text:
    Budd International Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102842.
    Promulgated November 19, 1941.

      Henry 8. Drinker, Esq., Frederich E. S. Morrison, Esq., and John W. Bodine, Esq., for the petitioner.

      Brooks Fullerton, Esq., for the respondent.

       SEC. 112. RECOGNITION OF GAIN OR LOSS.
      ♦ >h ★ * % ‡ ‡

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

   OPINION.

Sternhagen :

The first matter to be determined is the petitioner’s basis of gain on the sale of its Pressed Steel common in 1936. Petitioner demands the use of its own cost and respondent demands the use of the preceding owner’s cost. This dispute turns upon the legal question whether the exchange in 1930 by Schroder and the Manufacturing Co. of cash and assets, respectively, for petitioner’s shares was tax-free under the Revenue Act of 1928, section 112 (b) (5). If the proportions in which petitioner’s shares were issued to them were the same as their proportionate ownership had been of the assets and cash which they transferred to petitioner, the exchange was tax-free, and the basis to be used by petitioner in computing gain is the same as the basis applicable to the transferor Manufacturing Co. This, it is agreed by both parties, was the $1,000,000 cost which had been paid by the Manufacturing Co. in 1926. In using 'this basis the Commissioner made no affirmative determination, but only adopted that figure as used by petitioner on its 1936 return upon the conception that the 1930 exchange was tax-free under section 112 (b) (5).

In lieu of the transferor’s basis of $1,000,000, petitioner now demands the use of its own actual cost in 1930, and this it seeks by evidence to establish at $3,500,000. It argues that the shares issued by it in 1930 to the Manufacturing Co. and Schroder were not proportionate to the assets and cash which they respectively transferred to it, and that it is now incorrect to carry forward the Manufacturing Co.’s cost as its basis, as if section 112 (b) (5) were applicable. If that proposition be established, petitioner’s next step is to prove that the actual cost to it in 1930 of the Pressed Steel common which it sold in 1936 was more than $1,000,000.

Since we are of opinion that the petitioner’s cost of Pressed Steel common in 1930 has not been established at a greater figure than $1,000,000, we may adopt arguendo the view that the 1930 transaction was not tax-free under section 112 (b) (5). This view is only taken hypothetically, since a decision on the point is unnecessary and would be obiter; but we are inclined to the view that the Manufacturing Co.’s assets and Schroder’s cash were not in the same ratio as the petitioner’s shares which they respectively received. Both section 112 (b) (5) of the 1928 Act and section 113 (a) (8) of the 1936 Act are exceptions to the general clause of each of those sections. Unless the special facts appear which are described in those sections, the special clause has no application and the general rule applies. The general rule of section 112 (a) of the 1928 Act provides that the entire amount of gain shall be recognized, and the general rule of section 113 (a) of the 1936 Act provides that the basis shall be cost. Therefore, in the 1930 transaction the gain was required to be recognized, and in the 1936 sale the actual cost to the petitioner was required to be used, imless it was affirmatively established that the Manufacturing Go. and Schroder each received the petitioner’s shares in the same ratio as their ownership in the assets and cash they transferred. There has never been an official determination that those ratios were substantially the same, and such a finding may not be made merely because that postulate was apparently used by the Manufacturing Co. on its 1930 return, which was adopted by the Commissioner, and was again used by the petitioner as the basis for gain on its 1936 return and adopted by the Commissioner. There is nothing to indicate that at any time the actual or relative values of the assets transferred by the Manufacturing Co. to petitioner in 1930 were investigated or determined. The evidence in this proceeding gives little ground for a determination of the value of all the Manufacturing Co. assets or of the ratio of such value to the $3,000,025 cash paid by Schroder. If a finding of fact were unavoidable, the evidence would tend to establish that the ratio of assets and cash transferred was not the same as the ratio of shares issued to each. Thus the Manufacturing Co. would have had a recognizable gain based upon its actual cost of the Pressed Steel shares, and petitioner would not be required to use that cost as its own basis. Petitioner’s basis would be its own actual cost of the Pressed Steel shares, and this cost would be the value of such of petitioner’s common shares issued to Manufacturing Co. as could be identified or allocated as the price of the Pressed Steel shares.

It can not, however, be found as a fact upon the evidence that petitioner’s direct cost of the Pressed Steel common was more than $1,000,000, the figure which it used on its return. It paid 360,000 common shares for the composite group of assets and promises given by the Manufacturing Co. The $344,458.01 cash and the guaranty may properly be put aside as being clearly regarded as cost of the 1,000 shares of Pressed Steel preferred. It is impossible to assign any definite portion of petitioner’s common as the cost of the Pressed Steel common. Petitioner has submitted no evidence upon which such an allocation can be based. Its proof has been directed to the value of the Pressed Steel common at the time of the exchange, and has consisted largely of the opinions of persons who were at that time in one way or another connected with the business or with the financial aspects of the exchange transactions. These opinions, however, related to the value not of the petitioner’s shares given up, but of the Pressed Steel shares received. This obviously does not determine its cost, for a purchaser’s cost is not as a rule determined by the value of the property purchased. The value of all assets transferred to a newly formed corporation has sometimes been accepted as evidence of the value of all its shares; W. S. Parish & Co., 38 B. T. A. 150, 158; affd., 104 Fed: (2d) 833; Ida I. McKinney, 32 B. T. A. 450, 456; affd., 87 Fed. (2d) 811; but the value of one of several assets transferred for less than the aggregate of the shares issued gives no help in the effort to determine the specific value of the shares issued for the particular asset. Pierce Oil Corp oration, 32 B. T. A. 403, 430.

Since, therefore, the petitioner’s cost was 360,000 common for the entire conglomeration of Manufacturing Co. assets and promises (except the Pressed Steel preferred), it is not xrossible to say what portion thereof is assignable as the cost of the Pressed Steel common; and this is true even though the value of the Pressed Steel common was $3,500,000, as opined by witnesses, or $2,000,000, as entered on the books. There is no ground upon which to distribute the petitioner’s common among the several assets and promises received therefor; there is no proof upon which the number of shares issued as cost of the Ambi-Budd shares can be found either relatively or absolutely, and this is likewise true as to the absolute or relative number of shares to be regarded as the cost of the licenses, contracts, and promises. All of these seem to have been regarded as substantially valuable. For the purpose, therefore, of determining the cost of any part of what was received from the Manufacturing Co., it is of little or no assistance to know the several figures which witnesses regard as the value of the Pressed Steel common so received.

The issuance to Schroder of 68,572 preferred and 68,572 common for its cash of $3,000,025, while at the same time 8,000 preferred and 8,000 common were issued to the Manufacturing Co. apparently for its cash of $350,000, presents another obstacle to the proper evaluation of any portion of petitioner’s common to be used as cost of the Pressed Steel common. In petitioner’s brief, it is said that the 68,572 shares of common were issued to Schroder as a bonus with the 68,572 preferred. The preferred was said to have a value at that time of $43.75, which is the figure which results from dividing $3,000,025 by 68,572 preferred and dividing $350,000 by 8,000 preferred. If this value of the preferred were to be taken as the fact, it would leave the 68,572 common which were issued to Schroder and the 8,000 issued to the Manufacturing Co. as having no unit value. How then can it consistently be said that the 860,000 common are to be given the substantial value claimed for them? There is nothing in the evidence from which these two propositions can be reconciled and nothing from which a unit value can be attributed to all the common shares. That the common had substantial value is clear enough in view of its voting rights. It is impossible, however, to go further than that upon this record and determine what that value was.

It can not be found that the Pressed Steel common acquired by the petitioner from the Manufacturing Co. in 1930 had a cost in excess of the $1,000,000 which petitioner used on its return and respondent adopted without change. This figure must remain unchanged as the basis of gain to petitioner in the sale of 1936.

The petitioner claims that the gain from the sale of Pressed Steel shares was incorrectly computed because the disposition of such shares was partly in a “swap’’ for Schroder’s 68,572 International preferred shares received by it for redemption. There is not sufficient evidence to show that the transaction was in form or substance an exchange. The evidence shows that, irrespective of what may have been tentatively wished or expected, the disposition of the Pressed Steel shares was by sale to British Pacific and Schroder for separate definite money prices; and that petitioner also redeemed Schroder’s 68,572 shares of International preferred at $57 a share, and retired them. These were two transactions and their close proximity in time does not unify them in a single exchange. The 332,595 Pressed Steel common were sold to the British Pacific Trust, after petitioner had paid it £16,629/15/0 for a “put”, and were sold in accordance with its terms. British Pacific had no shares of petitioner and was therefore not making an exchange. The price paid, £1,122,508/2/6, was exactly the amount which British Pacific had agreed to pay, and this was credited to petitioner’s account by Schroder as petitioner’s banker in London. Although the stipulation states that the shares of Pressed Steel common were transferred to both the British Pacific Trust and Schroder, this is not explained and is inconsistent with the “put” and its exercise. So far, therefore, as the Pressed Steel common are concerned, there is no room for doubt that they were sold by petitioner for $5,601,315.54, the exchange equivalent of £1,122,508/2/6.

