author: Van Fossan :

text:
    Karl B. Segall, Transferee, Petitioner, v. Commissioner of Internal Revenue, Respondent. Walter F. Tant, Transferee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 82397, 82434.
    Promulgated July 12, 1938.

      T. 8. Forward, Esq., and Don M. Harlan, Esq., for the petitioners.

      Chester A. Gwinn, Esq., for the respondent.
   OPINION.

Van Fossan :

Two issues are presented and argued by the parties: (1) Did the transactions pursuant to the agreement of October 2, 1931, between the Timken-Detroit Co. and Silent Automatic Corporation accomplish a tax-free reorganization as provided in section 112 (b) (4) and (d) (1) of the Kevenue Act of 1928 or 1932, and (2) was the transaction completed and the profit, if any, taxable in 1931 or 1932?

The general principles governing reorganizations have been considered in many cases and need not be discussed at length. There must be a plan of reorganization. There must remain in the trans-feror or its stockholders a real, material, and substantial continuity of interest in the property transferred. It is necessary in certain cases also to determine whether the consideration paid consists of cash and “securities” or cash and “other property.”

The respondent’s' position here is that the transfer of the assets of Silent Automatic for cash of $760,000, a promissory note of $100,-000 and gold debenture notes of a face value of $1,021,700 (fair market value $920,000) did not effect a reorganization because the debenture notes did not represent the retention of a definite and material continuity of interest in the property transferred. He further urges that the debenture notes were not “securities” within the meaning of section 112 (b) (4), but are “other property” within the meaning of section 112 (d).

The petitioners contend that the debenture notes evidenced a definite, substantial and continuing interest of the transferor in the property transferred and were “securities” under the statute.

We disagree with both of respondent’s contentions. The agreement of October 2, 1931, clearly contemplated a plan of reorganization. In exchange for the Silent Automatic assets Timken agreed to give to the former company “cash and securities” aggregating $2,100,000 (later reduced by adjustment). The cash and debenture notes were distributed to the stockholders as provided in section 112 (d) (1). The vital question is whether or not the ownership of the debentures vested in the Silent Automatic or its stockholders a definite, material and continuing interest in Timken and the property of Silent Automatic transferred to it.

On consideration of the nature of the debentures, the obligations assumed by Timken under the indenture creating them, and the rights conferred on the trustee for the benefit and in protection of the rights of the debenture holders, we are of the opinion that through the debentures the holders retained a definite, material, and continuing interest in the property transferred. Though they were for relatively short terms, the interest conferred by them on their holders was very real.

The debentures were created under a formal indenture. They were unconditionally guaranteed by the Timken-Detroit Axle Co. Under the indenture Timken, undertook to maintain the property in good repair; to make necessary renewals, replacements, and improvements; to keep it insured to full value permitted; to pay and discharge all taxes, assessments, and legal charges, or, if contesting such taxes or charges, to indemnify the trustee for ultimate payment; to furnish a complete annual audit by auditors approved by the trustee; to permit inspection by the trustee. In case of default by the company as to any of the maintenance or insurance provisions, or in the payment of charges or compliance with legal orders, the trustee was empowered to perform the same, make advances therefor, and collect the sums so expended with interest from the company. Furthermore, the company agreed to maintain its corporate life; to provide an office for the payment of principal and interest of the debentures; and to replace the same if any debentures were lost or mutilated.

Respondent emphasizes the fact that the debentures were what he calls “short-term” and from this argues that they fall within the decision of the Supreme Court in Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462, in which Cortland Specialty Co. v. Commissioner., 60 Fed. (2d) 937, was cited with approval. In each of these cases the Court held the facts did not spell a reorganization. The transactions involved were held to be sales of assets, not reorganizations. The part of the consideration in question consisted of short term purchase money notes, a very different type of obligation from that here involved.

Although the Supreme Court has never ruled on a transaction involving solely bonds, or bonds and cash, as consideration for the transfer of stock or assets, the Board has held such a transaction to constitute a reorganization. Kaspare Cohn Co., Ltd., 35 B. T. A. 646; Frederick L. Leckie, 37 B. T. A. 252; Frances M. Averill, 37 B. T. A. 485.

That bonds are “securities” was held in Helvering v. Watts, 296 U. S. 387. In Burnham v. Commissioner, 86 Fed. (2d) 776; certiorari denied, 300 U. S. 683, the Court held that unsecured promissory notes due on or before 10 years after date fall within the term “securities.” We believe the debenture notes here involved should be likewise classified. The fact that they were accepted for filing by the Michigan Securities Commission is persuasive. They differed widely in character from the $100,000 note given at the same time, or the purchase money notes involved in the Pinellas and Cortland Specialty cases. The debentures were “securities” rather than “other property” referred to in the statute.

The conclusion we have indicated above is not in conflict with the holding of the Board in George D. Graham, 37 B. T. A. 623. Though the Board there characterized the debentures as “short-term of about six and one-half years,” it is noted that the debentures were in fact called within a year. Moreover, as observed in the opinion, the debentures were not the securities of the company which acquired the assets but those of a third party not a party to the claimed reorganization. We have noted, supra, the.many provisions of the indenture in the instant cases which created a continuing interest in the property transferred. In the Graham case obviously no such condition existed.

On the facts here present we hold that a reorganization was effected. Since the proceeds thereof were distributed, the corporation incurred no tax and petitioners are not liable as transferees.

In view of our decision, it is unnecessary to discuss the remaining issue.

Reviewed by the Board.

Decisions of no transferee liability will be entered.

       SEC. 112. RECOGNITION OB' GAIN OR LOSS.
      (a) General rule. — upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.
      (b) Exchanges solely in Mnd.—
      *******
      (4) Same — Gakn op corporation. — No gain or loss shall be recognized if a corporation a party to a reorganization exchanges properly, in pursuant of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization.
      * * *****
      (d) Same — Gain of corporation. — If an exchange would be within the provisions of subsection (b) (4) of this section if it were not for the fact that the property received in exchange consists not only of stock or securities permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then—
      (1) If the corporation receiving such other property or money distributes it in pursuance of the plan of reorganization, no gain to the corporation shall be recognized from the exchange, * * *.
      [The pertinent provisions of the Revenue Acts of 1928 and 1932 are identical.]


source: Caselaw Access Project

author: Van Fossan:

license: Public Domain

text:
    Florence Scofield Stone and Grace Scofield Bonnet, as Executrices under the Last Will and Testament of Marion Scofield, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 80628.
    Promulgated July 13, 1938.

      John M. Bovey, Esq., for the petitioners.

      Irving M. Tullar, Esq., for the respondent.
   OPINION.

Van Fossan:

As heretofore indicated, the three issues presented by this case are (1) whether there should be included in the decedent’s gross estate a proportionate interest in a certain irrevocable trust fund of which decedent was one of the creators; (2) whether there should be deducted from the gross estate the sum of $1,000 paid by petitioners as executrices of the estate pursuant to a promise made by the decedent prior to her death to aid a scholarship fund in a private school; and (3) whether or not interest accrued, subsequent to decedent’s death, on a Federal income tax deficiency and paid by petitioners as executrices of the estate, might be deducted as an expense of the estate.

It is conceded by the stipulation of facts that the transfer in question is not a gift in contemplation of death. Kespondent, however, urges that it is “a transfer, by trust * * * intended to take effect in possession or enjoyment at or after * * * death.” (Sec. 302 (c), Bevenue Act of 1926.)

The parties to this proceeding are agreed that there is no dispute as to the facts, but rest their entire respective contentions upon the conclusion of law to be reached on the facts.

The law is now well established that there should not be included in the gross estate of the decedent property that has been transferred in trust by an absolute conveyance, with the provision, in the terms of the grant, that the property was to revert to the donor or creator of the trust in the event the beneficiary predeceased him. The landmark case on this principle is Helvering v. St. Louis Union Trust Co., 296 U. S. 39. In that case it was held that the event which gives rise to a transfer tax is the death of the decedent, with the resulting 'transfer of his estate by will or intestacy law, and that a transfer inter vivos to be taxable as a “transfer intended to take effect in possession or enjoyment at or after death” must have been made as a substitute for disposition by will or under intestacy law. The Court specifically held that the provisions of an irrevocable trust estate that the estate should revert to the grantor in case the beneficiary predeceased him, where the latter contingency did not occur, created a situation wherein the corpus was not taxable as a “transfer intended to take effect in possession or enjoyment at or after death.”

The reasoning of the Court clearly appears from the following quotation :

If, therefore, no interest in the property involved in a given case pass “from the possession, enjoyment, or control of the donor at his death,” there is no interest with respect to which the decedent has created a trust intended to take effect in possession or enjoyment at or after his death. The grantor here, by the trust instrument, left in himself no power to resume ownership, possession, or enjoyment, except upon a contingency in the nature of a condition subsequent, the occurrence of which was entirely fortuitous so far as any control, design, or volition on his part was concerned. After the execution of the trust he held no right in the trust estate which in any sense was the subject of testamentary disposition. His death passed no interest to any of the beneficiaries of the trust, and enlarged none beyond what was conveyed by the indenture. His death simply put an end to what, at best, was a mere possibility of a reverter by extinguishing it; that is to say, by converting what was merely possible into an utter impossibility. This is well stated by the court below, 75 F. (2d) 416, at page 418: “It was only in the case of the happening of certain contingencies over which he had no control that the property would revert to him. One of these contingencies was the death of his daughter prior to his death, while the trust still continued; and the second was a termination by the trustees of the trust during the lifetime of the grantor. Neither of these contingencies occurred, and there was, during the decedent’s lifetime, nothing more than a possibility that either would occur. In no proper sense was there an enlargement of the interests of the beneficiaries of the trust resulting from the death of the decedent. That event merely changed the possibility that the property would revert to him into an impossibility.”

