author: Disney:

text:
    E. C. Laster, and Mrs. E. C. Laster, Petitioners, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 96550, 97442, 97713, 97714, 97716, 100340, 100341.
    Promulgated December 27, 1940.

      Harry O. Weeks, Esq., and R. B. Garmon, Esq., for tbe petitioners.

      D. D. Smith, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: E. C. Laster, Inc. (Dissolved) ; Edward Carroll Laster, Transferee; Carolyn Faust Laster, Transferee; E. C. Laster, Transferee; E. C. Laster ; and Mrs. Eugenia E. Laster.

   OPINION.

Issue I.

Disney:

The first issue involves amounts disallowed by the respondent for intangible drilling and development costs deducted by the petitioners on account of the Lambert, Taylor, Brown, Coates, and Bollins wells upon the ground that the wells were drilled under turnkey contracts. The petitioners do not deny that amounts paid by an operator for the drilling of a well under a turnkey contract must be capitalized. The first point argued by the petitioners' upon brief is that they did not in any instance receive a completed and equipped well, and, accordingly, the wells were not drilled under turnkey contracts.as determined by the respondent.

The contract entered into on October 22, 1935, under the terms of which the Lambert wells were drilled, was construed in Retsal Drilling Co., 42 B. T. A. 1057, in connection with the deductibility of intangible drilling and development costs in the drilling of two wells on the Crosbar-Maxwell lease. Under that contract the leaseholder agreed to swab the wells in and to furnish water, fuel, tanks, flow lines, and a man to supervise the drilling of the sand area and the running of casing. We said that the Betsal Drilling Co. had contracted for a finished job and that its contract obligation to furnish items necessary to complete the work did not operate to convert the contract into one for the employment of labor and the purchase of equipment. So holding, we decided that no part of the amounts paid to the contractor was deductible as intangible drilling and development costs. The petitioners did not in any of the other contracts involved herein agree to furnish more than they agreed to furnish under the contract for the drilling of the Lambert wells.

The petitioners contend, however, that, aside from the question of whether the agreements were turnkey contracts, the amounts are deductible under article 23 (m)-16 of Begulations 94, since they were incurred for wages, fuel, hauling, etc., under a contract for the drilling' of wells to a specified depth at a specified price .per foot. The same contention was made in the Retsal Drilling Co. case and it was answered by pointing out that the contracts were for the drilling of wells to a designated sand and not to a specified depth and could not be classified as footage contracts. Here the contracts for the Lambert wells and the Rollins well obligated the contractor to drill .wells to the Woodbine Sand. The written contract under the terms of which the Coates wells were drilled could not be produced at the hearing, and the testimony on the contents of the contract does not cover the point. There, is testimony that the terms of. the oral agreements under which the Taylor and Brown wells were drilled provided for the drilling of the wells to “a certain depth.” Petitioners do not rely, however, upon this testimony as proof that the wells were to be drilled to depths ascertainable in a manner other than under the Lambert contract, ‘that is, to a specified sand, and there is nothing of record proving otherwise. Accordingly, petitioners have not shown that the Coates, Taylor, and Brown wells were to be drilled otherwise than to a specified sand.

The first issue is controlled by our decision in Retsal Drilling Co., supra, and, following that case we sustain the action of the respondent in disallowing the amounts in controversy.

Issue II.

The amount of $633 involved in the second issue is alleged by the petitioners to be deductible as an intangible drilling and development cost under the provisions of article 23 (m)-16 (a) (1) of Regulations 86, reading, to the extent material here, as follows:

* * * All expenditures for wages, * * * incident to and necessary for the drilling of wells and the preparation of wells for the production of oil or gas, may, at the option of the taxpayer, be deducted from gross income as an expense or charged to capital account. Such expenditures have for convenience been termed intangible drilling and development costs. Examples of - items to which this option applies are, all amounts paid for labor, * * * in the construction of such derricks, tanks, pipe lines, and other physical structures as are necessary for the drilling of wells and the preparation of wells for the production of oil or gas. * * * For the purpose of this option labor, * * * are not considered as having a salvage value, even though used in connection with the installation of physical property which has a salvage value. * * *

The respondent cites article 23 (m)-16 (a) (1) in contending that the item should be capitalized. This regulation provides, in part:

* * * The options do not apply to any expenditure for wages, fuel, repairs, hauling, supplies,- etc., in connection with equipment, facilities, or structures, not incident to or necessary for the drilling of wells, such as structures for storing or treating oil or gas. These are capital items and are returnable through depreciation.

The petitioners extend the regulations to wages paid to prepare a well for the production of oil, including pumping equipment necessary to extract the oil from the ground, and the respondent, by implication, and without extended discussion of the point, confines the regulations to drilling operations, exclusive of pumping equipment. As we view the question it will not be necessary for us to interpret the regulations to determine their meaning on the point of difference between the parties.

The bid of the Continental Supply Co. for the installation which Laster accepted was a lump sum for a completed job, ready for operation. This is shown beyond serious question by statements appearing in the bid that the work was to be a “Turnkey Installation.”

The situation does not differ from a turnkey contract for the drilling of a well, in which the contractor for a lump sum furnishes equipment and labor for a completed job. In such cases, the wages paid by the contractor are not the costs, as such, of the leaseholder and are not deductible by him under the regulations as intangible drilling and development costs. Grison Oil Corporation v. Commissioner, 96 Fed. (2d) 125; certiorari denied, 305 U. S. 613; O-W-R Oil Co., 35 B. T. A. 452. The respondent committed no error in refusing to allow the item as a deduction for intangible drilling and development costs.

Issue 111.

The difference between the parties on this issue is whether the basis of E. C. Laster in three oil payments acquired in the dissolution in 1936 of E. C. Laster, Inc., is recoverable through allowances for depletion, as determined by the respondent, or whether receipts under the oil payments are taxable only when and to the extent that they exceed cost. The same question was considered and decided adversely to petitioner’s contention in T. W. Lee, 42 B. T. A. 1217. Commissioner v. Laird, 91 Fed. (2d) 498, relied upon by the petitioner here, was considered by us in reaching our decision in the Lee case. On this issue we sustain the action of the respondent.

Issue IV.

The parties are in agreement that where, as here, there is a tax-free exchange, the property acquired takes the basis of the property given up. Secs.'113 (a) (6), 113 (b), and 114 (a), Revenue Act of 1936. The respondent followed the statute by assigning to the leases, including well equipment received, the basis of the property petitioner exchanged therefor, but allocated the amount thereof to the properties acquired according to tbe relative values of the properties exchanged, and in doing so decreased the basis for well equipment and increased the basis for the leaseholds, exclusive of well equipment. The petitioner alleges that respondent should not have altered the basis he had in his original well equipment. In other words, that he should have assigned to the newly acquired well equipment the basis he had in the well equipment given up in the exchange.

The petitioner’s argument is based upon the theory that there was an exchange of well equipment for well equipment and leasehold rights for leasehold rights. There is no support in the record for such a conclusion. The showing is that three leaseholds were exchanged for four leases, including the well equipment on each. There is some evidence of the value of two of the leaseholds exchanged by petitioner, but no evidence on the value of the other leaseholds or any of the well equipment.

The statute provides for a reasonable allowance for the exhaustion of property used in a trade or business. Sec. 23 (1), Revenue Act of 1936. Section 113 (a) (6) of the same act provides, in effect, that when property is received in a nontaxable exchange the basis of the property given up “shall be allocated between the properties (other than money) received, and for the purpose of the allocation there shall be assigned to such other property an amount equivalent to its fair market value at the date of the exchange.” Under a like provision of the 1926 Act, we held in Florence W. Hunt, 35 B. T. A. 1042, that upon the exchange in a nontaxable transaction of shares of common stock of one corporation for common and preferred stock of another corporation, the basis of the stock given up should be allocated between the two classes of new stock according to its fair market value at the time acquired. See Christian W. Von Gunten, 28 B. T. A. 702; P. L. Wheeler, 32 B. T. A. 917. Where a combination of depreciable and nondepreciable property is acquired for a lump sum, so much of the total consideration is assigned as a basis for the exhaustible property as its value bears to the aggregate value. Hazeltine Corporation, 32 B. T. A. 4.

If it could be held that there was an exchange of well equipment for well equipment, as alleged by the petitioner, there would still remain the question of how the basis of petitioner in the equipment on the leases should be allocated to the depreciable property on the four leases. Some sort of a division would be necessary under the circumstances, but none is suggested by petitioner. The method employed by the respondent does not reduce the basis petitioner had in the whole property exchanged. The amount by which the basis on the well equipment was reduced was added to the remainder, so that the entire basis will eventually he recouped — the equipment through allowances for depreciation and the leasehold rights by way of depletion, or as an offset in the event of sale. The respondent’s allowances for depreciation on the equipment are sustained.

Issue V.

The underlying theory of respondent’s action in taxing petitioner E. C. Laster, Inc., on a gain of $11,000 realized in the drilling by F. H. Brown of two wells on the Brown lease under turnkey contracts for $13,500 each, payable out of oil produced by all of the wells on the lease, is that there was an exchange of an oil payment, payable out of a fully depleted leasehold, for completed oil wells having a fair market value of $22,000. No attempt was made by petitioner to prove that the leasehold had a basis. We are not aware of the method pursued by respondent in determining the fair market value of the wells. Upon brief he contends that the evidence contains no proof that the oil payments did not have a fair market value of $22,000 and that, therefore, the wells, upon completion, had a value of that amount. The respondent determined a fair market value of $22,000 for the completed wells in connection with his determination of the deficiency and no evidence Avas offered by the petitioner to establish a different valuation. The record contains no showing that he ever determined a value for the oil payments, as such. There is indication, however, that respondent’s valuation of the wells is based upon an equal value for the oil payments. The respondent argues that there was a transfer of an interest in the lease for completed wells, resulting in taxable gain under Midfield Oil Co., 39 B. T. A. 1154.

