author: Smith :

text:
    Jefferson Standard Life Insurance Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89422.
    Promulgated April 29, 1941.

      Julius O. Smith, Esq., for the petitioner.

      Willis B. Lamford, Esq., for the respondent.
   OPINION.

Smith :

This proceeding is for the redetermination of a deficiency in income tax for 1933 of $18,942.85. The questions in issue are whether petitioner is entitled to deduct from its gross income of 1933 an amount equaling 3% percent of the mean of the. reserves which it set up on its books (1) for incurred disability benefits, and (2) for supplementary contracts not involving life contingencies, and, if the deduction in respect of the latter reserves is not allowable, whether the petitioner is entitled to deduct the full amount of alleged interest paid during the taxable year to beneficiaries under the supplementary contracts.

Certain of the adjustments made by the respondent in the determination of the deficiency and set forth in the deficiency notice are conceded by the petitioner to be correct. The essential facts have all been stipulated and are incorporated herein by reference.

Petitioner is a stock life insurance company, incorporated under the laws of the State of North Carolina. Its principal office and place of business is at Greensboro.

On its books of account the petitioner had a reserve at December 31, 1932, for incurred disability benefits of $2,857,794 and on December 31, 1933, of $2,927,291. In its income tax return for 1933 the petitioner deducted from gross income 3¾ percent of the mean of these reserves, pursuant to the provisions of section 203 (a) (2) of the Eevenue Act of. 1932. The respondent disallowed the deduction upon the ground that the reserve was not one of the “reserve funds required by law” within the meaning of the above referred to section of the taxing statute. It is stipulated that this question shall be disposed of in accordance with the determination of the Board and the courts in the case of Oregon Mutual Life Insurance Co., Docket Nos. 85182 and 88299. Our decision in that case was affirmed by the United States Circuit Court of Appeals for the Ninth Circuit, 112 Fed. (2d) 468, and by the Supreme Court, 311 U. S. 267. In accordance with the stipulation, of the parties the petitioner is entitled to the deduction from the gross income of 1933 of 3¾ percent of the mean of this reserve.

The second question in issue is whether the petitioner is entitled to deduct from the gross income of 1933 the amount of $45,893.81 representing 3¾ percent of the mean of its reserve funds maintained against a liability shown in its balance sheets as “present value of amounts not yet due on supplementary contracts not involving life contingencies.” The petitioner contends that it is entitled to consider such assets retained against- the mentioned liability as “reserve funds required by law” within the meaning of section 203 (a) (2) of the Eevenue Act of 1932; but that if the deduction in respect of such reserves is not allowable, it is then entitled to deduct from gross income the full amount of the interest paid to the beneficiaries under the supplementary contracts during the taxable year.

In the determination of the deficiency the respondent has held that the so-called supplementary contract reserves are not “reserve funds required by law” and has accordingly disallowed the deduction from gross income of 3% percent of the mean of such reserves for the taxable year. In lieu of this deduction he has allowed the petitioner to deduct $16,702.70, which represents the guaranteed interest paid by the petitioner in respect of its liability on a part of its supplementary contracts.

The form of insurance contract regularly issued by the petitioner, which is a part of the stipulation of facts filed with the Board, provides for optional methods of settlement as follows:

