author: Akundell :

text:
    George Whittell & Company, Inc., a Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 72414.
    Promulgated October 7, 1936.

      George J. Hatfield, Esq., Mabel Walker Wülébrandt, Esq., W. F. Williamson, Esq., and George E. H. Satchell, C. P. A., for the petitioner.

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

Akundell :

The whole question here is whether the transaction at bar can be broken into its component steps and a gain held recognizable where if considered as a single transaction pursuant to a plan of reorganization no gain would result. The plan here was simply to-change the state of incorporation from California to Nevada for the: purpose of avoiding a California corporation franchise tax. The result intended and accomplished was that assets and liabilities of the California corporation were taken over by the Nevada company? which had the same capitalization and stockholders as the California corporation. The respondent concedes that if the California corporation had received in exchange for its assets the Nevada corporation’s stock and then distributed the stock to its stockholders, no gain would be recognizable. The procedure here, however, was that the sole, stockholder of the California corporation exchanged his stock for that of the Nevada corporation and then the assets of the California corporation were transferred to the Nevada corporation and the California corporation dissolved. The same result was accomplished as under the former method, but the respondent claims that the acquisition of assets was a separate transaction from the exchange of stock and must be taxed as a distribution in liquidation. If the transfer of assets is to be considered a separate transaction from the exchange of stock, the respondent’s position is correct. However, we are convinced that the transaction should be treated as a unit rather than as separate steps. “For income tax purposes, the component steps of a single transaction cannot be treated separately.” Bassick v. Commissioner, 85 Fed. (2d) 8. The substance of the transaction, was a transfer of assets of the California corporation in exchange-for stock of the Nevada corporation and we so regard it. There is-authority in somewhat analogous cases for considering the steps. pursuant to a plan of. reorganization as a single transaction ratlier than as isolated, unrelated transactions. Sylvester W. Labrot, 18 B. T. A. 332; aff'd., 57 Fed. (2d) 413; Helvering v. Security Savings & Commercial Bank, 72 Fed. (2d) 874; Thurber v Commissioner, 84 Fed. (2d) 815; Starr v. Commissioner, 82 Fed. (2d) 964; Bassick v. Commissioner, supra.

We think that the nature of the transaction at bar brings it within the type of business readjustment intended to be exempt from tax under the reorganization provisions of the statute. It was exactly what the statute defines as one kind of reorganization: “A mere change in identity, form, or place of organization” of the corporation. As to whether the particular procedure followed takes any part of the transaction out of the nonrecognition provisions, the intention of Congress is indicated by the Committee Reports accompanying the Revenue Bill of 1924, which first contained the counterpart of section 112 (b) (4):

Congress lias heretofore adopted the policy of exempting from tax the gain from exchanges made in connection with a re-organization, in order that ordinary business transactions will not be prevented on account of the provisions of the tax law. If it is necessary for this reason to exempt from tax the gain realized by the stockholders, it is even more necessary to exempt from tax the gain realized by the corporation.

This objective of exempting the gain to the corporation from a reorganization would be defeated if a reorganization could be split into parts and a tax levied on the isolated steps. The opinion of the drafters of the Revenue Act of 1924 that such a transaction as the one at bar is one type of reorganization is indicated by the statement of A. W. Gregg which accompanied the Treasury draft of the 1924 Revenue Bill.

We have decided a series of cases involving the basis for property received in connection with a reorganization where the facts were similar to those of the present case in that the exchange of stock was made as a separate, and in some instances a prior, step to the transfer of assets. Spang, Chalfant & Co., 31 B. T. A. 721; San Joaguin Fruit & Investment Co., 28 B. T. A. 395; affirmed on this point, 77 Fed. (2d) 723; Piedmont Financial Co., 26 B. T. A. 1221; Mente & Co., 24 B. T. A. 401; Michigan Limestone & Chemical Co., 26 B. T. A. 928; Evans Products Co., 29 B. T. A. 992; and Flushing Nurseries Co., 25 B. T. A. 938. In those cases we emphasized the unity of the whole transaction when carried out pursuant to a plan of reorganization and refused to consider the transfer of assets as a distinct transaction apart from the entire scheme.

The unity of the whole plan in the instant case is unquestionable. The liquidation and dissolution of the California company was not an afterthought separate and distinct from the transfer of the stock, but rather was the whole object of the plan, which was to get the corporation out of the State of California as quickly as possible to avoid the impending California franchise tax. The very first outline of the proposal was that the Nevada corporation should take oyer the assets and not merely the stock of the California corporation, and this objective was stated in every subsequent step in the formulation of the plan, whether formal or informal. It was embodied in the resolutions of the Nevada corporation at its organization meeting and the transfer of assets went forward as rapidly as the circumstances permitted. Dissolution followed shortly after the transfer of assets. The conclusion is inescapable that the assets were transferred in .consideration of stock in the Nevada company, although in point of time the transfer of assets followed the issuance of the stock. Since the assets then were in substance exchanged for stock in the Nevada corporation, no gain is recognizable to the Nevada corporation, since the issuance by a newly organized corporation of its stock in exchange for assets is a capital transaction and no income is realized therefrom. The reorganization here is within either subdivision (A), (B), or (D) of the reorganization definition (sec. 112 (i) (1), Revenue Act of 1928).

Our disposition of the case makes it unnecessary to decide whether the contribution of $600,000 by Anna L. Whittell to the capital of the California company should go to increase the basis of the assets to the California company, as contended by the petitioner, but we express our opinion that the petitioner’s point is well taken.

Reviewed by the Board.

Judgment will be entered under Rule 60.

       Report of the Committee on Ways and Means, H. R. Kept. No. 179, p. 13 ; Report of the Committee on Finance, S. R. No. 39S, p. 14.

       “A corporation in connection with a reorganization may dispose of its assets in one of three ways: It may transfer them to a new corporation in exchange for stock or cash ; it may transfer them to the new corporation, the consideration being the payment by the new corporation of stock or cash to the stockholders of the old corporation; or the new corporation may buy, with its stock and cash, from the stockholders of the old corporation their stock and then liquidate the old corporation. * *


source: Caselaw Access Project

author: Hill:

license: Public Domain

text:
    Wells-Gardner & Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 61138.
    Promulgated October 13, 1936.

      E. E. McDermott, Esq., for the petitioner.

      H. D. Thomas, Esq., for the respondent.
   OPINION.

Hill:

The question for determination here is whether the petitioner and its parent corporation were authorized to make a consolidated return for the calendar year 1930, which was the taxable year of the parent corporation, notwithstanding that the petitioner had previously made and filed a separate return for the fiscal year ended June 30, 1930. Such authority, if it existed, must be found in the provisions of section 141 of the Revenue Act of 1928 and the regulations prescribed by the Commissioner thereunder.

Section 141 confers upon an affiliated group of corporations the privilege of making a consolidated return for the taxable year 1929 or any subsequent taxable year, upon condition that all corporations of such affiliated group consent to all the regulations under subsection (b) prescribed prior to the making of such return. It is provided further in that section that the making of a consolidated return shall be considered as such consent. Subsection (b) of section 141 gives the Commissioner authority, with the approval of the Secretary, to prescribe such regulations as he may deem necessary to determine, compute, assess, collect, and adjust tlie tax liability of an affiliated group of corporations and of each corporation of the group in such manner as to reflect clearly the income and prevent avoidance of tax liability.

Pursuant to that authority the Commissioner, with the approval of the Secretary, prescribed in Regulations 75 for the carrying into effect of the provisions of section 141. Article 10 of these regulations requires that the privilege of making a consolidated return for any taxable year of an affiliated group must be exercised at the time of filing the return of the parent corporation for such year. Article 14 provides that the taxable year of the parent corporation shall be the taxable year of the affiliated group which makes a consolidated return, and that the consolidated net income must be computed on the basis of the taxable year of the parent corporation.

The consolidated return in this case was made in strict accordance with the provisions of section 141, supra, and of the regulations prescribed thereunder. The consolidated return was made voluntarily and in the exercise of a privilege granted by section 141 after the corporations involved affirmatively consented to the provisions of said regulations in addition to the consent imposed by statute upon the filing of a consolidated return.

Petitioner contends, however, that the consolidated return was made without authority of law, for the assigned reason that petitioner had previously made a separate return for the fiscal year ended June SO, 1930, covering the first six months of the taxable year for which the consolidated return was made. This contention is based on the argument that the petitioner by making the separate return had elected not to join in a consolidated return for the calendar year 1930 and that the election was irrevocable and binding upon petitioner, its parent corporation and the respondent, notwithstanding the subsequent making and filing of the consolidated return. We find that neither the provisions of section 141 of the Revenue Act of 1928 nor the regulations thereunder support this argument.