The disposition of the 81,667 shares of Pressed Steel preferred must also be regarded as a sale to Schroder for $504,303.93, the exchange equivalent of £101,062/18/3, which was credited by Schroder, in its capacity of petitioner’s banker, to petitioner’s account. This was the form of the transaction accepted by all concerned, and its character is not changed by the insistence of Schroeder that its holdings of International preferred shares should be redeemed. Petitioner was concerned with securing funds with which to curtail the outstanding loan by the Federal Reserve Bank to the Manufacturing Co. Its primary interest at that time was not the redemption of its outstanding preferred. It was because of Schroder’s demand that' petitioner agreed to the acquisition of its 68,572 preferred, and it was adventitious that, since Schroder was both petitioner’s banker and the holder of International preferred, the two transactions were accounted for on Schroder’s books. All of the writings which passed between the parties to the transaction, which are in evidence, speak of the transaction as a sale by petitioner of its Pressed Steel shares for a stated price. Nowhere does it appear that the disposition of the Pressed Steel shares was to be accomplished by an exchange; and such a character can not be attributed to all or any part of the transaction consistently with what the parties said they were doing and what they actually did. The first letter on the subject, which is in evidence as Stipulation Exhibit 14, written on December 11, 1935, by Schroder to a representative of the Bank of England, describes the proposed transaction as follows:

Budd International Corporation have now received a cash bid for the whole of its holding of the Pressed Steel Company Ordinary Shares of £1 each of a price of £3. 7. 6 per Share, involving a total payment of about £1,122,500. The purchaser is the British Pacific Trust Ltd. of Cleveland Row, S. W. 1.
It is the intention of the Budd International Corporation to redeem out of the proceeds of the sale of the Pressed Steel Company’s Ordinary Shares the whole of its own Preference Shares at the price of $57 per Share, with the result that £780,000 will be payable to us in redemption of our holding of these Preference Shares.
The transaction will be carried out as follows:
The total purchase price for the Pressed Steel Ordinary Shares will be paid to us in £stg. by the buyers and the Budd International Corporation will authorize us to retain for our own account £788,000 being the equivalent of $57 per Share, for the redemption of the Budd International Corporation Preference Shares held by us. The balance of the purchase price, i. e. about £342,500 will be transferred to the Budd International Corporation in the United States in Dollars.
****** *
* * * Incidentally we ourselves are purchasing for our own account from the Budd International Corporation their holding of 81,667 Pressed Steel Company Limited 6% Preference Shares at the price of LI. 4. 9 per Share net * * *.

On January 3, 1936, petitioner’s directors passed a resolution to exercise the “put” and require British Pacific to buy petitioner’s 332,595 Pressed Steel common at £3.7. 6.

On February 14, 1936, petitioner’s solicitors in London wrote to petitioner that the sale of the Pressed Steel common to British Pacific was completed and that British Pacific had paid to Schroder in London £l,122,508/2s/6p; that to Schroeder had been delivered 81,667 Pressed Steel preferred for a credit of £101,062/18s/3p.

We understand that Messrs. J. Henry Schroder & Co. are carrying out your instructions with regard to the purchase of your Corporation’s own Preference Shares at $57 per share * * *.

In view of this consistently clear treatment of the transaction as a sale by petitioner of the 332,595 shares of Pressed Steel common to British Pacific at a stated price and the 81,667 shares of Pressed Steel preferred to Schroder at a stated price, and the separate redemption of Schroder’s International preferred for a fixed price of $57 per share, which petitioner was paying out of the proceeds of the sale of the Pressed Steel shares, it would be a wholly unjustified and forced construction to characterize these several transactions as a single unified exchange of Pressed Steel common and preferred for, International preferred and cash. In fact, there was no such exchange; and we see no reason now, for the sake of a tax effect, to say that petitioner should be treated as if it had made such an exchange.

It would be an impossible Procrustean task to attempt to shape the various steps to fit the conception of an exchange. Certainly British Pacific was no party to an exchange, and yet petitioner would say that the Pressed Steel common shares were to some extent exchanged for International preferred. International preferred was redeemed by petitioner at $57 a share, and this could only have been paid, as it was, to a large extent with the cash derived from British Pacific. At the fixed price at which Pressed Steel preferred was sold to Schroder, the proceeds were wholly inadequate to provide an amount sufficient to redeem the International preferred at the fixed redemption price. Furthermore, within a short time after these transactions were completed, petitioner redeemed the remaining 8,000 shares International preferred held by the Manufacturing Co. and the redemption price was at the same $57 rate as that paid to Schroder. Against this harmonious group of facts it would be wholly unwarranted to find that a swap had taken place, largely because there is testimony that petitioner’s representative at the outset of the negotiations thought that a swap might be worked out and the transactions consummated in that manner.

It may be added, however, that, even if the Schroder part of the transaction could be regarded as a swap, there would still be too little support for relieving the petitioner of a tax on the resulting gain. Begulations 94, art. 22 (a)-16, in effect in 1936, were different from that considered by the Court in Commissioner v. Reynolds Tobacco Co., 306 U. S. 110, and provided that the recognition of gain depended upon “the real nature of the transaction.” See Trinity Life Building Corporation, 44 B. T. A. 1219; Brown Shoe Co., 45 B. T. A. 212. The redemption of International preferred was not so dominant as to characterize the supposed exchange as not primarily the sale of petitioner’s Pressed Steel preferred, but the redemption of its own preferred. The evidence shows, rather, that, for the purpose of getting funds with which to curtail the Manu-factoring Co.’s indebtedness to the Federal Reserve Bank, petitioner was selling an asset. This was the dominant fact which more properly determines the “real nature of the transaction”, and while we confess to some difficulty with the term “real nature of the transaction”, we can not conclude that upon the evidence it is controlled by the redemption of the International preferred.

The dispositions of the Pressed Steel common and preferred were correctly treated as sales; the sale price was $5,830,990.34 (after subtracting the expense charge which is not in dispute); the basis was $1,344,458.01, and the correct gain was $4,486,532.33, as adopted in the determination of the deficiency.

The amount of deduction for Pennsylvania franchise tax is stipulated and the amount of the deduction for Pennsylvania income tax will, the parties agree, be computed in accordance with the Federal tax resulting from the disposition of the issues in this proceeding. Both deductions will, it is agreed, be given effect in the computation under Rule 50.

The petitioner claims a deduction for 1936 of the $49,400 Federal capital stock tax for the fiscal year 1935-1936 which it deducted for its income tax calendar year 1936 and which the Commissioner disallowed on the ground that it was properly deductible for the income tax year 1935. In 1935, acting upon the capital stock tax statute of August 30, 1935, petitioner on its books accrued $5,587.91 as the capital stock tax of 1935-1936. This was upon the basis of a continuation of the declared value of $4,000,000 which had been used in 1934-1935 under the 1934 Act, section 701, to which was applied the increased rate of $1.40 per $1,000 which had been imposed by the 1935 Act, section 105. The books were generally on an accrual basis. The Revenue Act of 1936, section 401, changed the rate back to $1 per $1,000 in June 1936, and petitioner, having in mind the proceeds from the sale of the Pressed Steel shares and the excess profits tax thereon, concluded to avail itself of the right to declare a new value of capital stock. It declared the value at $55,000,000, with the resulting tax of $55,000 instead of the $5,600 which it had accrued. This additional $49,400 it accrued on its books for its income tax year 1936, and deducted the amount on its 1936 income tax return. Later in 1936 it computed its capital stock tax for 1936-1937 upon the same basis of declared value of $55,000,000, accrued this capital stock tax on its books in the calendar year 1936, and deducted the tax on its 1936 income tax return. It insists upon the right to the deduction in 1936 of both amounts. The Commissioner has disallowed the $49,400 applicable to the year 1935-1936.

Upon the taxpayer’s method of accounting, it must be held that the entire capital stock tax for 1935-1936, payable upon the value which it declared, was the tax which accrued in the calendar year 1935. While the amount was not stated in 1935, and indeed may not have been known as long as the declared value was not decided, the accrual of capital stock tax was an established practice, and this had been followed by the petitioner’s accrual of the tax which at that time was believed by it to be the entire and correct tax. Having chosen and been allowed that method of accounting for its capital stock taxes, it had the right to use it in respect of the capital stock taxes for 1935-1936. But it could not split up the single annual tax of this year and deduct part for 1935 and the rest for 1936. Its method of accounting must be consistently used and an error or accident may not be permitted to be the means of accomplishing an obvious distortion. Ho point is made of the petitioner’s change of valuation; and although it might have had some right, upon application, to change its accounting method if it had applied the change to the entire new tax, this question is not here. Petitioner had no right, while adhering to its accounting method and accruing one part of the year’s tax, to accrue the remaining part in the following year and spread the deduction. This is made stronger by the petitioner’s adherence to the adopted accounting method in the latter part of 1936, when it accrued the entire capital stock tax for 1936-1937, and deducted it on its 1936 income tax return.