It is our opinion that the present case is identical in principle with the case last discussed. There, as here, the trust was irrevocable in so far as the donor was concerned and there, as here, the donor of the trust predeceased the beneficiary. The conclusion necessarily follows that in the case at bar there was merely a possibility of reverter with interest passing by reason of the donor’s death. The control and disposition of the property were to be governed by the terms and operation of the trust and were not affected by the donor’s death.

The respondent’s contention is that by the terms of the trust instrument the decedent and her two sisters, as grantors, parted only with a limited life interest in the income of the trust res not to exceed $5,000 a year in favor of the beneficiary, and retained for themselves the remainder interest not only in the income in excess of $5,000 per year but also in the trust property. The facts do not disclose this to be the true situation and we do not accede to the respondent’s contention that the decedent had a remainder interest in one-third of the trust property, plus the interest remaining after the grant of specified income of the property to the beneficiary for life. Her interest, as we have said, was a mere possibility of reverter should the life beneficiary predecease her.

Respondent relies strongly upon the case of Klein v. United States, 283 U. S. 231. This is the same case relied upon by the Government in Helvering v. St. Louis Union Trust Co., supra. In the last cited case the Court at some length drew a distinction which is equally applicable in the present case. The Court said:

There [in the Klein case] the grantor, 15 months prior to his wife’s death, conveyed to his wife by deed a life estate in certain lands. But in the event that she survived the grantor, “and in that case only,” she was to take the lands in fee simple. The effect of this deed, we held, was that only a life estate was vested, the remainder being retained by the grantor; and whether that should ever become vested in the grantee depended upon the condition precedent that the grantor die during the life of the grantee. The grantor having died first, his death clearly effected a transmission of the larger estate to the grantee. But here the grantor parted with the title and all beneficial interest in the property, retaining no right with respect to it which would pass to any one as a result of his death. Unlike the Klein Case, where the death was the generating source of the title, here, as the court below said, the trust instrument and not the death was the generating source. The death did not transmit the possibility, but destroyed it.

Respondent also relied upon Commissioner v. Schwartz, 74 Fed. (2d) 712, which was a case decided by the Second Circuit Court of Appeals prior to the decision of the Supreme Court in Helvering v. St. Louis Union Trust Co., supra. The Second Circuit Court of Appeals has since that time decided, per curiam, Brooks v. Commissioner, 87 Fed. (2d) 1000, affirming the Board on the authority of Helvering v. St. Louis Union Trust Co., supra. Commissioner v. Schwartz, supra, therefore must be rejected as authority.

The principle established in Helvering v. St. Louis Union Trust Co., supra, has been applied frequently by the Supreme Court, the intermediate courts, and this Board.

Respondent’s arguments, based on the retention by the decedent of a share in any possible excess income, are not well founded. The trust indenture was made in November 1927, prior to the amendment of the law by the Joint Resolution of Congress of March 5, 1981. Helvering v. Helmholz, 296 U. S. 93; Hassett v. Welch, 303 U. S. 303. Moreover, by the stipulated facts, the provision in the instant trust agreement for the payment to the grantors of any trust income in excess of $5,000 per annum was but doing lip service to the New York law prohibiting an accumulation of income in such trusts. And in addition, the nature of the trust investments is such that the probability of excess trust income is remote to the degree of being impossible.

The second issue arises by reason of respondent’s denial of a deduction of $1,000 paid by petitioners to the Bonita School. The basis for this denial was that it was not shown that the pledge was contracted or incurred for a full and adequate consideration in money or money’s worth.

By the stipulated facts, the decedent agreed with petitioner Grace Scofield Bonnet to pay $1,000 of the $2,400 scholarship fund if petitioner Grace Scofield Bonnet agreed to pay the balance of $1,400, which petitioner Grace Scofield Bonnet agreed to do.

The Board has many times had. similar contentions before it and has consistently held that the monetary pledges of others constituted an adequate and full consideration within the meaning of the statute. Jeptha H. Wade, Jr., et al., Executors, 21 B. T. A. 339; Maude L. Porter et al., Executors, 34 B. T. A. 798; aff'd., 92 Fed. (2d) 426; Robert A. Taft, Executor, 33 B. T. A. 671; Margaret Day et al., Executors, 34 B. T. A. 11, affirmed per curiam, 91 Fed. (2d) 1009, and reversed on other issues, 92 Fed. (2d) 179; Commissioner v. Bryn Mawr Trust Co., 87 Fed. (2d) 607, affirming B. T. A. memorandum opinion; Edna F. Hayes et al., Executors, 34 B. T. A. 808; Frances Plumer McIlhenny et al., Executors, 22 B. T. A. 1093; David A. Reed et al., Executors, 24 B. T. A. 166. We, therefore, hold that the $1,000 paid by petitioners toward the sum of $2,400 to be used for scholarship purposes in connection with the Bonita School is deductible from the gross estate.

As stated in the findings of fact, after the filing of the petition in this case, petitioners, as executrices of the estate, made expenditures totaling $1,174.15 in connection with the litigation and settlement of decedent’s 1930 and 1931 income tax. By the stipulation, respondent concedes that this sum should be allowed as a deduction from the gross estate for the purpose of computing the net estate and the tax thereon. This adjustment will be made under Kule 50.

The remaining issue concerns petitioners’ contention that there should be allowed as a deduction from the gross estate the amount of interest paid respondent on a deficiency in income tax due by decedent, which interest accrued and was paid, together with the additional tax, after decedent’s death.

We are unable to find a basis for allowing this deduction from the gross estate. Petitioners’ contention is that the deduction should be permitted, either as a debt or as an administration expense. With this we do not agree. The court in Old Colony Trust Co. v. United States, 15 Fed. Supp. 417, was confronted with this same question and said :

As to tlie item of $348,136.16 which represents interest on the income tax due from the decedent which accrued after his death, I can find no authority for deducting this from the gross estate of the decedent subject to federal estate tax. Section 302 of the Revenue Act of 1924 (43 Stat. 304) provides that: “The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated.”
At the decedent’s death, there was due the United States the sum of $1,680,-395.67 as principal and $51,777.47 as interest on that principal. As a debt of the estate to the United States, both principal and interest accruing at that time were proper deductions. Interest accruing after the date of the death, however meritorious may have seemed the contention that the estate was not liable to such income tax, was not within the meaning of the act prescribing the time and method of computing the estate of the deceased person for the purposes of estate taxes. To allow the deduction of interest accruing while resisting a valid claim against the estate might result in defeating the very purpose of the Estate Tax Law. * * *

Nor is tlie sum in question conceivably an administration expense. We, therefore, hold for respondent on this issue.

Decision will he entered wider Bule 50.

         Bingham v. United States, 296 U. S. 211; Becker v. St. Louis Union Trust Co., 296 U. S. 48; Bullard v. Commissioner, 90 Fed. (2d) 144 (cf. Welch v. Hassett, 90 Fed. (2d) 833); Walker v. United States, 83 Fed. (2d) 103; Cross v. Nee, 18 Fed. Supp. 589; Smith v. United States, 10 Fed. Supp. 397; Myers v. Magruder, 15 Fed. Supp. 488; Estate of Waldo C. Bryant, 36 B. T. A. 669; Jeanette E. Rushmore, Executive, 36 B. T. A. 480; Daisy Christine Patterson, Executrix, 36 B. T. A. 407 (cf. Warren H. Corning, 36 B. T. A. 301) ; Frederick Davis Van Sicklen, 35 B. T. A. 306; Jacob Schneider, 35 B. T. A. 183; Anna Ball Kneeland et al., Executors, 34 B. T. A. 816. Cf. Stewart W. Bowers, Trustee, 34 B. T. A. 597; Mary Q. Hallock et al., Trustees, 34 B. T. A. 575; Guaranty Trust Co. of New York et al., Executors, 33 B. T. A. 1225.


author: TURNER:

text:
    Hariot Reynolds Schultz, et al., Executrices of the Estate of Marie B. Reynolds, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81060.
    Promulgated July 13, 1938.

      John A. Selby, Esq., for the petitioners.

      John W. Smith, Esq., for the respondent.
   OPINION.

TURNER:

In his notice of deficiency the respondent stated that the addition to the gross estate of the decedent in respect of the two contracts described in our findings of fact was made under the provisions of section 302 (c) of the Revenue Act of 1926, as amended by section 803 of the Revenue Act of 1932. The case was submitted and originally briefed by both parties solely on the question of applicability of section 302 (c). Subsequently, however, counsel for the parties were requested to consider the question as to whether or not the value of the two contracts at the decedent’s death was includable in the gross estate under section 302 (d) of the Revenue Act of 1926 by reason of certain of the provisions of the contracts designated as “Privileges and Conditions”, which provided for the surrender of the contracts for amounts equal to the principal sum stated and for loans thereon not exceeding such principal sums.

In the supplemental brief filed for the petitioners, it was contended that the contracts here are controlled by decisions in insurance cases wherein it has been held that in the absence of the reservation of a right to change the beneficiary, the insured, or owner, may not surrender the insurance contract for cash or obtain loans thereon without the consent of the beneficiary, or beneficiaries, even though the contract contains provision for loans and the surrender of the policy for cash, citing Edith Huggard Sharp et al., Executors, 30 B. T. A. 532; 33 B. T. A. 290; affirmed on this point, 91 Fed. (2d) 804; Levy’s Estate v. Commissioner, 65 Fed. (2d) 412; Helvering v. Parker, 84 Fed. (2d) 838; and Pennsylvania Co., etc. v. Commissioner, 19 Fed. (2d) 295. The respondent in his supplemental brief still contended for the application of section 302 (c), supra, and made no claim that section 302 (d), supra, was applicable.