OPTIONAL METHODS OF SETTLEMENT
The payee of any lump sum due in accordance with the provisions of this policy may have the net proceeds payable applied in any method described in the following options provided such net proceeds equal or exceed $1000 and further provided no method of settlement may be elected under which the periodic payments might be less than $10.00 each.
1—Payment of equal monthly installments for a specified number of years, the first installment being payable ¡mediately, in accordance with the following Table per thousand of net proceeds available: [Table.]
* * * * * * I*
3—Retained by the Company for specified period, or during the lifetime of a designated beneficiary and while so retained', interest paid at the end of each interest period at such rate as the Directors of the Company may declare, but not less than 3½% per annum. The amount of interest payments for each $1000 of the net proceeds shall not be less than $35.00- annually, $17.35 semiannually, $8.64 quarterly or $2.87 monthly. At the expiration of the designated period the net sum available will be paid to such person or persons and in such manner as shall have been agreed upon with the Company:
4-Payment of equal annual, semi-annual, quarterly or monthly installments of such an amount as may be selected until the net proceeds together with interest at such rate as the Directors of the Company may declare, but not less than 3½'% per annum, shall have been exhausted. The fixed amount payable each year shall be not less than 5% of the original proceeds left with the Company.
Provision may be made under either Option (1) or Option (2) for equivalent annual, semi-annual or quarterly installments, such installments being computed at an interest rate of 3½% per annum.
The amounts guaranteed above under Options [Option] (1) * * * are based on a guaranteed interest earning of 3½⅞ per annum. Such excess interest as the Directors of the Company may declare shall be payable on the 15th day of December of each year, * * *
The Insured may select any of the above options for the payment of the proceeds of this policy as a death claim and subsequently change or revoke a previous selection, such selection, change or revocation to take effect upon receipt of written notice at the Home Office of the Company in Greensboro, North Carolina, and endorsement of same upon this contract by the Company during the lifetime of the Insured.
The Beneficiary can neither assign nor commute unpaid installments nor make any change in a method of settlement selected by the Insured unless such right is given to the Beneficiary by the Insured in writing and endorsed on this contract by the Home Office during the lifetime of the Insured.

The reserves set up under options (1), (3), and (4) above are all in controversy, being the reserves for “supplementary contracts” referred to in item (f) of the deficiency notice. The amount disallowed as a deduction in respect of these reserves is $45,893.81, or 3¾ percent of the mean of the reserves.

As to the amounts of the reserves set up in connection with each of the options (1), (3), and (4) and the amounts of interest paid to beneficiaries under such options, it is stipulated as follows:

XI.
(A) That in connection with and under Option No. 1, the petitioner paid in the calendar year 1933 to beneficiaries who selected Option No. 1, after the proceeds became payable to said beneficiaries in a lump sum, the following:
(a) Guaranteed interest in accordance with the terms of the contract— $2,089.00
(b) Interest over and above the guaranteed interest, as determined by
the Board of Directors of the petitioner- 1,251. 00
Total__§4,240.00
that in connection with the said supplementary contracts, upon which payments were made as aforesaid, the petitioner set up on its books as of December 31, 1932, the reserve of $75,804.00, and as of December 31, 1933, $89,507.00, the mean of which is $82,655.50, and 3¾% of said mean is $3,099.58.
(B) That in connection with and under Option No. 1, the petitioner paid in the calendar year 1933 to beneficiaries under policies where the insured prior to the date of his death selected settlement option No. 1, as follows:
(a) Guaranteed interest in accordance with the terms of the contract- $9, 693.00
(b) Interest over and above the guaranteed interest, as determined by the Board of Directors of the petitioner_ 3, 997. 00
Total_$13,690.00
that in connection with the s'aid supplementary contracts upon which payments were made as aforesaid, the petitioner set up on its books as of December 31, 1932, the reserve of $272,892.00, and as of December 81, 1933, $281,774.00, the mean of which is $277,333.00, and 3¾% of said mean is $10,399.99.
XII.
That in connection with payments of interest under settlement option No. 3, the petitioner paid, and the Commissioner allowed, guaranteed interest in the amount of $16,702.70; that the petitioner paid in addition to said guaranteed interest of $16,702.70 the further sum of $7,158.30, representing additional interest as determined by the Board of Directors of the petitioner, which said sum was not allowed. The reserves set up under Option No. 3 constitute the balance of the total of reserves for supplementary contracts shown in paragraph V above which are not segregated in paragraphs XI and XIII hereof.
XIII.
(A) That in connection with and under Option No. 4, the petitioner paid in the calendar year 1933 to beneficiaries who selected Option No. 4, after the proceeds became payable to said beneficiaries in a lump sum, the following:
(a) Guaranteed interest in accordance with the terms of the contract- $1,052.00
(b) Interest over and above the guaranteed interest, as determined by the Board of Directors of the petitioner-._ 390.00
Total-$1,442.00
that in connection with the said supplementary contracts upon which payments were m&de as aforesaid, the petitioner set up on its books, as of December 31, 1932, the reserve of $29,706.00, and as of December 31, 1933, $36,977.00, the mean of which is $33,341.50, and 3⅜% of said mean is $1,250.31.
(B) That in connection with and under Option No. 4, the petitioner paid in the calendar year 1933 to beneficiaries under policies where the Insured prior to the date of his death selected settlement Option No. 4, as follows:
(a) Guaranteed interest in accordance with the terms of the contract- $9, 522
(b) Interest over and above the guaranteed interest as determined by the Board of Directors of the petitioner_:_ 2,582
Total-■-$12,104
that in connection with the said supplementary contracts upon which payments were made as aforesaid, the petitioner set up on its books as of December 31, 1932, the reserve of $241,805.00, and as of December 31, 1933, $306,603.00, the mean of which is $274,204.00, and 3¾% of said mean is $10,282.65.