The Midfield Oil Co. case involved an exchange of an oil payment, limited in amount, for an overriding royalty giving the holder the right to a return on his investment so long as oil or gas might be produced from the property. The taxpayer admitted a gain measured by the difference between the fair market value of the overriding royalty and the unrecovered cost of the oil payment if the transaction was not a nontaxable exchange under section 112 (b) (1) of the Kevenue Act of 1934. We held that the exchange was not of properties of like kind and recomputed the gain under the admission of the taxpayer.

The only consideration received by the drilling contractor here for the drilling of the wells was a right to share in the proceeds of production of the lease to the extent of the oil payments. This interest in oil in place was something growing out of rights acquired by the lessees from the fee owner, but did not give the contractor an interest in tbe lease by purchase or otherwise, as contended by the respondent. Dearing v. Commissioner, 102 Fed. (2d) 91.

In Transcalifornia Oil Co., Ltd., 37 B. T. A. 119, percentage interests in the proceeds of production of a well to be drilled were issued as additional consideration for assignment of the lease and for legal and supervisory services performed and to be performed in the drilling of the well, and for cash. All of the cash was- to be used to finance drilling operations and purchase oil well equipment. Each 1 percent interest was liable for $10 per month to pay taxes and the cost of operating the well. All of the cash received from the disposition of percentage interests was expended in the drilling of the well. The Commissioner contended that royalty interests were disposed of in sales and that, as the lease had no recoverable base, the total amount received constituted taxable income. We held that the cash was received subject to an implied trust to use it in the drilling of the well and, as all of it was expended for that purpose, no income was received by the lessee subject to tax.

The Transcalifornia Oil Co. case and this one do not differ in substance. In the former cash was invested in a well for a right to participate in its production so long as it continued to produce oil. The holder of the oil payment had a capital investment in oil in place and was entitled to deductions for depletion. Palmer v. Bender, 287 U. S. 551. Upon the completion of the well the lessee held title to it and was required to share its production with the percentage certificate holders, according to their interests. Here the drilling contractor, instead of advancing cash to the lessees for drilling costs in consideration of oil payments, paid drilling costs from his own funds and turned over to the lessees completed wells for oil payments limited in amount. The lessees here received nothing more than completed wells, the cost of which constituted an investment of a third party for a right to share in production. The wells no doubt enhanced the value of the lease, but, as we held in effect in Transcalifornia Oil Co., supra, that fact alone does not make the transaction taxable.

On this issue we hold for the petitioner.

Issue VI.

The parties differ under this issue only upon whether it is controlled by Thomas v. Perkins, 301 U. S. 655, or Anderson v. Helvering, 310 U. S. 104. The respondent contends that the Anderson case governs, upon the assumption that the oil payment was secured by a lien upon the wells drilled, Nos. 5 and 6, and was payable out of two-sixths of the production of the six wells on the lease.

The respondent’s contention as to the lien appears to be based upon a single sentence in the drilling contract reading as follows: “The Contractor is hereby granted and given a first and prior lien upon the said wells, No. 5 and No. 6, until the said sum of thirty-two thousand ($32,000.00) dollars shall have been paid.” Other provisions of the contract demonstrate lack of intention to give the contractor a lien upon the wells themselves for payment of the amount óf the oil payment. The contract provides that the consideration of $32,000 is payable out of proceeds of 2%2 of the first oil and gas produced, saved and marketed from wells Nos. 5 and 6, that the lessee shall not be personally liable for the consideration, and that the consideration “shall never be paid out of any oil and gas but that produced from the above described wells, No. 5 and No. 6.” These provisions of the contract make it clear that the security was confined to the production of wells Nos. 5 and 6, and did not cover any other property. A lien upon production alone does not- make the proceeds therefrom taxable to the lessee. Anderson v. Helvering, supra.

What has been said respecting the contents of the drilling contract partially answers the second point raised by the respondent. Other provisions of the contract are that for measuring the production of wells Nos. 5 and 6, and therefore the extent of the contractor’s right to participate in the proceeds of each run of oil, the wells shall be deemed to produce their proportionate share of all of the six wells on the lease. This was nothing more than a means agreed upon in advance to gauge the quantity of oil produced by the wells to which the contractor was required to look for recovery of his investment. In other words, it was a mere substitute for actual production of wells Nos. 5 and 6 and in nowise alters the fact that the oil payment was payable out of production and from no' other source. Accordingly, the case of Thomas v. Perkins, supra, applies and it follows that the sum of $2,105.40 in question does not constitute taxable income of E. C. Laster, Inc.

Issue VII.

Petitioner E. C. Laster owned all of the stock of E. C. Laster, Inc., and the Eetsal Drilling Co. The latter acquired the working-interest in two leases, part of the production of which was subject to oil payments held by E. C. Laster, Inc. The interest of the Eetsal Drilling Co. in the leases was increased in 1936 by the transfer to it without consideration of oil payments held by E. C. Laster, Inc. Petitioner E. C. Laster testified that “We just demolished the oil payment in favor of the Eetsal Drilling Company.” The respondent placed an aggregate fair market yalne of $6,243.78 on the oil payments and included the amount in gross income of E. C. Laster, Inc., citing section 45 of the Revenue Act of 1936 as his authority. The petitioner admits that the oil payments were assigned without consideration and does not question the valuations determined by the respondent.

Section 45 authorizes the Commissioner in any case where, as here, two businesses are owned by one individual, “to distribute, apportion, or allocate gross income or deductions between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.”

Petitioner upon brief contends that the respondent’s action was not an allocation of gross income to prevent evasion of taxes or necessary to clearly reflect income, but created income where none existed.

The respondent does not contend that the application of section 45 is necesary in order to prevent evasion of taxes. He does argue that he exercised the right conferred upon him by the provision in order to clearly reflect the income of each corporation. Tire effect of his argument seems to be that the transferee realized taxable income upon the receipt of the oil payments equal to the increase in value of its assets because of their “cancellation” and that the amount thereof should be allocated to the transferor on account of its failure to obtain full consideration for the oil payments.

An acquisition of property without or for less than an adequate consideration does not ordinarily result in taxable income. The respondent cites Walker v. Commissioner, 88 Fed. (2d) 170, and B. F. Avery & Sons, Inc., 26 B. T. A. 1393, on the point. Those cases involved the question of whether forgiveness of indebtedness results in the receipt of taxable income. Here, the transfers increased the value of the assets of the transferee, whether it canceled the oil payments upon their receipt or kept them alive for probable sale. Not having paid any consideration for the additional interest in production, it had no basis in the oil payments, and if it sold them, the whole of the selling price would represent taxable gain. They were income-producing assets in the hands of the transferor, not liabilities such as accounts or notes payable, and any income received by the transferee under the oil payments would be taxable to it.

The situation is similar to the one before the court in Tennessee-Arkansas Gravel Co. v. Commissioner, 112 Fed. (2d) 508. There the same interests owned the stock of two corporations which agreed that certain equipment owned by one of them could be used by the other in 1934 without charge. The Commissioner determined a rental of $12,000 for the year and included the amount in gross income of the owner as a proper allocation of income under section 45. The court, in deciding that the petitioner realized no taxable income in the transaction, said: “Section 45, supra, did not authorize the Commissioner to set up income where none existed. The principal purpose of the section was to clearly reflect income that did exist.”

177

The acquisition by the Retsal Drilling Co. of the oil payments without cost did not result in income to it or the transferor. It follows therefrom that there was no income to distribute or allocate under section 45. On this issue our holding is for the petitioner.

Issue VIII.

The disallowance by the respondent of a deduction of $4,200 taken by E. C. Laster, Inc., in 1936 as ordinary and necessary business expenses for legal fees was upon the ground that the amount was accrued for legal work performed in connection with the dissolution of the corporation and the creation of two trusts by E. C. Laster, the sole stockholder of the corporation.

■ It is established by the record that the law firm was retained for a monthly fee of $350 to perform general legal services for the corporation and its fee of $4,200 for 1936 was paid in 1937. It is well settled that legal fees properly accrued by corporations for general legal services and for services rendered in connection with dissolution proceedings are deductible as ordinary and necessary business expenses. Saks & Co., 20 B. T. A. 1151; Pacific Coast Biscuit Co., 32 B. T. A. 39. The evidence also establishes that no part of the fee in controversy was paid for services performed by the firm in connection with the creation of the trusts by E. C. Laster for the benefit of his children. E. C. Laster consulted the senior member of the firm about the matter and the firm drafted the instruments. The fee of the firm and Harry C. Weeks for their services was included in one bill rendered to E. C. Laster by the latter and when the fee was paid the senior member of the firm declined to accept the firm’s share thereof.

It is apparent from the facts before us that no part of the item of $4,200 was accrued by E. C. Laster, Inc., for legal services rendered by the law firm to the corporation’s sole stockholder in connection! with the formation of the two trusts. For this service a separate charge was made and presumably paid by E. C. Laster. The entire amount of the item is deductible as an ordinary and necessary business expense of E. C. Laster, Inc., and we so hold.

Decision will be entered under Rule 50.


source: Caselaw Access Project

author: HaRROn:

license: Public Domain

text:
    The Louisville Fire Brick Works, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100482.
    Promulgated December 27, 1940.

      Frank A. Ropke, Esq., and J. H. McMurtry, Esq., for the petitioner.

      Stanley B. Pierson, Esq., and Roy N. McMillan, Esq., for the .respondent.
   OPINION.