The contracts herein, with the exception that they contain no reservation of the right to change the beneficiaries, are the same in all essential respects as the contract considered by us in Old Colony Trust Co. et al., Executors, 37 B. T. A. 435, and we there held that the contract under consideration was not a life insurance contract but an annuity contract. See also Chemical Bank & Trust Co. et al., Executors, 37 B. T. A. 535. It does not follow therefore that the decisions relied upon by the petitioners in respect of insurance policies are applicable to the contracts before us and that annuity contracts which contain loan and cash surrender privileges are not revocable within the meaning of section 302 (d), supra, even though the right to change the beneficiary is not reserved. Since these contracts may not be classified as insurance contracts, the answer to the question of revocability is to be found in the terms of the contracts themselves in the same manner as the revocability of grants to trusts or other transfers are determined in applying the provision of the statute under consideration.

While the contracts do make provision for their surrender for an amount equal to the principal sum and for loans to the annuitants in similar amounts, they also provide that the surrender for cash may be made “providing there is no legal restriction to the contrary” and that the loans may be made to the annuitants “upon proper assignment” of the contracts. The contracts contain no provision, or provisions, which specifically reserve to the decedent, alone or in conjunction with any specified individual or individuals, the right to revoke, alter, or amend the terms of the contracts. As we read the clauses mentioned, they were intended to bind Sun Life to pay the principal sum or to make the loans thereon, provided all of the parties having interests under the policies should agree to such surrender or to loans to the annuitants, rather than that they were intended as a reservation in the grantor of the right, alone or in conjunction with some person, to surrender the contracts for the principal sums designated or to procure loans to the extent of the cash surrender value. A right to revoke which requires consent of all the beneficiaries is not such a right of revocation as will bring the contracts within the terms of section 302 (d), supra. Helvering v. Helmholz, 296 U. S. 93. In view of the above, we do not consider it necessary to consider the fact that the rights of minors or unborn children might be involved.

As to the applicability of section 302 (c), supra, there is no showing or claim that the payment of the “premiums” was made in contemplation of death and it is well settled that a transfer, by trust or otherwise, made prior to March 3, 1931, whereby the grantor has retained for life or any period only the right to income from the property transferred, is not a transfer intended to take effect in possession or enjoyment at or after death. May v. Heiner, 281 U. S. 238; McCormick v. Burnet, 283 U. S. 784; Morsman v. Burnet, 283 U. S. 783; and Hassett v. Welch, 303 U. S. 303.

Decision will be entered for the petitioners.

       Sue. 302. The value of the gross estate of the decedent shall be determined by Including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
      *******
      (c) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after his death, or of which he has at any time made a transfer, by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom; except in case of a bona fide sale for an adequate and full consideration in money or money’s worth. * * *

       (d) To the extent of any interest therein of 'which the decedent has at any time made a transfer, by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power, either by the decedent alone or in conjunction with any person, to alter, amend, or revoke, or where the decedent relinquished any such power in contemplation of his death, except in case of a bona fide sale for an adequate and full consideration in money or money's worth. * * *


author: Hill: Smith,

text:
    Farmers Union Co-operative Oil Company, Nelson, Nebraska, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 83485.
    Promulgated July 13, 1938.

      Wilfred Wimmell, Esq., for the petitioner.

      James O. Maddox, Esq., for the respondent.
   OPINION.

Hill:

The sole question presented for determination is whether petitioner is exempt from the payment of income tax in the taxable year involved. The petitioner claims such exemption under the Revenue Act of 1932, section 103 (12) (b), which in pertinent part is as follows:

(12) Farmers’, fruit growers’, or like associations organized and operated on a co-operative basis * * *
(b) For tbe purpose of purchasing supplies and equipment for the use of members or other persons, and turning over such supplies and equipment to them at actual cost, plus necessary expenses. Exemption shall not be denied any such association because it has capital stock, if the dividend rate of such stock is fixed at not to exceed the legal rate of interest in the State of incorporation or 8 per centum per annum, whichever is greater, on the value of the consideration for which the stock was issued, and if substantially all such stock * * * is owned by producers who * * * purchase their supplies and equipment through the association; * * * 8110⅛ an association may * * * purchase supplies and equipment for nonmembers in an amount the value of which does not exceed the value of the supplies and equipment purchased for members, provided the value of the purchases made for persons who are neither members nor producers does not exceed 15 per centum of the value of all its purchases.

To constitute such, exempt status for petitioner all of the following facts must be established:

1. That it is a farmers’, fruit growers’, or like association organized and operated on a cooperative basis.

2. That it was organized and operated for the purpose of purchasing supplies and equipment for the use of its members or other persons, and turning over such supplies and equipment to them at actual cost, plus necessary expenses.

3. That its stock dividend rate is fixed at not to exceed the legal rate of interest in the state of incorporation or 8 per centum per annum, whichever is greater, on the value of the consideration for which the stock was issued.

4. That substantially all of the stock of petitioner was owned by producers who purchase their supplies and equipment through petitioner.

5. That the supplies and equipment purchased for nonmembers do not exceed in value the value of like purchases for members.

6. That the value of the purchases made for persons who are neither members nor producers does not exceed 15 percent of the value of all its purchases.

Our discussion of whether such requisite facts have been established will follow the numerical order of their statement.

1. The evidence shows that petitioner was a corporation organized by farmers under the cooperative laws of Nebraska and that its business operations consisted solely in buying petroleum products and selling them to any one desiring to purchase from it, whether members or nonmembers. To three of its shareholders sales of gasoline and other petroleum products were made on a nonprofit basis. These three shareholders were farmers’ cooperative organizations and sales were made to them at actual cost plus only 2 cents a gallon to cover expense of hauling such products from petitioner’s station or warehouse at Nelson to the purchasers. The sale prices to such patrons included none of the general necessary expenses of petitioner totaling $4,827.22. To four nonmember patrons sales were made on the same basis. These nonprofit sales totaled $4,434.11. To all other patrons, members and nonmembers alike, sales totaling $23',809.31 were made at regular commercial retail prices determined without regard to actual cost plus necessary expenses. These latter prices were intended to, and did, include a profit above actual cost plus necessary expenses.

Patronage dividends were paid or credited only to patrons of record to whom sales were made at regular retail prices, but only members received payment of such dividends. Nonmembers, even though credited therewith, did not receive payment of patronage dividends. A nonmember had to qualify for membership and pay $10 for a share of petitioner’s capital stock before he could receive payment of a patronage dividend credited to him. Moreover, it affirmatively appears that there were a number of nonmember patrons to whom patronage dividends were credited who could never qualify as members and, therefore, could never under any condition receive payment of such dividends. It also affirmatively appears that there was a considerable though unascertainable number of unknown nonmember patrons to whom patronage dividends were not, and could not be, credited or paid.

It therefore appears that three member and four nonmember patrons were preferred over all other patrons. The sales to them were at actual cost without adding thereto any amount to cover necessary expenses (except truckage), stock dividends, or reserves. All other member and recorded nonmember patrons purchased at competitive retail prices, fixed without regard to actüal cost plus necessary expenses, and received payment and credit, respectively, of patronage dividends out of profits remaining after actual costs, necessary expenses, stock dividends, and statutory reserves had been deducted from gross sales. All unrecorded patrons purchased at competitive retail prices and received neither payment nor credit of patronage dividends.

The preferred group of patrons realized a saving which was tantamount to a bonus on their purchases, measured by the proportionate share of the necessary general expenses of petitioner which they would have been required to pay had they purchased on a basis of actual cost plus necessary expenses. Their share of the necessary expenses was paid by the other patrons. Not only did this preferred group contribute nothing to petitioner’s profits or to defray its necessary expenses, but the three shareholders in that group received stock dividends out of petitioner’s profits from sales to other patrons at regular retail prices. The evidence negatives the fact that petitioner was operated on a cooperative basis, either as among its members alone, or as between its members and nonmembers.

2. We have found as a fact that petitioner was not operated in the taxable year for the purpose of purchasing supplies and equipment for the use of its members or other persons, and turning over such supplies and equipment to them at actual cost, plus necessary expenses. Our discussion in paragraph 1 next above is sufficient to show the correctness of our finding of fact referred to and reiterated in this paragraph.

3. Petitioner meets the requirements of statute as to the rate of stock dividends fixed.

4. All of the stock of petitioner was owned by producers, but the evidence fails to show that all of its shareholders purchased their supplies and equipment through petitioner.

5 and 6. The evidence shows that no specific purchases of supplies and equipment were made by petitioner either for members or nonmembers. The evidence merely shows that the value of supplies and equipment sold by petitioner to nonmembers was less than the value of such sales to members and that the value of such sales to persons who were neither members nor producers did not exceed 15 percent of the value of all its purchases.

We, therefore, conclude and hold that petitioner was not exempt from payment of income tax in the taxable year herein involved. The following cases support in principle our conclusion: Fruit Growers’ Supply Co., 21 B. T. A. 315; Central Co-operative Oil Association, 32 B. T. A. 359; Farmers Co-Operative Co. of Wohoo, Neb. v. United States, (Ct. Cls.), 23 Fed. Supp. 123.