All of the interest set out above was paid by the petitioner to beneficiaries during 1933 and not merely credited to the beneficiaries or to supplementary contract reserves.

Relative to the petitioner’s claim that the supplementary contract reserves are “reserve funds required by law” within the meaning of section 203 (a) (2) of the Revenue Act of 1932, we held in Penn Mutual Life Insurance Co., 32 B. T. A. 876, 878, that such reserves were not “reserve funds required by law” within the meaning of the Revenue Act of 1928, which, so far as material, is the same as the Revenue Act of 1932. Our decision in that case was in effect affirmed per curiam by the .United States Circuit Court of Appeals for the Third Circuit, at 92 Fed. (2d) 972, although that case was remanded to the Board with instructions to redetermine the tax in accordance with the principle of law enunciated in Penn Mutual Life Insurance Co. v. Commissioner, 92 Fed. (2d) 962.

In Commissioner v. Pan-American Life Insurance Co. (C. C. A., 5th Cir.), 111 Fed. (2d) 366, the question before the court was whether reserves for disability benefits were reserve funds required by law within the meaning of section 203 (a) (2) of the Revenue Act of 1932. The court held that they were. In its opinion it said:

* * * The method of computation so employed is wholly consistent with that used for establishing amounts of premiums and reserves for ordinary life-, insurance and annuity contracts, and is wholly inconsistent with reserves created to defray accrued and definite liabilities payable in the future. This is the distinguishing feature between the case at bar and those relied upon by the commissioner, which dealt with the reserves for the payment of accrued obligations for fixed amounts created by contract. The latter are mere solvency reserves having no relation to true insurance risks. [Citing McCoach v. Insurance Co. of North America, 244 U. S. 585; United States v. Boston Insurance Co., 269 U. S. 197; Helvering v. Inter-Mountain, Life Insurance Co., 294 U. S. 686; Helvering v. Illinois Life Insurance Co., 299 U. S. 88.]

Upon the convention form of report on which the petitioner and every other life insurance company makes reports to state insurance departments, the petitioner’s liability, “present value of amounts not ■ yet due on supplementary contracts not involving life contingencies”, is set up separately from its legal reserve. Although this fact is not determinative of the question in issue, it is significant that its liability is not included under the caption “net reserve.” In any event the petitioner’s liability in respect of its supplementary contracts constitutes fixed indebtedness. In every case after a policy has matured or, as in this case, the insured has died, the policy becomes noncancelable, the premium-paying period has passed, and the liability of the petitioner to pay the proceeds of the policy according to its provisions is fixed. In Duffy v. Mutual Benefit Life Insurance Co., 272 U. S. 613, the Court said:

* * * Until the maturity of a policy, the policyholder is simply a member of the corporation, with no present enforceable right against the assets. Upon the maturity of the policy he becomes á creditor with an enforceable right. Then for the first time there is an indebtedness. See Mayer v. Attorney General, 32 N. J. Eq. 815, 820-822. In the meantime, each member bears a relation to the mutual company analogous to that which a stockholder bears to the joint stock company in which he holds stock. * * *

A reserve maintained to pay a fixed indebtedness is not to be included in the amount of “reserve funds required by law” within the meaning of section 203 (a) (2) of the applicable taxing statute. See Equitable Life Assurance Society of the United States, 44 B. T. A. 293.