The petitioner has cited and relies upon a number of cases based upon the provisions of previous revenue acts relating to the filing of separate and consolidated returns by affiliated corporations.

There is clearly a difference between the provisions of section 141 (a) of the Revenue Act of 1928 and section 240 (a) of the Revenue Act of 1921. Under section 141 (a) of the 1928 Act an affiliated group of corporations has the privilege -of filing a consolidated return for the taxable year 1929 or any subsequent taxable year, and such privilege is not lost or forfeited by postponing the election to file such return to any taxable year subsequent to the taxable year 1929.

Under section 240 (a) of the Revenue Act of 1921 an affiliated group of corporations was permitted to file either a consolidated return or separate returns for any taxable year beginning on or after January 1, 1922, but the kind of return (consolidated or separate) filed for the first taxable year beginning on or after January 1,1922, was required to be the basis for returns for subsequent taxable years by such corporations unless and until such basis was changed by permission of the Commissioner.

Under the 1928 Act the election applies only to consolidated returns and may be exercised as to any taxable year subsequent to the taxable year 1928, but when the privilege to file a consolidated return is once exercised, the basis can not be changed without permission of the Commissioner, whereas under the 1921 Act the privilege of election applied to separate as well as consolidated returns and could be exercised only for the first taxable year beginning on or after January 1, 1922.

Section 240 (a) of the Revenue Act of 1924 and section 240 (a) of the Revenue Act of 1926 are identical with section 240 (a) of the Revenue Act of 1921, except in respect to the first taxable years to which the later acts apply. Under the Acts of 1921, 1924, and 1926 the filing of a separate return constituted an election to continue to file such return for subsequent taxable years until permission to change to a consolidated return basis was granted by the Commissioner. Also under those acts the filing of a consolidated return for the first taxable year constituted an election to continue to file such return for subsequent taxable years until permission to change to the basis of separate returns was granted by the Commissioner.

Under the 1928 Act the filing of a separate return does not constitute an election to continue to file such return until permission to change is granted by the Commissioner, but the filing of a consolidated return under that act does constitute an election to continue to file consolidated returns on such basis until permission to change is granted by the Commissioner. Therefore, the filing by the petitioner of a separate return for the fiscal year ended June 30, 1930, constituted no legal hindrance or impediment to the making of a consolidated return by petitioner and its parent corporation for the calendar year 1930, which was the taxable year of the parent corporation.

Section 141 of the Revenue Act of 1928 is new law that prospectively supersedes and annuls those provisions of section 240 of the Revenue Acts of 1921, 1924, and 1926 constituting the filing of a separate return an election to continue to make returns on that basis. Hence, the cases cited and relied on by petitioner in support of its contention that the filing of its separate return for the fiscal year ending June 30, 1930, foreclosed it from joining in the consolidated return for the calendar year 1930 have no pertinency in the instant case.

The petitioner, exercising its legal right to join in a consolidated return for the calendar year 1930, included therein its income and losses during the period from January 1 to June 30, 1930, its losses substantially exceeding its income for that period. Its net loss was deducted from its substantial net income for the last half of the calendar year 1930.' Petitioner in its separate return for its fiscal year 1930 also deducted its net losses sustained during the period from J anuary 1 to June 30, 1930, from its income for the period July 1 to December 31, 1929. Petitioner, therefore, had a double deduction of the loss sustained in the period January 1 to June 30, 1930, and in each return the loss was absorbed.

The petitioner and its parent corporation, in exercising their legal privilege to file a consolidated return for the calendar year 1930, pursued a course which safely assured the avoidance of any tax liability for either corporation for such taxable year. This course involved, however, a double deduction of the loss sustained by petitioner during the period J anuary 1 to June 30,1930. The law does not contemplate nor countenance the avoidance of tax liability through such device. As bearing upon the question of the double deduction of losses, the following citations are pertinent: Summerfield Co., 29 B. T. A. 77; Ilfeld Co. v. Hernandez, 292 U. S. 62; National Casket Co., 29 B. T. A. 139; Burnet v. Riggs National Bank, 57 Fed. (2d) 980. In the last case the court said: “Double credits equally with double taxation are to be avoided where possible in construing laws passed by Congress.”

It is obvious that petitioner is not entitled to deduct its loss incurred in the period January 1 to June 30,1930, from both its income for its fiscal year 1930 and its income for the calendar year 1930. Petitioner’s tax liability for its fiscal year ending June 30, 1930, was determined by its separate return for that taxable year. But subsequent to the determination of that tax liability petitioner joined with its parent corporation, the Gulbransen Co., in exercising the privilege granted by statute to make a consolidated return for the calendar year 1930. Under this consolidated return petitioner’s tax liability for the entire calendar year 1930 was determined, and upon that basis it was found that petitioner had no tax liability for such year.

Exercise of the privilege of filing a consolidated return imposed upon the petitioner and its parent corporation acceptance of the following conditions: (1) That they consent to all the regulations prescribed prior thereto under subsection (b) of section 141 of the Revenue Act of 1928; (2) that the consolidated return be made at the time of filing the return of the Gulbransen Co., the parent corporation; (3) that the consolidated return be made for the taxable year of the parent corporation, which was the calendar year 1930; and (4) that the consolidated net income he computed on the basis of the taxable year of the parent corporation.

Under no other conditions and on no less than all of the conditions named is a consolidated return authorized under the statute and the regulations, which have the force of a statute.

No question as to the validity of the regulations referred to has been raised.

In Ilfeld Co. v. Hernandez, supra, the Supreme Court, referring to consolidated returns under the above act and Regulations 75, prescribed under section 141 (b) thereof, said:

The making of the consolidated return constituted acceptance by petitioner and its subsidiaries of the Regulations that had been prescribed. No question •of validity is raised.

The same position was taken on that question in Wishnick-Tumpeer, Inc., 27 B. T. A. 548, and in the same case at 77 Fed. (2d) 774.

The petitioner not only consented to filing a consolidated return for the parent’s taxable year 1930, but consented to all the regulations prescribed prior thereto. Such consent can not be withdrawn or revoked after the consolidated return is filed. Art. 12 (5), Regulations 75.

If petitioner’s contention herein should be upheld it would avoid a portion of its tax liability by reason of the fact that it has twice deducted from its income the loss sustained in the six-month period from January 1 to June 30, 1930 — once from the income for the period July 1, 1929, to June 30, 1930, and again for the period January 1, to December 31, 1930.

In order to reflect properly the income of petitioner and determine its correct tax liability for the overlapping periods of the fiscal year 1930 and the calendar year 1930, it was necessary that there be an adjustment of the return of one of those taxable years.

The Commissioner accepted the consolidated return, as he was compelled to do under section 141 of the Revenue Act of 1928 and articles 10 and 14 of Regulations 75, and determined the tax liability thereon for the calendar year 1930. This operation reflected properly the income and tax liability covered by the period of such return, but disturbed the tax liability of petitioner as previously determined on the basis of its separate return for the fiscal year ending June 30, 1930. Hence, it became necessary, in order to reflect properly the taxable income of petitioner for the eighteen-month period from July 1, 1929, to December 31, 1930, to adjust the separate return for the fiscal year 1930 by limiting it to the period July 1 to December 31, 1929.

It was the duty of the Commissioner to make such adjustment. His action is, therefore, approved.

Reviewed by the Board.

Judgment will Toe entered for the respondent.

       SEC. 141. CONSOLIDATED RETURNS OE CORPORATIONS — 1929 AND SUBSEQUENT TAXABLE YEARS.
      (a) Privilege to file consolidated returns. — An affiliated group of corporations shall, subject to the provisions of this section, have the privilege of making a consolidated return for the taxable year 1929 or any subsequent taxable year, in lieu of separate returns. The making of a consolidated return shall be upon the condition that all the corporations which have been members of the affiliated group at .any time during the taxable year for which the return is made consent to all the regulations under subsection (b) prescribed prior to the making of such return; and the making of a consolidated return shall be considered as such consent. * * *


author: HaeRon :

text:
    East St. Louis Finance Company, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 75090.
    Promulgated October 13, 1936.

      Sidney J. Hayles, O. P. A., for tlie petitioner.

      O. W. SioeoJcer, Esq., for the respondent.
   OPINION.

HaeRon :

This deficiency arises out of the respondent’s determination that the petitioner is not entited to deduct as an ordinary and necessary business expense, under section 23 (a) of the Revenue Act of 1928, the entire amount of $8,000 which it paid to the Audit Corporation for auditing and supervision during the year 1931. The only issue raised by the pleadings is whether the respondent erred in disallowing the full amount of the deduction claimed.