In Fruit Growers Supply Co. and Central Co-Operative Co., supra, the deficiencies determined by the Commissioner were based only on that part of petitioner’s income which represented profits on sales to nonmembers and was not distributed to them. The Board in both cases upheld the Commissioner’s determination, but the question of whether an association claiming exemption from income tax as a farmers’ cooperative association could under the statute be partially exempt and partially not exempt was not presented to the Board in either of the cases. The decision in Fruit Growers'1 Supply Go. was cited as authority for the holding in Gentral Co-Operative Oil Association. In the report in the first case we said:

What the Commissioner did was first to determine the petitioner’s net income for each year in a manner similar to that which would be followed in the case of any taxable corporation. Since we have held that the petitioner is not an exempt corporation, his initial step in such a determination would seem to be a proper one. From the total net income as thus determined the Commissioner then allowed a further deduction of all patronage dividends which were applicable to the respective years and considered the difference between the total net income and the patronage dividends as taxable income. And if we understand clearly tlie amounts which have been allowed in this latter deduction, the effect was to give the petitioner the benefit as a deduction of all patronage dividends declared or paid during the years with which we are concerned. The essence of what the petitioner asks is to say that all surplus earnings for a given year which have not been paid out as such dividends by the end of such year automatically became patronage dividends accrued, without any action on the part of the petitioner declaring them as dividends, and that they are therefore deductible under its accrual system of accounting * * » "vYg are unable to agree with the foregoing contention. In the first place, we find nothing in the governing statute which provides for a partial exemption from taxation of corporations of the character of the petitioner.

In Eugene Fruil Growers' Association, 37 B. T. A. 993, petitioner was a cooperative marketing association and had marketing agreements only with fruit growers who were members of the association. Nonmembers did not participate in such operations. The only issue before the Board in that case was whether the cooperative operations were exempt. No claim of exemption as a cooperative purchasing association was made in that case. In the opinion therein the Board said:

For all that appears they (fruit supplies) were handled at cost and although such articles were admittedly supplied to some extent to nonmembers, no attemfpt was made by respondent to elicit further details.

Compare, also, as supporting the principle of our holding in the instant case, Producers’ Creamery Co. v. United States (C. C. A., 5th Cir.), 55 Fed. (2d) 104, in which the court held that the appellant in that case was not a cooperative association as contemplated in the act and said:

It is a universal rule that one who would claim the benefits of a statute must bring himself, at least substantially, within its terms. Especially is this true of claimants under statutes purporting to exempt from taxation.

Reviewed by the Board.

Decision will he entered for the respondent.

Smith,

dissenting: The findings of fact in this case are to the effect that “less than 15 percent of the value of the total sales was made to nonproducers.” This, I think, is tantamount to holding that the value of purchases made for persons who were neither members nor producers does not exceed 15 percent of the value of all its purchases. The evidence in the case clearly supports such finding.

In Producers’ Creamery Co. v. United States (C. C. A., 5th Cir.), 55 Fed. (2d) 104, the rule is laid down that a corporation is not exempt from income tax unless it proves that it is “substantially” within the terms of the statute. I think that the petitioner has shown that it is substantially within the terms of the statute. To its members who were other cooperatives it made sales of gasoline at cost. In such case there was, of course, no necessity for crediting them with any part of the patronage dividends. The fact that those sales did not bear any part of the overhead cost seems to me to be da minimis. I think that the petitioner qualifies as a cooperative exempt from income tax.

Mellott agrees with this dissent.


author: Steenhagen:

text:
    American Cities Power and Light Corporation, Manager, the North American Company Common Stock Trading Account #5, Petitioner, v. Commissioner of Internal Revenue, Respondent. Consolidated Holdings Corporation, Manager, the North American Company Common Stock Trading Account #6, Petitioner, v. Commissioner of Internal Revenue, Respondent. Consolidated Holdings Corporation, Manager, Preferred Stock Trading Account, Petitioner, v. Commissioner of Internal Revenue, Respondent. Consolidated Holdings Corporation, Manager, the North American Company Common Stock Trading Account #3/3-2, Petitioner, v. Commissioner of Internal Revenue, Respondent. Consolidated Holdings Corporation, Manager, North American Company Common Stock Trading Account No. 3-2, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 82582, 82583, 82584, 82585, 85027.
    Promulgated July 15, 1938.

      John F. Doolmg, Jr., Esq., for the petitioners.

      Eugene E. Smith, Esq., for the respondent.
   OPINION.

Steenhagen:

The primary question at issue is whether, as the Commissioner has determined, each of the “accounts” is to be treated under the revenue act as an “association” taxable as a corporation. The petitioners say they are not associations, and urge that there are no features of these accounts giving them the semblance of corporate organization sufficient to justify calling them associations within any fair conception of that term. The petitioners’ contention is, in our opinion, clearly correct. It is unnecessary again to catalogue the features which would bring an organization within the statutory term “association” as that term has been broadly construed in Morrissey v. Commissioner, 296 U. S. 344; Swanson v. Commissioner, 296 U. S. 362; Helvering v. Combs, 296 U. S. 365; Helvering v. Coleman-Gilbert Associates, 296 U. S. 369. The purpose of setting up these accounts was, as clearly shown by the evidence, not to carry on a business but to provide a more convenient means of converting the stock dividends of the North American Co. into cash and at the same time minimizing the disturbances of the market. While a substantial number of shares sold by the managers of the accounts were bought on the market, this was to stabilize the market and can not fairly be called carrying on business. It is hardly enough to support the respondent’s point that the function of the accounts was primarily to promote profit and is thus similar to the function of a business corporation. The respondent argues that the participants were not partners and they had limited liability. The petitioners agree now that there were no partnerships and that their filing of partnership returns was mistaken. But this negation of partnership character is not an affirmative demonstration of corporate character. If the accounts must be characterized, they might better be called joint ventures or agencies, for they had but a single narrow purpose and a definitely limited duration. The participants’ liability was not limited, as in a corporation, but entire, and indeed included liability for the default of each. They had nothing resembling capital stock, and the shares or interests of the participants could be transferred only if all the other participants consented. The arrangement in each of the accounts is less like a corporation than that in Commissioner v. Whitcomb Coca-Cola Syndicate, 95 Fed. (2d) 596; Commissioner v. Gerstle, 95 Fed. (2d) 587; Darol Trading Account, 34 B. T. A. 837; or W. S. Farish, 36 B. T. A. 1114 (on review C. C. A., 5th Cir.). The determination that these petitioners are to be taxed as corporations is reversed.

The petitioners argue also that even if they be taxable as corporations, the deficiency determinations were not timely, since the statutory period of limitations had expired when they were made. They also argue that if they be taxpayers, the deficiency notices were defective in that they were addressed not to the taxpayers, namely the accounts themselves, but to the “managers.” Neither of these points requires decision now that it is held that the accounts are not taxable.

Judgment will be entered for the petitioners.


author: Smith:

text:
    International Shoe Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 82264, 82265, 83607, 87162.
    Promulgated July 19, 1938.

      Riáhard O. Rumer, Esq., R. E. Blake, Esq., and Charles B. Mclnnis, Esq., for the petitioner.

      Frank M. Thompson, Jr., Esq., and Joseph B. Harlacher, Esq., for the respondent.
   OPINION.

Smith:

1. The first question presented by these proceedings is whether the International Shoe Co. and the Illinois-International Shoe Co. are entitled to deduct from gross income of the fiscal years 1932 and 1933 the amounts paid out for lasts, dies, and patterns.

From the beginning of business of each company all amounts paid out for lasts, dies, and patterns have been charged to expense and deducted from gross income as ordinary and necessary expenses of operation. They have been charged to expense upon the company’s books of account because lasts, dies, and patterns are continually being replaced by new purchases, have ordinarily a life of not to exceed one year, and have no resale value. The respondent never raised any question as to the right of each company to deduct the amounts thus charged to expense up to the time of an audit of the tax returns for the fiscal year ended November 30, 1932. He then held that the cost of lasts, dies, and patterns should be capitalized and such capitalized cost charged off over a two-year period, the assumed economic life of such items. In the absence of definite information as to dates of purchase during each year, the respondent assumed that the average date of purchase was June 1, that is, the middle of each year. He then determined that the cost should be charged off as follows: 25 percent in the year of purchase, 50 percent in the following year, and 25 percent in the third year. In his brief he states:

A simple illustration will probably show more clearly than in any other manner the position taken by the Commissioner in his treatment of petitioner’s expenditures for lasts, dies and patterns. Assuming that the annual purchases in a single factory amount to an average of $50,000 a year, the following computation illustrates his method of handling the items based upon an average two-year life:

Since the petitioner had charged off to expense the entire cost of lasts, dies, and patterns purchased up to the close of the fiscal year ended November 30, 1931, the only portion of the cost of such items accrued during the fiscal year 1932 is 25 percent of the cost — except that the respondent has allowed as a deduction the cost of remodeling lasts done by the petitioner’s own employees.

The taxing statute provides that:

The net income shall be computed * * * in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. * * * [Sec. 41, Revenue Act of 19S2.]

The statute further provides for the deduction from gross income of “A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence.” (Sec. 23 (k), Revenue Act of 1932.)

Regulations 77 were promulgated under the provisions of the Revenue Act of 1932. In article 323 it is provided:

It is recognized that no uniform method of accounting can be prescribed for all taxpayers, and the law contemplates that each taxpayer shall adopt such forms and systems of accounting as are in his judgment best suited to his purpose. Each taxpayer is required by law to make a return of his true income. He must, therefore, maintain such accounting records as will enable him to do so. * * *
*******
(2) Expenditures made during the year should be properly classified as between capital and expense; that is to say, expenditures for items of plant, equipment, etc., which have a useful life extending substantially beyond the year should be charged to a capital account and not to an expense account; ⅜ * *

Article 342 provides in part:

Each year’s return, so far as practicable, both as to gross income and deductions therefrom, should be complete in itself, and taxpayers are expected to make every reasonable effort to ascertain the facts necessary to make a correct return. The expenses, liabilities, or deficit of one year can not be used to reduce the income of a subsequent year. * * * A taxpayer has the right to deduct all authorized allowances, and it follows that if he does not within any year deduct certain of his expenses, losses, interest, taxes, or other charges, he can not deduct them from the income of the next or any succeeding year. It is recognized, however, that particularly in a going business of any magnitude there are certain overlapping items both of income and deduction, and so long as these overlapping items do not materially distort the income they may be included in the year in which the taxpayer, pursuant to a consistent policy, takes them into his accounts. * * *

The evidence in these proceedings clearly disproves the respondent’s contention that the lasts, dies, and patterns used in the business of the two shoe companies have an economic life of two years. The average life of those used in connection with the manufacture of style shoes was not in excess of one year and in many cases the lasts, dies, and patterns gotten out for a particular style of shoe had a life of less than six months. The International Shoe Co. has shown for a five-year period, including the fiscal years in question in these proceedings, the respective percentages of its staple and style shoes to its total production. The average respective percentages for this period were 13.7 percent staple and 86.3 percent style. It has further shown that during the fiscal years 1930 to 1936 the amounts spent for the purchase of lasts, dies, and patterns used in manufacturing staple shoes was only 1.4 percent of the total of such expenditures and that the remaining 98.6 percent was used in producing style shoes.

