author: Opper :

text:
    J. C. Wynne, Petitioner, v. Commissioner of Internal Revenue, Respondent. Fleet Wynne, Petitioner, v. Commissioner of Internal Revenue Respondent.
    Docket Nos. 108874, 108875.
    Promulgated September 22, 1942.

      Harry G. Weeks, Esq., for the petitioners.
    Z>. D. Smith, Esq., for the respondent.
   OPINION.

Opper :

Although that fact does not appear, it seems to be assumed by the parties that the installment note in controversy had been received in payment for property which cost petitioners nothing, so that capital gain was realized in the year when that transaction occurred, which only the installment sale provisions of section 44 prevented from being taxable in its entirety at that time. The dispute is whether an acceleration of the tax due on the unpaid installments was brought about in the instant year by the dissolution of the debtor corporation and assumption of the debt by a successor partnership of which petitioners were members, under Revenue Act of 1938, section 44 (d) 4

The contention, of course, is that the obligation was disposed of by the transaction, since petitioners could not be their own debtors and the dissolution and transfer to the partnership would have brought that about if the obligation is not viewed as having been discharged.

One or two preliminaries should be clarified at the threshold. Respondent rests upon section 44 (d) and continually refers to the “sale, exchange, or disposition” of the installment note. But it was the obligor corporation which dissolved and, of course, a debtor can not sell or otherwise transfer its creditor’s rights. A debt can not be considered a corporate asset available for liquidating distribution. This disposes of the reference to Waddell v. Commissioner (C. C. A., 5th Cir.), 102 Fed. (2d) 503, relied upon by respondent for some obscure purpose. What probably lurks in the contention is that the debt was “satisfied” upon the liquidation, either by its assumption by petitioners’ partnership, or by the transfer of assets in an amount equal to the unpaid balance. But, of course, a satisfaction would not be a sale or exchange. Hale v. Helvering (App. D. C.), 85 Fed. (2d) 819. And if this were a satisfaction in the strict sense, section 44 (d) does not reach it, for that provision operates only if the obligation “is satisfied at other than its face value” and respondent makes clear his position that the $50,000 remaining due was scrupulously and exactly discharged upon the liquidation.

It does not follow, however, that respondent has no remaining refuge. Subdivisions (a) and (b) require that taxpayers return as income the proper proportion “of the installment payments actually received in that year.” If, therefore, this obligation was discharged in full by a payment “actually received,” the deficiency would be supportable. But there are other difficulties with it.

Whatever may be the merits in other fields of the controversy respecting the entity theory of partnerships, it is now too late to question it in the law of taxation, at least in certain situations. We know, for example, that “ownership by the partnership is not identical with ownership by the partners” and that partnership property does not, in the absence of statute, retain the individual partner’s basis, Edward B. Archbald, 27 B. T. A. 837; affd. (C. C. A., 2d Cir.), 70 Fed. (2d) 720; that a partner may be indebted to his partnership, Finucane v. United States (Ct. Cls.), 21 Fed. Supp. 122; and, what is most relevant to the present discussion, that a partnership may own stock, D. G. Jackling, 9 B. T. A. 312, and Edward B. Archbald, sufra, and may be indebted to one of its members, Samuel Burns, 13 B. T. A. 579.

On the rock presented by this principle the entire vessel of respondent’s argument founders. For it is only the disappearance of the installment obligation or its removal from the hands of the obligee that creates the occasion for invoking the provisions of section 44 (d), or, more properly as applied to this proceeding, of section 44 as a whole. See II. Kept. 2, p. 16, and S. Bept. 960, p. 24, 70th Cong., 1st sess. If the obligation is paid in full in anticipation, which is what respondent says occurred here, or if it is otherwise discharged or transferred, as described in subsection (d), the obligee will have no future tax liability upon the due date of subsequent installments, and hence the tax situation must be liquidated contemporaneously. But if, as we think was the case here, the installment note remained to be collected by the same obligee from the partnership which replaced the old obligor, cf. Samuel Burns, sufra, there was no prospect of a termination of the continuing tax liability of these petitioners on future instalhnents and hence no necessity for construing the assumption by the partnership as a payment in full under subdivision (a) or (b) or as resulting in gain or loss under subdivision (d).

We have found as a fact, at respondent’s request, that the corporate assets were distributed to the partnership, so that there is no basis for assuming that petitioners received them directly in payment of the debt. Langstaff v. Lucas (C. C. A., 6th Cir.), 13 Fed. (2d) 1022; certiorari denied, 273 U. S. 721, is not to the contrary, for that case dealt only with the distribution of corporate surplus, the excess of assets over admitted and recognized liabilities, the treatment of which here is concurred in by both parties. Since there is nothing in these individual circumstances or in the general principles to be applied which casts doubt upon the continued existence of the installment obligation, the continued liability of the partnership for its discharge, and its continued status as a source of taxable income in the hands of these petitioners, we think this part of the deficiency was improvidently determined.

The remaining question is the amount of gain resulting from the corporate liquidation, and specifically whether the undisputed value of the assets distributed may be reduced by a contested outstanding Federal tax claim.

In considering this point we must recognize that although a partnership may be an entity separate from its members for tax-computing purposes, yet a distribution in liquidation by a corporation of which the partners were stockholders is to be treated as a liquidating dividend taxable, ultimately to the partners as of the date of liquidation. On this point the parties are in agreement. And see Snead v. Elmore (C. C. A., 5th Cir.), 59 Fed. (2d) 312. As a consequence, we consider it permissible to treat this phase of the transaction as though the partnership and the partners were interchangeable.

So approached, the short result is that the partnership directly, and the partners indirectly, received assets of a value which is not in controversy, in exchange for the stock and their agreement to pay certain debts. The definite and contractually specified amount of the undisputed liabilities represented corresponding diminution in the profit accruing from the exchange of stock for assets, the deductibility of which from the gain on liquidation no one is disposed to question. But the contested tax claim, which was uncertain both as to enforceability and as to amount, and was subsequently discharged for a nominal sum, is another matter.

We think the correct result is dictated by the principle of Board v. Commissioner (C. C. A., 6th Cir.), 51 Fed. (2d) 73, and North American Oil Consolidated v. Burnet, 286 U. S. 417. This property was received “under a claim of right and without restriction as to its disposition.” The contested and wholly contingent assumed liability for taxes was hence no proper offset. The taxpayer “has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent.” Whether payment of a substantial amount in a subsequent year would have given rise to a deduction then or would be the proper subject of an adjustment in the year here in issue, since that remains open, it is not necessary to decide. See E. B. Elliott Co., 45 B. T. A. 82; cf. North American Oil Consolidated v. Burnet, supra. For the insignificant payment actually made has been recognized by respondent in his computation. We can not say that this is error. Benjamin Paschal O'Neal, 18 B. T. A. 1036.

That the parties might have been liable as transferees even in the absence of their agreement of assumption, or that the tax claim was set up as a contingent liability on the partnership books, seems to us inconclusive factors. The important circumstance is that the claim was never recognized as valid and that the transferee continued to contest it. See William M. Davey, 30 B. T. A. 837. It' never agreed to pay more than was actually paid, since this is all that was ultimately found to be due. We see no reason why more should be deducted.

Decision will be entered tmder Bule 50.

       SEC. 44. INSTALLMENT BASIS.
      * * ⅜ * * * *
      (d) Gain oe Loss upon Disposition op Installment Obligations. — If an installment obligation is satisfied at other than its face value or distributed, transmitted, sold, or otherwise disposed of, gain or loss shall result to the extent of the difference between tho basis of the obligation and (1) in the case of satisfaction at other than face value or a sale or exchange — the amount realized, or (2) in case of a distribution, transmission, or disposition otherwise than by sale or exchange — the fair market value of the obligation at the time of such distribution, transmission, or disposition. Any gain or loss so resulting shall be considered as resulting from the sale or exchange of the property in respect of which the installment obligation was received. The basis of the obligation shall be the excess of the face value of the obligation over an amount equal to the income which would be returnable were the obligation satisfied in full. This subsection shall not apply to the transmission at death of installment obligations if there is filed with the Commissioner, at such time as he may by regulation prescribe, a bond in such amount and with such sureties as he may deem necessary, conditioned upon the return as income, by the person receiving any payment on such obligations, of the same proportion of such payment as would be returnable as income by the decedent if he had lived and had received such payment. If an installment obligation is distributed by one corporation to another corporation in the course of a liquidation, and under section 112 (b) (6) no gain or loss with respect to the receipt of such obligation is recognized in the case of the recipient corporation, then no gain or loss with respect to the distribution of such obligation shall be recognized in the case of the distributing corporation.

       See, e. g., Revenue Act of 1934, sec. 113 (a) (13).


source: Caselaw Access Project

author: TurneR:

license: Public Domain

text:
    Bishop Trust Company, Limited, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101569.
    Promulgated September 22, 1942.

      Urban E. Wild, Esq., for the petitioner.

      Franje T. Horner, Esq., for the respondent.
   OPINION.

TurneR:

We have for determination two questions: (1) Whether the petitioner should report the income and gain received or realized and deduct the losses sustained in transactions in and operations relating to the Waterhouse assets, and (2) whether it is entitled to deduct the losses sustained by it in removing from the portfolios of certain trusts and estates bonds of the Honolulu Bond & Mortgage Co. The petitioner has filed no brief and its contentions are disclosed only in its petition and statements made by counsel at the time of the hearing.