The burden of proof to establish the deductibility of the expense and the amount of it, clearly is upon the petitioner. Burnet v. Houston, 283 U. S. 223. It is not questioned that the petitioner may deduct from its gross income a reasonable amount representing compensation for services rendered in keeping a record of its transactions and supervising- the management of its business. Although salaries are generally paid to individuals for such services, there is no apparent reason why amounts paid to another corporation should not come within the provision of the statute. But it must be shown that the compensation is reasonable in amount and that it is for personal services actually rendered. The action of the directors of the petitioner corporation in ratifying the payment in question is not conclusive of the reasonableness of such payment. See L. Schepp Co., 25 B. T. A. 419, 429, where this Board held:

* * ⅜ j^or ftjg pm'p0Se of determining taxable net income, the deduction is limited to amounts which are reasonably commensurate with the personal services actually rendered and thus are no more than ordinary and necessary expenses of carrying on the business. Hence the directors’ duty to the corporation is no criterion of the Commissioner’s duty to limit the tax deduction within the statutory bounds, and the two are not in conflict. When the Commissioner has made a determination, the taxpayer who attacks it must prove by evidence of the services rendered and their value that a correct determination would exceed that of the Commissioner. Where the payments are to kinsfolk or to shareholders, the proof must also show that they were not influenced by family considerations and were not disguised distributions of profits. See Botany Worsted Mills v. United States, 278 U. S. 282; Becker Bros. v. United States, 7 Fed. (2d) 3; United States v. Philadelphia Knitting Mills, 273 Fed. 657; Benz Bros. Co., 20 B. T. A. 1214; C. S. Ferry & Son, Inc., 18 B. T. A. 1261; Home Industry Iron Works, 8 B. T. A. 1267; Meyer Hecht, 2 B T. A. 319; Gustafson Mfg. Co., 1 B. T. A. 508.

In New York Talking Machine Co., 13 B. T. A. 154, 161, it was held: “The question of the reasonableness of the salaries must be determined with reference to the volume of business, the profits made, the character of the services for which the compensation was paid, and all other pertinent facts shown.”

In the instant proceeding the services performed for the petitioner by the Audit Corporation appear to have been ordinary bookkeeping services. The Audit Corporation owned all of the capital stock of six subsidiary companies, including the petitioner, and each company presumably received the same service from the Audit Corporation, so that each company should have had a similar expense. The Audit Corporation, however, did not charge all of its subsidiary companies for the services rendered during the taxable year but charged only the petitioner, the Peoria Purchasing Co., and the East St. Louis Brokerage Co., in the respective amounts of $8,000, $1,000, and $1,000. It is alleged in the petition with respect to the charges thus made against only three of the six subsidiary companies, as follows:

The charges were not made until the end of the calendar year for the reason that the parent corporation did not wish to burden its subsidiary corporations with adequate charges for supervision and financing if such charges would result in creating a deficit on the books of the subsidiaries. The charges made by the parent corporation to its subsidiaries were never more but oftentimes less than commensurate with the benefits derived by the subsidiary corporations from their affiliation with the parent corporation.

The president of the petitioner testified that the charge of $8,000 was not based on any contract between the petitioner and the Audit Corporation. In reply to a question as to how this figure of $8,000 was arrived at, the president said:

I don’t know why I was assessed that. I don’t know why I had to pay $8,000. There might have been more work and more expense for them for us than some of the others.

The petitioner asserts that “the charges made by the parent corporation to its subsidiaries were never more * * * than commensurate with the benefits derived by the subsidiary corporations from their affiliation with the parent corporation.” Whether or not this is true is within the judgment of the directors of the petitioner corporation. But to sustain its claim for deduction of the full amount of these charges from its gross income, the petitioner is obliged to show that the amount of the charges in question was reasonable and meets the statutory requirements for a tax deduction. In spite of this burden on the petitioner, it has failed to produce evidence to show the real value of these services to its business, or what amount it would be required to pay to some other agency for the same services as those rendered by the Audit Corporation, or whether the services were unique and of unusual value. The Audit Corporation had offices in Atlanta, Georgia, where the hearing was held, but none of its officers was present to testify on behalf of the petitioner with respect to the services rendered or the reasonableness of the total amount of the charge. Under these circumstances it is concluded that a charge of $8,000, constituting approximately one-third of petitioner’s gross income, is not a reasonable charge for the services rendered within the statutory qualifications of the tax deduction.

The respondent has allowed a deduction of $1,901.88 for these services, and here again the burden is upon the taxpayer to prove that the services were worth more than the amount allowed by the respondent for the purposes of tax deduction. The petitioner has failed to prove that the services rendered to it by the Audit Corporation during the taxable year were reasonably worth more than $1,901.88. Having reached this conclusion, it is unnecessary to discuss the petitioner’s contention raised in its brief that the provisions of section 45 of the Revenue Act of 1928 have not been properly applied in this case, and the respondent’s theory that the payment of $8,000 amounted in part to a distribution of profits to the petitioner’s parent corporation.

Judgment will be entered for the respondent.


author: Van Fossan :

text:
    Broadway-Brompton Buildings Liquidation Trust, American National Bank and Trust Company of Chicago, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 82818.
    Promulgated October 13, 1936.

      Harry B. Sutter, Esq., and Peter L. Wentz, Esq., for the petitioner.

      S. L. Young, Esq., for the respondent.
   OPINION.

Van Fossan :

This proceeding was brought to redetermine a deficiency in the income tax of the petitioner for the fiscal year ending August 31, 1933, in the sum of $2,305.34, together with an excess profits tax deficiency of $838.31 for the same year.

The only question at issue is whether the petitioner is taxable as an association or as a trust. Several other assignments of error were made but were withdrawn or settled by stipulation. It was further stipulated that no excess profits tax is due and that if the petitioner is taxable as a trust the correct amount of its income tax is $1,359.60.

The petitioner was created by a trust agreement dated August 15, 1932, and designated as Trust No. 1578. Its office is in Chicago. Its trustee is the American National Bank & Trust Co. of Chicago, formerly the Straus National Bank & Trust Co. of Chicago. The beneficiaries are persons who held bonds secured by two first mortgages on the properties known as the Broadway-Brompton Buildings and Broadway-Brompton Garage Annex in Chicago. Certificates of 6,970 units of beneficial interest were issued to such bondholders in uniform and direct proportion to the amount of bonds owned by each of them. The trustee continues to act under the original trust agreement, without modification, amendment or alteration.

The Broadway-Brompton Buildings consisted of two adjacent three-story store and apartment buildings, each of which contains 20 apartments and six stores. The Broadway-Brompton Garage Annex is a garage of 350-car capacity, about 200 feet by 250 feet in size and operated as a public garage. The heating plants are separate but the hot water for all the buildings is supplied from the garage 'boiler. The apartment buildings and garage were built by the same persons and were managed and operated as one project.

In 1927 the owners of the Broadway-Brompton Buildings placed a mortgage on the property and issued bonds in the amount of $650,000, against which, in 1930, the sum of $35,500 had been paid. In 1928 the owners of the Broadway-Brompton Garage Annex (being the same persons) placed a mortgage on that property and issued bonds in the amount of $85,000, none of which was paid. The aggregate indebtedness standing against the two properties in 1931 when acquired by the petitioner was $699,500.

All of the bonds were issued through Huszagh, Musson & Co., an old established firm dealing in real estate bonds. Two Chicago banks held a substantial amount of the bonds as collateral. Bonds in small amounts were purchased by many individuals, such as elderly persons, owners of small businesses, women, and widows who had the proceeds from life insurance policies to invest. Such bondholders considered them as “gold bonds”, nonspeculative, and productive of a sure return at a fixed rate.

After default on December 15, 1930, in the payment of principal and interest on the bonds there was no market for them. Under the terms of each of the mortgages joint action of the bondholders was required to foreclose. Thereupon the bondholders under the two mortgages formed a protective committee to look after their interests and deposited with it over 99½ percent of the bonds outstanding under such mortgages. The committee attempted to make some arrangement with the owners of the buildings to protect the interests of the bondholders and to avoid a foreclosure, but was unsuccessful. The committee thereupon foreclosed, acquired title to the property, and attempted to sell it. The bondholders insisted that the assets be liquidated forthwith, if possible. The chairman of the committee demanded that' some method be employed to force liquidation of the properties. Counsel for the committee assured him that the trust would accomplish such result. In order to hold the legal title until a purchaser could be found and to preserve, conserve, and manage the property in the interim the committee chose the trust agreement as the form of instrument best suited to its needs. A compulsory sale within five years was suggested but in view of the uncertain duration of the depression and the impossibility of immediate liquidation, that period was lengthened to 15 years. After the formation of petitioner the title to the properties was transferred to petitioner.