The petitioner does not contend that in no case did lasts, dies, and patterns have an economic value not to exceed one year. It admits that those used in the manufacture of staple shoes had a life somewhat longer than one year, but it insists and the proof shows that most of the expense for lasts, dies, and patterns for the fiscal years here in question was for style production and that they had a life not to exceed one year.

Substantially the same question as is presented by these proceedings was before the Board in Conrad Shoe Co., 1 B. T. A. 798. That case involved the taxable years 1919 and 1920 — a period when, according to the evidence in these proceedings, the style feature was of much less importance than it was during the fiscal years 1932 and 1933. In that case, the taxpayer had been engaged prior to 1920 in the production of the so-called standard style shoes. It had followed the practice of capitalizing its expenditures for lasts, dies, and patterns and depreciating such expenditures on the basis of 50 percent in the year of purchase and 50 percent in the following year. During 1920 the taxpayer changed its production from the standard style shoes to style shoes and wrote off as a deduction in the year 1920 its total expenditures for lasts, dies, and patterns in that year. In the same year it deducted the remaining 50 percent of its 1919 expenditures for lasts, dies, and patterns. The Commissioner approved the deduction of the taxpayer’s 1920 expenditures, but refused to permit it to deduct the remaining 50 percent of its 1919 expenditures in the year 1920.

It will be noted that in that case the Commissioner was contending that the cost of lasts, dies, and patterns was an expense of the year of purchase. Hence, his contention that the taxpayer was not entitled to deduct, from the gross income of 1920', 50 percent of the cost of lasts, dies, and patterns acquired in 1919. The Board held, however, that the taxpayer was entitled to deduct in 1920 not only the amount spent for lasts, dies, and patterns in that year, but also the unamortized cost of the standard style lasts, dies, and patterns acquired in 1919.

The lasts, dies, and patterns purchased by the petitioner during the two fiscal years before us did not expand its production facilities. They merely enabled it to keep abreast of the times and to present merchandise to the public that had a sales appeal. The amounts spent merely served to replace obsolete lasts, dies, and patterns by new lasts, dies, and patterns. The evidence is all to the effect that they had no asset value in the sense that they could be sold for any amount whatever.

It appears to us that the situation here is much the same as that which obtained in United States v. Roden Coal Co., 39 Fed. (2d) 425; Marsh Fork Coal Co. v. Lucas, 42 Fed. (2d) 83; Commissioner v. Brier Hill Collieries, 50 Fed. (2d) 777; West Virginia-Pittsburgh Coal Co., 24 B. T. A. 234; Tennessee Consolidated Coal Co., 24 B. T. A. 369; Preston County Coke Co., 24 B. T. A. 646; Cunard Coal Co., 26 B. T. A. 234. The question in the above cited cases was whether a coal mining company was entitled to deduct from gross income as an expense the cost of equipment which served to keep up the production of the mine. There was no question but that many of the assets acquired, such as electric locomotives, had a useful life of many years. The courts held, however, that the mere fact that they had a useful life of more than one year was not determinative of the question whether the amounts constituted ordinary and necessary expenses deductible from gross income. In each case the amounts spent for such assets were held to be ordinary and necessary expenses and deductible from gross income. Cf. also Osterloh v. Lucas (C. C. A., 9th Cir.), 31 Fed. (2d) 277; Welch v. Helvering, 290 U. S. 111.

The action of the respondent in disallowing the deduction from gross income of the amounts spent for lasts, dies, and patterns is reversed.

2. The second question in issue is tbe rate of depreciation to be used in the determination of the depreciation allowance on machinery and equipment.

As the result of a conference between the petitioner and the respondent’s counsel in 1925 it was agreed that a rate of 9 percent should be used in the computation of the depreciation allowance on machinery and equipment. This was the rate which was wai’-ranted by the very accurate records kept by the International Shoe Co. over a period of years. Depreciation allowances for prior years were adjusted upon that basis and the same rate of depreciation has been used in computing allowances for depreciation upon machinery and equipment since 1925. The petitioner’s records tend to show that the 9 percent composite rate is less rather than more than the rate warranted. Its records for discarded machinery over a period of years warrant the finding that the average useful life of the machines discarded was not in excess of 11⅜ years, which would warrant the 9 percent rate. There is no evidence whatever to sup-poi’t the respondent’s determination of a useful life of machinery of 15 years. The action of the respondent in changing the rate of depreciation on machinery and equipment for the taxable years from 9 percent to 6% percent is reversed.

3. The next question relates to the depreciation rate on brick buildings. The petitioner agreed with the respondent in 1925 that a rate of 2½ percent was the correct rate. Its subsequent experience, however, has shown that this rate does not provide for obsolescence actually sustained. With the advent of high speed ma-chineiy and changes in manufacturing processes it has been found that multiple-story shoe factories are less satisfactory and less profitable than the one-story type. The petitioner has found it advantageous to abandon and dispose of some of its multiple-story buildings. There is, however, a small market for such buildings and the petitioner’s experience has shown that it has been unable to sell the buildings abandoned at the depreciated cost.

In its reports to its stockholders the petitioner deducted from gross income for the fiscal years 1932 and 1933 larger amounts for depreciation of brick buildings than were claimed on the income tax returns. This was for the purpose of presenting to the stockholders a true picture of its finances. The petitioner felt obligated, however, in filing income tax returns to continue with the 2½ percent rate which it had agreed in 1925 was the proper rate to use. Beginning with the fiscal year 1934 the petitioner has claimed on its tax returns a depreciation allowance on its brick buildings based upon a 30-year life, or at the rate of 3⅜ percent. The evidence supports the petitioner’s contention for a rate of 3½ percent on brick buildings for the fiscal years 1932 and 1933.

4. The final question presented by these proceedings is whether the petitioner is entitled to deduct $150,500 from gross income of 1932, $500 of which represents attorneys’ fees and $150,000 the amount paid in settlement of a suit which was instituted against it and its officers and directors. In that suit the plaintiff alleged that the petitioner and its officers had acted illegally and had conspired to injure it. The petitioner never filed any answer to the suit, although it did file demurrers to certain allegations of the petition. The petitioner was receiving much unfavorable publicity as a result of the suit and its officers felt that its business was suffering therefrom.

The petitioner’s officers deemed it advisable to consult Charles Nagel, a well known attorney of St. Louis, for the purpose of getting his advice in the matter. Nagel had represented the petitioner in former years. He was not, however, employed as the petitioner’s attorney in the case. After spending about a month in investigating the situation Nagel reached the conclusion that there was practically no merit in the plaintiff’s claims but that it might be advisable to negotiate a settlement by reason of the fact that a former president of the petitioner, no longer living, was implicated in the suit and if the case went to the jury it might not be possible to convince the jury that some, of the contentions of the plaintiff were not well founded. Nagel was instructed to ascertain what arrangements could be made for a settlement of the suit and he advised the petitioner that the entire proceeding could be settled upon payment of $150,000. That payment was made. In addition to that, $500 was paid a prior attorney who had filed one or more motions with the court.

The respondent contends that the amount paid was not an ordinary and necessary expense of the petitioner in 1932, and cites in support of his contention National Outdoor Advertising Bureau, Inc. v. Helvering, 89 Fed. (2d) 878. In that case it was held that where a consent decree had been entered in a suit brought by the United States against the National Outdoor Advertising Bureau, Inc., and others declaring that a certain contract was illegal, null, and void, the “Bureau” was not entitled to deduct from its gross income that part of the costs of defending the suit which appertained to the illegal contract.

We are of the opinion that the principle announced by the court in that case has no application to these proceedings. Here there is no evidence that the petitioner and its officers had entered into any conspiracy or committed any illegal act. The petitioner was, however, receiving unfavorable publicity from the suit and its officers considered that it might be advisable to pay a reasonable amount to settle the controversy.