A question is raised affirmatively by the respondent relating to the deduction taken by the petitioner on its 1937 income tay return for capital stock tax of 1937-1938. The Revenue Act of 1936 was in force in 1937 and carried the $1 capital stock tax which has been considered in the preceding point. Before the end of 1937, petitioner accrued on its books the $54,318 capital stock tax based upon its adjusted declared value of $54,318,128.80 as used in the 1936 return and deducted it on its 1937 income tax return. This was not changed by the Commissioner in determining the deficiency. By the act passed in May 1938, the provisions of the capital stock tax were changed and the petitioner availed itself of the opportunity to declare a new capital stock value. It substituted a declared value of $15,000,000 and this resulted in a capital stock tax of $15,000 instead of the $54,000 which had been accrued and deducted. The Commissioner now demands a correction of the deduction and a disallowance of the excessive $39,000.

There is no escape from the Commissioner’s position. A taxpayer may not deduct more than the correct amount of the tax, irrespective of the accounting method. He may not support a deduction by making an incorrect accrual of an excessive amount, even though he is unaware of the correct amount. Such an excessive accrual is only provisional. The question which might emerge from such a mistake as to the proper treatment of a subsequent refund of an excessive amount paid, has given rise to much discussion, see E. B. Elliott Co., 45 B. T. A. 82. But there is no doubt that a correction of the original deduction when timely made while the determination of the correct tax for the original year is still in litigation, may properly be demanded and is not to be denied. The Commissioner’s affirmative claim is sustained.

In computing the undistributed profits tax of section 14, the Commissioner allowed a credit of $654,858 for dividends paid. This was the amount of the dividend of $1.50 per share paid February 20, 1936, on the outstanding 436,572 common shares. The petitioner, however, demands additional credits, both for dividends paid on the preferred shares and for an amount alleged to be the subject of an express contractual prohibition covered by section 26.

There is no need to repeat what has been said in holding that the disposition of the Pressed Steel shares was not an exchange for International preferred. The entire proceeds of $5,830,990.34 were within the petitioner’s earnings and profits for 1936 and not only the $1,922,386.34 which remained at petitioner’s disposal after the International preferred purchase price to Schroder had been applied against it. The prior demand of Schroder that its International preferred should be redeemed did not have the effect of taking this amount out of petitioner’s earnings and profits. It must be regarded as first coming to petitioner as income and then going from petitiorfer to Schroder in payment of the redemption price on International preferred. The fact that petitioner had been committed to the redemption and that Schroder used the British Pacific proceeds as payment in redemption does not make the funds so used anything other than the income they would have been if transmitted by Schroder as banker to petitioner and by it in turn sent back to Schroder as shareholder in redemption of the shares.

That under proper circumstances an amount paid to shareholders in liquidation of their shares may be regarded as the proper subject of the dividends paid credit is established by Helvering v. Credit Alliance Corporation, 122 Fed. (2d) 361. But this can not serve the petitioner in this proceeding, because it is met by the preclusion of the statute, section 27 (g), that the amount of a preferential dividend may not be the subject of a credit. When the petitioner made its payment to Schroder for the 68,572 preferred shares, it made no similar payment to Manufacturing Co. in respect of its 8,000 preferred shares and had no commitment by resolution or otherwise to make such a payment either as a dividend or in redemption. It was purchasing Schroder’s 68,572 shares because Schroder required it to do so, and not because of any uniform plan to redeem all the shares of the same class outstanding. To the extent that the $57 a share paid to Schroder may have been a dividend under section 27 (f), it is not the proper subject of a credit because it was a preferential dividend under section 27 (g), May Hosiery Mills, Inc. v. Commissioner, 123 Fed. (2d) 858, affirming 42 B. T. A. 646; Forstner Chain Corporation, 45 B. T. A. 19.

There is also a lack of foundation for the credit under the contract provision of the statute, section 26 (c). That section provides for the credit if the taxpayer is prohibited from paying a dividend by the express terms of a contract relating to dividends. There is no such contract. The petitioner relies upon the correspondence between it and Schroder agreeing to the redemption; but construing-the letters and cablegrams most favorably for petitioner, they contain nothing prohibiting the payment of a. dividend. They simply agree to the purchase or redemption and fix the price at $57 a share to be paid by a debit against the British Pacific proceeds. They contain no reference to a dividend, either express or implied. Nor is there anything in the point that the terms of the preferred issue must be regarded as the terms of a contract. This contention was considered in Lehigh Structural Steel Co., 44 B. T. A. 422 (on review C. C. A., 3d Cir.), and it was held that the terms of shares are not contractual within the statutory meaning and do not support the credit. See also Belle-Vue Manufacturing Co., 43 B. T. A. 12; Oregon City Manufacturing Co., 43 B. T. A. 212.

There is, however, ground for credit of the $98,000 dividend paid upon the 8,000 shares of preferred held by the Manufacturing Co. After petitioner had. redeemed the 68,572 shares of preferred held by Schroder, the 8,000 of preferred held by Manufacturing Co. were the only shares of this class still outstanding. On February 17 and at the same time that it declared the $1.50 on the common, petitioner declared a dividend of the accumulated $12.25 a share on the outstanding preferred. This was a dividend of $98,000 which involved no preference among the holders of shares of that class. Not until March 5, 1936, were the 8,000 shares redeemed at $44.75 a share. No part of this was a dividend and the petitioner does not so contend. Its argument treats the $12.25 paid on each preferred share held by both Schroder and the Manufacturing Co. as the subject of a dividends, paid credit. The reason against this is, as has been stated, that so much as was paid to Schroder was what the statute calls a preferential dividend, the credit for which is expressly pror hibited. No such reason is, however, applicable to the dividend later paid on the remaining 8,000 shares held by Manufacturing Co.,, and therefore the credit for $98,000 may not be denied.

The Commissioner in the determination of deficiency held that petitioner, in surrendering Ambi-Budd shares having a cost basis of $86,704.54 for the purpose of enabling the corporation to transfer them to the syndicate participants for their acquiescence in the sale of the Adler shares, is entitled to the deduction of only $2,000 thereof, because the surrender “constituted a sale of a capital asset.” Thus the Commissioner has held that the petitioner sustained a loss (see Peabody Coal Co. v. United States, 8 Fed. Supp. 845), and relies upon the limitation of its deduction under section 117 (d), Revenue Act of 1936. This provides: “Losses from sales or exchanges of capital assets shall be allowed only to the extent of $2,000.” It is applicable to corporations, Inter-State Grocery Co., 39 B. T. A. 182. These shares clearly were “capital assets” as that term is defined in subdivision (b) of the section; and if they were sold or exchanged, the limitation applies. Much of the argument has been pointed at the question whether petitioner in fact sustained a loss, but that question has never been properly at issue, in view of the Commissioner’s recognition that a loss was sustained, the deduction of which is limited to $2,000; so the fact of loss may be adopted, and the decision limited to the question of its deductibility.

The $2,000 limit upon gain is only applicable to the gain from sale or exchange, Joseph A. Guthrie, 42 B. T. A. 696, and, since the statute speaks of “gain or loss”, it is likewise true that the deduction of loss is limited to the loss resulting from sale or exchange. In Fairbanks v. United States, 306 U. S. 436, it was held that the gain received by a bondholder in the redemption of his bond was not derived from a sale or exchange and was therefore not subject to the. capital gain tax, but to ordinary tax. See also Bingham v. Commissioner, 105 Fed. (2d) 971; Hale v. Helvering, 85 Fed. (2d) 819. There is nothing in the circumstances of the disposition of petitioner’s shares to give color to the idea that there was a sale or exchange. Petitioner received nothing, unless it be the possible effect upon its remaining shares. What the effect was does not appear; but there was nothing more tangible. It merely gave up its shares to the issuing corporation and received nothing. Since a taxpayer bondholder receiving money on redemption is held not to have disposed of his bond by sale or exchange, it is impossible consistently to say that a shareholder who surrenders his shares for no money, property, or rights is making a sale or exchange.

The undisputed loss is deductible to its full amount, and the Commissioner’s limitation of the deduction is reversed.

Other matters suggested in the petition have not been covered in the trial or the briefs, and are therefore regarded as abandoned.

Decision wiV be entered wider Rule 50.


source: Caselaw Access Project

author: Arnold :

license: Public Domain

text:
    G. Harold Gillan, Petitioner, v. Commissioner of Internal Revenue, Respondent. Lee E. Gillan, Petitioner, v. Commissioner of Internal Revenue, Respondent. Samuel W. Gillan, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 104149, 104150, 104151.
    Promulgated November 19, 1941.

      Harold J. Requartte, Esq., for the petitioners.

      William V. Grosswhite, Esq., for the respondent.
   OPINION.

Arnold :

These proceedings, consolidated for hearing and decision, involve deficiencies in unjust enrichment taxes for 1937 as follows: G. Harold Gillan, $506.98; Lee E. Gillan, $506.99; Samuel W. Gillan, $506.98. The issue is whether petitioners were unjustly enriched by reimbursements from vendors of amounts representing processing taxes.