The trust agreement of August 15, 1932, relates the history of the bond issues and the conditions under which the bondholders acquired the property. It refers to an agreement of the bondholders made on January 2, 1931, and states that the purposes of that agreement were to acquire, sell, and liquidate the property and to distribute the proceeds thereof to the bondholders as soon as practicable. The trust agreement repeats that purpose as a factor in creating the trust. The essential portions of the trust agreement are as follows:

Article I.
Tlie name of this trust shall be the Broadway-Brompton Buildinos Liquidation Trust, and its object shall be the acquisition, sale and liquidation of the Trust Property and of all such other property incidental thereto as may hereafter be acquired from time to time under this trust, and the distribution of the net proceeds thereof as soon as may be practicable in the opinion of the Trust Managers, and in the meantime the conservation thereof (and to that end the management and control thereof), and the division of the net income, proceeds and avails of said Trust Property among the beneficiaries hereof, hereinafter referred to as “Certificate Holders.”
It is the intention and purpose hereof that the Certificate Holders shall be trust beneficiaries only; that the Certificate Holders, the Bondholders Committee and its members, and the Trustee and the Trust Managers as herein constituted shall have no other relationship hereunder; and that there shall be no relation of or liability hereunder as partners, or any other relation or personal liability whatsoever, legal or equitable, among themselves or one with the other or any of them, or with any other person or persons, corporation or corporations; and that the Certificate Holders shall have only a beneficial interest in the net income, proceeds and avails which may come into the hands of the Trust Managers and the Trustee through sales, leases, assignments or other dispositions, conversions or uses of the Trust Property or any part or parts thereof.
Article II.
The Trustee shall have full power to perfect and secure its right, title or interest to the Trust Property or any portion thereof and shall have the power to redeem in equity or otherwise from any sale under a decree or judgment, and to acquire title to property or any interest or right therein directly or through a nominee or otherwise, and the Trustee shall hold all of the Trust Property in trust, to sell and convert the same into cash or other real and/or personal property, and to distribute the net proceeds thereof to the beneficiaries hereunder, and in the meantime, for the purpose of the ready sale and conversion of the property and with that end always in view, it shall have full power (subject as hereinafter provided) to manage, operate, improve, protect and maintain the same; from time to time to lease and demise said Trust Property or any parts thereof, with the improvements thereon or to be erected thereon, in possession or in reversion, for any length of time (even for terms extending beyond the duration of the trust and any such term may commence either in praesenti or in futuro), and to contract to make leases and to grant options to lease and options to renew leases, and to contract respecting the manner of fixing the amount of present or future rentals, and to modify and amend all existing and/or future leases in all respects, and generally and without limitation or. restriction, to lease from time to time and upon any terms and conditions whatsoever, the whole or any part or parts of the Trust Property. * * * [Here follow more specific rights and powers, all necessary and incidental to the primary purpose of liquidating the identical trust property, the Broadway-Brompton Buildings, hereinbefore described.]

The trust agreement contains no provision for continuing business but the trustee is required to distribute the proceeds of the operation and liquidation of the property. It may set up such reserves as it deems advisable.

The trust may be terminated whenever the trust managers in their sole discretion may determine, or upon the direction of two-thirds of the beneficiaries, but in any event within 15 years. The termination clause contains this statement:

* * * It being the intention, however, that the Trust property be sold and liquidated as soon after the institution of this trust as conditions may permit, and the net proceeds thereof distributed to the Certificate Holders;

The trust managers have acted principally through their managing agent, a salaried employee. The managing agent initiates negotiations relating to the business and obtains the approval of the trust managers on all major matters. They have not leased it or any parts of it, for long terms. They have not invested in securities. They have retained no depreciation reserve. They have made no additions or improvements to the property.

Since the creation of the trust the trustee and trust managers have made continuous and persistent efforts to sell the trust corpus. The property was listed with many active real estate brokers in Chicago. Detailed statements of earnings and an elaborate description of the property were given to the brokers, who were informed that the beneficiaries and the trustee were anxious to sell and would entertain anjr reasonable offer. The beneficiaries originally did not want to take over the property but consented to the establishment of the trust only as a last resort and as an emergency measure pending the sale and liquidation of their investment. The beneficiaries and the trustee agree that the property will be sold when an offer acceptable to two-thirds of the former is received. Both the large certificate holders, such as banks (now in receivership), and the small investors are anxious to liquidate the principal of their investment as soon as possible. They are willing to accept $400,000 for the property. No offer of even 40 percent of the cost to the petitioner has been received.

The trust managers have at all times considered the liquidation of the property as their primary object and have engaged in the active operation of the property only in so far as was necessary to continue the enterprise as a going concern in order to preserve its maximum salability. In so doing, they have hired a manager for the garage and have rented the store rooms and apartments. The principal business of the garage is storage but gas, oil, and other supplies are sold incidentally.

At the hearing and on brief the petitioner contended that it was created for the single purpose of liquidating the properties known as the Broadway-Brompton Buildings; that due to the abnormal national economic situation in 1982 no immediate sale could be made; and that, therefore, the trust managers continued to manage and operate the properties solely in order to keep them in the best salable condition for the purpose o,f disposing of them as soon as possible.

The respondent relies on Morrissey v. Commissioner, 296 U. S. 844, and similar cases decided contemporaneously. He argues that the bondholders were not compelled to establish the petitioner trust and that, therefore, they chose to operate a business for profit. He also advances the theory that the trust was created to prevent liquidation rather than to effect it and that since the revenue from the operation of the buildings is producing 4 percent on the original investment, when such revenue increases “the desire to sacrifice the property will cease.”

From a consideration of the trust agreement and other facts of record, we are of the opinion and find that petitioner was a liquidating trust, organized for the single purpose of liquidation, and that its activities were all reasonably necessary to, and consistent with, the accomplishment of that purpose.

Respondent points to the activities of the trust in renting the properties and the profits therefrom as indicating a business purpose. The law does not require that in liquidating a property the owner must abandon all ordinary business judgment and sacrifice the property immediately without regard for condition of the market or amount of loss. The liquidation is to be accomplished with reasonable regard for all surrounding., circumstances. These circumstances may vary with the type of property and the state of the market. If the activity of the trust or property owner in the interim is only such as a reasonably prudent man would .undertake in the preservation of the property or the minimizing of his loss, and is consistent with the primary purpose of liquidation, the owner is not to be penalized for such activity. If, on the other hand, the purpose of liquidation be so obscured by the manifold business activities of the trust that the declared purpose can be said to be lost or abandoned, a very different case is presented. Here, the activities of the trust were all reasonably incident to and consistent with orderly liquidation. The declared purpose was neither obscured nor abandoned and its accomplishment was the primary consideration at all times.

We have carefully considered the recent decisions of the Supreme Court and do not believe they dictate a contrary conclusion. In the Morrissey case the Chief Justice was at pains to point out that the trust in question “was not a liquidating trust.”

Consequent on the above, it is held that petitioner is taxable as a trust and not as a corporation. See Dolese & Shepherd Co., 30 B. T. A. 1171, and cases there cited.

Reviewed by the Board.

Decision will be entered under Rule 50.

TURNER and Hill dissent.


author: Sterniiagen : Van Fossan,

text:
    Rands, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 74942.
    Promulgated October 15, 1936.

      Raymond H. Berry, Esq., Ralph W. Barbier, Esq., and Thomas O. Marlar, Esq., for the petitioner.

      DeWitt M. Evans, Esq., and Leonard G. Mitchell, Esq., for the respondent.
   OPINION.

Sterniiagen :

The Commissioner determined for each of the years 1927, 1928, 1929, and 1930:

* * ⅜ you have incurred liability under the provisions of section 220 of the Revenue Act of 1926 and section 104 of the Revenue Act of 1928. The fact that your company is a mere holding or investment company and has permitted your gains and profits to accumulate beyond the reasonable needs of the business instead of being distributed, is construed as prima facie evidence of a purpose to prevent the imposition of the surtax upon your stockholders. Accordingly, you are subject to a tax equal to 50 per cent of your net income as defined in section 220 (d) of the Revenue Act of 1926 and section 104 (c) of the Revenue Act of 1928.

The petitioner assails this determination.