HaRROn:

Petitioner claims deduction in 1936 in the amount of $12,695.92, the unrecovered cost for income tax purposes of the track extension, as a loss uncompensated for by insurance or otherwise, under section 23 (f) of the Revenue Act of 1936. The facts show that in 1936 all possible benefit to petitioner from the railway extension ended. The extension had been deeded in its entirety to the C. & O. in 1927, without reverter of the land on which the track was laid. When the track was removed in 1936 nothing remained to benefit petitioner. Under these facts the question is whether or not petitioner sustained a deductible loss from its original investment in bringing into existence a railway extension reaching to its lands for the purpose of providing it with railway transportation facilities.

Petitioner expended $19,532.19 in excess of the sum it received upon conveyance of the extension to the C. & O. It claims deduction of $12,695.92, having received tax deductions for depreciation in the sum of $6,836.27 in prior years. Whether or not petitioner properly took deductions for “depreciation” in prior years with respect to this particular kind of capital expenditure is not a question in this case, and need not be considered.

Respondent disallowed the deduction in 1936 on the ground that the loss, if any, was sustained in 1934, As will be shown hereafter, this was error. Petitioner sustained a loss in 1936 for which it is entitled to deduction.

It should be pointed out first that, while petitioner’s claim for a loss deduction is sustained, it is not sustained upon the ground that the loss resulted from a “breach of contract” by the C. & O. upon its removal of the track in 1936. The agreement with the C. & Q. consists of letters between the parties confirming oral agreements relating to the construction by petitioner and Ashland and the purchase by C. & O. The material letters, dated June 30, 1926, and August 12, 1926, which are in evidence, do not state any covenant by C. & O. to maintain service over the railway extension for any period of time, or to refrain from removing the track, or any other matter from which it could possibly be concluded that the C. & O. breached its contract in 1936 or in prior years. There is no merit to this argument of petitioner. If there was a “breach of contract” petitioner 'would be presumed to have a right of recovery to compensate it for loss.

Petitioner expended in 1926 a substantial sum to construct a railway extension, with Ashland, intending to deed it to the C. & O. Railway without retention of any rights in tangible property. Such expenditures, heretofore considered by this Board and the courts, have been held to be in the nature of capital expenditures. See Gauley Mountain Coal Co. v. Commissioner, 23 Fed. (2d) 574; Colony Coal & Coke Corporation, 20 B. T. A. 326; affd., 52 Fed. (2d) 923; Kauai Terminal, Ltd., 36 B. T. A. 893; Chicago & North Western Railway Co., 39 B. T. A. 661; affd., 114 Fed. (2d) 882.

The expenditure made by petitioner was for the purpose of bringing a railway track to its lands to provide it with more accessible railway transportation facilities. This was intended to and expected to benefit petitioner in the conduct of its business. The expenditure was made for a benefit, and as long as the railway extension physically existed in the particular location the benefit to petitioner, actual or potential, existed. This benefit, tangible or intangible, was an asset to petitioner and the acquisition thereof required a substantial expenditure by petitioner. On October 1, 1934, the C. & O. obtained permission from the Interstate Commerce Commission to abandon the extension. The certificate granted a permission. It was not a mandate to abandon the extension. The C. & O. could have changed its attitude. When the C. & O. discontinued service over the railway extension during 1934 and 1935 there remained the possibility that service might be resumed, for as long as the track remained in place service could be resumed. As long as that situation obtained petitioner did not sustain a loss. Respondent, accordingly, errs in his contention that the loss, if any, was sustained prior to the year 1936. When the track was removed in 1936 there came to an end both the possibility of resumption of service and all potential benefit to petitioner from the very existence of the railway extension. If a loss was sustained, it was sustained in 1936.

The ultimate question, whether or not petitioner sustained a loss, under the particular facts, is a question of first impression in this proceeding. Respondent argues that petitioner can not be said to have sustained a loss because it had no tangible property interests in the railway extension, which was owned by the C. & O. In Gauley Mountain Coal Co., supra, the court considered the question whether, as here, payments made by a coal company to a railroad company in consideration of the railroad’s agreement to construct a railway line from the main line to the coal mines could be treated as invested capital for the purposes of computing income and excess profits taxes, within the provisions of section 326 of the Revenue Act of 1918. The facts relating to the method of payment of the consideration to the railway company differed from the method of payment here, but otherwise the facts are the same. Title to the railway extension was in the railway company. The court held that the expenditure by the coal company constituted invested capital because, among other things, the coal company acquired a valuable right. The court stated, in part, as follows:

* * * Whether the rights acquired as a result of the railroad connection obtained are to be defined as tangible or intangible property, it is not necessary to inquire. Intangible property, which enables a taxpayer to save or earn money, is as legitimate a form of capital investment as tangible property. * * * The railroad connection itself is quite tangible, the rights flowing therefrom are intangible; * * * the connection and the rights incident thereto are of great value to the taxpayer, and save it many thousands of dollars annually in marketing its coal.
$ $ $ $ $ $ ‡
It is clear that, although the track does not belong to the taxpayer, and the contract does not provide a specific period during which the service over it shall be continued, nevertheless the laying of the track and the railroad connection resulting therefrom established for the taxpayer a relationship with the railroad of mutual advantage and of great and continuing value to the taxpayer.

The court considered, exhaustively, the various arguments against the concept of “invested capital.” It concluded that what was acquired by the payments made in consideration for the construction of the railway line to the mines was not “a mere transitory service, nor a mere intangible increase in the value of property.”

In this case, which comes squarely within the ambit of the court’s reasoning in the Gauley Mountain case, petitioner paid out money to obtain intangible rights of benefit to its business. There can be no question, under the conclusion reached in the above cited case, that its expenditure in 1926 constituted invested capital. It is not material that petitioner’s use of the rights obtained was less than it and the C. & O. anticipated, for it is evident that originally the benefits were expected to extend over an indefinite period of time, looking to the future development of petitioner’s lands. (It appears that Ashland made use immediately of the rights it obtained.) Under such circumstances the removal of the track in 1936 was as much a loss of an asset to petitioner as would be true if one of its physical properties, a plant or equipment, had been destroyed. The intangible right obtained by petitioner by an expenditure of money was capable of destruction in a real sense, for it could be terminated. In fact, the relation with the railroad, which had a real value to petitioner and for which petitioner expended capital, was terminated by the removal of the tracks in 1936. With the termination of the relation petitioner’s capital investment was lost. Undoubtedly, in order to obtain like rail facilities in the future, petitioner would have to make a new expenditure of capital. In such a situation petitioner should be allowed deduction for a loss.

It is concluded that petitioner sustained a loss in the taxable year in the amount of $12,695.92 under the provisions of section 23 (f).

Reviewed by the Board.

Decision will Toe entered under Rule 50.


author: Oppek:

text:
    Murray Baldwin, Individually, and as Executor of the Last Will and Testament of Janet M. Baldwin, Deceased, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 86050.
    Promulgated December 31, 1940.

      Allen Spivoch, Esq., for the petitioner.

      Marry R. Morrow, Esq., for the respondent.
   OPINION.

Oppek:

The original hearing in this proceeding was held October 3, 1938, pursuant to a mandate of the Circuit Court of Appeals for the Ninth Circuit, reversing an order of the Board which dismissed the proceeding for the reason that the petition did not comply with the requirements of Rule 5 (g) of the Board’s Rules of Practice. See Baldwin v. Commissioner, 94 Fed. (2d) 355. Accordingly, although the petition herein was signed by only one of two executors, the Board has jurisdiction to consider it.

A memorandum findings of fact and opinion was entered after that hearing on November 9, 1939. Upon motion of petitioner this findings of fact and opinion was set aside and vacated by an order dated December 20, 1939, and the proceeding was restored to the calendar “for further hearing.” On May 20, 1940, a few days before the further hearing was held, petitioner filed a motion to strike all the testimony of respondent’s sole witness, David Cosgrave, or, in the alternative, for a hearing de novo. At the further hearing the first alternative was granted over respondent’s objection, the testimony of petitioner’s three witnesses remaining in the record, but the testimony of respondent’s witness Cosgrave being stricken subject to the right of respondent to recall and reexamine him. Thereupon Cos-grave testified on direct and cross-examination and petitioner was recalled for rebuttal testimony. Petitioner objected to certain questions asked of Cosgrave at the further hearing, upon the ground that, since Cosgrave was decedent’s attorney, they called for a disclosure of confidential communications of the decedent. The objections were overruled, and at the conclusion of the hearing petitioner moved to strike all the testimony of this witness upon the same ground. This is the motion which was taken under advisement, to be ruled upon in connection with the decision of the case itself.

The substantive question in the case is whether certain real property owned by decedent was conveyed by her to her son in contemplation of death or as a transfer intended to take effect in possession or enjoyment at or after death, so as to justify respondent’s proposed inclusion in the gross estate of the value of that property. We have found as a fact the second of the two alternatives. Although the facts might justify a further finding that the transfer was made in contemplation of death, or that conclusion might follow as a matter of law from the evidentiary facts, we have refrained from finding it also as a fact because, in the view we take, the proceeding is sufficiently disposed of by the ultimate finding which we have made.