The proceedings were submitted on a written stipulation of facts. We find the facts to be as stipulated, and hereinafter set forth the pertinent portions thereof.

The petitioners are individuals, with legal residences in York, Nebraska.

In the calendar year 1937 the Gillan Baking Co., a partnership of the three petitioners, received, as reimbursement for Federal excise tax burdens included in prices paid by it for wheat flour purchased and used to make bread and pastry in 1935, the following amounts: From the Omar Baking Co., $1,348.26; from the Crete Mills, $500.44; from the Pillsbury Mills, $52.50, total, $1,901.20.

The number of barrels of flour represented by these reimbursements was 1,931.5, weighing 196 pounds each.

The selling price of the articles produced from 1,931.5 barrels of flour was $49,852.02.

The cost of 1,931.5 barrels of flour, plus other ingredients entering into the articles, was $24,669.70. Said sum does not include the cost of bread and pastry wrappers, nor has it been reduced by the amount of reimbursements received.

During and after 1928 the Gillan Baking Co. was in the business of wholesale and retail baking. The five-year period 1928 to 1982, inclusive, is a sufficient base period for the purposes of these proceedings. During said period 17,760 barrels of flour, weighing 196 pounds each, were processed into bread and pastry. The selling price of the articles was $443,699.86. The cost of the flour and other ingredients entering into the articles was $201,260.89. This cost did not include bread and pastry wrappers.

During 1935 and the base period 1928-1932, inclusive, the Gillan Baking Co. incurred expenses as follows:

During 1935 Gillan Baking Co. used 2,888 barrels of flour weighing 196 pounds each.

During the entire year 1935 there existed in the trade territory of the petitioners a “price war” which adversely affected the sale prices of petitioners’ products. This “price war” was started by competitors of the petitioners.

Respondent determined that the distributive share of the processing tax reimbursements was taxable to each petitioner under 501 (a) of the Revenue Act of 1936.

Title III of the Revenue Act of 1936 imposes a tax of 80 percent on the unjust enrichment accruing to any person as a result of shifting to others the burden of Federal excise taxes. Three classifications of persons subject to the unjust enrichment tax are set up by said act, which may be briefly described as follows: (1) Persons who shifted the excise tax burden to their vendees but failed or refused to pay the excise tax; (2) persons who shifted the burden to their vendees but received reimbursement for the excise tax burden from their vendors; and (3) persons who shifted the burden to their vendees but received refunds or credits from the Government. Sec. 501 (a). Petitioners received reimbursement from their vendors and will be subject to the tax, if otherwise liable, under the provisions of section 501 (a) (2) of the Revenue Act of 1936.

The first question which arises under section 501 (a) (2) is the amount of net income that petitioners realized from the reimbursement. A statutory method for computing this net income is provided by section 501 (d). Said section provides that the “net income from reimbursement * * * shall be computed as follows: From the total payment * * * of reimbursement to the taxpayer from vendors for amounts representing Federal excise tax burdens included in prices paid by the taxpayer to such vendors . * * *, there shall be deducted the expenses and fees reasonably incurred in obtaining such reimbursement * * Under the stipulated facts the net income of these petitioners would be the entire amount of the reimbursements as no showing has been made that any expenses or fees were incurred in securing the reimbursement.

The second question under section 501 (a) (2) is the extent to which petitioners have shifted the burden of the excise tax to their vendees. For the purposes of determining the extent to which the taxpayer has shifted the burden to others, the statute provides that the amount of the shift shall be presumed to be an amount computed as follows (section 501 (e) (1)) :

(1) From tile selling price of the articles there shall be deducted the sum of (A) the cost of such articles plus (B) the average margin with respect to the quantity involved; * * *

Section 501 (e) (2) provides an alternative method of computation “If the taxpayer so elects by filing his return on such basis * * *.” However, we do not know whether the petitioners filed returns, or whether they elected to take advantage of the alternative computation, and therefore we must compute the extent of the shift, if any, under the provisions of section 501 (e) (1).

The presumption created by section 501 (e) is rebuttable by the express terms of section 501 (i), which permits either party to rebut the presumption “by proof of the actual extent to which the taxpayer shifted to others the burden of the Federal excise tax.” Subdivisions (1) and (2) of section 501 (i) indicate the wide scope and range of proof permitted in rebutting the presumption. For the purposes of this decision we need set forth in the margin only the provisions of section 501 (i) (l).

Petitioners contend that the cost of wrappers for their bread and pastries is a proper element of “the cost of such articles” to be considered in determining the extent to which they shifted the burden of the excise tax under section 501 (e). Respondent has refused to include the cost of bread and pastry wrappers as a part of the “cost of such articles” in making the computations under section 501 (e), and he concedes that this is the principal difference of opinion between the parties.

Section 501 (f) (2) of the 1936 Act defines the term “cost” in the case of articles manufactured or produced by a taxpayer as meaning “the cost to the taxpayer of materials entering into the articles; or, in the case of articles purchased by the taxpayer for resale, the price paid by him for such articles (reduced in both cases by the amount for which he is reimbursed by his vendor).” In our opinion the term “cost” as used in 501 (f) (2) and elsewhere in section 501 includes the cost of wrapping the bread and pastries. The finished article for sale to customers in the bread and pastries wrapped. The cost of wrappers was specifically found to be one of taxpayers’ costs of production under section 501 (i) (1) (B) in E. W. Stockton, 44 B. T. A. 514, and we see no reason for a different conclusion under section 501 (i) (1) (A).

A computation in accordance with the formula provided by section 501 (e) (1) (A), based upon the stipulated facts and our holding that “the cost of such articles” should include the cost of wrappers for bread and pastry, creates a presumption that the burden of the excise tax was not shifted by petitioners to others.

As rebuttal, in the event that we decide the presumption is with petitioners, respondent points to the stipulation that during the entire year 1935 a “price war” existed in petitioners’ territory which adversely affected the sale prices of petitioners’ products. We are asked to recognize as a matter of common knowledge that the effect of a price war is to reduce selling prices and consequently reduce the gross margin. Respondent submits that the price war rather than the excise tax explains the decrease in margin and that there was in fact a shifting of the entire burden of the tax. He contends that but for the price war petitioners would have made their ordinary profits and the presumption would have been what was actually true, namely, that petitioners shifted the entire burden of the tax.

We are not persuaded by respondent’s argument. Actually petitioners’ 1935 selling prices per barrel of flour increased over their selling prices for the base period by $0.8269 per barrel, but increased costs of production for the same periods more than offset the price increase. Wrapper costs alone increased by $0.6753 per barrel, while other costs, after deducting the amount reimbursed, increased by $0.4563 per barrel. We think that where increased items of cost are established, as they have been here by the stipulation, there is no reason to assume that other factors, such as the excise tax, intervened and caused petitioners to shift the tax burden and bear the burden of the increased costs of production. Under the statute the presumption is that petitioners did not shift the burden. We are not convinced by the rebuttal evidence that the presumption is overcome by the existence of a price war.

Decision will be entered under Bule 50.

       SBC. 501. TAX ON NET INCOME FROM CERTAIN SOURCES.
      (a) The following taxes shall be levied, collected, and paid for each taxable year (to addition to any other tax on net income), upon the net income of every person which arises from the sources specified below:
      *******
      (2) A tax equal to 80 per centum of the net income from reimbursement received by such person from his vendors of amounts representing Federal excise-tax burdens included to prices paid by such person to such vendors, to the extent that such net income does not exceed the amount of such Federal excise-tax burden which such person in turn shifted to his vendees.

       (i) Either the taxpayer or the Commissioner may rebut the presumption established by subsection (e) by proof of the actual extent to which the taxpayer shifted to others the burden of the Federal excise tax. Such proof may include, but shall not be limited to :
      (1) Proof that the change or lack of change in the margin was due to changes in factors other than the tax. Such factors shall include any clearly shown change (A) in the type or grade of article or materials, or (B) in costs of production. If the taxpayer asserts that the burden of the tax was borne by him while the burden of any other increased cost was shifted to others, the Commissioner shall determine, from the respective effective dates of the tax and of the other increase in cost as compared with the date of the change in margin, and from the general experience of the industry, whether the tax or the increase in other cost was shifted to others. If the Commissioner determines that the change in margin was due in part to the tax and in part to the increase in other cost, he shall apportion the change in margin between them.

       Computation under section 501 (e) (1)— Selling price of articles-$49, 852. 02
      Less:
      (A) Stipulated cost_,_$24, 669. 70
      Less reimbursement- 1, 901. 20
      $22, 768. 50
      Cost of wrappers (1,931.5 bbls.)- 3, 323. 30
      (B) Average margin of quantity involved ($12.6055 x 1,931.5)_ 24, 347. 52
      Total_$50, 439. 32
      $12.6055 is obtained by the following computation: ($443,699.86 — $219,825.47)-4-17,760. The $219,825.47 consists of $201,260.89 + $18,564.58.


author: Murdock:

text:
    Charles H. McGlue, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100465.
    Promulgated November 19, 1941.

      Edmund V. Maloney, Esq., for the petitioner.