The general purpose and scope of the statutory provision have been considered in previous decisions, United Business Corporation of America v. C ommissioner, 62 Fed. (2d) 754; R. & L., Inc. v. Commissioner, 84 Fed. (2d) 721; United States v. Tway Coal Sales Co., 75 Fed. (2d) 336; Keck Investment Co. v. Commissioner, 77 Fed. (2d) 244, affirming 29 B. T. A. 143; Saenger, Inc. v. Commissioner, 84 Fed. (2d) 23, and that ground need not be gone over again. The existence of some or all of the conditions requiring the additional tax is a question of fact. If from the evidence it appears that the facts set forth in subdivision (a) exist, the 50 percent tax is levied; and if the facts of subdivision (b) exist there is a presumption which supports the 50 percent tax unless overcome.' The essential question always is whether the corporation was formed or availed of to relieve the shareholders from surtax. When the Commissioner determines a deficiency under this section of the statute, the taxpayer can only succeed by affirmatively proving that this is not so.

In our opinion, the evidence supports the Commissioner’s determination. Although Bands testified categorically that in forming the corporation he had no thought of taxes, we find it impossible in view of the remaining evidence to let this oral testimony of the most interested witness control the judgment. Cf. Edward G. Swartz, Inc., 33 B. T. A. 355. Bands had accumulated a fortune, the income from which placed him in the high surtax brackets. He would be more naive than he appeared to be on the witness stand if he were unmindful of his heavy taxes. To provide an occupation for his son and to give himself something to do are not motives which necessarily compel the organization of a corporation and the transfer to it of securities worth $1,500,000, comprising one-third of his estate. Such motives are not inconsistent with a tax-saving purpose.

But the statute is not dependent alone upon the purpose of the forming of the corporation, being equally applicable if the corporation after its formation is availed of for such purpose. As to this, there can be little doubt. To it, Bands, substantially its sole shareholder, transferred large amounts of his personal funds each year as loans without interest. If these amounts had been employed by Bands in normal use or investment they would have yielded to him substantial amounts of income taxable to him. By lending these amounts to his controlled corporation without interest such income inured to the corporation and was taxable at the fixed corporation rate. Because the corporation made no distribution, Bands escaped the surtax entirely. This we should think was exactly the scheme which has ever since the Bevenue Act of 1913 been aimed at by Congress. And in this instance we think the statute has not missed the mark.

The petitioner’s counsel, with ability, devote much of their evidence and argument to interesting questions as to the legal meaning of the terms of the section — “holding company”, “investment company”, “mere”, “reasonable needs of the business.” But this case is too patently within the obvious intendment of the statute to permit such dialectical treatment. The term “holding company” does not exclude one which actively deals with the funds contributed by its principal and almost sole shareholder, instead of being a passive repository or “holder” of the funds or assets. Cf. Keck Investment Co. v. Commissioner, supra; R. & L., Inc. v. Commissioner, supra. An investment company is not to be defined as one restricted to long term investments for regular income and excluding one which trades in the market and buys and sells speculative stocks or real estate.. The reasonable needs of the business are not to be regarded as controlled by the judgment of a stock trader, or even of a student of the-market, as to the amount necessary to survive a sudden drop in the market or to take advantage of a rise. If there is difficulty, as petitioner suggests, in formulating a concept for the reasonable needs of the business for such a corporation as this, it does not help the petitioner and does not require that a definition be made which will fit such corporations as a class. Cf. Williams Investment Co. v. United States, 3 Fed. Supp. 225; R. & L., Inc. v. Commissioner, supra; Saenger, Inc. v. Commissioner, supra; Wm. C. deMille Productions, Inc., 30 B. T. A. 826 (on review C. C. A., 9th Cir.); Cecil B. deMille, 31 B. T. A. 1161 (on review C. C. A., 9th Cir.); Edward G. Swartz, Inc., supra. Here subdivision (b) needs no consideration at all, since it appears clearly enough that the crucial subdivision (a) is applicable. This, in our opinion, is no less true as to 1929 and 1930 than as to 1927 and 1928, notwithstanding that the diminution in value of petitioner’s asset securities wiped out surplus. The corporation had taxable income, which but for its intervention would have been taxable to Bands, and it continued to be the instrumentality which enabled him to escape surtax. Saenger, Inc. v. Commissioner, supra; R. & L., Inc. v. Commissioner, supra.

The point is made that the provision is unconstitutional, but prior decisions have upheld it. United Business Corporation of America v. Commissioner, supra; Williams Investment Co. v. United States, supra; Saenger, Inc. v. Commissioner, supra; R. & L, Inc. v. Commissioner, supra.

The Commissioner’s determination that section 220 and section 104 are applicable is sustained.

In 1927 petitioner received $390,000 in redemption of debenture notes of Motor Products Corporation and in 1929 it received $157,920 in redemption of some of the preferred shares of that corporation. The controversy is as to how much of these amounts is taxable gain, and the parties are agreed that this question is narrowed down to whether the original basic figure to be used is the value of Motor Products Corporation shares in 1916, as the Commissioner has held, or of the Hands Manufacturing shares on March 1, 1918, as petitioner claims. Both of these figures of value have been stipulated, and it must now be decided as a matter of law, which one should be used in the computation of gain. It is not necessary, and would only be confusing, to restate the intermediate facts as to changes in organization between the consolidation of May 1916 when Hands, the individual, first received the old Motor Products shares, and 1925, when this petitioner acquired the new Motor Products shares from Hands in a transaction which gave it his basis for gain or loss. In other words, the problem is to be treated as if in the tax years 1927 and 1929 this petitioner had sold the old Motor Products shares, received in 1916 in exchange for the Hands Manufacturing Co. shares, which it had acquired before March 1, 1913, at a cost of $25,000, and which on that date were worth $1,669,597.97 and which in the consolidation of 1916 were exchanged for Motoi Products shares and cash aggregating $1,184,193.60.

By the consolidation of 1916, the Hands Manufacturing shares were turned in for cash and property amounting in the aggregate ($1,184,193.60) to more than original pre-1913 cost ($25,000) and to less than March 1, 1913, value ($1,669,597.97). There was, therefore, no deductible loss or taxable gain at that time. United States v. Flannery, 268 U. S. 98; Ludington v. McCaughn, 268 U. S. 106; Goodrich v. Edwards, 255 U. S. 527; Walsh v. Brewster, 255 U. S. 536.

The determination of gain or loss in 1927 and 1929 is governed, as to the redemption of debentures in 1927, by the provisions of the Hevenue Act of 1926, and, as to the redemption of shares in 1929, by the Revenue Act of 1928. The applicable provisions of both acts are identical and are projections of similar provisions of the Hevenue Act of 1924. Those of the 1926 Act are set forth in the margin. From them it will he seen that the consolidation of 1916 was what the 1926 Act called a reorganization, and that the exchange by Rands of his shares in Rands Manufacturing Co. for shares of the newly consolidated Motor Products Corporation was an exchange in a statutory reorganization whereby Rands received property and cash. This is squarely within section 204 (a) (6). In other words, the Motor Products Corporation shares were acquired upon an exchange in a statutory reorganization. Gain or loss was, under the statute in force at that time, as construed by the decisions of the Supreme Court, not properly to be recognized, and therefore the basis of the Motor Products shares thus received must, by section 204 (a) (6), be taken as the same as the basis of the Rands Manufacturing Co. shares exchanged for them. Colloquially speaking, there was not in 1916 what the Commissioner calls a “closed transaction.” Under these circumstances, the basis to be used antedates the consolidation of 1916 and becomes either the original cost of the Rands Manufacturing Co. stock or its March 1, 1913, value, whichever is higher, and this is the $1,669,591.97 stipulated as the value on March 1, 1913. There is no substantial distinction between the problem in this proceeding and those considered in Securities Co. v. Commissioner, 64 Fed. (2d) 330, and Philip D. C. Ball, 27 B. T. A. 388, 397, and those decisions are authority to sustain the petitioner’s contention and reverse the Commissioner’s determination.

3. The petitioner assails the respondent’s disallowance of a deduction of $289,480 as the aggregate of losses sustained upon the seven transactions set forth in the findings. Explaining his disallowance, the respondent, in the notice of deficiency, said:

On the return a loss of $289,480 was claimed on the transfer of several blocks of stock to Mr. W. C. Bands, Sr. This loss has been disallowed on the ground that there was not an actual sale, as explained in the beginning of this statement.

The earlier explanatory statement is as follows:

* * * There was no cash involved in these transfers and the entries on the books of the corporation consisted simply of debits to the account of Mr. Hands and to losses on common stocks and credits to the assets transferred. In view of the circumstances and inasmuch as Mr. Hands is the sole stockholder of the corporation, it is held that this transfer does not constitute an ordinary sale, and therefore the loss of $289,480 has been disallowed.

The evidence, in our opinion, establishes that in fact the sales, with the resulting losses, occurred, and findings to this effect have been made. It follows as a matter of law that the petitioner is entitled to the deduction claimed and that the Commissioner incorrectly-disallowed it.