The evidence upon which we have based that finding is that given by Cosgrave, which we believe to have been properly admitted. Cosgrave testified that he represented only the decedent, and according to his testimony the material facts with reference to the real property in issue were in part communicated in the presence of a third person, decedent’s son, or were, as to the balance, to be communicated to him pursuant to decedent’s instructions. Under settled rules of general law as well as under the law of evidence of the District of Columbia, and of the State of California, which was decedent’s domicile, such circumstances are sufficient to remove the usual seal of secrecy from communications between attorney and client, from which their customarily confidential nature arises. Oliver v. Cameron, 11 D. C. (McArthur and Mackey) 237; Murphy v. Waterhouse, 113 Cal. 467; 45 Pac. 866; Ferguson v. McBean, 91 Cal. 63; 27 Pac. 518; Keohane v. Keohane, 38 Cal. App. 405; 176 Pac. 386; Collette v. Sarrasin, 184 Cal. 283; 193 Pac. 571, citing Rousseau v. Bleau, 131 N. Y. 177; Koeber v. Somers, 108 Wis. 497; Burnside v. Terry, 51 Ga. 186; Williams v. Bhamenthal, 27 Wash. 24; Bruce v. Osgood, 113 Ind. 360. See also Blackburn v. Crawfords, 70 U. S. 175, 194; Dickerson v. Dickerson, 322 Ill. 492; 153 N. E. 740. This being so, petitioner’s objection to Cosgrave’s testimony was properly overruled and for similar reasons his motion to strike that testimony taken under advisement at the hearing must be and it is denied.

The substance of Cosgrave’s testimony was that the conveyance of the property to petitioner’s son in lieu of testamentary disposition was accomplished by a deed to him duly recorded but prepared simultaneously with a return deed which, as understood by all the parties, was to be executed by the son and retained by Cosgrave, and was to be recorded in the event that the son predeceased decedent. It is petitioner’s contention that this testimony, even though admissible, should not be credited, first, because Cosgrave was a biased witness and, second, because his testimony is contradicted by petitioner and other witnesses appearing in his behalf. While it is true that Cosgrave’s testimony was flatly denied by petitioner and can not be reconciled with his statements, the testimony of the other witnesses was not necessarily inconsistent with that of Cosgrave. Such declarations by decedent to these witnesses as that she intended to give the property to her son or that she wanted him to have the income from it because of his impecunious condition are not at variance with Cosgrave’s version of what was actually performed. Nor are her assertions after she had executed the will and deed that “I have given the estate to Murray,” her son, or that after the execution of the return deed she is said to have told one of the witnesses “he gave it back to me” sufficiently significant or unequivocal to form a basis for any conclusion one way or the other as to the intention of the parties respecting the reversion-ary interest in the property, which is the crucial factor for us to consider in deciding the present proceeding.

Hence it is unnecessary, in order to accept Cosgrave’s statements on that point, to disregard the testimony of apparently disinterested witnesses. This, of course, does not apply to the evidence given by petitioner himself. But Cosgrave is an attorney of many years standing and one whose understanding and memory of the transactions was not successfully impeached. We are unable to conclude that his statements were deliberately false, as we should have to if we were to disregard them. As opposed to the testimony of Baldwin, an interested witness, and one whose understanding or memory may have been much less clear, we have reached the conclusion that Cosgrave is the more reliable witness.

On this version of the facts it seems evident that the effect of the two deeds was no different than would have been a single deed conveying the property to decedent’s son but with a reversion to her in the event that she survived him. Such a transfer is taxable as part of decedent’s estate. Klein v. United States, 283 U. S. 231; Hallock v. Helvering, 309 U. S. 106; Safe Deposit & Trust Co. of Baltimore, Executor, 41 B. T. A. 580. Bespondent was accordingly justified in determining a deficiency in estate tax based upon the undisputed value of the property.

Reviewed by the Board.

Decision will be entered wider Bule 50.

Leech concurs only in the result.

       The procedure at the hearing followed substantially the approved rule for examination of a witness under such circumstances stated in the following language in Collette v. Sarrasin, supra: “It is proper to ask the attorney whether or not with relation to the transaction under inquiry he was acting as the attorney for the person making the statements. If either of the parlies are not satisfied with the answer of the witness, the dissatisfied party can ask such questions as are essential to enable the court to determine whether or not the relationship existed. If the relationship is established to the satisfaction of the court, it remains to be determined whether or not the communication was of such a character as comes within any of the exceptions to the rule concerning communications between attorney and client. The burden of showing that the confidential relation existed was upon the respondent. The showing made being insufficient for that purpose, the rulings excluding the testimony were for that reason erroneous. * *


author: Tyson:

text:
    Puritan Mills, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 98890.
    Promulgated December 31, 1940.

      A. 8. Grove, Esq., and M. F. Pixton, O. P. A., for the petitioner.

      F. L. Van Haaften, Esq., for the respondent.
   OPINION.

Tyson:

The respondent has determined deficiencies in personal bolding company surtax in the amounts of $325.73 and $69.82 for the calendar years 1934 and 1936, respectively, and 25 percent penalties, amounting to $81.43 and $17.46, for those respective years, for petitioner’s failure to file personal holding company surtax returns.

Petitioner assigns error in the respondent’s determination (1) that its income for the years involved was derived from “royalties” within the meaning of section 351 (b) (1) of the Revenue Acts of 1934 and 1936, and (2) that it is subject to the asserted 25 percent penalties for failure to file personal holding company surtax returns for those years.

Petitioner is a Georgia corporation, with its principal office in Atlanta. The parties have stipulated that, in so far as the ownership of petitioner’s outstanding capital stock during the taxable years is concerned, the petitioner comes within the statutory definition of a “personal holding company.”

For each of the years 1934 and 1936 petitioner filed an income and excess profits tax return on the accrual basis, Form 1120, with the collector for the Georgia district. On its 1934 return, the petitioner described its “Kind of Business” as “Owning Patent Rights on Feed and Flour Formulae” and reported its “Gross Income” as consisting entirely of “Royalties” in the amount of $1,658.63. On its 1936 return, the petitioner described its “Kind of Business” as “Flour and Feed Formulae’.’ and reported its “Gross Income” as consisting entirely of “Royalties” in the amount of $1,364.23. The petitioner did not file a personal holding company surtax return, Form 1120H, for either of the years 1934 or 1936. Pursuant to the provisions of section 3176, of the Revised Statutes, the Commissioner made and filed for the petitioner a personal holding company surtax return. Form 1120H, for each of those years and such returns show the Commissioner’s computation of the taxes and penalties in controversy in this proceeding.

Prior to and during the taxable years in question all of the petitioner’s outstanding capital stock, of the par value of $1,000, was owned by the Atlanta Flour & Grain Co., and the officers of the latter were also the officers of the former. The petitioner was incorporated in 1926 for the purpose of keeping the Atlanta Flour & Grain Co. from becoming involved in nuisance law suits which might arise in connection with the latter’s production of flour and feeds.

The petitioner did not own a mill or plant and never manufactured any products; it made no purchases of materials of any kind; it had no salesmen or other employees and paid no salaries; it had no bank account and it kept no cash on hand. All of petitioner’s expenses and bills, which consisted only of various taxes in small amounts totaling less than $90 for each of the years in question, were paid by the Atlanta Flour & Grain Co., but no reference to such arrangement was contained in petitioner’s corporate minutes.

The minutes of a meeting of petitioner’s directors held on January 26,1927, are in part as follows:

There being no old business to come before the directors, Morris Abelman stated that be had made an agreement with the Atlanta Elotjr & Grain Company as to a royalty to be paid to the Puritan Mills by the Atlanta Flour & Grain Company for the use of Puritan Mills brands etc. The royalty for the year 1926 amounted to $1892.68, same amount being placed to the credit of the Puritan Mills.

Petitioner’s books of account were maintained in a double entry ledger kept by its secretary-treasurer and there were entered therein, as income, and carried into surplus, the amounts of petitioner’s bills paid and also the amounts termed royalties credited to petitioner by the Atlanta Flour & Grain Co. during each year. Such income was accumulated in petitioner’s surplus account until dividends were declared at irregular times to its sole stockholder, the Atlanta Flour & Grain Co.

The Atlanta Flour & Grain Co. was a jobber of flour and feeds under various trade and brand names. It purchased, entirely in its own name, different kinds of flour and raw grains. In its own blending plant it produced from the flour and raw grain so purchased various brands of flour and feeds, all of which were put up in bags bearing the inscription “Manufactured by Puritan Mills”, and also the name of one of various brands, some of which were owned by the Atlanta Flour & Grain Co. The Atlanta Flour & Grain Co. paid all costs of raw materials used by it and all of the expenses in connection with its blending operations and its retail sales through its own salesmen. In the instance of sales made within the city of Atlanta the customers were billed on billheads of the Atlanta Flour & Grain Co. In the instance of all orders received from customers-outside tlie city of Atlanta the invoices bore the name of Puritan Mills, the petitioner, because such customers preferred to deal with a mill rather than a jobber. The accounts receivable arising out of all of those sales were carried on the books of the Atlanta Flour & Grain Co. and actually constituted its own accounts receivable. The petitioner’s name was used by the Atlanta Flour & Grain Co. on all of the latter’s products, and, pursuant to an arrangement between those two companies, the amounts credited to petitioner and termed royalties for each year were computed on the basis of a percentage of the retail sales during each year as to which the invoices bore the petitioner’s name. Such credits to petitioner were made for the use of its name by the Atlanta Flour & Grain Co.

The petitioner contends that the amounts shown by the record to have been credited to it by the Atlanta Flour & Grain Co. during each of the taxable years 1934 and 1936, were inadvisedly termed royalties and that such amounts constituted commissions on sales or voluntary payments by the parent company to enable petitioner to meet its expenses. Petitioner further contends that its income, received through such credits during the taxable years, was not derived from “royalties” within the meaning of that word as used in prescribing the income of a “personal holding company” as defined by section 351 (b) (1) of the Revenue Acts of 1934 and 1936, the pertinent portions of which are set out in the margin.