With respect to the first question, it is the claim of the petitioner that by reason of the merger it acquired all of the assets of Water-house and succeeded to all of its liabilities and obligations in a nontaxable transaction and that it should therefore in each year thereafter report as its own all of the income, gains, and losses therefrom in the same manner and on the same basis as Waterhouse would have done had it continued. The difficulty with that proposition is that it did not succeed to the unfettered ownership of the Waterhouse assets. It acquired those assets subject not only to the liabilities of Water-house generally but also to the rights of the special noteholders, after the satisfaction of which it was entitled to the gain, if any, that might be realized therefrom or thereon. Until the assets were liquidated, leaving nothing-for the special noteholders, or until the special noteholders should be paid off, the petitioner had no right to apprópriaté ór .use the Waterhouse assets or proceeds therefrom for its own purposes. It is argued that the value, of the Waterhouse assets had shrunk to such an extent that it could not in good judgment be said that there was any reasonable hope or probability that anything could or would be realized for the special noteholders, and some evidence tending to support that argument was submitted at the time of the hearing. The record shows, however, that a similar argument was made to the special noteholders prior to the beginning of the taxable year, with the request that they release the petitioner of any and all claims in respect of the Waterhouse assets and thereby eliminate needless administration expense. The note-holders refused to agree to the proposal and the petitioner, as it-was obligated to do, retained the Waterhouse assets intact and; accounted for all gains and losses thereon or in respect thereto separate and apart from the gains and losses from its other operations'. At the end of 1934 the petitioner still held Waterhouse assets which had a book value of $2,282,884.44, and while the surveys which it had made indicated that a net loss probably would be sustained in the end, it still had a credit balance of $147,513.69 in the fund which had been set up' from the proceeds of the special notes to be applied on the Waterhouse losses. We accordingly conclude and hold that with) respect to the Waterhouse assets and operations there was no completed or closed transaction in the taxable year from which income should be reported or losses deducted by the petitioner. Corn Exchange National Bank & Trust Co., 46 B. T. A. 1107. Shrinkage of assets does not supply the basis for a loss deduction in determining-net income.

In determining the deficiency herein, the respondent not only disallowed as deductions the excess of sustained losses over the income and gain realized on the Waterhouse assets, but in addition added to petitioner’s income a further sum of $81,610.97, representing interest and rent accrued on petitioner’s books against said assets. These additions were not reported as income, nor claimed as deductions by petitioner in its income tax return, and such treatment of the items in question was obviously correct. The petitioner has no right, under its agreement with Waterhouse originally or with' the special note-holders, to any such charges on the Waterhouse assets or operations.

With respect to the amounts expended by petitioner in removing the-bonds of the Honolulu Bond & Mortgage Co. from the portfolios of certain estates and trusts.for which it acted as fiduciary, the respondent argues that the petitioner is entitled to no deduction for losses sustained or for any of the amounts expended, on the ground that the-acquisition of the bonds from the trusts and estates and their subsequent disposition was not in the nature of a transaction or transactions' entered into for profit. The statute grants to corporations the right to deduct ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business; also losses- sustained during the taxable year and not compensated for by insurance or otherwise. Sec. 23 (a) and (f), Revenue Act of 1934. In the case of individuals it permits the deduction of losses sustained during the taxable year and not compensated for by insurance or otherwise “if incurred in a trade or business” or “if incurred in any transaction entered into for profit.” Sec. 23 (e), Revenue Act of 1934. The respondent’s argument appears to have been based upon the language of section 23 (e), which applies to individuals, for certainly it may not be said that the losses sustained by the petitioner in the instant case do not fall literally within the provisions of section 23 (f). But even though we assume that section 23 (e) is applicable in the instant case, we find no merit in the respondent’s contention. The petitioner, through its trust department, acted as fiduciary for trusts and estates with a view to making a profit. In the course of its operations it had acquired for certain of the trusts and estates the bonds of a corporation in which it, as the owner of all the common stock, had a direct proprietary interest. The bonds had so shrunk in value that the estates and trusts holding them were faced with substantial losses. The petitioner in the course of its trust business took the necessary steps to rectify its .own mistakes and in so doing was required to expend the sum here in question, without any basis for hope of recovery. We think therefore that the deduction claimed in respect of the losses sustained or the expenditures so made not only must be allowed, under section 23 (f), as a loss not compensated for by insurance or otherwise but might reasonably be regarded as ordinary and necessary expenses incurred in the operation of the petitioner’s business, under section 23 (a), or as losses sustained in transactions entered into for profit, under section 23 (e), if that provision of the statute were applicable to corporations. See also John Abbott, 38 B. T. A. 1290.

Decision will be entered wider Bule SO.


author: Kern: Smith,

text:
    Cotton States Fertilizer Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105397.
    Promulgated September 23, 1942.

      Charles J. Bloch, Esq., for the petitioner.

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

Kern:

The first question presented in this proceeding is whether petitioner is entitled to the credit provided by section 26 (c) (1)- of the Revenue Act of 1936. In order to be so entitled, petitioner must show (1) a written contract; (2) executed by it before May 1,1936, (3) expressly dealing with the payment of dividends, (4) which would be violated by- its distribution during the taxable year of amounts as dividends. The written contract executed by petitioner in 1934 provided that “applicant will not',' without the prior'written consent of B,. F. C. * * * declare or pay any dividend or make any distribution upon- its capital stock.” Petitioner did not ask for the consent of B. F. C. to the payment of dividends; none was granted; and petitioner paid no such’dividends during the taxable year. The precise issue, therefore, is whether, under the facts shown, the distribution of dividends by petitioner during the taxable year would have been in violation of the quoted provision of the contract.

It seems to us obvious that it would have been. A distribution of dividends by petitioner would not have been a violation of such contract only if consented to in writing by the other party to the contract. Such a consent would have been in the nature of a waiver or modification of an obligation by. the obligee of a contract, which is always possible even though not expressly provided for, but until the obligation is waived or modified, it is in full force and can not be violated with immunity. That such consent might have been granted by K. F. C. if requested by petitioner seems to us immaterial. It was not granted and no request was made. Moreover, we can not assume that B. F. C. would have given its consent. Sutcliffe Co., 41 B. T. A. 1009, 1014.

In Kilty Steel Co., 41 B. T. A. 1237, we held that a similar contractual provision effectively prohibited the payment of dividends. It is true that in that case it was stipulated that a request for permission from the obligee to pay dividends would have been refused, that the payment of dividends by the taxpayer would not have been sanctioned by sound business practice, and that the taxpayer knew that any request to pay dividends would have been refused. These facts, however, were not essential to our holding. The essential fact is pointed out in one sentence: “It [taxpayer] did not request * * * permission from either of the banks to pay a dividend nor was such permission granted.”

The situation here presented is the legal converse of that considered by us in Atlantic Co., 45 B. T. A. 657. There the taxpayer corporation could declare a dividend without violating a contract, but if it did, then the creditor could take certain steps. Here the petitioner could not make a dividend distribution without violating a contract, but if the creditor consented, then and only on that condition could such a distribution be made.

On.this issue we decide in favor of petitioner.

The second issue has to do with the right of petitioner in the taxable year to deduct officers’ salaries in amounts in excess of those authorized by its contract with the Reconstruction Finance Corporation. The salary items in question consisted of certain increases in the salaries of the president and treasurer of petitioner which were made by petitioner’s board of directors in the taxable year, “subject to the approval of the Reconstruction Finance Corporation during the time their loan to the company is in effect, and any part thereof not approved by said Reconstruction Finance Corporation shall be cumulative and subordinated to the Reconstruction Finance Corporation loan.” The Reconstruction Finance Corporation in the following taxable year approved only a part of such increases and petitioner in the latter year paid to the officers in question only that part of the increases so approved. The stipulations of fact do not disclose whether petitioner is on the accrual basis of accounting and do not disclose how petitioner treated the amounts, paid and unpaid, of such salary increases on its books during the taxable year. Petitioner’s tax returns for the taxable year were not introduced in evidence.

Even if we assumed in petitioner’s favor that it was on the accrual basis during the taxable year, we are still not of the opinion that the salary increases provided for in the quoted resolution are items properly subject to being accrued, because of the contingency of petitioner’s obligation to pay them. Commissioner v. Brooklyn Radio Service Corporation, 79 Fed. (2d) 833; Ames Reliable Products Co., 44 B. T. A. 176.

On this issue we decide in favor of respondent.

Reviewed by the Board.

Decision will be entered pursuant to Rule 50.

Smith,

dissenting: In its income tax return for the fiscal year ended June 30, 1937, the petitioner deducted from gross income an increase of $4,600 in salaries voted to its president and treasurer. The increased salaries were to be paid monthly. They were to be paid, however, subject to approval by the Reconstruction Finance Corporation. At the close of its fiscal year, June 30, 1937, the petitioner had not received the authority of the Reconstruction Finance Corporation to pay the additional salaries and the amount of the salaries unpaid was $4,600. The respondent disallowed the deduction of these accrued salaries in the determination of the deficiency.

It is stipulated that the Reconstruction Finance Corporation on September 3, 1937, approved the increase in the salary of the president in the amount of $2,400 and $1,200 of that amount was paid to-the president on September 13, 1937. On October 11, 1937, the Reconstruction Finance Corporation approved the payment of an additional salary of $600 to the treasurer, which had theretofore been authorized by the petitioner for the taxable year, but disapproved the payment of the balance authorized.

In the Board’s opinion it is stated that:

* * * The stipulations of fact do not disclose whether petitioner is on the accrual basis of accounting and do not disclose how petitioner treated the amounts, paid and unpaid, of such salary increases on its books during the taxable year. * * *

I do not think that this statement is correct in view of the stipulated facts. The trial balance clearly shows that the petitioner was on the accrual basis. It includes among its assets inventories and deferred charges and among its liabilities accrued expenses, including officers’ salaries in the amount of $11,600. It is not necessary to stipulate specifically that the return was made on the accrual basis where the stipulated facts show that it was.

In United States v. Anderson, 269 U. S. 422, the Supreme Court held that the accrual system was incorporated into the law:

* * * to enable the taxpayers to keep their books and make their returns according to scientific accounting principles, by charging against income earned during the taxable period, the expenses incurred in and 'properly attributable to the process of earning income during that period. * * * [Italics supplied.]