We come now to the alternative contention of the petitioner, that it is entitled to deduct from gross income the interest paid during the taxable year upon its indebtedness represented by its supplementary contracts.

The applicable provisions of the Revenue Act of 1932 are as follows:

SEO. 203. NET INCOME OF LIFE INSURANCE COMPANIES.
(a) GeSnebal Rule.—In the case of a life insurance company the term “net income” means the gross income less—'
*******
(8) Interest.—All interest paid or accrued within the taxable year on its indebtedness, except * * * [exception immaterial].

The petitioner contends that it is entitled to deduct the full amount of interest' set out in the stipulation of facts above—not only the guaranteed interest, but also the excess interest as determined by its directors.

Under option 3 of its policy contracts the insured or the beneficiary has the right to elect to have the proceeds of the policy “retained by the' Company for a specified period, or during the lifetime of a designated beneficiary, and while so retained interest paid at the end of each interest period at such rate as' the directors of the Company may declare, but not less than 3½% per annum.” The respondent allowed the deduction of all the interest paid under this option at the 3½ percent rate. The evidence does not show separately the amount of interest paid where the insured selected the option and the amount where the beneficiary selected such option. During the taxable year the petitioner retained large amounts of the proceeds of matured policies in accordance with the provisions of option 3 and paid interest thereon at the rate of 5 percent per annum. Counsel for the petitioner states that this rate of interest had been paid for many years prior to 1933; ' In the determination of the deficiency the respondent has allowed the deduction of the interest paid at the rate of 3½ percent per annum, but has disallowed the deduction of the excess interest paid.

We do not see any sound reason for disallowing the deduction of any part of "the interest paid under supplementary contracts represented by option 3. Clearly the amounts retained by the-insurance company pursuant to such option constitute interest-bearing indebtedness of the company. The statute permits a life insurance company to deduct interest paid upon its indebtedness. Treasury Decision 4'615, approved December 18, 1935, amended article 975 of Regulations 77, promulgated under the provisions of the Revenue Act of 1932, by adding to that article the following paragraph;

(4) If a life insurance company pays interest on tbe proceeds of life insurance policies left with it pursuant to the provisions of supplementary contracts, not involving life contingencies, or similar contracts, the interest so paid shall be allowed as a deduction from gross income, * * *

It will be noted that the regulation does not provide for the dis-allowance of any part of the interest paid upon such indebtedness.

If the petitioner had obligated itself to pay interest at the rate of 5 percent per annum, or at the legal rate, during the taxable year there could be no question but that it would be entitled to deduct the interest so paid. The petitioner has obligated itself to pay upon these retained proceeds interest “at such rate as the Directors of the Company may declare, but not less than 3'½ percent per annum.” Because the rate is indeterminate at the time the contract is made is no ground for the disallowance of any part of the interest paid, so long as the payment is in fact of interest. The petitioner is not a mutual life insurance company and there is no element of a dividend in the excess interest paid. In this respect this case differs from Penn Mutual Life Insurance Co. v. Commissioner, supra. We are of the opinion that the respondent was in error in the disallowance of excess interest in the amount of $7,158.30.

Under option 1 the petitioner is required upon the maturity of the policy by death to make installment payments to the beneficiary during the settlement period, such installment payments to include interest computed at the rate of 3½ percent per annum. Under option 4 the petitioner agrees to make: '

Payments of equal annual, semi-annual, quarterly or monthly installments of such an amount as may be selected until the net proceeds together with interest at such rate as the Directors of the Company may declare, but not less than 3½% per annum, shall have been exhausted. * * *

The petitioner argues on brief that there should be no difference in treatment between the interest payments under option 1 and under option 4. The only real difference between the options is that under option 1 the insured or the beneficiary elects to receive proceeds of the policy in equal monthly installments computed at the rate of 3½ percent per annum. In addition to the guaranteed payments the payee may receive additional interest. Under option 4 the rate of interest is not fixed. The payee elects the amount of the installment and he receives that installment until the proceeds of the policy with interest have been exhausted.