Although there is no dispute as to the facts in evidence, the respondent contends that the transactions can not be recognized as sales because of the following circumstances: They were actuated by a purpose to reduce income taxes, they were transactions between .a “one man corporation and its sole stockholder”, the certificates twrere at all times in the name of Rands, no Federal transfer tax was )paid at the time or until several years later, and the transfers were Ji©t by actual delivery, but by mere bookkeeping entries. In our • opinion, none of these circumstances separately or collectively serves -■to prevent recognition of the sales. The separate existence of Rands .and the corporation must be respected not only as a general precept, Burnet v. Commonwealth Improvement Co., 287 U. S. 415; Jones v. Helvering, 71 Fed. (2d) 214, but because this is the only view which is consistent with the application of section 104 and the levy of the <50 percent tax upon the corporation. It could not in the same determination be said that Rands had availed himself of a corporation to save surtaxes, but, that sales to the corporation are sham because it is his creature and may not be recognized. While such a circumstance invites suspicion and requires strict adherence to the legal xequi sites of a sale, it does not vitiate a sale otherwise complete. Commissioner v. McCreery, 83 Fed. (2d) 817. So long as the .taxpayer hews to the line* the sale must be respected. If the ^corporation had reacquired the shares or had sold them at other than a fair price or had not taken the usual steps to account for the transfer either upon its own books or in the records of the safekeeping department of the bank, there would have ‘been less foundation for the recognition of a sale than there was. IBut these supporting circumstances are beyond dispute. The purpose to save income taxes is now legally above reproach, and will not serve to .stamp the transaction as other than a sale, Gregory v. Helvering, 293 U. S. 465; Jones v. Helvering, supra. This is likewise 'true .of the circumstance that the shares were held in Rands’ name. ‘This is not uncommon in respect of shares owned by a corporation ’.where trading on the market is frequent and corporate action is ’Cumbersome and inconvenient. The failure of the corporation to pay The transfer tax contemporaneously with the sales tends slightly to ¡support .the Commissioner’s view, but can not be regarded as controlling or sufficient to weigh clown the scale. In view of the undisputed fact that Hands individually was a heavy creditor of the corporation, it is not significant that the consideration for the transfer was a credit against this indebtedness of which appropriate entries were within the year made upon the books of account, William H. Albers, 33 B. T. A. 373 (C. C. A., 6th Cir., dismissed June 30, 1936).

Shoenberg v. Commissioner, 77 Fed. (2d) 446, is cited by the respondent to support the nonrecognition of the sale. In that case, however, there- were circumstances including the reacquisition of the shares by the taxpayer which demonstrated the unreality of the sale and of the taxpayer’s alleged intent to dispose of the property.

The respondent’s disallowance of the deduction is reversed.

Reviewed by the Board.

Judgment mil be entered under Rule 50.

Black concurs only in the result.

Van Fossan,

dissenting: In my opinion the record in this case does not support a finding that petitioner corporation was either formed or availed of for the purpose of preventing the imposition of the surtax on the stockholders. For this reason I dissent from the majority conclusion as to this issue.

       SEC. 104. ACCUMULATION OP SURPLUS TO EVADE SURTAXES.
      (a) If any corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed, there shall be levied, collected, and paid for each taxable year upon the net income of such corporation a tax equal to 50 per centum of the amount thereof, which shall be in addition to the tax imposed by section 13 and shall be computed, collected, and paid upon the same basis and in the same manner and subject to the same provisions of law, including penalties, as that tax.
      (b) The fact that any corporation is a mere holding or investment company, or that the gains or profits are permitted to accumulate beyond the reasonable needs of the business, shall be prima facie evidence of a purpose to escape the surtax.
      (c) As used in this section the term “net income” means the net income as defined in section 21, increased by the sum of the amount of the dividend deduction allowed under section 23 (p) and the amount of the interest on obligations of the United States issued after September 1, 1917, which would be subject to tax in whole or in part in the hands of an individual owner.

       Sec. 204. (a) The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that—
      *******
      (6) If the property was acquired upon an exchange described in subdivision (b), (d), (e), or (f) of section 203, the basis shall be the same as in the case of tile property exchanged, decreased in the amount of any money received by the taxpayer and increased in the amount of gain or decreased in the amount of loss to the taxpayer that was recognized upon such exchange under the law applicable to the year in which the exchange was made. If the property so acquired consisted in part of the type of property permitted by paragraph (1), (2), (3), or (4) of subdivision (b) of section 203 to be received without the recognition of gain or loss, and in part of other property, the basis provided in this paragraph 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. This paragraph shall not apply to property acquired by a corporation by the issuance of its stock or securities as the consideration in whole or in part for the transfer of the property to it; *******
      Sec. 203. (b) (2) No gain or loss shall be recognized if stock of securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
      *******
      (f) If an exchange would be within the provisions of paragraph (1), (2), (3), or (4) of subdivision (b) 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 or loss, but also of other property or money, then no loss from the exchange shall be recognized.


author: SteRNhagen :

text:
    William C. Rands, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 62066, 68846.
    Promulgated October 16, 1936.

      Raymond H. Berry, Esq., and Ralph W. Barbier, Esq., for the petitioner.

      DéWitt M. Evans, Esq., and Leonard C. Mitehell, Esq., for the respondent.
   OPINION.

SteRNhagen :

The respondent has determined that for each of the four years in question the income which the petitioner has treated as income of the two trusts, one for his wife and one for his son, was in reality income of his own, taxable to him as an individual. In the notice of deficiency covering the years 1927, 1928, and 1929, the Commissioner held “that the beneficial title to the corpus of the trusts created by you for your wife and son was never relinquished, and the income from same represents taxable income to you as grantor.” This is assailed by the petitioner, who vigorously insists that by the two instruments of 1923 he established trusts consisting of 2,500 shares of Motor Products Corporation stock, or such other property as by exchange or reinvestment should be acquired in lieu thereof. The respondent argues that both from the language of the instruments themselves and from the method and circumstances of their administration, there were in truth no trusts; and that in any event, if trusts may be recognized, they must be limited to the income from the alleged funds after it is derived by the petitioner as owner of the securities. In the evidence can be found detailed facts which tend to support each side of the controversy, and the ultimate decision can only be reached after carefully weighing the entire record.

The instruments themselves give the impression of declarations of trust in behalf of the wife aiid son of 2,500 shares of Motor Products stock, with the right in the trustee to sell and reinvest the proceeds and also to vote the shares. A closer examination, however, indicates that all that the so-called beneficiary was said to have was a right to receive the dividends from the original shares or an equivalent amount of periodical income from the successor securities during the life of the beneficiary. All of the substantial rights and incidents of ownership in the principal were retained by Sands as an individual, without let or hindrance from either the beneficiary or any other person. The only obligation which he purported to impose upon himself was the duty to distribute income “to the end that the dividend payable to said beneficiary shall remain undisturbed”; and this only so long as the beneficiary lived. Thereafter both the securities and the income therefrom were his own or his estate’s.

If there were any doubt that the interest of the beneficiary was in each case limited to the dividends or equivalent income, this doubt would be dispelled by Rands’ testimony as to the understanding and habitual practice with which he administered the trusts. He said that the beneficiary was in no event entitled to a distribution of gains or profits in the corpus, and the instrument itself indicates that the income from such gains and profits was not distributable. Consistently with this practical oral construction by the trustee of his own duties under an ambiguous instrument, the evidence shows that no profit has been in fact distributed and less income than the amount of dividends on the original shares. Thus the effect of the arrangement has been that Rands has never parted nor undertaken to part with the so-called corpus, but has retained the right and has fully exercised the right to build up the corpus for himself and his estate, qualified only by the undertaking to distribute an amount equivalent to the dividends upon the original 2,500 shares. In practice, so much only has been actually distributed as “they required”; whether in the judgment of Rands or of the beneficiaries is not clear.

There is evidence to indicate that Rands conducted himself as the sole and unqualified owner of the funds and in a manner wholly inconsistent with a proper regard for fiduciary responsibility. Large amounts which were supposed to be in the trust funds were loaned to Rands, Inc., a corporation of which Rands held substantially all the shares and which was engaged in active speculative trading in the stock market (see Rands, Inc., 34 B. T. A. 1094). These loans were made without interest or security. Substantial amounts were also loaned to brokers on call. Whether in fact these uses of the funds proved to be profitable or otherwise is beside the point. Their significance is as an indication that no one regarded them as trust funds in the custody of a fiduciary or that they were subject to any restrictions by -virtue of the instruments' of 1923'.