Quite clearly the additional salaries voted the petitioner’s president and treasurer were “expenses incurred in and properly attributable to the process of earning income” during the taxable year. They were not expenses of the taxpayer of the years during which the payments were made.

It is furthermore to be noted that petitioner’s income tax return for the fiscal year ended June 30, 1937, was not due to be filed until September 15, 1937. Prior to that date the Reconstruction Finance Corporation had approved the payment of an additional salary to the petitioner’s president of $2,400. I do not see in any event how the Board can say that that was not an expense of the petitioner of the taxable year.

In Fawcus Machine Co. v. United States, 282 U. S. 375, it was held that additional excise taxes upon the profits of the petitioner for the year 1918 accrued in that year even though the Revenue Act of 1918 was not passed until February 24, 1919, and made changes in the rates. The court held that the change made by Congress in the rates of the excise tax was made in ample time to enable the taxpayer to deduct from gross income in its income tax return for 1918 the excise taxes which, had accrued for the year 1918 at the increased rates authorized by the Revenue Act of 1918. By the same process of reasoning I think that it should be held that petitioner is entitled to deduct the additional salary for its president authorized by the petitioner’s board of directors during and for the taxable year to the extent of .$2,400.

The Reconstruction Finance Corporation did not authorize any additional payment of salary to the petitioner’s treasurer for „the taxable year until October 11, 1937. The additional salary of $600 was paid to the treasurer on June 9, 1938. I think, however, that under the principle of the cases above cited it must be held that the additional salaries voted to the petitioner’s president and treasurer for and during the taxable year should be allowed as deductions from the gross income of the taxable year to the extent approved by the Reconstruction Finance Corporation. They were not expenses of the year in which the payments were made.

       SEC. 26. CREDITS OF CORPORATIONS.
      In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax—
      * * * * * * *
      (c) Contracts Restricting Payment of Dividends—
      (1) Prohibition on Payment of Dividends. — An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. * * *


author: I&RN:

text:
    Maud Gamble Comer, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 108072.
    Promulgated September 23, 1942.

      John W. Townsend, Esq., for the petitioner..
    . J. Marvin. Kelley, Esq,, for the respondent.
   OPINION.

I&RN:

Respondent has determined deficiencies in petitioner’s income tax liability for the years 1938 and 1939 in the respective amounts of $1,226.31 and $207.35. Petitioner has alleged that respondent erred in such determination in two respects. Respondent has conceded ■one of the two errors alleged in the petition, and therefore, this proceeding presents but one issue.

All of the facts were stipulated by the parties and we find the facts to be as stipulated. They may be stated as follows:

The petitioner is an individual and resides at 1036 Yineville Avenue, Macon, Georgia. She filed her income tax returns with the collector of internal revenue for the district of Georgia.

During the year 1938 petitioner owned seventeen $1,000 5½ percent first mortgage bonds of Wesleyan College, a corporation organized and existing under the laws of the State of Georgia. These bonds had been acquired by the petitioner in 1928 and 1929 and had in her hands .a cost basis of $17,050.

The entire issue of Wesleyan College bonds, aggregating $998,000, having been defaulted as to principal and interest on February 15, 1933, the petitioner, on or shortly after Junfe 1, 1936, deposited the seventeen bonds owned by her with a “Bondholders Protective Committee”, pursuant to a deposit agreement, following which she received a “Certificate of Deposit.”

On March 1, 1938, the mortgage securing the aforesaid issue of Wesleyan College bonds was foreclosed by the Citizens & Southern Rational Bank, as trustee under the bond mortgage in a suit brought by the trustee as sole petitioner, and the properties of the said corporation were thereupon sold to the bondholders’ protective committee, the only bidder, for the sum of $225,000. Judgment was also entered in favor of the trustee for the deficiency in principal plus interest and attorney fees. No assets of Wesleyan College have been found against which the judgment could be levied.

After deducting expenses incident to the foreclosure sale above mentioned the court determined and directed that each $1,000 bond be credited with the sum of $222.1657. On her seventeen bonds having a cost basis of $17,050, the petitioner, pursuant to the court’s decree and after the deduction of certain committee expenses, received a net credit of $3,699.81.

In her individual income tax return for the calendar year 1938 the petitioner deducted the sum of $13,223.18 as a bad debt, and she ■now claims the proper deduction to be $13,350.19.

The Commissioner has determined that the petitioner’s loss as the result of the foregoing transaction was a capital loss and has limited it to $6,678.09 under the provisions of section 23 (k) (2) and-(8) and section 117 (b) of the Eevenue Act of 1938.

Petitioner contends that the indebtedness owed to her by Wesleyan College and originally evidenced by the bonds above referred to was extinguished by the foreclosure proceeding and merged into the deficiency judgment rendered therein; that thereafter and at the time the debt was ascertained to be worthless and charged off the debt was evidenced by the judgment and not by any security within the meaning of section 23 (k) (2) and (3) of the Revenue Act of 1938, and that therefore no limitation of section 117 of the revenue act is applicable.

We do not pass upon the validity of petitioner’s argument in cases where a mortgage is given directly to the holder of a bond of the mortgagor and suit is brought by the holder of the bond to recover judgment on the bond and to foreclose the mortgage securing it. This is not the situation present in this proceeding. Here the suit was brought by the trustee under the mortgage, and not by the bondholders suing upon the bonds. The bondholders were not parties to the foreclosure suit, and, in the absence of extraordinary circumstances not present here, would not have been proper parties plaintiff. Fletcher, Cyclopedia Corporations (1917) § 1371; 19 C. J. S. § 1202. The trustee under a mortgage securing a bond issue has no right to bring suit on the bonds themselves. Consequently, the bonds are not merged in any deficiency judgment obtained by the trustee against the corporation in a suit to foreclose the mortgage. Fletcher, Cyclopedia Corporations (1917) §1344; 19 C. J. S. § 1208 (p. 885). Machay v. Randolph Macon Goal Co., 178 Fed. 881. Therefore, petitioner’s argument fails.

Upon the issue presented we decide against petitioner. However, because respondent has conceded error as to the other issue raised by the petition,

Decision will be entered under Rule 50.

       SEC. 23. deductions FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions :
      ♦ • * - • * * * * ■ *
      (k) Bad Debts.—
      *******
      . (2) ■ Securities becoming worthless. — If any securities (as defined in paragraph (3) .of this subsection) are ascertained to be worthless and charged off within.the taxable year and are capital assets, the loss resulting therefrom shall, in the case of a taxpayer other than a hunk, as defined in section 104, for the purposes of this title, be considered as a loss from the sale or exchange, on the last day of such taxable year, of capital assets.
      (3) Definition of securities. — As "used in this subsection the term "securities” means bonds, debentures, notes, or certificates, or other evidence of indebtedness, issued by any corporation (including those issued by a government or political subdivision thereof), with interest coupons or in registered form.


author: Mellott:

text:
    International Mining Corporation (Incorporated in 1936-Successor Company), Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 107094.
    Promulgated September 24, 1942.

      Eliot Bailen, Esq., for tbe petitioner.

      Charles Oliphant, Esq., for tbe respondent.
   OPINION.

Mellott:

Respondent bas proposed an assessment against petitioner, as transferee of tbe assets of tbe International Mining Corporation, of a liability of $36,379.06 representing an alleged income tax deficiency of tbe latter corporation for the calendar year 1936. Petitioner admits liability for any tax deficiency of its predecessor company but contends that none exists.

The sole question is whether petitioner’s predecessor is entitled, either by virtue of a distribution of 400,055 shares of stock of petitioner made by it to its stockholders on December 4,1936, or by virtue of a cash dividend in the amount of $251,037 paid by petitioner on December 24, 1936, to a dividends paid credit under section 27 of the Revenue Act of 1936, in addition to the dividends paid credit allowed by the respondent, and, if so, the amount thereof.

The proceeding was submitted upon a stipulation of facts. The facts are found to be as stipulated. For present purposes the following summary will suffice:

Petitioner was incorporated under the laws of Delaware on October 29, 1936. Its predecessor, also called the International Mining Corporation and hereinafter referred to as the predecessor company, was incorporated under the laws of Delaware on August 9, 1929. The companies filed income and excess profits tax returns for the calendar year 1936 with the collector of internal revenue for the fifth district of New Jersey.

At the time of its organization, the predecessor company issued 500,000 shares of common stock of no par value for $20 per share, totaling $10⅜000,000. This amount was credited to its capital account as stated capital. On March 3, 1932, the certificate of incorporation of the predecessor company was amended, changing the no par stock to common stock having a par value of $1 per share. The difference of $9,500,000 was credited to capital surplus account. The predecessor company also issued, at the time of its organization, 650,000 common stock purchase warrants, each warrant entitling the purchaser to subscribe to one share of common stock on or before September 1, 1939, at $20. In May 1933 the predecessor company reduced the subscription price of the outstanding warrants from $20 to $10 per share.

The annual earnings and profits or operating deficits of the predecessor company from the date of its organization to December 31, 1935, within the meaning of section 115 of the Revenue Act of 1936', as amended, before any distributions to its stockholders, were as follows:

Aug. 9, 1929, to Dec. .31, 1929, operating deficit_ ($930, 559.29)
Calendar year 1930, do _ (311,691.79)
1931, do _ (2,245,157.23)
1932, do (774,334.36)
1933, do (532,156.07)
1934, earnings and profits_ 306,471.04
1935, do _ 636,040.51

Upon the creation of the capital surplus of $9,500,000 in 1932, the predecessor company transferred to and charged against it the accumulated operating deficit at December 31, 1931, of $3,487,408.31. Similar action was taken with respect to the operating deficits for the years 1932 and 1933. The earnings and profits of subsequent years were treated as earned surplus and were not combined with the balance of capital surplus at December 31,1933.