The respondent has determined, and now contends, that the amounts credited to petitioner as royalties during 1934 and 1936 constituted the receipt of income derived from “royalties” within the meaning of section 351 (b) (1), supra, and Article 351-2 (1) of Regulations 86 and 94, which article provides, in part, that “The term ‘royalties’ includes amounts received for the use of or for the privilege of using patents, copyrights, secret processes and formulas, good will, trade-marks, trade brands, franchises, and other like property.”

In our opinion this record clearly establishes that the credits here in question represented payments to petitioner by the Atlanta Flour & Grain Co. under an arrangement between those two companies, for the latter’s use of petitioner’s name, under which, as a trade name or trade-mark, the Atlanta Flour & Grain Co. sold all of its own products solely for its own account. Aside from allowing the use of its own name, and probably some trade brands, to its parent company, the petitioner, so far as this record discloses, rendered no services and sold no products of- any kind to anyone.. We bold that such.pay.-ments constituted income derived from “royalties”- and that the petitioner was a “personal - holding company” within the meaning of section 351. (b) (1), supra, as determined by respondent. Further, since no issue has been raised as to the correctness of the respondent’s computation of the -petitioner’s “undistributed adjusted net income!’ and the personal holding company surtax liability thereon for, the years 1934 and 1936,.we affirm the amounts of the deficiencies here in controversy as determined by the respondent.

The petitioner having failed to file personal holding company surtax returns for 1934 and 1936, the imposition of the asserted 25 percent penalties for those years is mandatory. O'Sullivan Rubber Co., 42 B. T. A. 721, 725, and Olean Times Publishing Co., 42 B. T. A. 1277.

Decision will be entered for the respondent.

       SBC. 351. SURTAX ON PERSONAL HOLDING COMPANIES.
      (b) DEFINITIONS. — As used in this title—
      (1) The term “personal holding company” means any corporation * * * if — (A) at least SO per centum of its gross income for the taxable year is derived from royalties, * * * and (B) at any time during the last half of the taxable year more than 50 per centum in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals. * * *


author: Oppee :

text:
    Regals Realty Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96360.
    Promulgated December 31, 1940.

      Richard P. Jackson, Esq., and Léland T. Atherton, Esq., for the petitioner. ,

      Z. N. Diamond, Esq., for the respondent.
   OPINION.

Oppee :

The first question is whether the “exchange” of petitioner’s real property for other property of a “like kind” was such as to result in postponement of the gain, not received “in cash or other property”, within the terms of the Revenue Act of 1936, sections 112 (b) (l) and 112 (c) (l). On this issue the single question is the applicability of these provisions, since in their absence the entire gain realized was unquestionably taxable in the year the transaction took place.

Without pausing to consider whether the original property was held for productive use or investment, whether the transaction was an exchange, and whether the property acquired was of like kind, it is sufficient for our present purposes to examine the remaining requirement which must be met. All of the aspects just described are insufficient to invoke the provisions of 112 (b) (1) unless the property received is also “to be held either for productive use in trade or business or for investment.” Unless petitioner has sustained its burden of proving the existence of that prerequisite, it can not be said to have brought itself within the situations there described.

The evidence shows that an offer of the same vendee to buy the property for an entirely cash consideration had been rejected a short time previously, after an examination of the extent to which the profit would be subject to Federal corporation and individual income tax; and that the substituted proposal for exchange was not considered favorably until the provisions of 112 (b) (1) had been observed and the arrangement made such that it was thought it would fit that section. An exact compliance with statutory requirements may suffice, even in the presence of an apparent motive to escape taxation. See Gregory v. Helvering, 293 U. S. 465. But in such circumstances we are commended to the strictest scrutiny to ascertain whether in fact that meticulous observance of the statutory formula undeniably appears. Gregory v. Helvering, supra.

In this case the task of thus scrutinizing the action taken is complicated by the character of the particular requirement to which we are directing our attention. It is necessary for us to find that the property was “to be held” for investment. This in our view imports the existence of an intent or mental condition on the part of the holder; so that for our decision to be favorable to petitioner we must be satisfied that its mental state was such that it intended to hold the property received as an investment. Such a motive would in itself be inconsistent with a finding that the real intention of the taxpayer had been to arrange an outright sale of property for cash, but that for tax purposes it had been compelled to create the appearance of a tax-free exchange. For, if the latter is the case, an intention to sell the substituted property for cash as soon as possible in order to achieve the final result originally desired would be more consistent with the underlying purpose than that the new property was also an investment venture. Even an asserted intention of that kind, if such were present here, which it is not, “means little in view of the evidence that the plan was conceived and executed to avoid the tax on that very ground. The whole transaction seems to us to have been artificial in the sense that, given no tax problem, it would almost certainly have been carried out in another way.” Fidelity-Philadelphia Trust Co., Executor, 23 B. T. A. 620, 624.

That is not to say, of course, that the taxpayer’s intention to hold the property as an investment would have been impossible, particularly if it had recognized that such an intention was a part of the procedure through which it must pass to obtain the tax benefits it sought. But that that is not the fact in the present proceeding seems to us to appear conclusively from the contemporaneous declarations of those responsible for petitioner’s actions. The deed conveying the property which petitioner received was dated July 29, 1936. On August 10,1936, at a special meeting of petitioner’s directors, it was decided to liquidate petitioner promptly, and in connection therewith to sell the real estate which had just been received and to distribute the proceeds of that sale to complete the liquidation. On the same day this course of action was approved by petitioner’s stockholders. It places an unbearable strain on the credulity to believe that under those circumstances the property acquired was “to be held” for investment. The action thus taken is the nearest one in point of time to the exchange itself. It is for this reason the most significant as to the intention with which the new property was acquired. That the property was not thereafter sold for cash may have been due to numerous, reasons, among them the possibility that inquiring purchasers were not considered satisfactory; that the price offered was thought to be insufficient; or that, as petitioner’s representative telegraphed to an inquirer on the day following the meeting, “no price has been put on building as yet.” Nothing of this kind is as persuasive in determining, the motive with which the new property was acquired as the action of petitioner’s directors and stockholders upon the consummation of the exchange. Far from sustaining petitioner’s burden of proof of compliance with the requirement of section 112 (b) ■ (1) that the property received was “to be held either for productive use in trade or business or for investment”, the evidence demonstrates affirmatively the reverse.

Petitioner contends that afi intention to transfer the new property •for cash can not reasonably be imputed to it, since the effectuation of such an intention would have the result of eliminating the possibility of any tax reduction. Its argument is that if the new property were thereupon sold for cash, gain on that sale would not be postponed and the total amount realized on the exchange and the sale would be immediately taxable to it. We assume that implicit in this contention is the thought that, petitioner being a corporation and not subject to individual surtax rates, the rates of tax would be the same whether it sold the entire property for cash in one year or received only part cash in one year and the balance in property and sold the exchanged property for cash in the next. This would presumably be true if the normal tax rates on petitioner as a corporation were the limit of our consideration or were the limit of the consideration of petitioner’s stockholders and managers. But if we assume that they had in mind the “undistributed surplus tax” provisions of the Revenue Act of 1936 and were aware that the taxable proceeds of any sale would have to be distributed to the shareholders in the year of receipt in order to obtain the benefit of the dividends-paid credit, and if the shareholders, being in the upper tax brackets, preferred to have such a distribution made in successive years rather than all at once, a sufficient motive might have existed for the treatment which we know to have been adopted. Of course such a consideration of possible motives is the purest speculation and we indulge in it only because of petitioner’s insistence that there could have been no tax-saving motive for the procedure which we have found petitioner selected.

Petitioner contends further that the intention should be gauged by what was actually done rather than by the expression of that intent. We are not persuaded that this is correct. But, assuming we were to do so, the result would be the same. For the action actually taken was to dispose of the property to another corporation controlled by the same interests. It may be true that this transaction was in the nature of a tax-free reorganization. Nevertheless it was a transfer from this petitioner and made it impossible for it to “hold” the property as an investment. We think the provisions of 112 (b) (1) were intended to apply only to the same taxpayer. We are not required to disregard the separate corporate entities of petitioner and its successor at the behest of their creators. Higgins v. Smith, 308 U. S. 473. Consequently, resort to what was actually done equally leaves this petitioner without foundation for its assertion that the intention was that it would continue to hold the property received as its own investment; and, as we have said, without that factor the provisions of 112 (b) (1) are without force. There was, accordingly, no error in respondent’s determination that the entire profit on the transaction was taxable to petitioner in the year before us.

In the view we have taken of the principal question it becomes unnecessary to consider whether the transferee of petitioner’s property assumed the payment of the mortgage thereon or merely accepted conveyance of the property subject to it, and, in either event, whether the amount of the mortgage represented “other property” received within the provisions of section 112 (c) (1).

A further controversy originally presented appears now to have been eliminated by a concession of petitioner’s counsel. The parties were in dispute as to whether the property in question was acquired by petitioner upon its formation, or remained in the beneficial ownership of petitioner’s promoters until approximately a year later, when the details of petitioner’s organization had been completed. The only materiality of that question under the present disposition of the case is to assist in determining petitioner’s basis for gain or loss, and in view of petitioner’s present concession, as we understand it, that in any event petitioner’s basis and the basis of its transferors would be the same under section 112 (b) (5), that issue is no longer of any moment and need not be decided.

Capital items expended during the promotion period are proper additions to cost on either theory. These items, as well as others, contributing to petitioner’s total cost basis are set forth in detail in our findings of fact. Although some were questioned by respondent and were made the foundation for a request for increased deficiency, evidence which would justify us in concluding that respondent has sustained his burden of proving the absence of such expenditures has not been produced. For this reason the facts as to those items have been found in accordance with petitioner’s original claim and the statement in the deficiency notice and respondent’s request for increased deficiency is denied.