By section 23 of the Revenue Act of 1932 a taxpayer is permitted to deduct from gross income “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” If an expense connected with litigation proximately results from the carrying on of a business, it is a legal deduction from gross income, Kornhauser v. United States, 276 U. S. 145, providing the expenses are not connected with a criminal prosecution or in connection with a proven illegal act. Cf. Burroughs Building Material Co. v. Commissioner (C. C. A., 2d Cir.), 47 Fed. (2d) 178; Gould Paper Co. v. Commissioner (C. C. A., 2d Cir.), 72 Fed. (2d) 698. In H. M. Howard, 22 B. T. A. 375, the Board allowed the deduction from gross income of a compromise payment to settle litigation and attorney fees paid in connection therewith, both growing out of and being incidental to the taxpayer’s business dealings. In its opinion the Board said:

Though the Kornhauser case [the case referred to above] involved only legal fees, we believe the reasoning employed applies equally to the compromise payment made to settle the lawsuit. This expense grew directly out of, and proximately resulted from, the business dealings between the parties. * * *

In Welch v. Helvering, 290 U. S. 111, Mr. Justice Cardozo, speaking for the Court, said:

* * * Now, what is ordinary, though there must always be a strain of constancy within it, is none the less a variable affected by time and place and circumstance. Ordinary in this context does not mean that the payments must be habitual or normal in the sense that the same taxpayer will have to make them often. A lawsuit affecting the safety of a business may happen once in a lifetime. The counsel fees may be so heavy that repetition is unlikely. None the less, the expense is an ordinary one because we know from experience that payments for such a purpose, whether the amount is large or small, are the common and accepted means of defense against attack. Cf. Kornhauser v. United States, 276 U. S. 145, 48 S. Ct. 219, 72 L. Ed. 505. The situation is unique in the life of the individual affected, but not in the life of the group, the community, of which he is a part. ⅜* * *

In Helvering v. Community Bond & Mortgage Corporation (C. C. A., 2d Cir.), 74 Fed. (2d) 727, tbe Board was affirmed in holding that an amount paid by a corporation for stock of an agency in order to procure tbe cancellation of an agency contract for tbe sale of the corporation’s stock and thereby preserve the corporation’s reputation and avoid a loss of business consequent on the agency’s method, constituted an ordinary and necessary expense. The court said:

* * * In the instant case, the taxpayer’s reputation was being injured by the conduct of its agent, and its primary motive in seeking the cancellation of the contract was to prevent the loss of earnings. Its contract with the agency proved to be unprofitable. This we think was an expenditure ordinary and necessary in carrying on the business, and deductible from the respondent’s gross income.

In Helvering v. Hampton, 79 Fed. (2d) 358, the Circuit Court of Appeals for the Ninth Circuit affirmed a memorandum opinion of this Board that an amount paid by the taxpayer in settlement of a judgment obtained against him in an action involving fraud was deductible as an ordinary and necessary expense. In the course of its opinion the court said:

There is no analogy between expenses of the hind here involved and those incurred by one accused of a crime. A suit for damages against a lawyer or doctor by a client or patient arises directly out of the business or profession of such lawyer or doctor. A criminal action against a druggist for violation of the narcotic laws has no direct connection with the druggist’s business. If the druggist, on the other hand, were sued for damages by reason of having improperly filled a prescription, the action would arise directly out of the business.

Upon the basis of the holding of the Board and of the courts in the above cited cases the Board holds in the instant proceedings that the amount paid in settlement of the suit brought against it by the Menzies Shoe Co. and the attorneys’ fees totaling $150,500 are a legal deduction from gross income.

Reviewed by the Board.

Judgments will be entered wider Bule 50.


author: Mellott :

text:
    ZaSu Pitts Woodall, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 84132.
    Promulgated July 19, 1938.

      P. D. Johnston, Esq., and T. H. Poole, G. P. A., for the petitioner.

      D. M. Evans, Esq., for the respondent.
   OPINION.

Mellott :

The position of the respondent is that under the above facts the petitioner’s ,earnings were her separate property. He relies partially upon section 169 of the Civil Code of California, which is as follows:

The earnings and accumulations of the wife, and of her minor children living with her or in her custody, while she is living separate from her husband, are the separate property of the wife.

In Makeig v. United Security Bank and Trust Co. (1931), 112 Cal. App., 138; 296 Pac. 673, the court construed the phrase “living separate”, as used in the above section, as applying “to a condition where the spouses have come to a parting of the ways and have no present intention of resuming the marital relations and taking up life together under the same roof”, but not to a condition where the spouses are residing temporarily in different places due to economic or social reasons. In Loring v. Stuart (1889), 79 Cal. 200; 21 Pac. 651, wherein it appeared that a husband left his wife on account of domestic infelicity and during his absence determined never to resume marital relations with her, his wife and children thereafter living together supported by her exertions, the court held that this was a “separate living” within the meaning of section 169 and that the earnings of the wife during that period were her separate property.

In Street v. Bertolone (1924), 193 Cal. 751; 226 Pac. 913, the court, discussing the effect of section 168, which provides that “the earnings of the wife are not liable for the debts of the husband”, said:

* * * Section 168 does not provide that the earnings of the wife are her separate property, but that they are not liable for the debts of her husband. They continue to be community property for the purposes of administration and for the purposes of investment and other management by the husband. In other words, tbe earnings of the wife living with her husband are subject to the rules governing community property except in the single respect mentioned in section 168; whereas, the earnings of a wife living separate from her husband are not subject to any of the rules governing community property. [Emphasis supplied.]

See also Boland v. Boland, 81 Cal. App. Dec. 1099; 46 Pac. (2d) 238; Tagus Ranch Co. v. First National Bank, 7 Cal. App. (2d) 457; 46 Pac. (2d) 809; Union Oil Co. v. Stewart (1910), 158 Cal. 149; 110 Pac. 313; Greve v. Echo Oil Co. (1908), 8 Cal. App. 275; 96 Pac. 904; Marlow v. Barlew, 53 Cal. 456; Tobin v. Galvin (1874), 49 Cal. 34; Lawrence v. Spear (1861), 17 Cal. 421.

The evidence clearly indicates that the parties had come to a parting of the ways. Although both testified that they hoped for, and discussed, a reconciliation, there is no evidence showing that either, at any time after the husband left the common home, harbored any “present intention” of resuming marital relations or again living together. The hope for a reconciliation which they, or either of them, may have had was not realized and such discussions as they had did not result in healing the breach between them. The divorce apparently was secured with all possible dispatch. It was initiated as soon/as possible after the necessary year had elapsed. Under the laws of California (section 107) desertion “must continue for one year” in order to be a ground for divorce. The separation occurred late in 1930 or early in 1931, and the suit was filed January 14, 1932. On April 20, 1932, the parties entered into the property agreement, in which, among other things, it was expressly stated that in consequence of certain unhappy differences they were and had been living separate and apart since on or about November 24, 1926. Within a few days after the property settlement was made, viz., on April 26, interlocutory judgment was entered. On May 2, 1933, and as soon as the year required by the statutes had elapsed, the final judgment of divorce was entered. There was little delay in making the separation a permanent one.

Counsel for the petitioner contends that, if section 169 defines or enlarges the separate estate of women, as defined by Article XX, sec. 8, of the Constitution of California of 1879, it is unconstitutional. He argues that' its constitutionality can be upheld only if it is construed to be merely a statute of exemption and in no sense defining separate property.

The cases cited by counsel in support of his contention that the section is unconstitutional are all from other states. Arnold v. Leonard, 114 Tex. 535; 273 S. W. 799; Kerr v. Tyler Guaranty State Bank (Texas), 283 S. W. 601; Stephens v. Stephens (Texas), 292 S. W. 290; Burruss v. Murphey (Texas), 5 S. W. (2d) 612; Frame v. Frame (Texas), 36 S. W. (2d) 152; Potorff v. Adams Co. (Texas), 70 S. W. (2d) 745. While there may be some similarity between, the statutes of those states and the statutes of California, no doubt there are also material differences, which, if explored by a court of general jurisdiction, and especially by an appellate court of California, would result in a holding that the section is constitutional.

The section in question was enacted in 1872. It was based on and superseded, Act 4661, Gen. Laws of California, pertaining to the protection of the rights of married women and the rights of a wife living separate and apart from her husband. (Stats. 1869-70, p. 226.) So far as we have been able to ascertain from a check of the California decisions, it has never been declared unconstitutional by any court in that state; nor has the petitioner called our attention to any case in which its constitutionality was even assailed. The decisions of the state courts as to property rights and interests of persons residing in that state are controlling upon Federal courts and the Board. Burnet v. Harmel, 287 U. S. 103. Since the section has never been declared unconstitutional by the courts of California, but on the contrary has been applied and held effective over a long period of time, it must be followed here. We hold, therefore, that the earnings of petitioner during 1932 and 1933 up to the time of the final decree were her separate property although the marital status was not dissolved until entry of the final decree.

Upon brief counsel for petitioner cite Abbott v. Wetherby, 6 Wash. 507; 33 Pac. 1070, and say that the supreme court of that state had construed a section of the Washington statutes which is identical with section 169 of the California Code, as being a statute of exemption and in no sense defining separate property. A reading of the garbled portion of the opinion set out in the brief indicates that the holding was as counsel contends; but the opinion itself shows that the court made no such holding. The court was discussing the section exempting a wife’s earnings from the debts of her husband, which is comparable to section 168 of the California Code referred to supra, and in its opinion said:

* * * It is true that section 1402 (Sec. 6895, Bemington’s Comp. Stats.) provides that the wife may receive the wages of her personal labor, but these sections must be construed together, and, thus construed, we must conclude that her earnings only become her separate property while she is living separate from her husband. Any other construction would render meaningless section 1403; for, if section 1402 created her earnings into a separate estate, the enactment of section 1403 would have been absolutely useless, as all its provisions, under this construction, are embraced in section 1402. And the same reason would apply to section 480, Code Proc. While the personal earnings of a wife are exempt, it must be construed to be a statute of exemptions, and in no sense defines separate property. The statute seems to definitely distinguish the rights acquired by wives who are living with their husbands from the rights acqmred by wives who are Iwing separate from■ their husbands. [Emphasis supplied.]

The statutes of California make the same distinctions as those pointed out by the Supreme Court of Washington between the rights of wives who are living with their husbands, and those acquired by wives who are “living separate” from their husbands. Street v. Bertolone, supra.

