holds each of several beneficiaries under a single trust to be donees requiring exclusion of $5,000. Considering the light given upon the intent of the Congress by the Senate Committee Report as to section 501 of the Revenue Act of 1932, it seems to me plain that within the purview of section 504 (b) the donee is the beneficiary under a trust. Cases like Seymour H. Knox, 36 B. T. A. 630, and Katherine S. Rheinstrom, 37 B. T. A. 308, involving a transfer in trust for several persons do not, I think, answer the question here propounded, as to the application of section 504 (b) to successive trusts in the same year for the same beneficiary; for there was in those cases one transfer, within the object of section 501. Here there are two, to the same person. The fact that section 504 (b) was amended by section 505 (a) of the Revenue Act of 1938 to exclude gifts in trust, along with gifts of future interests in property, is, I believe, indicative of the intent to clarify the earlier statute and that, being subject to erroneous interpretation, it should be clarified. Greensboro Gas Co., 30 B. T. A. 1362 (1374, 1375); Johnston v. Commissioner, 86 Fed. (2d) 732; certiorari denied, 301 U. S. 683. I think petitioner here has erroneously interpreted its meaning. I dissent.

Offer agrees with this dissent.

       SEC. 504. NET GIFTS.
      *******
      (b) Gifts Less Than $5,000. — In tbe case of gifts (other than of future interests in property) made to any person by the donor during the calendar year, the first $5,000 of such gifts to such person shall not, for the purposes of subsection (a), bo included in the total amount of gifts made during such year.

       Sec. 503. * * * The Committee is also proposing an amendment by which the exclusion would not apply to gifts in trust. The Board of Tax Appeals and several Federal courts have held, with respect to gifts in trust, that the trust entities were the donees and on that account the gifts were of present and not of future interests. The statute, as thus construed, affords ready means of tax avoidance, since a donee may create any number of trusts in the same year in favor of the same beneficiaries with a $5,000 exclusion applying to each trust, whereas the gifts, if made otherwise than in trust, would in no case be subject to more than a single exclusion of $5,000. * * *

       The words “transfer * * * by gift” and “whether * * * direct or indirect" are designed to cover and comprehend all transactions (subject to certain express conditions and limitations) whereby and to the extent (sec. 503) that property or a property right is donatively passed to or conferred upon another, regardless of the means or the device employed in its accomplishment. For example, * * * (8) a transfer of property to B where there is imposed upon B the obligation of paying a commensurate annuity to C would be a gift to C; * * * (7) where A creates a revocable trust naming B as beneficiary, a gift to B of the corpus is effected when A relinquishes the power to revoke or the power is otherwise terminated in B’s favor (the income payments to B in the interim being gifts from A in tbe calendar years when received.)


author: Murdock: Turner,

text:
    Dorothy A. D. Allen, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88569.
    Promulgated October 13, 1938.

      Edward H. Green, Esq., for the petitioner.

      Eugene G. Smith, Esq., and Lawrence A. Baker, Esq., for the respondent.
   OPINION.

Murdock:

The Commissioner determined a deficiency in gift tax for the year 1933 in the amount of $133,826.03. The petitioner contends that she made the gift prior to the enactment of the gift tax. The Commissioner argues that the gift became absolute and toot effect only after June 6,1932, the effective date of the gift tax, since the petitioner did not attain her majority until August 9, 1933, and she had by law the right to avoid the gift until that date. The facts are found as stipulated by the parties.

The petitioner transferred the property involved herein in trust on June 4, 1932. The transfer was absolute on its face. The petitioner did not reserve any power of revocation. She became of age on August 9, 1933. She has never revoked the transfer in trust. The trust was for the benefit of her mother, father, brother, and the children of the latter.

The question is, Is this gift subject to gift tax under section 501 of the Revenue Act of 1932? That section is as follows:

SBC. 501. IMPOSITION OP TAX.
(a) For tbe calendar year 1932 and each calendar year thereafter a tax, computed as provided in section 502, shall be imposed upon the transfer during such calendar year by any individual, resident or nonresident, of property by gift.
(b) The tax shall apply whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible; but, in the case of a nonresident not a citizen of the United States, shall apply to a transfer only if the property is situated within the United States. The tax shall not apply to a transfer made on or before the date of the enactment of this Act.
(c) The tax shall not apply to a transfer of property in trust where the power to revest in the donor title to such property is vested in the donor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such property or the income therefrom, but the relinquishment or termination of such power (other than by the donor’s death) shall be considered to he a transfer by the donor by gift of the property subject to such power, and any payment of the income therefrom to a beneficiary other than the donor shall he considered to be a transfer by the donor of such income by gift.