Reviewed by the Board.

Decision will be entered, under Rule 50.

Arttndell and Leech dissent.

       SBC. 112. RECOGNITION OP GAIN OR LOSS.
      a * 9 9 » *
      (b) Exchanges Solely in Kind.—
      (1) Property held for productive use or investment. — No gain or loss shall ba recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale, nor stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest) is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment.

       (c) Gain Prom Exchanges Not Solely in Kind.—
      (1) If an exchange would be within the provisions of subsection (b) (1), (2), (S), or (5) of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.

       See Webster’s New International Dictionary, 2d Ed., including among the uses of “to” as “introducing an infinitive as an adjective modifier: (1) indicating intention * * * a house to sell * *

       That this is petitioner’s conception, also, appears from its brief:
      “» * * it is necessary to consider:
      * * # * * * e
      (b) The intention of the transferor towards * * * the new property which was received * * *”

       The following testimony of petitioner’s president may throw some light on this situation:
      “* * * Each stockholder had a different problem. I explained to him that if the property was sold we would get $420,000, and under the provisions of the federal tax law we would have to pay that out of our dividends, and we would get that immediately.
      “Q. Who would get that immediately?
      “A. The stockholders, and I think oat of the $420,000 we would have to pay corporate and individual taxes, * * *”
      At another point he testified:
      “A. * * * So the stockholders suggested — and X did not see anything harmful in it — that the company be reorganized by liquidating Regáis, after transferring the property to another corporation, distributing the $105,000 in cash that way, so as to make available to the stockholders the provision I have referred to.
      “Of course, we recognized at the same time that we would be paying a tax on the new property; in other words, on the total profit and prospective profit.

        “Q. In other words, you were not saving a tremendous amount?
      “A. No; but I guess some of the stockholders were in very high brackets, and they thought that all of that $105,000 was going to go places for them, and I said, ‘All right.’ ”


author: Smith :

text:
    Oregon City Manufacturing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 96523, 96538.
    Promulgated December 31, 1940.

      William C. McCulloch, Esq., Andrew B. Winfree, Esq., and Herbert W. Winfree, Esq., for the petitioner.

      Edward O. Adams, Esq., for the respondent.
   OPINION.

Smith :

These proceedings, consolidated for hearing, involve income tax deficiencies for 1936 and 1937 of $12,322.15 and $4,680.45, respectively. The question in issue is whether the petitioner is entitled, under section 26 (c) (1) and (2) of the Revenue Act of 1936; to credits of $60,047.37 and $24,494.07 for 1936 and 1937, respectively, for contracts restricting the payment of dividends.

The proceedings have been submitted to the Board upon the pleadings, a signed stipulation of facts, and certain exhibits. These establish the following:

1. The petitioner is an Oregon corporation with its principal office in Oregon City.

2. The petitioner had an issue of bonds outstanding in the amount of $448,000, secured by a mortgage on real and personal property, which issue was refunded by a subsequent bond issue in the amount of $448,000 and covered by and pursuant to a trust indenture dated October 15,1935, entered into between the petitioner and the Portland Trust & Savings Bank.

The above mentioned trust indenture is now and at all times since the date of its execution has been in full force and effect. The trust indenture provides in part as follows:

Article II. Special Covenants of the Company.
The Company agrees that it will so long as any bonds of this issue be outstanding pay operating expenses and taxes for each year, and adequately main, tain the plant, and thereafter out of its net earnings it will first increase its present operating capital to the sum of One hundred and seventy-five thousand dollars ($175,000.00), and after said operating capital shall have attained said sum of One hundred and seventy-five thousand dollars ($175,000.00), it will then apply its net earnings in the following manner:
(a) To the creation of an interest payment fund, which shall be accumulated until there shall be in such fund a sufficient amount to pay the next six months’' interest on bonds then outstanding.
(b) To the creation of a bond retirement fund to be used and applied as hereinafter in Article IV set forth.

3. The petitioner paid no dividends upon its stock during the years 1936 and 1937. It had not by the end of 1937 an operating capital amounting to $175,000. It had earned surplus and undivided profits,, as shown by its income tax returns, of $21,086.02 at the end of 1936 and of $44,111.22 at the end of 1937.

4. In filing its income and excess profits tax returns for the taxable years 1936 and 1937 the petitioner claimed credits for contracts restricting dividend payments of $60,108.03 and $25,246.45, respectively, which said credits were equal to the amounts of taxable income reported on such returns, less the amount of normal tax computed thereon.

5. In the audit of the returns the respondent disallowed the claimed credits upon the ground that the trust indenture entered into by the petitioner with the Portland Trust & Savings Bank “does not meet the requirements of the Statute dealing with contracts restricting dividend payments.”

The sole question in issue is whether the petitioner, under section 26 (c) (1) and (2) of the Revenue Act of 1936, is entitled to a credit of the full amount of its undistributed net income, less income and excess profits tax accrual, for each year.

Section 26 of the Revenue Act of 1936, so far as material, provides as follows:

SEO. 26. CREDITS OF CORPORATIONS.
In the ease of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax—
***$*#*
(c) Contracts Restricting Payment of Dividends.—
(1) Prohibition on payment of dividends. — An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which, provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account.
(2) Disposition of profits of taxable year. — An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of the taxable year) to be paid within the taxable year in discharge of’ a debt, or to be irrevocably set aside within the taxable year for the discharge, of a debt; to the extent that such amount has been so paid or set aside. Dor the purposes of this paragraph, a requirement to pay or set aside an amount equal to a percentage of earnings and profits shall be considered a requirement to pay or set aside such percentage of earnings and profits. As used in this paragraph, the word “debt” does not include a debt incurred after April 30,1936.

The petitioner argues that under its contract with the Portland Trust & Savings Bank it could not “without violating a provision of a written contract executed by the corporation prior to May 1, 1936,” pay any dividends to its stockholders. It therefore argues that under either subdivision (1) or subdivision (2) of section 26 (c) it is entitled to the credits claimed.

We shall consider first the application of section 26 (c) (1) to the problem presented. This section allows credits only for contracts containing a provision which “expressly deals with the payment of dividends.” From a perusal of the trust indenture dated October 15, 1935, it is plain that it contains no provision which “expressly deals with the payment of dividends.” To be sure, the provision relied upon by the petitioner prevented it from paying any dividends to its stockholders during the years 1936 and 1937, but it is not every provision of a written contract which prevents a corporation from paying dividends upon its stock that warrants a credit under subdivision (1). If there could be any doubt upon this point, we think it was settled by the Supreme Court in Helvering v. Northwest Steel Rolling Mills, Inc., 311 U. S. 46. In its opinion the Supreme Court said:

* * * The natural impression conveyed by the words “written contract executed by the corporation-’ is that an explicit understanding has been reached, reduced to writing, signed and delivered. True, obligations not set out at length in a written contract may be incorporated by specific reference, or even by implication. But Congress indicated that any exempted prohibition against dividend payments must be expressly written in the executed contract. It •did this by adding a precautionary clause that the granted credit can only result from a provision which “expressly deals with the payment of dividends.”

The petitioner admits that, if by the phrase “expressly deals with the payment of dividends” is meant a provision of a contract which mentions the word “dividends”, the trust indenture involved in these proceedings does not fill the requirement of the statute. It is submitted, however, that a provision of a written contract which renders impossible the payment of dividends “expressly deals” with the payment of dividends. We think it clear that there is no merit in this contention. If a matter is “expressly” stated in a contract there is no ground for any “implication.”

We may not assume that it was the intention of Congress to grant a credit under subdivision (1) in such a case as we have before us. It would, of course, have been a simple matter for Congress to provide that, in any case where a corporation is prevented from the payment of dividends by the provision of a written contract, a credit shall be given. Thus, there is no reason to assume that Congress intended to grant a credit to a lessee corporation under subdivision (1) where by a written contract with a lessor it had bound itself not to pay dividends until its earned surplus should reach a certain amount. The entire language of subdivision (1) must be given effect.

Nor does the petitioner stand upon firmer ground in contending for a credit under subdivision (2). This subdivision has to do with a corporation which is contractually obligated to set earnings aside for the payment of debts. This petitioner did not so contract. Its earnings for the years 1936 and 1931, the years before us, were to be accumulated only for the purpose of increasing its operating capital. Quite clearly the petitioner is not entitled to a credit under subdivision (2). See Hub Clothing House, Ltd., 39 B. T. A. 900.

In support of its contention with respect to a credit under subdivision (2), the petitioner cites G. B. R. Oil Corporation, 40 B. T. A. 738. There the taxpayer borrowed money from a bank to purchase certain oil properties, assigning to the bank all of its income from the properties. The findings show that the bank received the income each month and had a monthly accounting with the taxpayer, which method is still being followed. Under such circumstances the Board held that the taxpayer was entitled to the credit provided by section 26 (c) (2). That case is distinguishable upon its facts from the present proceedings. The principle there applied is not applicable here.

In our opinion the respondent did not err in the determination of the deficiencies.

Decisions will be entered for the respondent.


author: Leech :

text:
    Phinley Holding Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88988.
    Promulgated December 31, 1940.

      Cowrtland Palm&r, Esq., for the petitioner.

      George R. Shemff, Esq., for the respondent.
   OPINION.

Leech :

The ultimate fact which we have found, that the petitioner received 8,100 shares of the stock of United Dry Docks, Inc., in exchange for the issue of all of its capital stock, determines the issues here. Since the consideration for this transfer of stock to petitioner was the issuance of petitioner’s capital stock, it was not received by petitioner as a commission or compensation in the sale of the assets of the Morse Co. to United Dry Docks, Inc., as determined by respondent. It follows that the preferred stock in question did not constitute income to petitioner.