We hold, following Penn Mutual Life Insurance Co. v. Commissioner, supra, that the petitioner may not deduct the interest where the insured has elected the option, but that it may deduct the interest where the beneficiary has elected the option. This is true, not only of the guaranteed interest of 3'½ percent per annum, but also of the excess interest paid.

Reviewed by the Board.

Decision will be entered under Rule 50.

SteRNhagen did not participate in the consideration of or decision in this report.

Akundell and Black dissent for the reasons set forth in the dissenting opinion in Equitable Life Assurance Society of the United States, 44 B. T. A. 293.


source: Caselaw Access Project

author: TijRNER:

license: Public Domain

text:
    Edward J. Epsen (Formerly Edward J. Epsten), Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97914.
    Promulgated April 29, 1941.

      Harry E. Judd, Esq., and William A. Schall, Esq., for the petitioner.

      Benjamin L. Bird, Esq., for the Respondent.
   OPINION.

TijRNER:

The pleadings present three questions: (1) Whether the price petitioner was to pay for the shares of stock was fixed by the corporation at $50 per share so as to effect the payment of further compensation for services which petitioner had rendered to it; (2) whether the stock was acquired by the petitioner during the taxable year ended March 31, 1935; and (3) whether the fair market value of the stock at the time acquired by petitioner was $266.93. With respect to the fair market value of the stock at the date of its acquisition by petitioner, the petitioner has offered no proof, and we accordingly sustain the respondent’s determination of $266.93 per share.

With respect to the compensation issue, it is the contention of the petitioner that the stock was obtained under an option granted to him by his father on January 10, 1928, and in no respect constituted compensation for services rendered by him to the corporation. In that connection it is noted that the option, referred to provided that the petitioner should have the privilege of buying at $100 per share a sufficient number of the shares owned by his father so as to make him the owner of one-half of the shares of stock outstanding after the shares then owned by certain minority interests had been retired. During the interval from January 10,1928, to April 3, 1931, the corporation had been very successful and the efforts of petitioner had been largely responsible for that success. No explanation is offered, nor is any reason given, why petitioner’s father did not carry out his agreement to sell the petitioner a sufficient number of his shares of stock to constitute petitioner the owner of one-half of the shares outstanding other than what may be inferred and concluded from the resolution of April 3, 1934. The argument seems to be that the transaction as carried out was in fact no different from that indicated by the option, since the total amount petitioner would have had to pay his father at $100 per share for 115½ shares, being the number of shares that would have been required under the option, is exactly the same, namely, $11,500, as the amount of cash paid by petitioner to the corporation for 231 shares at $50 per share. Such an argument, if it may be termed an argument, does not negative, however, the fact that the stock here in question was acquired from the corporation and not petitioner’s father, nor the reasons as expressed in the corporate resolution of April '3, 1934, for selling the 231. shares of stock to petitioner at $50 per share. In that resolution it is stated that “in recognition of the valuable and faithful services, of Edw. J. Epsten who has in fact had full responsibility for the practical and successful management of the business for many years and in appreciation of his loyal and untiring efforts in building the business” to its then existing status it is “resolved that the president of the Company authorize the issuance of 231 shares of the common stock of the corporation from the common stock of the treasury, for a consideration of $50.00 cash per share and valuable service.” Regardless of the fact that the petitioner may have had some claim on his father for 115½ shares at $100 per share, 115⅜ being a sufficient number of his father’s shares to constitute petitioner the owner of one-half of the shares outstanding, and regardless of the fact that that promise may have had some bearing upon the action of the corporation, the fact remains that the petitioner acquired 231 shares at $50 cash per share not from his father, but from the treasury stock of the corporation, and a part of the consideration for .such stock was the valuable service which had been rendered during, the interval by petitioner to the corporation.