It is further contended that petitioner’s earnings were community income because of an executed oral agreement to that effect. We are not concerned here with the question whether an oral agreement can be made between a husband and wife in California respecting their property interests which will be valid and effective to change community property into the separate property of either. For the purposes of this case it may be assumed that such an agreement can be made. Our question is simply whether the written agreement set out in our findings was actually modified by an executed oral agreement. Section 1698 of the Civil Code of California provides that:

A contract in writing may be altered by a contract in writing, or by an executed oral agreement, and not otherwise.

The testimony of the petitioner and Gallery with reference to the purported modification of the written property settlement agreement is not very satisfactory and rather indefinite. Both testified, in substance, that immediately after the agreement was signed at the office of the attorney they had an understanding to go ahead with their business relations the way they had been doing; to let their financial matters go exactly as they were; that they meant by this that their earnings were to remain community property. Assuming that such an understanding was in fact had — but the proof is not sufficient to justify us in finding that it was — we would still have the question whether or not the earnings of the petitioner were actually treated as community property; and in that connection the following discussion is pertinent.

Section 172 of the Civil Code of California gives the husband the management and control of the community personal property with the like absolute power of disposition, other than testamentary, which he has of his separate estate. But Gallery had no such management and control even if it be assumed that the modification of the written agreement were made. The earnings of the petitioner were turned over to the Equitable Investment Corporation and it, in conjunction with petitioner, had' full charge of her financial affairs. No withdrawals could be made from the account except by check first signed by the petitioner and countersigned by an officer of the company. Gallery had no authority to withdraw any funds from the account. Whatever he received from the earnings of the petitioner he received because payments to him, or for him, were authorized by the signing of checks by the petitioner or because petitioner gave cash to him. While some payments were made to, or for, him, as they were needed to pay his expenses or in an attempt to save his enterprises, there is no evidence showing that he had any control over such earnings or that he exercised the right to manage, control, or dispose of them as community property after the execution of the property settlement agreement. Gallery testified that prior to the time he left the petitioner he had handled the finances of the family. But it is apparent that he did not do so after the separation. He also testified that sometime in 1929 the account with the Equitable Investment Corporation was established with his knowledge and consent to protect the petitioner’s salary from his creditors. As heretofore mentioned the California law provides that the wife’s earnings are not liable for the debts of the husband. Nevertheless Gallery had the right, under section 172, to manage and control the community personal property. If an oral understanding actually existed between the parties that the petitioner’s earnings were to remain community property after the execution of the property settlement agreement, it is clear that such understanding was not carried out or executed by the parties as required by section 1698, supra, in order effectively to alter or modify the written contract. Cf. Brown v. Brown, 170 Cal. 1; 147 Pac. 1168. It is held, therefore, that there was no modification of the written contract by an executed oral agreement.

It is argued that the legal effect of the entry of an interlocutory decree of divorce is to make the separation of husband and wife lawful; that therefore it must be held that petitioner and Gallery were living apart by consent and agreement until the final decree of divorce was granted; and that no abandonment within the meaning of section 169, supra, had occurred. As heretofore pointed out, a “living separate” under section 169 does not necessarily contemplate an abandonment. It exists if there is a parting of the ways with no present intention to resume marital relations, whatever the cause of separation may have been. Cf. Makeig v. United Security Bank & Trust Co., supra. Nor can we conclude that there was no desertion on the part of petitioner’s husband, notwithstanding he so testified; for the court granted her a divorce on that ground. Section 99 of the Civil Code of California provides that “Separation by consent, with or without the understanding that one of the parties will apply for a divorce is not desertion.” We must assume that the court found that Gallery, as alleged by petitioner in her complaint, “willfully * * * without cause, * * * against her will, and without her consent” deserted and abandoned her. The contention that the granting of the interlocutory decree legalized or changed the desertion into a separation by agreement is also fallacious. Counsel’s argument that the separation was “lawful,” within the meaning of certain cases cited by him, is not persuasive. Of course it was lawful for the parties to remain separate and apart after the entry of the interlocutory decree in the sense that “ ‘lawful’ denotes something which, in its substance, is sanctioned or permitted by the law, as distinguished from conformity to positive rules of law.” Stauter v. Carithers, 185 Cal. 160; 196 Pac. 37. But that does not mean that there was no desertion or that the interlocutory judgment had turned it into a lawful separation. It merely sanctioned petitioner’s “living separate from her husband” because of his willful desertion without her consent as alleged in her divorce complaint. An interlocutory decree of divorce is an agreement or a contract only to the extent that it adjudicates whatever is properly embraced in the allegations of the complaint and prayer for relief pertaining to the personal marital obligations or property interests. Brown v. Brown, supra; London Guarantee & Accident Co., Ltd. v. Industrial Accident Commission, 181 Cal. 460; 184 Pac. 864; Peters v. Peters, 60 Pac. (2d) 313. Its office “is merely that of ‘declaring that the party in whose favor the court decides, is entitled to a divorce.’ ”

Nor is the argument that petitioner and her husband were not “living separate” within the meaning of section 169 until entry of final decree of divorce persuasive. Upon the entry of a final decree of divoree a married woman acquires the status of a feme sole. The language of the statute contemplates a separation during marriage as it refers to a “wife ⅜ * * living separate from her husband.” The construction urged by counsel would make the provisions of section 169 meaningless.

The respondent did not err in determining the deficiencies.

Decision will he entered for the resfondent.

       Sec. 8. All property, real and personal, owned by either husband or wife during marriage, and that acquired by either of them afterwards by gift, devise, or descent, shall be their separate property.


text:
    Langley Collyer, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 81239.
    Promulgated July 19, 1938.

      John R. McMullen, Esq., for the petitioner.

      Rudy P. LI erizo g, Esq., for the respondent.
   OPINION.

Van Fossan:

The notice of deficiency treated the interest of $8,743.04 received from the city on the award money as income, made an allowance of $2,015 for legal fees, and treated the difference between the principal of the award and a March 1, 1913, value of $12,000 for the property as income. Petitioner, by this proceeding, assails respondent’s refusal to deduct the above mentioned assessments.

The rule now seems well established that where owners are permitted to offset the award to them against the benefits assessed against them, the net amount received, and not the gross award, is the basis for computing gain or loss on the transaction. Central & Pacific Improvement Corporation v. Commissioner, 92 Fed. (2d) 88, reversing 34 B. T. A. 208; Christian Ganahl Co. v. Commissioner, 91 Fed. (2d) 343, reversing 34 B. T. A. 126; Wolf v. Commissioner, 77 Fed. (2d) 455, reversing 29 B. T. A. 702; and Carrano v. Commissioner, 70 Fed. (2d) 319, reversing B. T. A. memorandum opinion; Calvin C. Green, 37 B. T. A. 25; Jamieson Associates, Inc., 37 B. T. A. 92; Palladium, Amusement Co., 37 B. T. A. 149.

^Respondent concedes that the sum of $5,746 should be deducted from the award under the Carrano case, supra. He urges, however, that the established rule goes no further than to permit the offset of $5,746 retained by the comptroller of the city of New York.

Petitioner’s contention, as above indicated, is that there also should be set off against the gross award, (1) the balance of the benefit assessment on the same Merrick Boulevard project which amounted to $2,397.70 and was paid about 10 days subsequent to the collection of the award; (2) the special assessment of $9,024.58 on account of the Horstman Avenue sewer; and (3) the special assessment of $5,136.70 on account of the 114th Avenue sewer.

As we understand it, the rationale of Carrano v. Commissioner, supra, seems well expressed in the following quotation:

* * * Although the assessment was not an added cost until paid it became cost at the moment when it was set off against the award. Receipt and payment were simultaneous; it is as false to say that an award was paid before it was expended, as that it was expended before it was paid. * * * [Italics ours.]

However, the above cited decisions of the Ninth Circuit Court of Appeals, and subsequent decisions of this Board in line with those decisions, have somewhat broadened the rule, which is stated in the most recent Board opinion in Income Syndicate, Inc., 37 B. T. A. 926, as follows:

The rule of the above cases, which this Board followed in Galvin C. Green, 37 B. T. A. 25; Jamieson Associates, Inc., 37 B. T. A. 92; and Palladium Amusement Co., 37 B. T. A. 149, is that the condemnation of land for public purposes and the levying of special assessments covering the cost thereof are one transaction and the result should be treated as an entirety, i. e., the award should be reduced by the amount of the assessment. If the condemnation and assessment must be regarded as one transaction the fact that the payment of the assessment by the petitioner was postponed is immaterial.

Petitioner attempts to support his contention, that all the enumerated assessments should be deducted from the award, by the opinion of the Ninth Circuit Court of Appeals in Central & Pacific Improvement Corporation v. Commissioner, supra. In that case there was involved in part an assessment made in a year later than the award, and the court, with no discussion of this additional factor, held that case to be squarely within the rule set down in Wolf v. Commissioner, supra, and followed in Christian Ganahl Co. v. Commissioner, supra. Cf. Income Syndicate, Inc., supra, and cases therein cited.

The rule of the Central & Pacific Improvement Corporation case and the subsequent cases is sufficiently broad to permit petitioner to offset the balance of the benefit assessment on the Merrick Boulevard project, and this should be done. The assessments for the Horstman Avenue and 114th Avenue sewers, however, are not deductible from the award in computing income therefrom. In the Central & Pacific Improvement Corporation case, supra, on which petitioner relies, the subsequent assessment was a part of, and definitely related to, the project for which property was taken and the award made; and the assessment was against the remaining property. In the present case the sewer assessments were made for work completed prior to the vesting of title in the city and for entirely different projects. These assessments were sums due and payable irrespective of the Merrick Boulevard project and the award paid petitioner thereon. No property was taken in connection with the sewer installations. The relationship is merely coincidental. The mere fact that petitioner was without funds save for the money received from the condemnation award and apparently paid all of the benefit assessments in question out of such funds is not controlling. Nor are the facts that the Horstman Avenue sewer assessment was paid on April 6, 1931, shortly after the receipt of the award money from the city, and was paid in substantial part by the endorsement of the award warrant for $7,536.60, important.