This conclusion is, we think, inescapable on the record. The only evidence supporting the determination of the respondent that this preferred stock was received as income by petitioner is a comparatively short affidavit by Edward P. Farley, without detail, which was used by Courtland Palmer, attorney for the Morse Co., in a controversy with the Internal Revenue Bureau in connection with a tax deficiency proposed against the Morse Co., upon the basis that the Morse Co. had received the 10,000 shares of United Dry Docks, Inc., preferred stock here in question, as a part of the consideration for the sale of its assets to United Dry Docks, Inc. This affidavit, introduced here without objection and without limitation of the purpose for which it might be used, is so contradicted by established facts and circumstances that we are convinced of its falsity. Although subpoenaed by respondent, Farley was not called as a witness, for the reason, as stated by counsel for respondent, he was unable because of an engagement to be present until the next day, and “his testimony would only be cumulative, so far as I can see.”

Farley, in his affidavit, states that in negotiating the sale of the assets of the Morse Co. to United Dry Docks, Inc., he was acting for petitioner, that the option secured by him was the property of petitioner, and that the $1,000,000 in preferred stock of the United Dry Docks, Inc., which was held out of the consideration paid by that company to the Morse Co., was, in fact, a commission received by petitioner for making the sale.

In our opinion, this statement is disproved.

Courtland Palmer, the attorney for the Morse Co., testified that he was present at a conference of Morse and Farley following the “gift” by Farley of 1,900 shares of this preferred stock to Leary, the purpose of which conference was to determine the disposition of the remaining 8,100 shares between Farley and Morse. He stated that Farley had never been employed by petitioner nor had any contact with or knowledge of it, that Farley received the 10,000 shares of United Dry Docks, Inc., preferred stock as his own, that the transfer of the 8,100 shares to petitioner was at Palmer’s suggestion after he called Morse’s attention to the fact that Morse had organized the petitioner corporation which had never been used and that it could be utilized for the purpose of holding title to this stock if Morse and Farley so desired. His suggestion, he says, was accepted, the transfer was thereupon effected and a resolution entered on petitioner’s minutes authorizing the issuance of all of its stock, in equal shares, to Farley and Mrs. Morse, in exchange for these 8,100 shares of preferred stock of United Dry Docks, Inc.

This testimony is corroborated by independent facts and disinterested testimony. The attorney for United Dry Docks, Inc., who conducted the negotiations for his company, testified that all of these negotiations were held with Morse and Farley; that the option that was ultimately exercised was executed in the office of United Dry Docks, Inc., by Morse as vice president of the Morse Co. and there given to Farley; that Farley thereupon executed an assignment of the option to United Dry Docks, Inc.; that both instruments were witnessed by his secretary; that Leary was not present; that no mention was made of the petitioner; and that he never heard of the petitioner until he saw its name on the boobs of the United Dry Docks, Inc., some months later, as the holder of 8,100 shares of stock which his company had paid to the Morse Co. for its assets.

The evidence is that no stock of petitioner was issued until after the sale to United Dry Docks, Inc., when 50 shares were issued to Farley and 50 shares to Ada M. Morse, the wife of Edward P. Morse. The minutes of the petitioner, in evidence, show that this stock was “authorized to be issued for 8,100 shares of the 6% preferred stock of United Dry Docks, Inc.” Another entry in those books, a year and a half later, records the action of the directors in authorizing the transfer of 4,050 shares, or one-half of the stock, to a nominee of Farley’s, in exchange for the surrender of Farley’s one-half of the issued stock. That entry also recites that the shares of stock, basing the present dispute, were acquired by petitioner “in consideration of” the stock to be surrendered by Farley. Admittedly, Palmer was the secretary of the petitioner and prepared these minutes, but, to disregard them, we must assume that he deliberately forged these entries. The record, in our opinion, prevents this assumption.

An affidavit of Leary, used in the tax controversy involving the Morse Co., and introduced here without objection and without limitation as to its use, supports substantially all the important facts as-found, excluding the receipt and disposition of the United Dry Docks, Inc., preferred stock in connection with the transaction, about which Leary swears he knew nothing until September 1936. This affidavit,, however, squarely contradicts the Farley affidavit that the entire 10,000 shares of preferred stock of United Dry Docks, Inc., in controversy here, were the property of petitioner. Leary there states in substance that after the sale to United Dry Docks, Inc., Farley, individually, presented him with 1,900 shares of the preferred stock of that company which he (Farley) owned, and advised Leary that 1,100 more shares of his preferred stock of United Dry Docks, Inc., were being presented to Morse.

After the consummation of the sale of the assets of the Morse Co. and prior to the transfer of the 8,100 shares of preferred stock of United Dry Docks, Inc., to petitioner, the original certificate for the 10,000 shares of that stock, paid by the latter company for the Morse assets, was turned in by Morse and Farley and reissued. The record contains photostatic copies of all the stock certificates. This was at the time when, according to Palmer’s testimony, Farley and Morse were conferring as to their split of the stock remaining after the “gift” of 1,900 of the shares to Leary by Farley should have been effected. Tlie 10,000 shares evidenced by the original certificate, when canceled, were reissued by the transfer agent, at Farley’s direction, in 9 certificates for 1,000 shares each, 1 certificate for 900 shares, and 2 certificates for 50 shares each. It is quite apparent that this split-up was to permit the transfer of 1,900 shares to Leary, as was done by transferring one of the certificates for 1,000 and the one for 900, and to permit of a division of the remaining 8,100 shares standing in the name of the Morse Co., equally as contemplated, or 4,050 shares to Farley and Morse, each. It would have been quite unnecessary to so reissue the shares evidenced by the one original certificate for 10,000 shares, if they were to be transferred to petitioner as a commission belonging to it. Of the certificates covering the 10,000 shares of United Dry Docks, Inc., stock, all issued to the Morse Co., only two, in a total ■of 1,900 shares, were presented to Leary to sign in connection with their transfer. These were the ones representing his “gift” from Farley. The certificates covering the remaining 8,100 shares in the transfer to petitioner, were signed by Morse as vice president of the Morse Co. and Ms signature was witnessed by Palmer. In respect to his signature appearing on the two certificates for 1,900 shares, Leary testified that he had no recollection of signing them, but did not doubt that he had done so. He assumed that they had been brought to him by Morse with other papers or certificates for his signature, which he was accustomed to affix without question or examination under such conditions.

Kespondent contends that, to find that petitioner did not acquire the United Dry Docks, Inc., preferred stock as a commission but received the stock in exchange for the issue of its own stock, we must accept as true the testimony of Palmer, the attorney representing the Morse Co. He argues that this witness has been discredited by the contradictions which the record discloses in his statements, made at various times under different conditions, as to the facts in connection with the several transactions.

Whatever may be said of these inconsistencies and the merit or absence of merit in Palmer’s explanation of them, we are convinced his testimony here as to the controlling fact in this proceeding is correct. It is, in our judgment, corroborated by the numerous independently established facts and circumstances heretofore pointed out.

We conclude, and have so found, that the preferred stock of United Dry Docks, Inc., was received by Farley and that not until after it was so received was it transferred to petitioner and then only in exchange for the issuance of its capital stock. The deficiency falls, and with it both penalties.

Eeviewed by the Board.

Decision will be entered for the petitioner.

Turner dissents.


author: Arundell:

text:
    Estate of Thomas Spruance, Deceased, Alfred McKnight, Administrator, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 94784, 94785, 94820, 94821, 94786.
    Promulgated January 3, 1941.

      Marry O. Weeks, Esq., and B. B. Cannon, Esq., for the petitioner, Estate of Thomas Spruance, Alfred McKnight, Administrator.

      Warren Scarborough, Esq., for the petitioner, Hortense Spruance.

      D. D. Smith, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: Alfred McKnight, administrator of the Estate of Thomas Spruance; Alfred McKnight, administrator of the Estate of Thomas Spruance and Mrs. Hortense Spruance, surviving spouse; Mrs. Hortense Spruance.

   OPINION.

Arundell:

The issues presented here for decision are threefold: (1) Whether Thomas Spruance realized taxable income from the misapplication, misappropriation, and embezzlement of the funds of the First State Bank of Arlington; (2) whether, if the first be answered in the affirmative, such income may be regarded as community income and taxed one-half to petitioner Hortense Spruance; and (3) whether stock owned by petitioners in the bank became worthless in 1937.

On the first question petitioners argue that funds acquired through embezzlement are not income to the embezzler, since he never has lawful possession of them and since, further, simultaneously with the misappropriation he comes under an obligation to restore the amounts embezzled which offsets and nullifies the realization of in-

come. See Commissioner v. Turney, 82 Fed. (2d) 661. Cf. National City Bank of New York v. Helvering, 98 Fed. (2d) 93. The respondent cites as authority for his opposed view G. C. M. 16572, XV-1 C. B. 82, wherein it is said in part:

The United States Supreme Court has also defined income as “gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets.” (Eisner v. Macomber, 252 U. S. 189, T. D. 2010, C. B. 25.) This definition of income is likewise sufficiently all-inclusive to comprehend embezzled property. The proceeds of an embezzlement may surely be regarded as a gain, and if the court’s requirement that gain must be derived from labor may be taken to mean that the gain must result from some expenditure of human energy, then it would seem that the proceeds of an embezzlement are derived from labor.
Although there are no decisions holding directly that the proceeds of an embezzlement constitute taxable income, yet, in view of the foregoing, it may properly be said that there is no controlling authority to the contrary.* * *

The issue which is thus framed is a difficult one and authorities on which to rely in reaching a decision are meager. However, various considerations, the force of which is felt here, have received consideration elsewhere. The illegality of the acts by which Spruance acquired the funds may not at the outset prevent their taxation to him. See United States v. Sullivan, 274 U. S. 259; Chadick v. United States, 77 Fed. (2d) 961; certiorari denied, 296 U. S. 609; Christian H. Droge, 35 B. T. A. 829. The statute seeks to reach income with impartial hands and to spread equally the burden of taxation. The aims of law enforcement are not disserved by requiring the wrongdoer to yield up any part of his ill-gotten revenue.