Furthermore, although there was a showing on the books of account kept by Rands’ bookkeeper of separate accounts attributed to the two trusts, this showing itself indicates that there was no nice regard for the existence of trust property and income and no segregation of distributable income, nondistributable profits or increment, or the sources of such distributions or withdrawals as were made. We think, therefore, that a full and careful consideration of all the evidence offers no escape from the view that the alleged trusts were wholly without substance and that the income which the taxpayer omitted from his own return upon the theory that it was separately taxable to each of the two trusts is properly to be taxed as his own. Benjamin F. Wollman, 31 B. T. A. 37.

This is not to say as a general rule that the income of a trust legally created and administered may be lightly attributed to the settlor and taxed to him. When, however, one attempts such a scheme, particularly by placing himself in the equivocal position of being both the settlor and the trustee, he must execute the plan with the most exact, even meticulous, adherence to it. The integrity of each detailed act must be established. If there is any shilly-shallying by him, he can not expect the Government to give recognition to a structure for which he himself has less than a high regard. While a tax-saving motive does not vitiate a plan otherwise legal, it may serve, when coupled with loose and inexact administration, to confirm a suspicion that the plan is one without substance or reality. This we think is the situation here.

As an alternative to the view that there were no trusts whatever,, we think that at most the instruments established only an obligation upon Rands to hold the income in trust for these beneficiaries after it was derived by him from the securities, and that the securities themselves were at all times his own. Thus the legal effect was only as an assignment of future income, and as such did not operate to exclude it from his taxable income. It is only when the income-producing property is itself transferred that the income therefrom is no longer attributable to the transferor. McCauley v. Commissioner, 44 Fed. (2d) 919. Here it seems that at most Rands attempted to transfer the property itself to himself as trustee for himself and his estate as beneficiary, and the present ownership of the principal was still in him. Upon this view, if not upon the other, the petitioner has failed to establish that the income should, as a matter of law, be excluded from his return.

In determining the amount of gain derived from the redemption of the preferred shares and the debenture notes and from the sale of the common shares of the Motor Products Corporation, the respondent used as the basis for computation the agreed value of the old Motor Products shares received in 1916 rather than the higher value of the Rands Manufacturing Co. shares on March 1, 1913. The petitioner claims to be entitled to the use of March 1,1913, value as the basis. This controversy is precisely the same as that presented in Rands, Inc., supra, and, as in that proceeding, the decision here is that the respondent’s determination is in error. The March 1, 1913, value is the correct basis to be used.

The gain derived from the redemption of the Motor Products debentures and preferred shares was treated by the respondent in his determination of the deficiency as capital gain. He now, by affirmative pleading, claims that the capital gain provision does not apply to the proceeds of redemption because the redemption of shares or debentures is not a sale or exchange; and that such proceeds are therefore properly to be taxed as ordinary income. This question has been fully considered in John H. Watson, Jr., 27 B. T. A. 463, overruling Henry P. Werner, 15 B. T. A. 482, and followed in Arthur E. Braun, Trustee, 29 B. T. A. 1161, and George A. Hellman, 33 B. T. A. 901. We can see no distinction in principle, and the respondent’s contention that the proceeds shall be treated as ordinary income is sustained.

Reviewed by the Board.

Judgment will be entered imder Rule 60.

Smith and Leech dissent from the holding that the alleged trusts are without substance.


author: Disney:

text:
    R. C. Kuldell, Petitioner, v. Commissioner of Internal Revenue, Respondent. Ethelyn Cramer Kuldell, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 76799, 76800.
    Promulgated October 16, 1936.

      Walter E. Barton, Esq., Raymond G. Oushwa, Esq., and J. L. Bloch, G. P. A., for the petitioners.

      L. W. Greason, Esq., and Irving M. Tullar, Esq., for the respondent,
   OPINION.

Disney:

(1) The first question for our consideration and determination is whether or not the transactions here involved and set forth in our findings of fact constitute a sale of the securities involved to the Houston Land & Trust Co., as contended by petitioners.

The evidence is somewhat confusing and conflicting, but when all the facts and circumstances are carefully weighed and considered, looking through form to substance, we are of the opinion and hold that there was no sale of the said securities to the Houston Land & Trust Co.

After the incorporation of the Mount Rose Co., R. C. Kuldell decided to transfer the securities to that company, and it was to the secretary of that company that he took a series of cards descriptive of the securities which he desired to transfer to the “Mount Rose Land Corporation.” This corporation was, later, the successor to the Mount Rose Co., which plainly indicates that the witness Kuldell intended to designate the Mount Rose Co., and not the Houston Land & Trust Co. His written instructions to the Houston Land & Trust Co., which were followed, indicate clearly that it was his desire to transfer to the Mount Rose Co. In his written instructions the Trust Co. was not directed to purchase for itself, but for the Mount Rose Co. “Bought slips” were to be issued, not for the Houston Land & Trust Co., but for the Mount Rose Co. They were so issued and confirmed. The price of purported sale by R. C. Kuldell and purported purchase by the Mount Rose Co. was the same — the closing price of May 31, 1930. The purchase and sale confirmation slips show the transaction made as of May 31, 1930, consonant with his instructions, and the Mount Rose Co., claiming loss on its income tax return on certain of the securities, stated on oath they were purchased by the Mount Rose Co. on May 31, 1930, which indicates strongly that the written instructions and purchase and sales slips reflect the true situation— a transfer to the Mount Rose Co., not to the Houston Land & Trust Co. The Houston Land & Trust Co.’s record showed its cashier’s check, though issued to R, C. Kuldell, to have been purchased by the Mount Rose Co.

The bonds passed at $154,991.51. This includes $2,712.76 interest thereon, computed to May 31. The sale slips show the rate and the periods covered by the interest. Interest to June 5, 1930, at the same rate, would have been $160.46 additional. R. C. Kuldell collected m> interest after the sale. By $160.46 interest, therefore, the Houston Land & Trust Co. would have profited if it had in fact been a transferee of the bonds. Such a gratuity is not consistent with an actual sale. That company itself understood the securities were not to be retained as its own, but would be immediately transferred to the Mount Rose Co., designated by R. C. Kuldell, which was done with no profit or commission whatever to the Houston Land & Trust Co. Only one transfer tax was paid, and the only record of transfer of securities is to the Mount Rose Co.

We find it impossible to conclude that there was any intent to pass title to the Houston Land & Trust Co., and we hold that there was no; sale to that company, but that that company acted only as agent for petitioners in passing title to the Mount Rose Co.

(2) Did petitioners sustain a deductible loss in 1930 on the stocks and bonds involved herein by reason of their transfer to the Mount Rose Co. ?

The transactions which brought about a transfer of the securities to the Mount Rose Co. occurred almost simultaneously on June 5, 1930. In the transactions and transfer no actual money changed hands.

Section 112 (b) (5) of the Revenue Act of 1928 provides:

No gain or loss sliall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.

The community securities involved herein were transferred to the newly organized Mount Rose Co., and the interest of each of petitioners in its stock which was issued to them was substantially the same as their respective interests in the securities transferred, over which they immediately after the transfer had absolute control, through control and ownership of more than 80 percent of the stock of the corporation.

In the case of Labrot v. Burnet, 57 Fed. (2d) 413, affirming the Board, 18 B. T. A. 332, an interpretation of section 202 (c) (3) of the Revenue Act of 1921, corresponding to section 112 (b) (5) of the Revenue Act of 1928, was involved. It was there held that a husband and wife who acquired a farm as partners and thereafter organized a corporation controlled by themselves, to which they claimed to have sold the farm at a loss, could not deduct the loss from income. The Court of Appeals of the District of Columbia quoted the Board with approval and said:

The Board of Tax Appeals, in considering the application of that section to this ease said: “The substance of the transaction is that the partnership exchanged the farms for stock of the corporation, and that after the exchange the partnership was in control of the corporation, as the word control is used in the section of the statute just quoted. We are of opinion that the transaction is essentially one of the kind in which Congress did not intend for the purposes of taxation to recognize either gain or loss, and that we should be governed by its substance and not its form.” With that reasoning of the Board of Tax Appeals we agree.
In transactions like the one before us, substance and not form determines the applicability of the taxing act. Southern Pacific Co. v. Lowe, 247 U. S. 330, 38 S. Ct. 540, 62 L. Ed. 1142; Gulf Oil Corporation v. Lewellyn, 248 U. S. 71, 39 S. Ct. 35, 63 L. Ed. 133; U. S. v. Phellis, 257 U. S. 168, 42 S. Ct. 63, 66 L. Ed. 180.