Distributions made by the predecessor company to its stockholders from the date of its organization to December 31, 1935, were as follows:

400,055 shares of common stock and 523,945 warrants were issued and outstanding on December 31, 1935. The differences between these figures and the 500,000 shares and 650,000 warrants heretofore mentioned represent shares or warrants reacquired by the predecessor company and retired and canceled. The balance in the capital surplus account as of December 31,1935, amounted to $4,312,369.76, computed in the following manner:

Capital surplus created in 1932_$9,500, 000. 00 Less:
Operating deficits to December 31, 1933_$4, 793, 898. 74
Distributions, 1932 and 1933_ 83,251. 65
Other items (not here material)_ 310,479.85 5,187,630.24
Balance at December 31, 1935_ 4,312,369.76

In 1936, a plan of reorganization within the meaning of section 112 of the Revenue Act of 1936 was adopted by the predecessor company, which resulted in the organization of petitioner on October 29, 1936. Pursuant to the plan, the predecessor company’s assets, subject to its liabilities, were transferred to petitioner on December 3, 1936. On the following day, in consideration of the transfer, 400,055 shares of petitioner’s common stock were issued to the predecessor company. 157,906 additional shares of its common stock on the basis of one share of common stock for three warrants were also issued by petitioner to the holders of the warrants of the predecessor company. The predecessor company distributed the 400,055 shares in exchange for the surrender for cancelation of a like number of shares of its common stock then outstanding, and was dissolved on December 4, 1936.

The value, cost, and adjusted tax basis to the predecessor company of petitioner’s common stock, distributed on December 4, 1935,. by the predecessor company to its stockholders in liquidation, were each in excess of $5,000,000.

For 1934 and 1935 the predecessor company had earnings and profits within the meaning of section 115 and made distributions to stockholders as follows:

Earnings and profits:
Calendar year 1934_$306,471. 04
Calendar year 1935_I_ 636,040. 51
942,511. 55
Distributions to stockholders:
Calendar year 1934-$60, 000.00
Calendar year 1935- 260, 029. 00 320,029.00
Undistributed earnings and profits of the years 1934 and 1935. 622, 482. 55

The earnings and profits of the predecessor company and the petitioner for the calendar year 1936 and the cash distributions made by these two corporations to their stockholders were as follows:

The distribution of $251,037 was made in cash by petitioner on December 24, 1936, pursuant to a resolution adopted at a meeting of its board of directors held on December 7, 1936. The resolution provided:

Whereas, as a result of a transaction described in Section 112 of tbe Revenue Act of 1936 tbe earnings or profits accumulated after February 28, 1913, and the undistributed earnings or profits of tbe calendar year 1936 of International Mining Corporation, incorporated in 1929 (hereinafter referred to as the “Trans-feror”), have become the earnings or profits of this corporation subject to distribution as dividends by this corporation; and
Whereas, this corporation desires to make a distribution of dividends to its shareholders and in connection therewith desires to make an apportionment and allocation to tbe Transferor as a distribution of such earnings or profits of tbe Transferor in accordance with tbe provisions of Article 27 (f)-l (c) of Regulations 94, tbe income tax regulations under tbe Revenue Act of 1936,
Now Therefore, be it
Resolved, that a dividend of forty-five cents (450) per share be declared on the ■outstanding capital stock of this corporation, payable in cash on December 24, 1936 to stockholders of record at tbe close of business on December 17, 1936; and further
Resolved, that said dividend of forty-five cents (45⅜) per share (or so much thereof as may lawfully be so apportioned and allocated) be and it hereby is apportioned and allocated to tbe Transferor as a distribution out of tbe earnings •or profits of tbe Transferor.

The aforesaid distribution of $251,037 was allocated and apportioned on the respective books and income tax returns of the predecessor company and of the petitioner first: as paid out of the current •earnings and profits of the petitioner for the period from December 4 to December 31,1936, to the extent thereof, $5,309.37; second: as paid •out of the current 1936 earnings and profits of the predecessor company to the extent thereof, $229,926.17, the difference between it's ■earnings and profits -($409,950.92) and its cash distributions ($180,-'024.75) ; and, third: the balance ($15,801.46) as paid out of surplus .at December 31,1936. These amounts were claimed as dividends paid credits by tbe predecessor company and the petitioner on their 1936. income tax returns in accordance with such allocation and apportionment.

In the information returns (Forms 1096 and 1099) filed by petitioner with the Treasury Department on or about February 15, 1937, the distribution of the $251,037 made by the petitioner in December 1936 and the prior 1936 distributions totaling $180,024.75 were reported as constituting ordinary taxable dividends in the hands of the recipient stockholders.

Respondent determined that the dividends paid credit of the predecessor company for the purpose of determining its surtax on undistributed profits for the calendar year 1936 was $180,024.75, the amount of the dividends paid by the predecessor company between January 1 and December 3,1936. He refused to allow any dividends paid credit to the predecessor company on account of the distribution of $251,' 037 made by petitioner on December 24, 1936, or on account of the distribution of the 400,055 shares of stock of petitioner made by the predecessor company on December 4, 1936.

The parties have stipulated that:

* * ⅜ If Article 27 (f)-l (c) of Regulations 94 is applicable to entitle the * * * [predecessor] company to dividends paid credit as a result of the distribution of $251,037.00 made by petitioner in December 1936, then the * * * [predecessor] company and petitioner have otherwise complied with all requirements of the aforesaid article.

The portion of article 27 (f)-l (c), supra, relied upon by petitioner, is shown in the margin.

^£he record in the instant proceeding does not indicate why the respondent reduced the dividends paid credit to the amount of cash paid by the predecessor company prior to the reorganization. As we interpret the stipulated facts there were “one or more transactions described in section 112” and as a result the “undistributed earnings or profits” of the predecessor company became “the earnings or profits of another corporation [petitioner] subject to distribution as dividends, by such other corporation.” The dividend of $251,037 was paid “by the transferee corporation during * * * [a] portion of the trans-feror’s taxable year subsequent to the consummation of such tax-free-transaction” and respondent admits that petitioner and the predecessor company “have otherwise complied with all the requirements-of the aforesaid article.” No good reason is therefore apparent for the disallowance of the claimed deduction save the possibility that the regulation may be invalid; but since neither party has advanced such theory we assume that it is valid. If we were required to decide the point, it would seem that the regulation should be upheld; for it is equitable and fair, both to the fiscus and to the taxpayer, and consistent with the spirit of the Revenue Act of 1936 as well as with the rationale of Sansome v. Commissioner, 60 Fed. (2d) 931; certiorari denied, 287 U. S. 667, which has been applied in many subsequent cases. See, e. g., Murchison's Estate v. Commissioner, 76 Fed. (2d) 641; Baker v. Commissioner, 80 Fed. (2d) 813; and Harter v. Helvering, 79 Fed. (2d) 12.

From what has been said it is obvious we are of the opinion respondent erred in denying the claimed credit. We place our conclusion squarely upon the regulation and the payment of the dividend of $251,037 rather than upon the possible alternative theory that the distribution by the predecessor company of the stock of the transferee (petitioner) may have entitled the former to a dividends paid credit under section 27 (f). Such a contention was made in Reed Drug Co., 44 B. T. A. 573, but found to be unsound. Inasmuch as that case has now been affirmed by the Circuit Court of Appeals for the Sixth Circuit (Reed Drug Co. v. Commissioner, 130 Fed. (2d) 238) Ave pass, without discussion, petitioner’s suggestion that it is wrong in principle and should be overruledj

It is not clear whether other adjustments made by respondent to the net income reported, result in a deficiency in tax; therefore,

Decision will be entered under Rule 50.

       If, as a result of one or more transactions described in section 112, -a corporation’s, earnings or profits accumulated after February 28, 1913, and its undistributed earnings, or profits of the taxable year, shall have become the earnings or profits of another corporation subject to distribution as dividends by such other corporation, any dividend: paid by the transferee corporation during that portion of the transferor’s taxable year subsequent to the consummation of such tax-free transaction may, subject to the provisions of section 115, be apportioned and allocated to the transferor as a distribution out of such, earnings or profits of the transferor. « » *


author: SteRnhagen :

text:
    Estate of John Moir, Deceased, John A. Moir, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 109115.
    Promulgated September 24, 1942.

      Robert G. Dodge, Esq., for the petitioner.

      J. T. Haslam, Esq., for the respondent.
   OPINION.

SteRnhagen :

1. The Commissioner having determined that the gifts of February 1934, May 1934, and December 1935 were made in contemplation of death and therefore properly within the gross estate, the petitioner has undertaken to prove the contrary. The gifts were not made within two years prior to the death, so the statute does not require that they shall be deemed to have been made in contemplation of death. The Commissioner, however, has determined that to be the fact, and we are to say from the evidence whether the fact is shown to be otherwise.

The decedent did not discuss death, and upon the subjective fact as to whether, when he made these gifts, death was in his mind, the evidence is neutral. He never spoke of death, and, so far as anything he said discloses, it can not be known directly whether he thought of it when he made the gifts. The finding must be based upon circumstance and inference.

Were it not for the decedent’s advanced age and the’ cerebral hemorrhage of November 1933, with the resulting aphasia, there would! be nothing to suggest contemplation of death as the reason for the gifts. Each of them is explained upon its own grounds, without relation to death or taxes. The decedent had been making substantial gifts from time to time for many years, and they had not been in com templation of death. Except for the hemorrhage of 1933, there is no special circumstance to stamp these gifts differently from the earlier ones. The aphasia was not serious, and otherwise the decedent’s health was good.

The first of the gifts in question was made to the son in February 1934, when, because decedent got tired of holding and trying to sell the vacant and unproductive property in Chicago, he gave it to his son. It was worth $75,000, a comparatively small amount in his large fortune, and the explanation shown for the gift is plausible enough to leave no reason to inquire for another, such as the thought of making a testamentary disposition or minimizing death taxes.