      Davis Hashin, Esq., for the respondent.
   OPINION.

Murdock:

The Commissioner filed his answer in this proceeding on March 28, 1940, and in that answer, in paragraphs 8 and 9, made various allegations of fact to support his contention that a part of the deficiency for 1935 is due to fraud with intent to evade tax. No reply was filed on behalf of the petitioner within the time prescribed by the rules of the Board. On May 27, 1940, the Commissioner moved, under Bule 18 of the Board’s Buies of Practice, that the allegations of the answer contained in paragraphs 8 and 9 be deemed to be admitted. The petitioner was ordered to show cause, if any, why the prayer of that motion should not be granted. The petitioner ignored the order and the respondent’s motion was granted. The facts which were alleged in the respondent’s answer, and are thus deemed to be admitted, fully support the finding of fact that a part of the deficiency is due to fraud with intent to evade tax. Furthermore, the evidence introduced at the hearing shows that part of the deficiency is due to fraud with intent to evade tax.

The petitioner did not file a timely income tax return for 1935. He finally filed a return on July 1, 1939, in an attempt to avoid imprisonment under a sentence of the United States District Court of Massachusetts. No proof was offered to show that the penalty for delinquency under section 406 of the Bevenue Act of 1935 was improperly imposed, and the facts disclosed by the evidence show affirmatively that the maximum penalty of that section was properly imposed.

Several of the issues raised by the pleadings do not require decision by the Board. The Commissioner, in determining the deficiency, has taxed the petitioner on only one-half of a fee received from the New England Metal Culvert Co. The petitioner recognizes this and makes no further point about it. An assignment of error in regard to $1,000 allegedly paid as interest on a second mortgage on his residence, and another assignment relating to $165 allegedly paid as interest on loans, have been waived. There are no facts in the record which would support deductions under these two assignments even if they had not been waived.

The largest item in controversy is the $30,000 which the petitioner received during 1935 from the Lowell Gas Light Co. Closely related to this item is the $1,500 which the petitioner received during 1935 from the American Gas & Power Co. The petitioner admits that he received these amounts during 1935. He contends that only one-half of the $1,500 is taxable to him as income in 1935 because the other one-half belonged to Mullin. He says that he and Mullin had an agreement for equal division between them of all fees, less expenses, which should be received for services performed by the petitioner for Seymour and the various companies in which he was interested. He then argues that the work for which he was employed was still unfinished in 1935, the fees undetermined, and the $30,000 which he received was not fees but some kind of a trust fund to be used for expenses and disbursements in connection with further work to be done.

The petitioner testified that he had an agreement to divide fees with Mullin, but the question arises whether his testimony is always worthy of belief. The evidence shows that the payors of the $31,500 paid the money to the petitioner in consideration of his services and without any restriction or condition attached as to how he should use the money. They did not intend to pay him any additional fee and they have never since made any further payment to him. They did not expect the return of any of the money and none of it has ever been returned to them. The petitioner received the money and used it as he saw fit. He paid a part of it to some attorneys for the minority stockholders of the Lowell Gas Light Co. in effecting the settlement, and, apparently, he has spent all of the remainder as he desired for his own purposes. He reported the $1,500 received from the American Gas & Power Co. and $20,000 of the amount received from the Lowell Gas Light Co. as a part of his gross fées on the delinquent return which he filed on July 1,1939. He did not claim on that return that any part of the $21,500 belonged to Mullin. He attached a memorandum to that return in which he said he had received an additional $10,000 from the Lowell Gas Light Co. to be used by him in such way as he saw fit to bring about a tax abatement by reducing valuations of property of the Lowell Gas Light Co. He argued that this was an expense fund and not a fee, and he added, as an additional reason for not reporting it as income, that when the case was originally brought to him he had agreed to divide the fees equally with Mullin. Mullin never rendered any of the services for which the fees were paid and the payors had no understanding that Mullin was to render any of the service or to receive any of the fees. Mullin has never made any demand upon the petitioner for any part of the fees and the petitioner has never paid or offered to pay any part of those fees to Mullin. The allegation that there was an agreement to divide the fees is supported only by the testimony of the petitioner. The record contains no testimony from Mullin. The petitioner never tried to subpoena Mullin or to take his deposition. Mullin was subpoenaed by the respondent but failed to appear and advised the respondent that he was a member of the Legislature of Minnesota, which was then in session, and could not appear until later. We have found as a fact, after consideration of all of the evidence in the record, that there was no agreement between the petitioner and Mullin for sharing the fees. Moreover, since the petitioner received all of the $31,500 during 1935 and never paid any of it to Mullin or set any of it aside for Mullin, but, on the contrary, spent it or used it as he saw fit, it is taxable to him even if he should have paid a part to Mullin. We disagree with the statements in the petitioner’s brief that “The Petitioner has something to say about when money received by him becomes income. It is largely within his own knowledge and power to declare it or not, under the statutes.” This record does not show that the Commissioner erred in including the $31,500 in the gross income of the petitioner for 1935.

The Commissioner, in determining the deficiency, offset the $31,500 by $6,000 which he described as “paid to associates.” This represents money paid by the petitioner to counsel for the minority stockholders of the Lowell Gas Light Co. The petitioner says that he paid $14,000 in all to counsel for the minority stockholders. The difference of $8,000 has not been placed in issue by any assignment of error. We are unable to make a finding from the record that the $8,000 was paid during 1935 and the petitioner does not point out how this amount would be deductible under any particular provision of the revenue act. It is not clear that the amount would be deductible even if it had been paid in 1935. Obviously, no change in the determination of the Commissioner can be made based upon the $8,000.

The petitioner was entitled to one-half of a fee of $14,000 received in 1935 for services performed by McGlue & Eoche in connection with the Brooks estate. The petitioner does not deny that his share of the fee was $7,000 and he admits the receipt of $2,000 during 1935. He contends that the remaining $5,000 was not actually paid to him by Eoche until the latter part of January 1936, and, since he was on the cash receipts basis, that part was not income to him in 1935. The record, consisting of the testimony of the petitioner and Eoche and of some documentary evidence, does not clearly disclose whether a part or all of the $5,000 was paid to the petitioner or placed in trust for him in some way in 1935 or whether nothing was done as to the $5,000 during that year. The Commissioner has determined that all of the $7,000 was income to the petitioner for 1935 and any failure of proof works to the petitioner’s disadvantage. It is clear that Eoche received the $14,000 in 1935 and that he and the petitioner had associated themselves together for the purpose of this particular business. If they were partners, one-half of the fee would be taxable to the petitioner whether it was distributed to him or not. Even if they were not partners, receipt by Eoche, under the circumstances of their association, might be sufficient basis for taxing one-half of the fee to the petitioner in 1935. The petitioner knew in 1935 that Noche had received the money, he had the right to receive the amount from Eoche, and, so far as this record shows, he could have received it if he had demanded it. The determination of the Commissioner in regard to the $7,000 will not be disturbed.

The remaining contentions of the petitioner relate to alleged deductions. He attempts to relate two of these items to the Lowell Gas Light Co. income items. One is $3,000 which he says he paid to or for the use of John H. McAuliffe during 1935. Not only does the record fail to show just how much was paid for these purposes during 1935, but no amount would be deductible in any event under any provision of the revenue act. The petitioner argues, “Considering the quasi-politico-legal nature of the Petitioner’s profession, the money paid to McAuliffe, the money .spent for organization expenses for the Junior Democratic Crusaders, and sums spent for electing various officials to advance the interest of the Petitioner in Ms particular and specialized form of profession, was a perfectly proper business deduction to which the Petitioner is clearly entitled.” The petitioner described his idea as “sort of a political blitzkrieg” in which he would organize local branches of the Junior Democratic Crusaders in various communities throughout the state, not only to work in their own communities for the candidates favored by the petitioner and those in whom he was interested, but to be moved about the state into any community where he thought any candidate needed help. McAuliffe was to go all over the state in an effort to organize these local branches and to arrange meetings. The petitioner spoke at many of the meetings. He attempts to connect these political activities with his business by saying that the Lowell Gas Light Co. would be wanting its taxes reduced and abated in the several communities which it served, and he used this method of developing his prestige with the various elected officers with whom he might have to deal. Obviously, this work had no legitimate connection with the petitioner’s business of the practice of law. Not only are political contributions and campaign expenses not deductible, see David A. Reed, 13 B. T. A. 513, but expenditures for the purpose of exerting political influence are contrary to public policy and for that reason are not deductible. T. G. Nicholson, 38 B. T. A. 190; Easton Tractor & Equipment Co., 35 B. T. A. 189.

The petitioner contends that he is entitled to a deduction for 1935 on account of money which he advanced to Dobbins. He says that Dobbins was a real estate agent and appraiser whom he told to become familiar with the properties of the Lowell Gas Light Co. The petitioner’s idea was that, if he ever had to have the service of an appraiser in connection with the Lowell'Gas Light Co. tax abate-ments which he was seeking, this man would be available. The record does not show that Dobbins ever did anything or that any amount paid to Dobbins would have been deductible as an ordinary and necessary expense of the business of the petitioner under any circumstances. Furthermore, “I. G. U.’s” of Dobbins are in evidence showing that he acknowledged his indebtedness for the money advanced by the petitioner. The best evidence before us is that the advances were loans. The Commissioner did not err in disallowing the deduction claimed.