If the gift was made on June 4, 1932, it escapes tax because the act applies only to gifts made after its enactment and it was not approved and did not become a law until June 6,1932, at 5 p. m. The Commissioner contends, however, that the petitioner had a power to revoke the gift during infancy and for a reasonable period thereafter, which made the gift incomplete until that power no longer existed. The parties agree that there is a rule of law to the effect that an infant can avoid his conveyances at any time up to the date upon which he attains his majority and during some reasonable period thereafter, but this right is personal to the infant or his legal representatives and his conveyances are not subject to collateral attack. Thus, by law, this petitioner had the right to avoid her transfer of June 4,1932, and she continued to have it until some rather indefinite and undisclosed time after June 6,1932, when the gift tax became effective.

Nevertheless, the transfer was not subject to the tax. Subsection (c) provides that the tax shall not apply to the transfer in trust where the power to revest title to such property is vested in the donor but the relinquishment or termination of such power shall be considered as the taxable transfer, and any payment of income to the beneficiary in the meanwhile shall be a taxable gift. This language was not intended to apply to the power given by law to an infant to avoid his transfers, but was intended to apply to a transfer in trust where in the trust instrument a power was retained, either directly or indirectly, by the donor. Cf. Ralph Pulitzer, 36 B. T. A. 964. The latter kind of a power is well known in the law and does not include such a right as an infant has to avoid his tranfers. The present grantor, in the trust deed, retained no power. The protective power which by law remains in the infant donor, is not technically a power to revest but a power to render the gift void, i. e., to make it a nullity, as if nothing had ever passed from the donor or been vested in the donee. Thus, it is not the land of a power described in (c). The power of the infant extends not only to gifts by transfers in trust but also to direct gifts. Clearly (c) would not apply to the latter. Yet Congress could not have intended to tax the gift in trust and leave the other untaxed. The language of (c) is not appropriate had Congress had in mind a situation like the present where the right to avoid is a condition which the law imposes for the protection of infants. There would be a serious administrative difficulty of determining when such a right terminates. The last provision in (c), taxing the income as gifts when paid, would not apply, on the Commissioner’s theory, because those gifts too could be avoided by the infant.

The Supreme Court, in interpreting somewhat similar provisions of section 302 (d) of the Revenue Act of 1926, pointed out this very difference between a power to revoke and a condition which the law imposes. Helvering v. Helmholz, 296 U. S. 93. It also held that a power to revoke, which is within the meaning of such provisions, must arise from the instrument creating the trust. White v. Poor, 296 U. S. 98. The same reasoning applies in the present case.

Subsection (c) was repealed by section 511 of the Revenue Act of 1934, with the explanation by Congress that it was no longer necessary since it merely expressed a principle of law later well established by the decision in Burnet v. Guggenheim, 288 U. S. 280. Senate Report No. 558, 73d Cong., 2d. sess., p. 50; House Report No. 704, 73d Cong., 2d sess., p. 40. That is another indication that Congress did not intend to delay the tax on a transfer by an infant until the infant’s right to avoid the transfer had lapsed since the Guggenheim case dealt with a power to revoke reserved in the trust deed. There is some language in the Guggenheim case which indicates that the gift tax in the Revenue Act of 1924 was intended to be laid on a transfer only after it was beyond recall. Yet, in the light of the Helmholz and Poor cases and of the statutory provision, we think the court must take the view that an unqualified gift by an infant is consummate when made and the gift here was made before the law imposing the tax became effective.

Reviewed by the Board.

Decision will he entered, for the petitioner.

Disney and Keen dissent.