The gift to the daughter in May 1934 had been under consideration by the decedent ever since 1929, when he made the gift of Standard Brands shares to the son. The decedent wanted to equalize gifts to the two children, and he was stimulated to complete this plan by the fall in the daughter’s income, her dissatisfaction with her financial condition, and his desire to end recurring quarrels with her about money. This is an adequate explanation of the gift and it is not necessary to supplement it by a reference to its testamentary tax effect.

The gifts in May 1934 to the daughter-in-law and grandchildren are only explained as spontaneous acts of sentiment attributable to his affection for the son’s wife. He had wanted to make such a gift and had been dissuaded first by his wife and then by the son. There is no circumstance which explains these gifts other than a desire to give; but on the other hand there is nothing to suggest that they were prompted or hastened by the decedent’s thought of death.

The gift to the son in December 1935 was explained by the decedent himself, in the gift tax return and also in conversation, as actuated by the desire to make up for a shrinkage in the son’s income. There is no reason to find any other explanation than this, and nothing to suggest that the thought of death was present.

It must be remembered that the decedent was not giving away all or the larger part of his fortune when he made these gifts. He still had some $4,000,000 which would pass at his death. He was aware of the necessity of making a will, but be was in good health and refrained from doing so until March 1936, an indication that in 1934 and 1935 he was not engaged in making a testamentary disposition of his estate.

We are of opinion from the evidence as to the decedent’s health, habits, and motives, and the surrounding circumstances, that the gifts in question have been shown not to have been made in contemplation of death.

2. The Commissioner determined that the entire value of the decedent’s proportionate interest in the Chase & Sanborn employee trust was within his gross estate. The petitioner challenges this as a matter of law and argues that only so much may be included as is represented by the present value at the time of death of the future right to receive the distributive share of the trust upon its termination.

Section 302 (d) of the Revenue Act of 1926 requires the inclusion in the gross estate of any interest “of which the decedent has at any time made a transfer, by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a powder, either by the decedent alone or in conjunction with any person, to alter, amend, or revoke.” As to the decedent’s interest proportionate to his contribution, he had made a transfer by trust, and the enjoyment thereof was subject at the date of his death to a power exercisable by him in conjunction unanimously with the other trustees to alter, amend, or, indeed, revoke. By the express terms of the trust instrument, the trustees were given unlimited discretion and control of the choice of persons beneficiary. In their discretion they could entirely discontinue distributions at any time. Although paragraph 13, which gives such control, limits it by the proviso that a periodic payment once determined should be continued,, this proviso is emasculated by the succeeding clause, “unless the then trustees shall by unanimous vote otherwise determine.” Therefore,, if the trustees determine that all of the periodical payments should be discontinued, the income would all be distributable proportionately to the contributors. Thus the corpus would itself become unnecessary to carry out the functions of the trust and the entire amount would by the unanimous determination of the trustees be proportionately distributable to the contributors. As to the decedent, he thus had the power, in conjunction with another person, to alter, amend, or revoke the trust and take back his contribution thereto.

There is no significance in the fact that this power was reposed in him as a trustee, Welch v. Terhune, 126 Fed. (2d) 695, or that it affected the entire trust res — the contributions of the others as well as his own. As to his nwn contribution, the power to retake it was just as complete as if it were the entire trust property.

The Commissioner’s inclusion of the entire value ($245,515.53) of the property (2,512 shares) contributed to the trust by the decedent is sustained.

Decision will he entered under Rule 50.


author:
Aenold :
      Smith,

text:
    Oregon Pulp and Paper Company, a Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101543.
    Promulgated September 24, 1942.

      Clarence D. Phillips, Esq., for the petitioner.

      John E. Pigg, Esq., for the respondent.
   Aenold :

This proceeding involves income tax deficiencies for 1936 and 1937 in the respective amounts of $28,929.61 and $35,747.48. By an amended answer respondent asks the Board to increase the deficiencies to $28,938.24 for 1936 and $44,004.14 for 1937. Three issues are presented, viz.: (1) Whether petitioner is entitled to a credit for a contract restricting the payment of dividends under section 26 (c) of the Revenue Act of 1936 for each of the taxable years, (2) the amount of interest, if any, that petitioner is entitled to deduct on certain income bonds issued by petitioner, and (3) whether petitioner is entitled to a deduction of $912.24 representing additional Oregon excise taxes for 1934 that were paid during 1936.

The facts were stipulated and as stipulated are adopted as our findings of fact. The facts and opinion pertinent to. each issue will be treated separately.

FINDINGS OF FACT.

The petitioner is an Oregon corporation, with its principal business office at Portland, Oregon. Its books were kept and its returns for the taxable years were made on the accrual basis. In its 1936 and 1937 returns, filed with the collector of internal revenue at Portland, Oregon, petitioner reported net income in the respective amounts of $158,344.63 and $122,961.25.

Issue I.

Facts. — Petitioner claimed a credit of $135,752.94 for 1936 and $105,691.09 for 1937 because of contracts restricting dividend payments. The amount of the credit claimed for each year equaled the amount of the taxpayer’s adjusted net income. Respondent denied the credit for each year upon the ground that the provisions of the supplemental indenture (hereinafter more fully set forth) do not constitute such a contract as is contemplated by section 26 (c).

Under date of May 1, 1926, petitioner executed an indenture securing the payment of principal and interest on a $1,000,000 issue of first mortgage 6 percent bonds. By a second indenture, dated May 1, 1927, which supplemented the-first, petitioner further secured the payment of principal and interest of an additional issue of first mortgage 6 percent bonds in the amount of $330,000. The first mortgage bonds matured serially, as provided by the terms of the two indentures.

On September 1, 1932, petitioner’s outstanding first mortgage 6 percent bonds aggregated $980,000. As of that date a further supplemental indenture was executed for the purpose of extending the maturities on all outstanding bonds for a period of four years beyond the present maturities. Extension of the maturities followed approval thereof by the bondholders and was effective during 1933. Thereafter, and at all times material to this proceeding, the supplemental indenture of September 1, 1932, was in full force and effect,, and bonds deposited with the trustee were; endorsed by the trustee,, and the bondholders signed extension agreements, all in accordance with the provisions of the supplemental indenture.

Article IX of the original trust indenture provides in section 2 thereof that so long as the bonds remained unpaid “dividends shall not be paid on common stock in' excess of the rate of six per cent (6%) per annum,” except that the rate could be increased under certain circumstances immaterial to the present issue. Section 2, article III of the second trust indenture modified article IX, section 2, of the original indenture by providing that “so long, as any of said bonds are outstanding it [petitioner] will pay no dividends on the common stock of the Company if the payment thereof would reduce the ratio of the current assets to current liabilities * * * below a ratio of two to one and * ⅜ * would reduce the net current assets of the Company below fifty per cent (50%) of the amount of bonds outstanding * *

In securing the extension on its bonds petitioner covenanted with each bondholder and- with its trustee, that it would pay 6½ percent interest during the four-year extension, that it would issue no further bonds under the deeds of trust, and that “it will pay no cash dividends except”:

(a) After the bonded indebtedness shall he reduced to $600,000.00, the Company may thereafter pay dividends from earnings accrued subsequent to January 1, 1933 in an amount equivalent to the principal amount by which outstanding bonds are reduced below $600,000.00. ■
(b) The Company may pay from earnings accrued subsequent to January 1, 1933 dividends upon any preferred stock which it may thereafter sell for cash; provided, that dividends on such stock shall not be paid in any year at a rate greater than ten per cent of the net cash received from the sale of the stock on which paid.

As of January 1, 1936, December 31, 1936, and December 31, 1937, petitioner’s outstanding first mortgage bonds aggregated $980,000, $943,500, and $856,500, respectively. During the period January 1, 3933, to December 31, 1937, no preferred stock was issued or sold by petitioner for cash.

Petitioner’s assets and liabilities at the beginning and close of the calendar years 1936 and 1937, its common and 8 percent cumulative preferred stock, and| its surplus earnings and profits, are shown in the following condensed table:

No dividends, cash or otherwise, were declared or paid on petitioner’s outstanding preferred or common stock during the period 1932 to 1937, inclusive.

Petitioner’s bylaws applicable to the taxable year contained the following provisions in article B, subdivision (a) thereof:

The holders of the preferred stock shall be entitled to receive out of the surplus or net profits of the corporation, dividends at the rate of eight per cent (8%) per annum; and no more, such dividends to be cumulative and to be payable to the stockholders after being declared by the Board of Directors. All dividends which shall have accumulated on preferred stock shall he paid before any dividend is declared on common stock.

Petitioner’s preferred stock certificates contained a provision to the same effect as the foregoing quotation.

Opinion. — The first issue is whether petitioner is entitled as a matter of law to the credit, granted by section 26 (c) (1) of the Revenue Act of 1936 in computing its surtax on undistributed profits under section 14 of the 1936 Act. All pertinent facts have been stipulated or appear in documentary exhibits attached to and made a part of the stipulated facts. The issue turns upon the scope and extent of the contract restrictions, that is, whether the prohibition against the distribution of “cash dividends” applies also to other dividend distributions. Petitioner cites and relies upon our decision in Columbia River Paper Mills, 43 B. T. A. 263, which is stated to be “directly in point” and “conclusive of the question in this case.” On brief counsel for taxpayer, who was also counsel for Columbia River Paper Mills, pointed out that petitioner and the latter were companion corporations, operating paper plants in adjoining states, using a joint business office and having similar business problems.