The petitioner claims the right to deduct $7,500 as a debt ascertained to be worthless and charged off in 1935 within the meaning of section 23 (k). He kept no books and actually made no charge-off relating to this item during 1935. He must rely upon the deduction claimed on his delinquent return to satisfy the statutory requirement of a charge-off. It is inconceivable that a deduction claimed for the first time on July 1, 1939, could satisfy the requirement of the statute that a debt be charged off during the taxable year, which was 1935. Furthermore, the petitioner made no ascertainment of the worthlessness of a debt during 1935. He says that the six-year period of limitation for collection of the debt expired in 1935. Six years from the date the agreement was entered into would, be July 11, 1934. The evidence shows that he knew prior to 1935 that the $7,500 would never be paid to him. Additional reasons could be given why he is not entitled to the deduction for 1935.

The petitioner contends that he is entitled to a reduction of $4,-237.25 for business expenses, which include office rent, light, postage, stationery, other office supplies, telephone, traveling expenses, and automobile expenses. The Commissioner allowed a deduction of $998.75 for “Office rent and other expenses.” We have found as a fact that the petitioner is entitled to a deduction for these expenses of $1,500. This is obviously an approximation. The petitioner kept no books and has no complete record of any of these items. He introduced in evidence a few checks which were helpful, but otherwise merely estimated the amount which he thought he must have expended. We have doubt whether some of the expenditures described by him were actually connected with his business and, as to those, we have tried to keep on the safe side by bearing most heavily upon the petitioner, who has the burden of proof. Cohan v. Commissioner, 39 Fed. (2d) 540. Also, it has been necessary in the case of some of the items to estimate the minimum of such expenses. A determination of this kind is, of course, unsatisfactory. But the inexactitude is of the petitioner’s own making and he must suffer the consequences.

The petitioner claims the right to deduct $600 as interest on a mortgage, and $400 as real estate taxes on .his residence at 9 Marlboro Street. Section 23 (b) allows a deduction for all interest paid within the taxable year on indebtedness. This means indebtedness of the petitioner. Section 23 (c) allows a deduction for taxes. This refers to taxes for which the petitioner was liable. These deductions are not allowed where the indebtedness is indebtedness of another and the property subject to the taxes is property of another. The evidence shows that the petitioner did not own the property at 9 Marlboro Street during 1935. He lost it through foreclosure in 1932 and did not reacquire it until 1936. He occupied the residence during 1935, and he actually paid the $1,000 of interest and taxes. It is not clear whether he paid that amount for the privilege of occupancy, as part of the cost of reacquiring the property, or just why he paid it. He was not paying interest on his own indebtedness or taxes on his own property and, therefore, is not entitled to the deductions claimed.

The petitioner paid a personal property tax on his automobile for the year 1935 in the amount of $16.70, which entitled him to a deduction of that amount under section 23 (c). He claims the right to deduct $330 under section 23 (o) for contributions. He testified that he paid $35 in 1935 to insert an advertisement in a magazine of the Newspaper Guild, $16.80 to insert an advertisement in a book of the Workingmen’s Club, of Massachusetts, and that he gave an additional amount to that club for a charitable purpose. The evidence does not show that either of these recipients was the kind of organization described in section 23 (o). The petitioner estimated that he gave $270 to two churches which he attended. Having in mind the unreliability of his testimony, we do not feel justified in making any speculation as to the amount which he contributed to the churches. The petitioner testified that he had some income during 1935 from sources other than those heretofore mentioned and on his delinquent return he reported some other income. The Commissioner has not made any claim for an increased deficiency, however, so these items need no further consideration.

Decision will be entered wnder Rule 50.


author: Harron:

text:
    Sterling Morton, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 99967, 100899.
    Promulgated November 21, 1941.

      B. M. Pricé, Esq., for the petitioner.

      F. F. Korell, Esq., for the respondent.
   OPINION.

Harron:

The sole question is whether petitioner was taxable in 1935, 1936, and 1937 on the net income of the trust which he created on December 24, 1934. Eespondent determined that “under the provisions” of the Revenue Acts of 1934 and 1936 the net income of the trust was includable in petitioner’s gross income for the taxable years 1935 and 1937. In his brief respondent contends, inter alia, that in all of the taxable years petitioner was taxable on the net income of the trust under section 22 (a) of the Revenue Acts of 1934 and 1936 and in support of such contention relies especially on Helvering v. Clifford, 309 U. S. 331.

The net income of the trust in the taxable years was, in our opinion, taxable to petitioner under the rule of the Clifford case. The basic question, as stated in the Clifford case, is whether “the grantor after the trust has been established may still be treated * * * as the owner of the corpus” and the answer to that question depends “on an analysis of the terms of the trust and all the circumstances attendant on its creation and operation.” With respect to the particular trust involved in the Clifford case, the Supreme Court stated that “the short duration of the trust, the fact that the wife was the beneficiary, and the retention of control over the corpus by [the grantor] all lead irresistibly to the conclusion that [the grantor] continued to be the .owner for purposes of section 22 (a).”

The rule of the Clifford case is applicable here, for the following reasons: During the life of the trust, the net income was to be paid, and was paid, to petitioner’s wife. Thus, the trust income was to remain within the grantor’s own family group. Petitioner retained substantially complete control over the corpus of the trust. See Frank G. Hoover, 42 B. T. A. 786; Comimssioner v. Buck, 120 Fed. (2d) 775; Commissioner v. Barbour, 122 Fed. (2d) 165. This is most evident 'from the terms of the trust reserving in petitioner or his agent the exclusive right to direct the sale, exchange, investment, and reinvestment of the trust corpus. As a matter of fact the trustee could not make any purchases, sales, investments, etc., except under the direction of petitioner or bis agent. Article 3 of the trust provides as follows:

* * * So long as said rigLt to control investments is retained by tbe Grantor, acting either himself or through his agent, no sales or exchanges or changes in investments of the trust estate shall be made by the Trustee, except on directions from the Grantor or his agent.

Petitioner could, at any time, by written notice, relinquish investment control to the trustee, but he could likewise, at any time, upon written notice, resume investment control. There is nothing in the record to show that, from the time of the creation of the trust up to the present time, petitioner has ever relinquished investment control, nor is there anything in the record to show what changes, if any, have ever been made in the investments of the trust. Further evidence of the extensive control retained by petitioner over the trust corpus is found in the fact that the trustee was under a duty to make payments out of principal of the trust on loans against any insurance policies belonging to the trust in accordance with the directions of the grantor or his agent. During the taxable years, as far as the record shows, petitioner did not transfer any insurance policies to the trust, but he could have done so if he so desired, and if he had obtained, in advance, any loans under the insurance policies, the trustee could be required to apply the trust corpus in payment of such loans. Also, petitioner could direct the trustee to pay out of trust income the compensation due any agent appointed by the grantor for his services.

The trust in question had a maximum limit of ten years. It could be terminated before the expiration of ten years either by the death of petitioner’s wife or by the joint action of petitioner and his wife. Upon the. termination of the trust the balance of the corpus was to revert to petitioner or to his estate after payment to petitioner’s wife or his daughter of any profits realized from the sale or exchange of any of the securities constituting the trust corpus. In the event of petitioner’s death prior to the termination of the trust, the trustee is given very extensive powers to make loans to petitioner’s estate and to purchase property from his estate. See Commissioner v. Berolzheimer, 116 Fed. (2d) 628; Helvering v. Elias, 122 Fed. (2d) 171; Snowden A. Fahnestock, 43 B. T. A. 569; Commissioner v. Barbour, supra. Cf. Commissioner v. Jonas, 122 Fed. (2d) 169.

The retention of control over the corpus by petitioner, the short duration of the trust, and the fact that the wife was the beneficiary, lead to the conclusion here that petitioner continued to be the owner of the trust corpus for purposes of section 22 (a). This case is controlled by the Clifford case. See Commissioner v. Barbour, supra; Helvering v. Elias, supra. It is held that petitioner is taxable on the entire net income of the trust in each of the taxable years.

The parties have stipulated that, in the event of decision in respondent’s favor, there are deficiencies in income tax in each of the taxable years in the stipulated amounts. Accordingly,

Decision will be entered in Docket No. 99967 that there is a deficiency in income tax of $83,908.90 for 1935, and in Docket No. 100899 that there are deficiencies m income tax of $1,988.87 for 1936 and $11,688.68 for 1937.


author: Turner:

text:
    The Bishop and Babcock Manufacturing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101587.
    Promulgated November 21, 1941.

      Robert W. Wheeler, Esq., for the petitioner.

      Stanley B. Pierson, Esq., for the respondent.
   OPINION.