Turner,

concurring: I am unable to agree with that part of the majority opinion which discusses the effect of Helvering v. Helmholz, 296 U. S. 93, and White v. Poor, 296 U. S. 98. In my opinion the situation dealt with in Helvering v. Helmholz is in no way comparable to that involved in the instant case and the holding of the Court is not applicable here. There the trust instrument provided that the grantor should be entitled to a return of the property transferred in trust provided all of the beneficiaries agreed in writing that he should have it back. In this case the infant grantor alone and without regard to the desires or wishes of the beneficiaries had the power to revest in herself the title to the property transferred. A situation thus existed which was substantially and inherently different from that in Helvering v. Helmholz. As to White v. Poor, I am unable to find any basis for the conclusion that that case is authority for or lends support to any holding that section 501 (c) of the Revenue Act of 1932, is inapplicable unless the grantor derives the power to revest from the written instrument creating the trust. In that connection the statute merely says that “where the power * * * is vested, in the donor * * * the ⅜ * * termination of such power * * * shall be considered * ⅜ * a transfer ⅜ * * by gift * * There is nothing whatever to support the theory of the majority that the power must be reserved in the instrument of transfer.

For other reasons stated in the majority opinion, however, I concur in the result.

Opper concurs in the above.

       Tlie situation is peculiar in that the acts and contracts of the infant are valid and binding except only in case the infant himself chooses to exercise his law given power to avoid them, Bd. Kasch and wife, et al., 25 B. T. A. 284; affd., 63 Fed. (2d) 466; VoorJiees V. Wait, 15 N. J. B. 343 ; DeVito V. Mechanicville, 251 N. X. Ap. Div. 514; Williston on Contracts, § § 43, 105, 232.


author: Hill

text:
    Celia Seder, Executrix, Estate of Abraham Seder, Deceased, and Celia Seder, Surviving Wife, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 84934.
    Promulgated October 13, 1938.

      Charles H. Sachs, Esq., for the petitioners.

      Arthur Carnduf, Esq., and C. Chester Guy, Esq., for the respondent.
   OPINION.

Hill

: In the deficiency letter addressed by respondent to petitioners under date of March 3, 1936, it is stated “that the determination of the income tax liability of A. Seder, deceased, and Mrs. Celia Seder for the taxable year 1933 discloses a deficiency of $1,336.66” computed on the basis of a joint return filed by decedent and his wife.

In their appeal from respondent’s determination, petitioners assigned as error, (a) the action of respondent “in disallowing a loss of $32,357.50 incident to the sale of 800 shares of National Department Stores, Inc., stock;” and (b) the action of respondent “in attempting to make an assessment against Mrs. Celia Seder, indi-V vidually, wife of decedent, for an alleged tax liability of her husband, the decedent.” Bespondent denied the alleged errors. At the hearing counsel for petitioners stated that evidence was not available to establish the cost of the stock involved in issue (a), and that that portion of the appeal was abandoned. Thereupon, counsel for respondent moved for judgment against the estate of Abraham Seder in the amount stated in the notice of deficiency, on the ground that only issue (a) in any wise affected the tax liability of the estate.

The presiding Board Member granted such motion of the respondent, without objection by petitioners, and stated that decision would be entered against the estate for the amou/nt of the deficiency determined by respondent. Since respondent asserted joint and several liability against both petitioners, the granting of the motion directed an entry of judgment against the estate in the full amount of the deficiency. However, the action of the presiding Board Member was clearly predicated upon the theory, there urged by respondent and apparently tacitly conceded by petitioners, that issue (b) did not involve the tax liability of the decedent’s estate. The conclusions stated hereinbelow demonstrate that such theory was erroneous as a matter of law. Accordingly, the amount of the tax liability of the estate of Abraham Seder will be redetermined in accordance with this opinion, and judgment entered under Bule 50.

The parties stipulated the facts. During the calendar year 1933 Abraham Seder and Celia Seder were husband and wife, living together and maintaining a household. They were entitled to credit for two dependents. Abraham Seder died during the month of August 1934, and Celia Seder is “executrix” of his estate.

For the calendar year 1933, Abraham Seder and Celia Seder timely filed a joint Federal income tax return, signed by the husband and not by the wife, wherein there were reported as total income of Celia Seder the following items:

Dividends on stock of American Telephone & Telegraph Co_ $51.25
Interest on Liberty Bonds, 4½%_: 828.75
Dividends, Liberty-6, Inc_ 278.12
Dividends, Marbridge Building Co. Inc_ 300.00
Total_ 1,458.12

In determining the deficiency here at issue respondent increased the income of Celia Seder by the following items:

Interest, Union Savings Bank_$421.46
Interest from Liberty-6, Inc., a business corporation- 213. 61
Additional interest on Liberty Bonds_ 415. 02
Total_ 1,050.09