It it apparent, however, that there is some weight in petitioners’ argument that no income is realized from the possesssion of funds or other assets which belong to another. There is persuasive weight to it when the ownership of these funds is acknowledged and their repayment or payment-over is to be made in due course. See Commissioner v. Turney, supra. On the other hand, it is plain that assets rightfully belonging to another which a taxpayer has applied completely to his own use or disposed of for his own benefit, whether with or without color of legal right, differ very little in the realistic view from income. See National City Bank of New York v. Helvering, 98 Fed. (2d) 93, 96. In this situation it can count for little that the wrongdoer had no title to the funds which he received or that their restoration might through legal action be compelled, see Board v. Commissioner, 51 Fed. (2d) 73; Barker v. Magruder, 95 Fed. (2d) 122. And this is particularly so where the taxpayer has through insolvency rendered himself unable to make the restitution which in some instances might be demanded.

The case before us must be controlled by these principles. Although the evidence is not entirely clear that Spruance put to his own use the funds which he misapplied, no question is raised on the briefs as to this point and the approval by the executor of the claim made against his estate for the misappropriated assets must consti-. tute for our purposes an admission that they were so used. In our view, Spruance appropriated and applied to his own use the funds and assets belonging to the bank. He had, it is true, neither any claim to title nor any basis for retaining them as his property, but what is more important here is that he made use of them as his own property, and, after having received benefits from them which differ not at all from those he would have had from rightful income, he is unable to make any restoration. His death plus the insolvency of his estate render it unlikely that any restitution will ever be effected. We think in these circumstances that Spruance and his estate are estopped to deny that he received income in the amount of the misappropriations. See United States v. Wampler, 5 Fed. Supp. 796; see also National City Bank of New York v. Helvering, supra.

No great significance can, in this situation, be attached to the petitioners’ argument that since Spruance had neither title to the misappropriated assets nor the right to retain them they can not be considered income to him. Contentions of a similar nature were aptly answered by Judge Learned Hand in National City Bank of New, York v. Helvering, supra. There the deceased taxpayer, for whom the bank functioned as executor, during his life received certain sums as secret bonuses from dealings in contracts with the Prairie Oil & Gas Co. of which he was president. When the Commissioner sought to tax these amounts as income it was set up that they could not constitute income to him as they rightfully belonged to the corporation and were not his lawful property. In passing over this argument Judge Hand, speaking for the court there, said:

* * * [the funds] were property of the Prairie Oil Company in the sense that they could have reclaimed them: they were not therefore like the earnings of an illicit liquor seller which belong to him, however acquired. [Citations omitted.] But there are several cases in which persons have been taxed upon property which could be recovered from them. For example, the lender upon usurious interest — if on an accrual basis — must include his apparent profit in his return * * *. Although taxes are public duties attached to the ownership of property, the state should be able to exact their performance without being compelled to take sides in private controversies. Possession is in general prima facie evidence of ownership and is perhaps indeed the source of the concept, itself, though the time is long past when it was synonymous with it. It would be intolerable that the tax must be assessed against both the putative tort-feasor and the claimant; collection of the revenue cannot be delayed nor should the treasury be compelled to decide when a possessor’s claims are without legal warrant.

In the present situation this answer to petitioner’s argument is even more compelling when it can be shown that even though restitution be ordered, as indeed it has been in part, the estate is inadequate to make the restoration required. We, therefore, hold that as to the •estate of Thomas Spruance the misappropriated funds must be considered taxable income. We think, however, that the Commissioner erred in not making allowance for the deposit of the Universal Motor Co. in the amount of $36,968.50. This sum represents funds not used by Spruance for his benefit and moreover already reclaimed by the bank and, therefore, the income taxed to his estate should be reduced by this amount. As for the $25,000 paid on the guaranty bond, no allowance should be made. This in no way reduces the amount received by Spruance but merely involves a substitution of claimants through, the subrogation of the insurance company to that portion of the bank’s claims.

The reasoning by which we have held Spruance taxable does not compel us to hold petitioner Hortense Spruance taxable on one-half of the misappropriated funds. The evidence shows clearly that she received no benefit from the misappropriations of her husband. Her living expenses were met entirely out of her husband’s salary and her home was built with funds received by devise. Indeed, the evidence shows that she was without any knowledge of her husband’s wrongdoing until the time of his death. In such circumstances we think no theory of estoppel militating against the wrongdoer, cf. United States v. Wampler, supra, or against the recipient of the misappropriated assets can bar petitioner Hortense Spruance from showing that she has received no taxable income. In this case we think she has received none.

Ho part of the assets misappropriated by her husband may be taxed to Hortense Spruance unless under the laws of Texas these embezzled funds constitute community property. Poe v. Sanborn, 282 U. S. 101; Hopkins v. Bacon, 282 U. S. 122. The statutes of that state define community property as follows:

All property acquired by either the husband or wife during marriage, except that which is the separate property of either, shall be deemed the common property of the husband and wife * * *. [Article 4619, see. 1, Revised Civil Statutes of Texas (Vernon’s ed., 1936).]

The keystone term in that section — the word “acquired” — has been interpreted and applied by the courts of Texas in several varying situations. Under those cases, property is not “acquired” within the meaning of the community property laws by the mere possession of the property without some title or color of title in the possessor, Bishop v. Lusk, 8 Tex. Civ. App. 30; 27 S. W. 306; Sauvage v. Wanhop, 143 S. W. 259; and they hold that the adverse possession of land by husband or wife without color of title is no acquisition of such realty within the meaning of the community property statute. As a consequence, in the former case on the ripening of title after the wife’s death it was held that no claim to the land might be asserted by her heirs based on the premise that it formed a part of the community.

From the cases noted and others, see Gafford v. Foster, 36 Tex. Civ. App. 56; 81 S. W. 62; Cook v. Houston Oil Co. of Texas, 154 S. W. 279, it may be drawn, we think, as a general principle that property is not “acquired” within the meaning of the community property laws until there is some legal title in the spouse making the acquisition.

The community property laws of Washington have received an interpretation in line with this general principle. In Pappas v. Taylor, 193 Wash. 22; 244 Pac. 390, in a situation somewhat similar to that one before us now, property was transferred by a third party to one spouse with the understanding that she would hold it for him to enable the transferor to defraud his creditors and that she thereupon would reconvey it to him. It was held that the property so transferred did not become the community property of the transferee spouse and her husband, since no substantial title passed by the transfer.

The disposition of the present case must be governed by this principle. The bare possession by Spruance of the misappropriated funds without title was not sufficient to make of them community property. His application of these funds to his own use and benefit does not alter this result. Accordingly, the Commissioner’s basis for taxing to Hortense Spruance one-half of the sums embezzled fails and his action in doing so must be reversed.

We are left with the question of the worthlessness of the stock of the First State Bank of Arlington. Neither petitioners nor respondent question that the stock was without value after the bank’s closing in the month of April 1931. They differ as to the time at which it became worthless, the respondent claiming that it had no value at the beginning of the year 1937.

However, petitioners have produced convincing evidence to the contrary. In the year 1937 the events transpired which deprived the stock of its value — a shortage of $150,000 developed in the assets of the bank and was charged to> its president; the bank ceased to do business and was placed in the hands of the State Commissioner of Banking. The occurrence of this series of events marks most effectively the time at which the bank stock owned by petitioners ceased to have any value. See In re Hoffman, 16 Fed. Supp. 391; affd., Yocum v. Rothensies, 87 Fed. (2d) 200; Van Deusen v. Phillips, 19 Fed. Supp. 492. Cf. John H. Watson, Jr., 38 B. T. A. 1026. Up until that time the bank was a profitable going concern, a circumstance which gave market value to its stock regardless of the undisclosed shortage in assets which was revealed in the audit. Its stock sold at par and sometimes at a sum in excess of that figure during the years prior to 1936. Proof is made of a sale of the bank’s stock in January of 1937 at a price above par and, although the purchaser Avas Thomas Spruance, the Commissioner does not question that this was a sale made in good faith. In this circumstance the market value as thus shown must be taken as cogent evidence that the stock was not valueless at that time. See Frank C. Rand, 40 B. T. A. 233.

In view of the whole evidence adduced on this point, the petitioners are sustained in their contention that the stock became worthless in the year 1937.

We are confronted then with the problem of determining the number of shares held by Spruance at the time of the bank’s closing and their cost and of thus determining the extent of the loss. Petitioners have shown the following purchases at the following prices:

Shares Price
49_$5,580
20_ 1,600
40_:_ 5, 000

Petitioners are entitled to deduction for loss in these amounts.

For the 46 shares which Spruance agreed to purchase from Frank McKnight, deceased, and Frank McKnight, Jr., we think the petitioners may deduct as a loss only the amount which was paid under the contract of purchase, or $800. No loss is allowable for the balance of $3,800 due on the purchase price until that amount has been paid. Price v. Helvering, 309 U. S. 409.

Petitioners are entitled to no loss deduction for the remaining 79 shares which stood in the name of Thomas Spruance at the time of the bank’s closing, since they have not shown the cost or other basis -of these shares. See Forrester Box Co., 25 B. T. A. 128; Girard Trust Co. et al., Administrators, 32 B. T. A. 926.

Decision will be entered wider Buie 50.