The only thing which R. C. Kuldell and wife received in consideration for the transfer of securities was stock in the Mount Rose Co. They received no money. The $463,417.65 check given the Mount Rose Co. was entered on the journal voucher as “capital surplus.” This transfer took place within three weeks after the organization of the corporation and upon the same day that R. C. Kuldell’s earlier check for $10,000 was deposited. Under such circumstances, the securities were the consideration for the capital stock. Article 67 of Regulations 74, applicable to 1930 taxes, provides in effect that voluntary payments by a stockholder to a corporation which are credited to surplus “represent an additional price paid for the shares of stock held by the individual shareholders.” In W. F. Bavinger, 22 B. T. A. 1239, citing authorities, we held that where a stockholder paid an obligation due from a corporation for the purpose of protecting it from suit and protecting his interest therein “the payment * * * must be regarded as additional cost of the petitioner’s stock.”

The cost, then, to R. C. Kuldell and wife, of the stock in the Mount Rose Co., was the securities transferred, which was added to the $10,000 check, which, however, was deposited and put' through the bank only in connection with the transfer of these securities. R. C. Kuldell is therefore seen to have paid out no money upon the check, which went through the form of payment only when and because of the transfer of the securities. Plainly this was an exchange and not a sale to the Mount Rose Co. Since there had been, as we hold, no sale to the Houston Land & Trust Co., the cashier’s check to R. C. Kuldell, the deposit thereof permitting passage through the bank of the checks for $10,000 and $463,417.65, and the two checks for $154,991.51 and $318,426.14 from the Mount Rose Co., totaling $473,-417.65, to the Houston Land & Trust Co., are seen to constitute mere artifice for conveying the securities to the Mount Rose Co. There was no contribution of cash to the Mount Rose Co., for petitioners realized no cash, there being in fact no sale to the Houston Land & Trust Co. Even if it were considered that the securities were a contribution to capital surplus, instead of transferred for stock, petitioners would sustain no deductible loss.

. Petitioners owned the securities before the said transactions of June 5, 1930, and immediately thereafter, though the title to the securities was in the Mount Rose Co., they were in control of the corporation by virtue of their ownership of practically all, more than 80 percent of, its stock, in substantially the same proportions in which they had owned the securities transferred.

We are, therefore, further of the opinion and hold that the petitioners are not entitled to any deductible losses by reason of the transfer of securities to the Mount Rose Co. as shown herein, and the determination of the respondent in disallowing said alleged losses is accordingly approved.

Reviewed by the Board.

Decision will be entered for the respondent.


author: Smith :

text:
    Elizabeth H. Sterling, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 74789.
    Promulgated October 20, 1936.

      Edward Holloway, Esq., for the petitioner.

      Garroll Walicer, Esq., for the respondent.
   OPINION.

Smith :

The petitioner now contends that she received the amount of $46,156.25 in settlement of her claim to ownership of the property in question as the proceeds of its sale, and that the entire amount represented an inheritance from her father’s estate under his will and is not taxable as income to her.

There can be no doubt, we think, that upon the death of Emile Heydenreich under his will the remainder interest in the property in question vested in Louis V. Heydenreich, subject only to the payment of portions of the income to his two aunts. See Harry C. Kayser, 27 B. T. A. 816, and discussion therein of vested and contingent remainders under the laws of the State of New York. See also MacArthur v. Scott, 113 U. S. 340. Looking at the entire will, it was clearly the intention of the testator, Emile Heydenreich, that the real property mentioned in item second of his will should pass to his son irrevocably, subject only to the annual payments referred to' above. He made no provision in his will for any other distribution of the property, nor did the will contain any provision for the devisement of the son’s remainder interest upon any contingency whatever. Elsewhere in his will he made substantial bequests to his widow and both of his children. (See items first, second, and third of the will' quoted above.)

The stipulated facts do not disclose the terms of the agreement under which the petitioner received the payment of $46,156.25. We do not know whether that amount represented some proportional part of the price to which the petitioner was said to be entitled because of her present ownership in the property or whether it was merely an arbitrary amount paid to her in consideration for her agreement not to press her claim to all or any part of the property. We held in Bernard O. Kearney, 31 B. T. A. 935, that an amount of money paid to an heir of a decedent by the residuary legatees in consideration for the heir’s agreement not to contest the decedent’s will was not a gift, devise, bequest, or an inheritance and was all taxable income to the heir.

In her brief the petitioner contends that under any theory of this case the money received by her “was received by inheritance as it represented the amount received by her under or by virtue of the Will of Emile Heydeneeich.” It is certain, however, that the petitioner did not acquire any interest in the property in question under the will of Emile Heydenreich. ( She was not named in the will as even a remote legatee in respect of the property.

Apparently the petitioner based her claim to ownership of some part of the property, or some part of the proceeds from its sale, on her rights as an heir at law of the testator rather than as a devisee under the testator’s will. Undoubtedly such a claim would have had validity if there had been a failure of the testator’s will and a distribution of the property under the intestacy laws of the State of New York. The facts do not indicate that this is what took place. It is not shown that the petitioner was ever adjudged the owner of any part of the property itself, or that as owner she ever sold any interest in the property. Apparently she was required to execute the deed, as was also her mother, out of an abundance of caution on the part of the purchaser.

It is provided by statute under the Real Property Law of the State of New York, L. 1909, ch. 52, par. 57, McKinney’s Consolidated Laws of New York, Annotated, B,ook 49, p. 83, that: “an expectant estate may be defeated in any manner, or by any act or means which the party creating such estate, in the creation thereof, has provided for or authorized.”

As stated above, Emile Heydenreich, in creating the remainder, or “expectant”, estate in Louis Y. Heydenreich, did not provide for the defeat of the estate in any manner or by any means whatever.

It is further provided by the New York statutes, supra, ch. 52, par. 59, p. 85, that:

“Qualities of expectant estates. An expectant estate is descendible, devisable and alienable, in the same manner as an estate in possession.”

In In re Rohr's Estate, 145 Misc. 382; 260 N. Y. S. 181, the testator devised the residue of his estate to his executors in trust to pay certain of the income to a named beneficiary for life, with the remainder of the income to his son for life, and on the death of the son the remainder to certain nephews and nieces. The court held that the nephews and nieces took vested remainders on the death of the testator and that the interests or shares of those dying passed to their estates. The opinion reads in part as follows:

The will under consideration in Clark v. Peters, 68 Misc. 252, 124 N. Y. S. 961, is very similar to the one now being passed upon. In that case the testator gave to his daughter the use of a share of his estate during her natural life, “and after her death” gave and devised the same to her two children, and it was held that the two children took vested remainders upon the death of the testatrix, and upon the death of one of the children before the death of his mother that child’s interest passed to his issue.
The Court of Appeals held in Van Awte v. Fisher, 117 N. Y. 401, 22 N. E. 943, that the remainder was vested under a will which placed the residuary-estate in trust to pay the income to one during his lifetime and to pay the principal or so much thereof as then remained to another (the trustee having been given discretion to invade the principal for the life tenant’s use), and that, the remainderman having predeceased the life tenant, the corpus descended to the remainderman’s issue.
The use of words of time such as “at,” “on,” and “after” usually refer to the time of the enjoyment of an estate and not to the time of its vesting in interest. Connelly v. O’Brien, 166 N. Y. 406, 408, 60 N. E. 20; New York Law of Wills, section 955, Remsen, Preparation of Wills, 196.
It is therefore held that the named nephews and nieces of the decedent took vested remainders, and that, some of them having since died, the interests or shares of the latter pass to their estates, for vested remainders may be alienated, inherited, and devised. Real Property Law, sec. 59; Ham v. Van Orden, 84 N. Y. 257.

The remainder estate in the property in question was vested in Louis Y. Heydenreich at the time of his death and passed under his will to his widow, Elizabeth W. Heydenreich, and not to the petitioner.

To prove her contention that the amount of $46,156.25 which she received under the settlement agreement was a tax-free inheritance from her father’s estate, the burden is upon the petitioner in this proceeding to show that the amount represents that part of the estate which she received, or was entitled to receive, as the lawful owner. The stipulated facts offer no basis for this conclusion. It does not appear that this was the substance of the agreement under which the amount was paid to the petitioner. On the other hand, we have determined from the facts of record, and under the Real Property Laws of the State of New York, that the petitioner owned no interest whatever in the property itself. It follows, we think, that the amount received by the petitioner was in no sense an inheritance from her father’s estate.

Since there was admittedly a valid consideration for the payment, namely, the petitioner’s relinquishment of any and all claims to the property, and the proceeds from the sale thereof, the payment was not a gift to her.

We must conclude that the entire amount of $46,156.25 received by the petitioner is includable in her taxable income under section 22 of the Revenue Act of 1928 as “gains or profits and income derived from any source whatever.”

Reviewed by the Board.

Judgment will be entered for the respondent,

Sternhagen, Yan Fossan, Murdock, Arnold, and HaRROn concur only in the result.

Leech and Mellott dissent.