• The issue in this case presents a single, clear-cut question of law, i namely, whether a husband and wife who filed a joint Federal income tax return are by reason of that fact jointly and severally liable for any tax due thereon, or whether each is liable only for his or her part of the total tax apportioned on the basis of the net income ' attributable to each, where a correct and equitable basis for such , apportionment is established. ⅜

In Charles A. Rogers, 38 B. T. A. 16, we held that where a husband and wife did not disclose in their joint returns the income deductions attributable to each and at the hearing offered no proof to establish a basis for allocation of the deficiencies and penalties, and it further appeared that they kept no records from which the facts essential to the making of such allocations could be ascertained, they were jointly and severally liable. The decision of the United States Circuit Court of Appeals for the Fifth Circuit in Anderson v. United States, 48 Fed. (2d) 201, was based upon a similar factual situation, fit is too obvious to require discussion that those and other like cases are not, under the facts, applicable or controlling here, where the record clearly establishes an equitable basis for allocation.

A husband and wife do not become a single “taxing entity” and as such “the taxpayer” because they have elected to file a joint return. In such case they constitute a tax computing unit, but not a taxable or tax paying unit. In filing a single joint return they lose none of the rights they would possess if they had filed separate returns. Frank B. Gummey, 26 B. T. A. 894; Charles F. Fawsett, 31 B. T. A. 139.

The statute provides only that a husband and wife living together, if they come within the provisions requiring the making of returns, shall each make a return, or the income of each shall be included in a single joint return, “in which case the tax shall be computed on the aggregate income.” Sec. 51 (b) (1), (2), Kevenue Act of 1932. Sections 11 and 12 respectively levy a normal tax and a surtax “upon the net income of every individual.” The term “taxpayer” means any person subject to a tax imposed by the act, and the term “person” includes an individual. Sec. 1111 (a) (1), (14). Hence, within the statutory definitions, a husband and wife, even though they file a single joint return, are nevertheless separate taxpayers, since they are separate individuals, and persons subject to a tax imposed by the act.

In Cole v. Commissioner, 81 Fed. (2d) 485, reversing 29 B. T. A. 602, the Circuit Court of Appeals for the Ninth Circuit held that, although the deceased husband and wife filed a joint return, the husband’s estate was not liable for a deficiency tax where the deficiency was attributable to the wife’s, rather than the husband’s, income. The precise question presented in the instant case was discussed in the cited case, and it was held that the tax should be apportioned to the husband and wife according to the income attributable to each, a basis for such allocation having been established. In laying down this doctrine the court, after quoting with approval from the Board’s opinion in the Gummey case, supra, said:

One of the fundamental principles of taxation is that the incidence of a tax should be in accordance with the ability to pay. In income taxation, this means that the tax should be levied in proportion to income. That is all which the petitioner herein asks. If this cardinal principle is followed, justice will be done.
We do not believe that what the Commissioner terms the “unusual privilege” of filing a joint return was bought by the taxpayers herein, in the language of Fawsett v. Commissioner, “by the sacrifice of their other rights” — one of those rights being an equitable apportionment of their tax liability according to their ability to pay.

We have subsequently followed the Cole decision in Frank W. Barling, 34 B. T. A. 1062, and Ella T. Flaherty, 35 B. T. A. 1131.

On authority of the cited decisions, we hold that the total deficiency tax, the amount of which is not in controversy, should be apportioned between the estate of Abraham Seder, the deceased husband, and his surviving wife, Celia Seder, according to the net income attributable to each, which amounts may be determined from the facts stipulated by the parties and set out hereinabove.

There remains for consideration one further contention urged by petitioners, i. e., that petitioner Celia Seder is entitled to apply, as a credit against her net income, the personal exemption of $2,500. This contention must be denied.

Section 25 (c) of the Kevenue Act of 1932 allows such exemption to a married person living with husband or wife, but further provides that,

A husband and wife living together shall receive but one personal exemption. The amount of such personal exemption shall be $2,500. If such husband and wife make separate returns, the personal exemption may be taken by either or divided between them.

Thus, the statute grants a right of election with respect to the credit for the personal exemption only in the case of a husband and wife making separate returns. Furthermore, such right of election may be exercised only at the time of the filing of the returns, not afterwards. Cf. Automobile Loans, Inc., 36 B. T. A. 809; William A. Webster Co., 37 B. T. A. 800; Eaggar Co., 38 B. T. A. 141.

Judgment will be entered under Rule 50.