Turner:

Petitioner contends that the stock certificates issued to its stockholders constitute written contracts executed by the corporation within the meaning of section 26 (c) (1) of the Revenue Act of 1936, that under the provisions of said contracts it could pay dividends on its prior preference and preferred stock, only from “surplus or net profits” and could not pay dividends on its common stock if it was in arrears in paying accumulated dividends on its prior preference and preferred stock, that at all times during 1937 it was in arrears in paying accumulated dividends on its prior preference and preferred stock, that at no time during 1937 did it have any “surplus or net profits” but on the contrary had a huge profit and loss deficit, and for that reason it could not distribute during the year 1937 any sum as a dividend without violating the provisions of a written contract, and it is accordingly entitled to the credit provided for in the act. On brief the respondent contends that the provisions contained in petitioner’s stock certificates were obviously meant to conform to the usual requirements of state law respecting the payment of dividends by deficit corporations, but he argues that, even if it be assumed that the stock certificates constituted a contract between petitioner and its stockholders, “it is not the contract required under section 26 (c) (1) to obtain the benefit of the credit.” On this latter point his argument is that the contract must be one executed by the corporation with a creditor, rather than mere stockholders.

We think this question has already been decided by the Supreme Court adversely to the petitioner’s contentions. In Helvering v. Northwest Steel Rolling Mills, Inc., 311 U. S. 46, the Supreme Court, in holding that the taxpayer was not entitled to the credit claimed under section 26 (c) (1), supra, had the following to say with respect to the proper interpretation of that provision:

That the language used in section 26 (c) (1) does not authorize a credit for statutorily prohibited dividends is further supported by a consideration of section 26 (e) (2). By this section, a credit is allowed to corporations contractually obligated to set earnings aside for the payment of debts. That this section referred to routine contracts dealing with ordinary debts and not to statutory obligations is obvious — yet the words used to indicate that the section had reference only to a “written contract executed by the corporation” are identical with those used in section 26 (e) (1). There is no reason to believe that Congress intended that a broader meaning be attached to these words as used in section 26 (e) (1) than attached to them under the necessary limitations of 26 (c) (2).

In a footnote to that case tbe Supreme Court stated:

(17) Respondent contended that the stock certificates satisfied the statutory requisites even if the charter did not; but what we have here said with respect to the charter applies equally to the certificates.

We followed that decision in Lehigh Structural Steel Co., 44 B. T. A. 422. There the petitioner’s amended charter provided for a sinking fund for the retirement of preferred stock, whereby a percentage of net earnings of the taxable year after payment of preferred dividends was to be set aside before any other dividends could be paid. The charter provision was set out in preferred stock certificates. In holding that petitioner was not entitled to the credit claimed under section 26 (c) (1), supra, we said that the charter provision was not a contract within the meaning of the act, and further that “It derives no greater strength from the fact that it is spread upon the share certificate, for this is but a reprint of the charter provision.” In Thibout & Walker Co., 42 B. T. A. 29, we said that the legislative history of section 26 (c) (1), supra, “indicates that Congress was trying to relieve situations in which a corporation had contracted with creditors to retain its earnings for their protection, but did not have in mind contracts such as this one, entered into by parties inside the corporate group to refrain from declaring dividends for their own mutual benefit.” Cf. Atlas Supply Co., 43 B. T. A. 324 and Trianon Hotel Co., 44 B. T. A. 1073.

Petitioner relies on several rulings of the respondent which seem to support its contention, I. T. 3139, Cumulative Bulletin 1937-2, p. Ill, and I. T. 3152, Cumulative Bulletin 1938-1, p. 155, and on Airtherm Manufacturing Co., 43 B. T. A. 736, and Holden & Reaume, Inc., decided under authority of Airtherm Manufacturing Co. by memorandum opinion. In Airtherm Manufacturing Co., supra, the petitioner issued preferred stock certificates in 1936 which contained a provision that dividends on preferred stock would be cumulative, beginning with the year commencing May 1, 1989, and paid annually, before any dividend would be set apart or paid on the common stock. In the course of our opinion and with respect to the preferred stock certificates, we said: “The petitioner was a party to the issuance of these certificates, and, consequently, if there is any express provision contained therein restricting the payment of dividends during the taxable year, it would appear to be such a contract as is provided for in section 26.” We then pointed out, however, that the restriction stated in the stock certificate did not become operative until May 1, 1939, and held that there was no restriction on the payment of dividends on the common stock in the taxable year ended March 31,1937. In addition to being dicta in Airtherm Manufacturing Co., supra, the above quoted statement is contrary to the conclusions reached in the cases previously cited and the holding here and should not be regarded as controlling.

The stock certificates issued by petitioner do not constitute contracts within the meaning of section 26 (c) (1), supra, and the respondent’s disallowance of the credit is sustained. Northwest Steel Rolling Mills, Inc., supra.

Reviewed by the Board.

Decision will be entered under Rule 50.

AettNdell dissents.

       SEC. 26. CREDITS OP CORPORATIONS.
      In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax—
      H( * * if. * * *
      (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. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account.


author: Van Fossan:

text:
    Saginaw & Manistee Lumber Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103302.
    Promulgated November 21, 1941.

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

      E. A. Tonjes, Esq., for the respondent.

       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—
      ****** *
      (e) Contracts Restricting Payment op Dividends.— ****** *
      (2) Disposition op profits of taxable year, — An amount equal to the portion of the earnings and profits of the taxable year W'hich is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. For the purposes of this paragraph, a requirement to pay or set aside an amount equal to a percentage of earnings and profits shall be considered a requirement to pay or set aside such percentage of earnings and profits. As used in this paragraph, the word “debt” does not include a debt incurred after April 30, 1936.

   OPINION.

Van Fossan:

The petitioner contends that the amended mortgage indenture and other agreements among the several interested parties, as interpreted and carried out by the parties, constituted an “agreement expressly dealing with the disposition oí earnings and profits of the taxable year”, as provided by section 26 (c) (2) of the Revenue Act of 1936, citing G. B. R. Oil Corporation, 40 B. T. A. 738, and other cases. On this premise it is argued that all of petitioner’s receipts were required by contract to be used in payment of debts incurred prior to May 1, 1936. With greater vigor it is argued that at least to the extent of the payments into the sinking fund of $2.50 per thousand feet of lumber and logs shipped or used by petitioner it comes within the scope of the Board’s decision in Michigan, Silica Co., 41 B. T. A. 511, and thus is entitled to the credit contemplated by the cited section.

We disagree with the former and agree with the latter proposition. Although section 1 of article III of the mortgage, set out in the findings of fact, set up a sinking fund and required all moneys received by the trustees (with certain exceptions) to be paid thereto, this general requirement did not bind the petitioner to pay all receipts to the trustees. The fact that the parties interpreted the agreement as granting entire control of all receipts to Birkelund, who applied them to the retirement of bonds, does not satisfy the statute. Helvering v. Moloney Electric Co., 120 Fed. (2d) 617.

Petitioner’s obligation arose from section 3, which begins: “Payments shall be made in reduction of the principal indebtedness secured hereby in the amounts and at the times and in the method provided for in this section.” The section proceeded to obligate the mortgagor to pay $2.50 per thousand feet of logs and lumber used or sold. The funds so arising were to go to the trustee and be used toward liquidating the principal debt. Section 4 provided for release from the mortgage lien of property sold upon payment into the sinking fund of the agreed price. There is no evidence of any payments under this provision. In our opinion the provision for payments of $2.50 per thousand feet of lumber sold or used brings petitioner within section 26 (c) (2). G. B. R. Oil Corporation, supra; Michigan Silica Co., supra. This was a positive and express restriction,- requiring payment to the trustees and thus to the sinking fund to be used in discharge of a debt. It was entered into prior to May 1, 1936. Although the payment was not specified as to be made out of earnings and profits, we believe it comes within the reasoning of the Board in Michigan Silica Co., supra.

The respondent bases his argument largely on the assumption that the petitioner engaged in activities other than the lumber business and thus was not subject to the payments prescribed in article III, section 3, as amended. In its returns the petitioner listed as “other income” receipts from the company store and sales of electric power, as well as the sale of scrap iron, box wood, etc. The record shows that such items were offset by appropriate deductions in the general operating expense account and do not reflect true items of income.

The activities in which the respondent alleges the petitioner engaged were only incidental to its primary lumber business. The running of the company store obviously was a necessary operation and the generation of electric power was only a byproduct of the business. All of the property of petitioner was comprehended in the agreements of January 8, 1936, and necessarily was the source of any so-called “income” which the two departments of its business might produce.

From the foregoing it follows that for the years 1936 and 1937 the petitioner is entitled to a credit as provided in section 26 (c) (2), limited in amount to the sums paid in each year pursuant to article III, section 3, as amended.

Beviewed by the Board.

Decision will be entered under Buie SO.


text:
    Estate of Charles C. Ingalls, Deceased, W. E. Clark and Sterling Newell, Co-Executors, Petitioners, v. Commissioner of Internal Revenue, Respondent. Lewis Ingalls, Petitioner, v. Commissioner of Internal Revenue, Respondent. Robert Ingalls, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 101717, 101718, 101719.
    Promulgated November 21, 1941.