Our analysis of the stipulated facts in this case with the stipulated facts in the Columbia River Paper Mills case convinces us that the corporations had similar business problems which were handled identically. Furthermore, our comparative analysis of the stipulated facts indicates that it would be difficult to find two more nearly parallel cases. Each had outstanding common and 8 percent cumulative preferred stocks. Each was in arrears on dividends on preferred stock since September 1932. Each had an outstanding bond issue secured by a trust indenture that had been executed under similar circumstances and with substantially similar restrictions therein on dividend distributions. Each executed a supplemental indenture in September 1932 carrying substantially the same restrictions on distributions to stockholders. Each executed extension agreements with their bondholders agreeing that no “cash dividends” would be paid to the common stockholders except under circumstances not here material. Each had a bylaw which required the payment of all accumulated dividends on preferred stock before “any dividend is declared on common stock,” and word for word the provisions of this particular bylaw were identical. Other similarities exist, but those mentioned are deemed sufficient to demonstrate that the same principle should control each case.

In holding that the taxpayer was entitled to a credit under section 26 (c) (1) in the Coluvibia River Paper Mills case, supra, the Board stated that “in the circumstances óf this ca'se the petitioner could not have made any distribution to its stockholders except in the form o f cash.” (P: 266.) HoweVer, we agreed with the Commissioner that “if a dividend could have been paid by the petitioner during 1936 in any form other than cash the petitioner has not brought itself within the letter of section 26 (c) (1) of the taxing statute.” (P. 266.)

The Commissioner appealed the Board’s decision in ' Columbia River Paper Mills case, and the Circuit Court of Appeals for the Ninth Circuit reversed, Commissioner v. Columbia River Paper Mills, 127 Fed. (2d) 558. The Circuit Court agreed that if the taxpayer there could have distributed a dividend during 1936 in any form other than cash it had not brought itself within the taxing statute. It pointed out that the distribution of a cash dividend was prohibited by the contract with the trustee. But it denied that the bylaw restriction which prohibited “any dividend” on common stock while preferred dividends were in arrears constituted a written contract executed by the corporation within the meaning of the taxing statute. The court held, therefore, that, since there was no contract as described in the statute which prohibited the distribution of a stock dividend, the credit should be denied.

In Helms Bakeries, 46 B. T. A. 308, and Valentine-Clark Corporation, 46 B. T. A. 821 (now on appeal C. C. A., 8th Cir.), we had before us the question of the effect of written contracts restricting the payment of cash dividends. We there held that as dividends in form other than cash were not prohibited the credit was not allowable under section 26 (c) (1). See also United States v. Dakota Tractor & Equipment Co., 125 Fed. (2d) 20. We therefore hold petitioner is not entitled to the credit claimed and on this issue we sustain the respondent.

Issue II.

Facts. — On December 1, 1936, petitioner adopted a plan under which it offered to issue 5 percent income bonds, dated February 1, 1936, and maturing January 1, 1966, in exchange for its'outstanding preferred stock and accumulated dividend rights thereon, on the basis of $133,331/8 face value of bonds for each share of preferred stock. Interest on the bonds was to be paid annually, if earned, and, if not earned in whole or in part in any year, such portion of the interest was to accumulate and be payable before any dividends were paid on any class of stock.

The proposal was submitted by letter dated December 1, 1936, to petitioner’s preferred stockholders, together with forms of the proposed income bonds and coupons. Stockholders consenting to the consummation of the plan were requested to endorse their stock certificates and forward them to the agent designated by petitioner to make the exchange contemplated. The “5% income bond” provided, inter alia, for interest payments “from February 1, 1936, to and including December 31, 1965”; that interest was payable on June 1, 1937, and on each June 1 thereafter during the term of the bond if and to the extent that “available net income,” as therein defined and as determined and declared by petitioner’s board of directors, should be sufficient for such payment; that interest should be cumulative from and after February 1, 1936; that in any event all accumulated and unpaid interest should become due and be payable at maturity; that the bonds might at petitioner’s option be redeemed, prior to maturity on any interest-paying date for the principal amount plus accumulated and unpaid interest; that in the event of liquidation the bonds, plus accumulated interest, should be paid at face value before distribution of any assets to any class of stockholders; and that petitioner would not declare or pay any dividends upon any class of stock so long as any interest upon said bonds might be unpaid.

On February 1, 1936, the accumulated and unpaid dividends on petitioner’s preferred stock amounted to $33,331/0 per share, and on December 1,1936, to $40 per share.

Pursuant to the above plan the petitioner issued its 5 percent income bonds in exchange for preferred stock and accúmulated dividend rights thereon in the principal amounts of $49,500 for 1936 and $679,300 for 1937, with the result that such bonds were outstanding as of December 31, 1936, and December 31, 1937, in the principal amounts of $49,500 and $728,800, respectively.

The issuance and exchange of $49,500 of income bonds for preferred stock in 1936 occurred on various dates during the period December 26 to 31, 1936; On its 1936 return petitioner claimed a deduction of $2,268.75 as representing interest paid or accrued in respect of the principal amount of the income bonds outstanding on December 31, 1936. Of this amount the sum of $26.62 represents the portion thereof attributable to the period between the date of the exchange and the close of the year; the balance, $2,242.13, represents the portion thereof attributable to the period between February 1, 1936, and the date of the exchange.

The issuance and exchange of $679,300 of income bonds for preferred stock in 1937 occurred on various dates during the calendar year 1937. On its 1937 return petitioner claimed a deduction of $67,737.91 as representing interest paid or accrued in respect of the principal amount of income bonds outstanding on December 31, 1937. Of this amount the sum of $25,463.88 represents the portion thereof attributable to the calendar year 1937, in respect of income bonds issued in 1936, and the portion thereof attributable to the period between date of exchange in 1937 and the close of that year. The balance, $42,274.03, represents the portion attributable to the period between February 1, 1936, and the various dates of issue and exchange in 1937.

In determining the deficiencies herein respondent disallowed interest deductions as claimed by petitioner in the amounts and to the extent of $2,242.13 for 1936 and $42,274.03 for 1937 upon the ground that these portions of interest deductions claimed did not represent interest on indebtedness within the meaning of section 23 (b) of the Revenue Act of 1936. By his amended answer respondent asserts that he erroneously allowed deductions of $26.62 for 1936 and $25,-463.88 for 1937 as and for interest paid and accrued in respect of the income bonds outstanding at the end of those years and asks for increased deficiencies accordingly.

The amounts of $2,268.75 and $67,737.91 represented interest accrued or paid by petitioner on its 5 percent income bonds for the respective years 1936 and 1937.

OpiNxon. — This issue requires our determination of the amount of' interest on certain 5 percent income bonds that petitioner is entitled to deduct under section 23 (b) of the Revenue Act of 1936. The bonds were exchanged for preferred stock during the last few days of December 1936 and during 1937. The bonds bore interest from February 1, 1936, regardless of when the exchange occurred, and petitioner deducted interest on its 1936 and 1937 returns upon the basis of bonds outstanding at December 31,1936 and 1937, the bonds issued in 1937 bearing interest from February 1, 1936.

Respondent, while allowing a deduction of interest on said bonds for each year in determining the deficiencies herein, has by amended answer denied the right to any interest deduction and has asked for increased deficiencies. Respondent cites and relies, inter alia, upon our decision in Journal Co., 44 B. T. A. 460, and Pacific Southwest Realty Co. v. Commissioner, 128 Fed. (2d) 815, affirming 45 B. T. A. 426. Petitioner cites and relies upon our decision in Columbia River Payer Mills, 43 B. T. A. 104, which it urges conclusively determined the question at issue.

Subsequent decisions by the courts have strengthened petitioner’s contention. The Journal Co. case, supra, was reversed in Journal Co. v. Commissioner (C. C. A., 7th Cir.), 125 Fed. (2d) 349, the court holding that the payment therein was interest on indebtedness, and not a part of the purchase price, and the Columbia River Paper Mills case, supra, was affirmed by the U. S. Circuit Court of Appeals for the Ninth Circuit, 126 Fed. (2d) 1009. The latter case, factually, is very similar to the present, and in our opinion controlling. The court there pointed out that it was plainly the intent of the taxpayer that preferred stockholders who exchanged their stock for bonds should receive interest at the designated rate from the date of the bonds. The court further pointed out that the situation was one where the parties to the transaction, being free to contract, had agreed on a definitely ascertainable sum as compensation for the use of money over a stated period of time. The court thought such compensation was interest as commonly understood and therefore deductible under section 23 (b), Revenue Act of 1936. We do not find the Pacific Southwest Realty Go. case, sufra, applicable. On this issue we sustain the petitioner.

Issue III.

Facts. — During 1935 petitioner made certain entries on its books of account the effect of which was to reduce the credit balance of its reserve for depreciation account with a corresponding increase in the .credit balance of its surplus account. These entries or adjustments were based upon and were the result of certain depreciation adjustments made in connection with petitioner’s 1933 and 1934 Federal income tax returns by the respondent. By reason of these adjustments the Oregon taxing authorities demanded from petitioner during 1936 the payment of additional Oregon excise taxes based upon 1933 and 1934 net income. During 1936 petitioner paid the State of Oregon $912.24 additional excise taxes for 1934.

In its return for the year 1936 the petitioner claimed a deduction of said $912.24. In his determination of the deficiency for 1936 the Commissioner disallowed the deduction so claimed by petitioner “for the reason that, as your books are kept and your returns are filed on the accrual basis, the tax in question is allowable as a deduction only for the year in which the income upon which it was based was earned.”

OPINION. — Our findings show that petitioner paid the State of Oregon during 1936 certain additional excise taxes for the year 1934. Although petitioner is on the accrual basis, it seeks to deduct said payment from its 1936 gross income. The rule is well established that taxes accrue when all events have occurred that fix the amount of the tax and determine the taxpayer’s liability to pay it. United, States v. Anderson, 269 U. S. 422; Haverty Furniture Co., 20 B. T. A. 644; Floyd, Inc., 43 B. T. A. 101; Rawlings Manufacturing Co., 44 B. T. A. 161; Guy T. Gibson, Inc., 46 B. T. A. 1015.