It is our view that this type of benefit assessment subsequently paid by petitioner, being an assessment on a project not related to the condemnation award, may not be deducted from the award money received.

Although the assessment, under the charter of the City of Greater New York, becomes a lien on the property (section 985), it “was not an added cost until paid.” Carrano v. Commissioner, supra. Payment on account of the two projects in question was not simultaneous with the payment of the award. The Horstman Avenue assessment was paid “a few days” after the receipt of the Merrick Boulevard award (March 1931) and the 114th Avenue assessment was not paid until August 1935.

It is recognized that there may seem to be an inequity in the present situation. However, we believe it to be more seeming than real. If, as contended by petitioner and apparently conceded by respondent, the assessments were against the remaining property, not including that taken on condemnation, petitioner’s contention must be denied because the sewer projects are not shown to be related to the Merrick Boulevard project and the assessments therefor were not paid until after the award. In so far as the assessments increase petitioner’s basis on such remaining property, petitioner will get the advantage thereof on disposition of such remaining property.

The valuation of the property in question on March 1, 1913, was made an issue by the pleadings, but petitioner introduced no proof on this issue and the value determined therefor must stand.

No serious challenge is made by petitioner of the penalties proposed for negligence and late filing and these additional amounts are sustained.

Petitioner suggests that part of the award money was consequential or severance damages to the remaining property, and that the proceeds from the condemnation constituted damages, which as such were not taxable. We can not sustain this contention.

Although petitioner introduced testimony to the effect that the condemnation proceeding was considered a damage proceeding by the court, there is no evidence showing a breakdown of the total award or proving what portion could be considered severance damage. Marshall C. Allaben, 35 B. T. A. 327. It should be also noted that the New York law interchangeably terms the proceeding as one for ascertaining compensation (sec. 1001) and an award for damages (sec. 1004). See also Calvin C. Green, 37 B. T. A. 25, which case includes severance damages in determining the total amount awarded. Jamieson Associates, supra, was a case arising, as does the instant case, under New York law. It was there held that no consequential or severance damages were awarded by the local court.

Bespondent admits, and we have found as a fact, that the property in question was held by petitioner on behalf of himself and his brother, each owning one-half. Consequent adjustment should be made therefor in the computation under Bule 50.

Bespondent, in his brief, urges that if this Board finds that the property in question was trust property, one-half of which was held by petitioner in trust for his brother, certain other adjustments should be made relative to petitioner’s deductions as head of a family and as the support of his “indigent” brother. As related above, respondent, by the pleadings, admitted this status for the property. Bespondent has not set up a plea in his answer for alternative relief and, on the state of the record, we are not in a position to make the adjustments requested by him.

Decision will be entered, under Bule SO.


author: Turner:

text:
    China United Lamp Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 82050.
    Promulgated July 19, 1938.

      J. B. Allman, Esq., for the petitioner.

      G. W. Brooks, Esq., for the respondent.
   OPINION.

Turner:

Counsel for petitioner argues on brief that respondent erred in disallowing the deductions referred to in our findings of fact. He states that the deductions were denied pursuant to respondent’s regulations dealing with domestic corporations and argues that such regulations are not applicable to corporations organized under the China Trade Act. He states that business conditions and methods of doing business in China are different, that such corporations should be set apart and dealt with as a special class, and argues that Congress did not intend that the same regulations should be applicable in determining its net income.

An examination of the amended petition shows that petitioner did not make a clear and concise allegation of error in respect of the deductions disallowed by the respondent and there was no evidence offered at the hearing relative thereto. A fair interpretation of the petition leads to the conclusion that petitioner did not intend to raise any such issue, and the Board and the courts have held in numerous cases that our jurisdiction is limited to issues raised by the pleadings. North American Coal Corporation, 28 B. T. A. 807; and Hanby v. Commissioner, 67 Fed. (2d) 125. In any event, however, petitioner’s position is clearly in conflict with the provisions of the China Trade Act, 1922, as amended, which provides under the title dealing with “Federal taxation”, as follows:

Sec. 25. That section 2 of the Revenue Act of 1921 is amended by adding at the end thereof a new paragraph to read as follows:
“(12) A corporation organized under the China Trade Act, 1922, shall, for the purposes of this Act, be considered a domestic corporation.” [See also sec. 1111 (a), (4), Revenue Act of 1932.]

Article 1151 of Regulations 77, promulgated pursuant to the Revenue Act of 1932, provides as follows:

Abt. 1151. Income of China, Trade Act corporations. — The items of gross income to be included in the return of a corporation organized under the China Trade Act and the deductions allowable are the same as in the case of other domestic corporations.

The petitioner’s principal contention is that, after respondent recomputed its net income by restoring the items mentioned above, he erred in failing “to allow the entire dividend paid to the stockholders by this corporation as a tax credit against the tax that would otherwise have been imposed upon the corporation.” In other words, the petitioner contends that the amount of the tax imposed should have been diminished by reason of the “general” dividend as well as the “special” dividend. On this point the statute is plain and unambiguous.

Section 261 of the Revenue Act of 1932 (sec. 245, China Trade Act, 1922) provides that for the purpose of the tax imposed there shall be allowed, in the case of corporations organized under the China Trade Act, a credit against net income of an amount equal to the net income derived from sources within China, provided that in no case shall the amount of the tax diminished by reason of such credit exceed the amount of the special dividend certified under subsection (b) of this section. Subsection (b), “Special Dividend”, provides that such credit shall not be allowed unless the Secretary of Commerce has certified to the respondent the amount which, during the year ending on the date fixed by law for filing the return, the corporation has distributed as a special dividend to or for the benefit of its stockholders, and that such special dividend was in addition to all other amounts distributed to its stockholders.

There is no dispute as to the amount actually distributed by petitioner under its special dividend, and there is no dispute as to the correctness of the certificate issued by the Department of Commerce. Petitioner implies that its contention is not strictly in keeping with the letter of the statute, but counsel argues on brief that the resolution adopted by its stockholders relating to the special dividend was “elastic” in that its officers were authorized to pay a special dividend in an amount equal “to the amount of income tax which the corporation would otherwise have to pay”, and that if the general dividend can not be allowed as a tax saving dividend without certification from the Secretary of Commerce, “then this petitioner should be allowed to amend its income tax return in accordance with the Treasury findings with respect to the net income, and then amend same as to the payment of the tax saving dividend.”

There would be no basis in law or fact for the amendment of the return as to the payment of the tax saving dividend. The respondent’s determination herein allows to the peititoner as a credit the full amount of the special tax saving dividend actually paid by the petitioner and certified by the Secretary of Commerce as having been paid. By the provisions of the statute the allowance of the credit by the respondent is dependent upon the certification by the Secretary of Commerce of the payment of the special tax saving dividend and the Secretary of Commerce is authorized to certify to the Commissioner .only “the amount which, during the year ending on the date fixed by law for filing the return, the corporation has distributed as a special dividend.” The admitted facts are that the petitioner distributed as a special dividend only the amount of $1,076.11 and there is no provision of law which would permit the certification by the Secretary of Commerce, or the allowance as a credit by the Commissioner of Internal Revenue, of any amount in excess of the amount actually paid as such special dividend.

The provisions of the statute are plain and unambiguous. The debates in the Senate relating to the conference report on the House Bill (Congressional Record, September 13, 1922, vol. 62, part 12, p. 12433) indicate that Congress intended a “carefully guarded tax exemption.” While we realize that it was possible for petitioner to have arranged its affairs so as to have been completely exempt from income tax, the test is what was done rather than what could or should have been done. United States v. Phellis, 257 U. S. 156. As the Supreme Court said in Weiss v. Steam, 265 U. S. 242, “Questions of taxation must be determined by viewing what was actually done, rather than the declared purpose of the participants * * Counsel for petitioner implies on brief that petitioner has been caught in a “legal net” through no fault of its own, but we find nothing in the statute or in the regulations which would prevent such a corporation from including in its special dividend an amount sufficient to cover deficiencies arising from the disallowance of doubtful deductions. After having failed to do so, petitioner asks that it be permitted to rearrange its affairs so as to escape the predicament in which it finds itself, but, as we have already pointed out, such action is not permitted by the statute.

Decision will be entered for the respondent.

       SEC. 261. CREDIT AGAINST NET INCOME.
      (a) Allowance oe Credit. — Eor the purpose only of the tax imposed by section 13 there shall he allowed, in the case of a corporation organized under the China Trade Act, 1922, in addition to the credit provided in section 26, a credit against the net income of an amount equal to the proportion of the net income derived from sources within China (determined in a similar manner to that provided in section 119) which the par value of the shares of stock of the corporation owned on the last day of the taxable year by (1) persons resident in China, the united States, or possessions of the United States, and (2) individual citizens of the United States or China wherever resident, bears to1 the par value of the whole number of shares of stock of the corporation outstanding on such date: Provided, That in no case shall the amount by which the tax imposed by section 13 is diminished by reason of such credit exceed the amount of the special dividend certified under subsection (b) of this section.
      (b) Special Dividend. — Such credit shall not be allowed unless the Secretary of Commerce has certified to the Commissioner — -
      (1) The amount which, during the year ending on the date fixed by law for filing the return, the corporation has distributed as a special dividend to or for the benefit of such persons as on the last day of the taxable year were resident in China, the United States, or possessions of the United States, or were individual citizens of the United States or China, and owned shares of stock of the corporation;
      (2) That such special dividend was in addition to all other amounts, payable or to be payable to such persons or for their benefit, by reason of their interest in the corporation ; « * *

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