      William A. Sout7morth, Esg., for the petitioners.

      W. W. Kerr, Esq., for the respondent.
   OPINION.

Turner:

In their petitions, petitioners Lewis and Robert Ingalls raised no question as to whether they, are transferees of the estate. At the hearing they admitted liability as transferees for the deficiency determined against the estate in event it is finally determined that the estate is liable for a deficiency. Consequently, the only questions in controversy relate to the correctness of the respondent’s determination with respect to the estate.

Relying on the provisions of sections 115 (c) and 117 (a) (2) and (b) of the Revenue Act of 1938 and the fact that the preferred stock in the Ingalls Stone Co. had been held by the estate for more than ten years, the petitioners contend that only 50 percent of the gain realized on the redemption of the stock should be taken into account in the computation of the estate’s net income.

The Revenue Act of 1938 provides as follows:

SEO. 115. DISTRIBUTION BY CORPORATIONS.
* ***** *
(c) Distributions in Liquidation. — Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Despite the provisions of section 117, the gain so recognized shall be considered as a short-term capital gain, except in the case of amounts distributed in complete liquidation. * * *
SEO. 117. CAPITAL GAINS AND LOSSES.
(a) Deetnittons. — As used in this title—
*******
(2) Short-term capital gain. — The term “short-term capital gain” means gain from the sale or exchange of a capital asset held for not more than 18 months, if and to the extent such gain is taken into account in computing net income;
*******
(4) Long-term capital gain. — The term “long-term capital gain” means gain from the sale or exchange of a capital asset held for more than 18 months, if and to the extent such gain is taken into account in computing net income;
****** *
(b) Peecentage taken into account. — In the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net income:
100 per centum if the capital asset has been held for not more than 18 months;
66% per centum if the capital asset has been held for more than 18 months but not for more than 24 months;
50 per centum if the capital asset has been held for more than 24 months.

Petitioners concede that tlie amount received by the estate on the redemption of the preferred stock in the Ingalls Stone Co. constituted a distribution in partial liquidation of a corporation within the meaning of the provisions of section 115 (c) and also that under those provisions the gain realized by the estate on the stock redemption constituted short-term capital gain. However, relying on the absence of any provision in section 115 (c) specifying the percentage of gain that is to be taken into account in computing net income, petitioners contend that the mere characterization by section 115 (c) of the gain here in controversy as short-term capital gain does not determine what percentage of the amount thereof is to be taken into account in computing net income. They contend that that question is determined solely by the provisions of section 117 (b), which are the only provisions specifying the percentages of gain that are to be taken into account in computing net income, and that the percentages specified therein are predicated solely upon the period for which the taxpayer has held the asset from which the gain arises and not upon whether the asset is characterized by the act as short-term capital gain or long-term capital gain.

The distribution made to the estate by Ingalls Stone Co. in November 1938 clearly was not in complete liquidation of the corporation and therefore does not fall within the exception contained in the last sentence of the above quoted portion of section 115 (c). Under these circumstances it is our opinion that by the provisions of section 115 (c) Congress has definitely provided that, despite anything to the contrary in section 117, gain such as is involved here is to be considered as short-term capital gain and that it is to be so considered even though the stock from which the gain arises actually was held by the estate for a longer period than the holding period stated in the definition of short-term capital gain as contained in section 117 (a) (2). Since such gain must be considered as short-term capital gain under section 115 (c) and short-term gain is defined by section 117 (a) (2) as gain resulting from the sale or exchange of a capital asset held for not more than 18 months, it follows by the terms of section 117 (b) that such gain must be treated for income tax purposes in the same manner as gain resulting from an asset held for not more than 18 months and that 100 percent thereof is to be taken into account. To grant the construction sought by the petitioners would render meaningless the provision of section 115 (c) to the effect that gain resulting from partial liquidation of a corporation shall be considered as “short-term capital gain.” The language of the statute will not permit such a construction.

The petitioners contend that under the provisions of sections 28 (g) and 117 (b) the estate is entitled to take into account in computing net income 50 percent of the loss of $1,338.33 or $666.67 sustained on the sale of stock in the Citizens National Bank to the Ingalls Stone Co. The respondent’s position'is that the deduction of such amount is not allowable under the provisions of section 24 (b) (1) of the act.

It is to be noted from the provisions of section 24 (b) (1) that “no deduction” is to be allowed “in any case” in respect of losses from sales or exchanges of property between the parties specified in paragraphs (A), (B), (C), (D), (E), or (F). Here the sale was made by an estate to a corporation more than 50 per centum of the stock of which was owned by the estate. None of the provisions referred to specifically deny deduction by an estate of a loss so sustained and the parties have narrowed the issue to the applicability of section 24 (b) (1) (B), which is to the effect that no deduction shall-be allowed in respect of losses resulting from the sale of property between “an individual and a corporation more than 50 per centum in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual”, the respondent contending that for the purposes of that section the estate must be regarded as an individual and the petitioners contending to the contrary. The word estate is not defined in the act. 'In section 901 of Title VI — General Provisions, the term “person” is defined to mean “an individual, a trust or estate, a partnership, or a corporation”, thereby indicating a recognition of difference between an individual and an estate. Section 24 (b) (2) of the Revenue Act of 1938 was obviously inserted to make clear what was meant by the words “directly or indirectly” as used in section 24 (b) (1) and as indicating the parties owning the said property and participating in the sale or exchange thereof. In paragraph (A) of section 24 (b) (2) the statute states that “stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust, shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries.” From that provision it thus appears that for the purpose of applying section 24 (b) (1) the stock sold by the estate of Charles C. Ingalls to the Ingalls Stone Co. is to be regarded as having "been owned by the beneficiaries of the estate and by them sold to the Ingalls Stone Co. It is to be noted, however, that the stock must “be considered as being owned proportionately” by the beneficiaries of the estate and in the instant case the petition and answer show that the estate had four distributees. It would seem therefore that under the facts in this case it may not be said that the sale occurred between “<m individual and a corporation more than 50 per centum in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual(Emphasis supplied.) The vendor here being an estate, section 24 (b) (2) (A) is applied to determine the indirect owners of the stock sold and it is found that the owners were the beneficiaries of the estate, were four in number, and owned the stock proportionately. Accordingly the stock was sold not by “an individual”, but by a group of individuals, and, further, no “such individual” owned “more than 50 percentum in value of the outstanding stock” of the purchasing corporation. Section 24 (b) (1) does not therefore prohibit the deduction of the loss in question and the second issue is determined for the petitioners.

The respondent makes no claim that the stock in question was owned or sold by a family or any member thereof, nor does he suggest or claim that the distributees of the estate were or may have been members of a family within the meaning of the statute. We do not therefore consider or decide whether the statute would require a different result in a case where there is a claim that a family relationship does or may exist between the beneficiaries of the estate making the sale.

Reviewed by the Board.

Decision will be entered under Rule 50.

Opper dissents on the second point.

       SEC. 23. deductions FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:
      *******
      (g) Capital Losses.—
      (1) Limitation. — Losses from sales or exchanges of capital assets shall be allowed only to the extent provided in section 117. •
      *******

       SEC. 24. ITEMS NOT DEDUCTIBLE.
      *******
      (b) Losses From Sales or Exchanges op Property.—
      (1) Losses disallowed. — In computing net income no deduction shall in any case be allowed in respect of losses from sales or exchanges of property, directly or indirectly—
      (A) Between members of a family, as defined in paragraph (2) (D) ;
      (B) Except in the case of distributions in liquidation, between an individual and a corporation more than 50 per centum in value of the outstanding stock of which is owned directly or indirectly, by or for such individual;
      (C) Except in the case of distributions in liquidation, between two corporations more than 50 per centum in value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same individual, if either one of such corporations, with respect to the taxable year of the corporation preceding the date of the sale or exchange was, under the law' applicable to such taxable year, a personal holding company or a foreign personal holding company;
      (D) Between a grantor and a fiduciary of any trust;
      (E) Between the fiduciary of a trust and the fiduciary of another trust, if the same person is a grantor with respect to each trust; or
      (E) Between a fiduciary of a trust and a beneficiary of such trust.

       (2) Stock ownership., family and partnership rdle. — For the purposes of determining, in applying paragraph (1), the ownership of Btock—
      (A) Stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust, shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries;
      (B) An individual shall be considered as owning the stock owned, directly or indirectly, by or for his family ;
      (C) An individual owning (otherwise than by the application of subparagraph (B)) any stock in a corporation shall be considered as owning the stock owned, directly or indirectly, by or for his partner ;
      (D) The family of an individual shall include only his brothers and sisters (whether by the whole or half blood) spouse, ancestors, and lineal descendants; and
      (E) Constructive ownership as actual ownership. — Stock constructively owned by a person by reason of the application of subparagraph (A) shall, for the purpose of applying subparagraph (A), (B), or (C), be treated as actually owned by such person, but stock constructively owned by an individual by reason of the application of subparagraph (B) or (C) shall not be treated as owned by him for the purpose of again applying either of such subparagraphs in order to make another the constructive owner of such stock.