The deduction which petitioner seeks to take was not a proper deduction from its 1936 gross income. All events had transpired prior to 1936 which fixed the amount and the liability of petitioner to the State of Oregon for the 1934 excise tax. Petitioner erroneously computed the amount of its tax to the state, but this error would not alter the correct amount of the tax, nor petitioner’s liability therefor. The subsequent discovery of the error and the correction thereof in 1936 related' back to the taxable year in which the mistake occurred. Haverty Furniture Co., supra, p. 646. The determination of the respondent as to this issue is approved.

Reviewed by the Board.

Decision will be entered under Rule 50.

Leech dissents.

Smith,

dissenting: During 1936 the petitioner, which kept its books of account and made its returns upon the accrual basis, was required to pay an additional Oregon excise tax of $912.24, based upon its net income for 1934. The occasion for the payment of this tax was that the respondent in the adjustment of petitioner’s income tax return for 1934 disallowed the deduction of a part of the allowance for depreciation claimed by the petitioner in its income tax return. The petitioner acquiesced in the disallowance of the deduction of the depreciation and paid any additional income tax arising therefrom to the United States. It adjusted its books of account in 1935 to show an increase in the surplus for 1934. The State of Oregon in 1936 claimed an additional excise tax for 1934 and the petitioner in 1936 paid the $912.24 demanded. The Board approves the respondent’s disallowance of this deduction upon the ground that the amount was properly chargeable against the petitioner’s gross income for 1934.

The question as to when an expense becomes an accrued liability is covered by-the Commissioner’s regulations. It was early recognized in the administration of the income tax law that oftentimes some of a taxpayer’s accrued income and some of his accrued deductions were not determined until a later year. It was impracticable to follow meticulously the rule that every accrued item of income and every accrued item of expense be reported in the year of accrual. The Commissioner therefore provided in his regulations (see article! 43-2 of Regulations 86 and Regulations 94, promulgated under the Revenue Acts of 1934 and 1936, respectively) that taxpayers making their] returns c f income upon the accrual basis should allocate to the proper year accrued items of income and accrued items of expense. The regulations provided, however:

⅜ * * It is recognized, however, that particularly in a going business of any magnitude there are certain overlapping items both of income and deduction, and so long as these overlapping items do not materially distort the income they may be included in the year in which the taxpayer, pursuant to a consistent policy, takes them into his accounts. * * *

In the instant proceeding it was clearly impossible for the petitioner to know in 1934, or at the time it was required to file its income tax return for 1934, the additional excise tax which would be demanded of it by the State of Oregon for the year 1934. There was no additional excise tax due the State of Oregon at that time. Demand was made upon petitioner for the payment of the additional excise tax for 1934 in 1936. The petitioner treated it as an accrued item for 1936.

I see no reason why petitioner should not be allowed the deduction from gross income of 1936 of the $912.24 which was demanded! of it by the State of Oregon and paid in that year. It was impossible for the petitioner to know prior to 1936 that it had this liability.

The income tax acts should be administered in a sensible fashion. A sensible construction of the income tax acts warrants the petitioner to deduct from the gross income of 1936 the $912.24 here, in question. It is unreasonable in my opinion to say that the petitioner is not entitled to the deduction. The Commissioner’s regulations allow it.

Aiujndell agrees with this dissent.

       SBC. 26. CREDITS OB’ CORPORATIONS.
      In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax—
      * * * ⅜ ⅜ * «
      (C) CONTRACTS RESTRICTING PAYMENT OP DIVIDENDS.-
      (1) Prohibition on payment op dividends. — An amount equal to the excess of the adjusted net income over the aggregate amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation. prior to May 1, 1936, which provision expressly deals -¡vith the payment of dividends. *. * * . '■ • .


author: SteRNHagen:

text:
    Raymond F. Flanagan, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 107373.
    Promulgated September 25, 1942.

      Lawrence J. Schorh, Esq., for the petitioner.

      Harold I),. Thomas, Esq., for the respondent.
   OPINION.

SteRNHagen:

The petitioner testified that, in entertaining the public officials of the several counties and towns with which he had long been doing business, he had no purpose to influence them in their consideration of his offers or contracts, but that this sort of entertainment had been carried on many years by him and his competitors and if he should discontinue it he “would be crucified” — “looked upon as a nonentity.” He therefore regards the cost of the entertainment as an “ordinary and necessary expense of carrying on his business.” Even though this might be literally true, the question is whether the statutory language is to be applied literally or is to be interpreted to exclude such expenses from its meaning.

Such entertainment of public officials who necessarily have a direct or indirect relation to the contracts which petitioner seeks is, speaking generally, commonly regarded as contrary to the public interest. It is as much against public policy as expenditures to influence legislation ; and such expenditures have been consistently denied deducti-bility, irrespective of the absence in the concrete case of a venal motive. Textile Mills Securities Corporation v. Commissioner, 314 U. S. 326. If the expenditures were expressly prohibited by state law, they would be denied recognition as ordinary and necessary expenses for the purpose of tax deduction, Easton Tractor & Equipment Co., 35 B. T. A. 189. We hold that the deduction is also withheld by the statute from expenditures by one who is selling materials under contract with towns and counties for entertaining public officials, even though it does not appear that the expenditures are repugnant to express provisions of law.

The disallowance of the amounts of $4,059.24 and $3,259.42 spent in entertaining public officials is sustained.

Decision will he entered under Rule 50.


author: ARundell : Disney,

text:
    Estate of Edward Lathrop Ballard, Deceased, Alden C. Noble and Elizabeth Biglow Ballard, Executors, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105033.
    Promulgated October 1, 1942.

      Edward S. Bentley, Esq., for the petitioners.

      Charles P. Reilly, Esq., for the respondent.
   OPINION.

ARundell :

The first question presented is whether or not the corpus of the children’s trust is includible in decedent’s gross estate under the provisions of section 302 (c) of the Revenue Act of 1926, as amended, or section 302 (d) of the Revenue Act of 1926, as amended. Petitioners contend that decedent retained no interest in the children’s trust after the amendment of January 31, 1924, by which decedent relinquished his power to amend, modify or revoke the trust and gave such power to his wife. They maintain that the possibility that decedent might again have attained the relinquished power by surviving his wife without her having revoked the trust, can not be treated as an interest in the trust corpus taxable to decedent’s estate. Respondent argues that decedent reserved a reversionary interest in the trust so that the trust corpus is includible in decedent’s gross estate as a transfer to take effect in possession or enjoyment at or after death within the doctrine of Helvering v. Hallock, 309 U. S. 106. He asserts that decedent made no completed gift upon creation of the trust or at the time he relinquished to his wife his then power to amend or revoke the trust. Respondent further argues that the value of the children’s trust corpus is includible in decedent’s gross estate under section 302 (d) of the Revenue Act of 1926, as amended.

We are of the opinion that the possibility of decedent again obtaining the power to amend or revoke the children’s trust does not bring the trust corpus into decedent’s gross estate. Respondent concedes that there is no question of a transfer in contemplation of death. Thus, if section 302 (c), as amended, is applicable, it must be on the ground that decedent made a transfer intended to take effect in possession or enjoyment at or after his death. Respondent rests his argument relating to section 302 (c) on the contention that decedent’s retained contingent power is within the ambit of Helvering v. Hallock, supra, and Bryant v. Helvering, 309 U. S. 106.

In the Halloeh and Bryant cases and in Klein v. United States, 283 U. S. 231, the case which the Supreme Court relied upon in Halloeh and Bryant, the grantor-decedents retained interests in the property transferred sufficient to cause the inclusion of the transfers in the gross estates of the grantors as tranfers intended to take effect in possession or enjoyment at or after death. In Klein v. United States, supra, the decedent transferred property to his wife for life but reserved a reversion in fee if bis wife should die first. The remainder was to go to his wife if she should survive him. In Helvering v. Hallock, supra, the decedent created a trust with the income payable to his wife for life. Upon her death the trust was to terminate and the principal and accrued income were to be paid over to the decedent if he survived, but if he did not survive the principal and accrued income were to be paid over to his son and daughter. In the Bryant case the trust income was payable to decedent’s wife for life and upon her death to the decedent if he survived her. Upon the death of the survivor of decedent and his wife the principal of the trust was to be paid over to the executors •or administrators of decedent’s estate. The trust instrument also contained a provision giving the power to the grantor and his wife jointly during their lives and to the survivor of them to revoke, modify, or alter the trust instrument. In all three of the cited cases the grantor had a “possibility of reverter” which was cut off by his death. Something passed from the dead to the living because of the death of the grantor.

We find nothing in the present case that decedent gave contingently upon his death or that was transmitted by it. The widow, certainly, took nothing by that event. Her interests in and control over the trust fund were not affected in any way either by the grantor’s continued life or by his death. She did not, as in the Brycmt case, obtain for the first time upon the grantor’s death the power alone to alter, amend, or revoke the trust. She had been the sole possessor of that power since January 31, 1924. While decedent lived the wife had the undisputed power at any time to appropriate the trust corpus to her own purposes as absolute owner and thereby deprive decedent, even if he survived her, of any interest in or power over the property. In the Hallock and Klein cases the death of the decedent was an event which gave to the beneficiaries a dominion over the trust corpus which they did not have prior thereto. That can not be said here, and it is in this respect, in our view, that the fundamental distinction is to be drawn between those cases and this proceeding.

Nor can we say, from the standpoint of the children, that there was any transmission from the dead to the living. Their interests, since decedent’s renunciation in 1924 of his power to alter, amend, or rei-voke, had been held at the sufferance of their mother. The same situation prevailed after decedent’s death. The transfer to them was in effect made contingently upon her death, not his. By the grantor’s death the children received no “valuable assurance” resulting from a termination of control exercisable by the grantor. See Porter v. Commissioner, 288 U. S. 436. It is true that if the wife had predeceased the grantor his death would then have assumed controlling significance. That contingency, however, never occurred. Up until the time he died, as the facts demonstrated, the transfer was complete and irrevocable in so far as decedent was concerned. His death did not terminate any control by him and consequently did not vest control in anyone else.

The Circuit Court of Appeals for the Third Circuit, in Commissioner v. Kellogg, 119 Fed. (2d) 54, refused to extend the doctrine of Hélvering v. HaTlooh, supra, to a case where the trust property transferred by the decedent might revert to the decedent not by virtue of the terms of the trust instrument but because of failure of the trust. The Kellogg case imposes a logical limitation on the scope of section 302 (c). We think that here, too, the application of the Halloch doctrine would cause an unwarranted extension of that section.

This case has another all-important feature distinguishing it from the decided cases involving “possibility of reverter.” Here decedent gave his wife every important power over the trust property. She exercised these powers by modifying the trust, revoking it in part, substituting securities, and finally by dividing the trust into two parts, one for the benefit of each of the surviving children. The presence of these powers in decedent’s wife, plus their actual exercise by her, makes decedent’s “string” on the trust property a practical nullity. Consequently, it becomes apparent that when decedent relinquished, in 1924, his present power to revoke the trust he did not retain an interest in the trust which would subject the trust property to tax under section 302 (c), as amended. See Estate of Flora W. Lasker, 47 B. T. A. 172.

Respondent makes a further argument with regard to the children’s trust. He claims that the trust principal is includible in decedent’s estate under section 302 (d) of the Revenue Act of 1926, as amended. That section applies only where the decedent had at the date of death the power either alone or in conjunction with another person to alter, amend, or revoke a previous transfer of property. Decedent' had no such power at the date of his death. At no time after January 31, 1924, did decedent have a present power to alter, amend, or revoke the children’s trust. Nor does the fact that decedent, at the date of his death, had a contingent power to alter, amend, or revoke cause the inclusion of the trust property in his gross estate under section 302 (d). Tait v. Safe Deposit & Trust Co. of Baltimore, 74 Fed. (2d) 851. At the date of his death the power to amend or revoke the trust was vested in decedent’s wife. While decedent’s wife was living she and she alone could exercise that power.

Respondent has vigorously argued that for all practical purposes decedent had the power to amend or revoke the trust by virtue of his position as husband and head of family. He contends that decedent at all times possessed the power to alter or revoke the trust in conjunction with his wife because of the marital relationship, which the evidence' shows was always harmonious. We reject this contention because there is no indication that decedent had such control over his wife’s actions as to permit the finding that he could, by joint action with her, amend or revoke the trust. The evidence shows that decedent’s wife talked matters over with him and respected his judgment on financial matters. That does not mean, however, that the familial relation gave decedent the power to amend or revoke the trust. As a matter of fact, the testimony of decedent’s widow presented at the hearing indicates that she gave considerable thought to the problems of the children’s trust. She had been taught to handle money and took care of her own financial affairs. Thus, we do not feel that Helvering v. Clifford, 309 U. S. 331, and similar cases involving substantial ownership of trust property by the grantor have any application here. We have heretofore rejected respondent’s argument in substantially similar circumstances, Stephen Hexter, 47 B. T. A. 483; Estate of Frederick S. Fish, 45 B. T. A. 120, 123, pointing out in the latter instance that the doctrine of family solidarity enunciated in the Clifford case was rather an economic consideration having to do with reallocation of income within the family group than a presumption that its members will act in accordance with the wishes or dictates of the family head. We hold that no portion of the value of. the children’s trust is includible in decedent’s estate.

The second issue is whether or not decedent’s retained power to redesignate the life beneficiary of the Crehore trust causes the inclusion of that life interest in decedent’s gross estate under section 302 (c) of the Revenue Act of 1926, as amended, or section 302 (d) of the Revenue Act of 1926, as amended.

There is no question that at the date of his death decedent had the power to deprive the life beneficiary of the Crehore trust of her interest and to designate someone other than himself or his estate as the life beneficiary. This retained power comes within the specific words of section 302 (c), as amended. Petitioners, however, contend that the value of the life interest can not constitutionally be included in decedent’s gross estate because the trust was established and the life interest created prior to the passage of the Joint Resolution of March 3, 1931, which was held to be applicable only to transfers after March 3, 1931, by the Supreme Court in Hassett v. Welch, 303 U. S. 303. We need not decide, however, whether Hassett v. Welch, supra, applies to that part of section 302 (c) of the Revenue Act of 1926, as amended by section 803 (a) of the Revenue Act of 1932, which respondent urges to be applicable here. We are of the opinion that section 302 (d) of the Revenue Act of 1926, as amended, is sufficiently broad to cover the Crehore trust. The retention of the right to redesignate the life beneficiary was certainly a right to alter or amend the trust. Consequently., the enjoyment of a life interest by decedent’s sister was subject at decedent’s death to a change through the exercise of decedent’s power to designate another' beneficiary. This is clearly subject to section 302 (d) of the Revenue Act of 1926, as amended. Commissioner v. Chase National Bank of New York, 82 Fed. (2d) 157; certiorari denied, 299 U. S. 552; Commissioner v. Bridgeport City Trust Co. (Ailing), 124 Fed. (2d) 48; certiorari denied, 316 U. S. 672.

We can see no constitutional objection to the application of section 302 (d), as amended, to the life interest in the Crehore trust. Decedent at any time after the creation of the trust could have relinquished his power to redesignate the life beneficiary. The fact that the trust was established prior to the enactment of the 1924 Revenue Act, in which section 302 (d) first appeared, does not make the application of that section to the instant case a violation of the clue process clause of the Fifth Amendment. Porter v. Commissioner, supra.

Petitioners contend that since the power to redesignate the life beneficiary of the Crehore trust remained in decedent’s wife after his death, nothing passed from the dead to the living at his death. For purposes of section 302 (d), this transfer in trust was not complete until decedent’s death eliminated the string which he had retained on the trust. The fact that the power to designate continued in decedent’s widow is not material and the value of the life estate must be included in decedent’s gross estate. Welch v. Terhune, 126 Fed. (2d) 695; Estate of John H. Storer, 41 B. T. A. 1156.

Other questions raised by the pleadings were disposed of by the stipulation of the parties, to which effect will be given upon recomputation.

Reviewed by the Board.

Decision will oe entered wader Rule 50.

Kern concurs only in the result.

Disney,

dissenting: I can not agree with the majority opinion on the first issue. In the Klein case the taxpayer had a reversion in fee if the wife died first. In the HaTloek case the trust principal and income reverted to him if the wife died. In the Bryant case the trust income reverted to him if the wife died first, and the principal later went to his estate at his death. Also, he had the power to revoke, if he survived. Such interests were held to cause taxation to the estate of the decedent.

Ballard, if he survived his wife, also would receive a reversion, that is, of the right to alter, amend or revoke. His death put an end to such a contingency. It is true that his death transmitted nothing to his wife, because he had already conveyed to her the power to alter, amend, or revoke; but it seems to me that his death did transmit rights to the children, that is to say, it freed their interests from the possibility that he, if he survived, might alter, amend, or revoke. Their interests, in other words, were subject to two contingencies, first, that the wife during her lifetime might alter, amend, or revoke, and if she did not revoke, secondly, the husband might, if he survived her, alter, amend or revoke. The second contingency was removed by his death, leaving only the contingency that she might alter, amend, or revoke. Therefore it would appear that by the death of the decedent, although nothing passed to the wife, something passed to the children, because when he died there was left only the contingency that the wife might alter, amend, or revoke. If he had survived, a very serious possibility, that of complete revocation, would have faced the beneficiaries’ interests. His death obliterated that possibility and something was transmitted by virtue of his death to the beneficiaries, unless it can soundly be said that, since he had given the right to revoke, etc., to his wife, prior to death, he had! no such right to transmit by his death. The fact that he did give it to his wife does not seem to be the answer, because he gave it to her only for her life, retaining that power after her death, and his death prior to hers removed that possibility and transmitted an interest to the beneficiaries in the same way that it would have done so, if he had survived and later died. Certainly, if he had survived, thereby reassuming the right to revoke, his death would have transmitted rights to the beneficiaries. His death prior to any such survival, that is prior to his wife’s death, likewise terminated a possibility, the only difference being that it was a mere contingent possibility. Since in the Klein, Bryant, and Halloch cases, death having put an end to a contingent or reversionary interest, is held to have transmitted a right, and therefore to cause taxation to the estate, the same transmittal and taxation here seem to follow, for the only difference is that there is transmission of a second contingency, instead of a first, to the beneficiaries.

The children could not receive the estate until both father and mother were dead, without exercising the power to revoke. Therefore the deaths of both transmitted rights to the children, the husband’s transmission being merely subject to the contingency that the wife did not herself revoke. I dissent.

Smith and Qppek agree with this dissent.

       Sbc. 302. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, ■wherever situated, except real property situated outside the United States — •
      ****** *
      (e) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after his death, or of which he has at any time made a transfer, by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom; except in case of a bona fide sale for an adequate and full consideration in money or money’s worth. Any transfer of a material part of his property in .the nature of a final disposition or distribution thereof, made by the decedent within two years prior to his death without such consideration, shall, unless shown to the contrary, be deemed to have been made in contemplation of death within the meaning of this title. [As amended by section 803 (a) of the Revenue Act of 1932 and section 404 of the Revenue Act of 1934.]

       (d) (1) To the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona-fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power (in whatever capacity exercisable) by the decedent alone or by the decedent in conjunction with any other person (without regard to when or from what source the decedent acquired such power), to alter, amend, revoke, or terminate, or where any such power is relinquished in contemplation of decedent’s death. [As amended by sections 401 and 404 of the Revenue Act of 1934 and section 805 (a) of the Revenue Act of 1936.]