The petitioner makes an argument, however, which in effect is that the resolution does not mean what it says and some of the answers elicited by petitioner’s counsel from the petitioner and his father seemed directed to the thought that no directors’ meeting was held on April 3, 1934, and that the resolution was written up not to indicate action taken but for the.benefit of petitioner’s two younger brothers in the event they might later complain that the father had discriminated against, them in favor of petitioner. The resolution as set forth in our findings of fact regularly appealed as a part of the corporate minutes at the time respondent’s agent made his examination herein in 1936, which minutes were signed by Ed. C. Epsten, as president, and Edward J. Epsten, as secretary and treasurer. Later at a formal conference in the office of the revenue agent in charge in Omaha petitioner and his counsel presented what purported to be the minutes of the meeting of April 3, 1934, claiming that the resolution as set forth therein was the correct resolution. The resolution so submitted read as foEows:

RESOLUTION
Whebeas, in consideration of an agreement or promise of Ed. C. Epsten several years ago to sell Edw. J. Epsten a sufficient portion of his holdings at not over par value so that the stock holdings of Ed. 0. Epsten and Edw. J. Epsten would be identical, and to simplify the mechanics of fulfilling this promise:
Be It Resolved that the President of the Company authorize the issuance of two hundred and thirty-one (231) shares of the common stock of the Corporation from the common stock in the treasury, for a consideration of fifty dollars ($50.00) cash per share.

The explanation offered with respect to the absence from the minute book of the minutes as they originally stood was “We haven’t them any more; they have been destroyed.” At the hearing in this proceeding the minute book was produced and the resolution appearing therein as having been adopted at the directors’ meeting of April 3, 1934, was in the same form and words as it appeared originally, one difference being however that the minutes produced at the, hearing were not signed. In the light of the above, it is our conclusion that the resolution as it appears in our findings of fact was regularly adopted by the board of directors on April 3, 1934, and properly reflects the action of the board of directors taken on that day. That resolution, as we have previously indicated, shows that the consideration for the 231 shares of common stock of the corporation sold to petitioner was $50 per share and the valuable services which had been rendered to the corporation by the petitioner. Having acquired the said shares for the consideration stated, compensation was realized by petitioner in an amount equal to the difference between the price paid by him for the stock and the fair market value of said stock. Albert Russel Erskine, 26 B. T. A. 147; W. M. Ritter Lumber Co., 30 B. T. A. 231; and Electric Storage Battery Co., 39 B. T. A. 121. Cf. Delbert B. Geeseman, 38 B. T. A. 258; Gordon M. Evans, 38 B. T. A. 1406; and Herbert H. Springford, 41 B. T. A. 1001.

The remaining contention of the petitioner is that in any event the stock was not acquired until after the close of the taxable year, and even though he did receive compensation for services rendered as a result of the transaction, such compensation was not received during the taxable year. He relies on entries made in the books of account and in the stock book to show that the stock was not acquired by him until June 3, 1935. Answering this contention of the petitioner, the respondent relies, among other things, on the statements appearing in an affidavit signed by petitioner and in an affidavit signed by his father submitted to the respondent in protest of any determination that the petitioner realized any sum as compensation upon the purchase of said shares. In both of the affidavits it is stated that the stock was acquired by the petitioner in 1934. The explanation offered by the petitioner and his father when they appeared as witnesses at the hearing was that these affidavits were prepared by others and that they were not then aware of the entries appearing on the corporate books under date of June 3, 1935. Such action on the part of these two individuals to say the least indicates a careless disregard of the importance of an oath. Furthermore in our opinion the statements appearing in the affidavits rather than the statements made from the witness stand present the true picture. In the resolution adopted on May 24, 1935, it was provided that there should be issued as a stock dividend to each holder of common stock of the corporation one share of common stock for each share “now held by the stockholders as is shown by the books of the corporation.” Under authority of that resolution 250 shares of stock were issued to petitioner as a stock dividend. If petitioner had not acquired the original 231 shares here in question until June 3, 1935, as he now contends, he would not, according to the resolution of May 24, have been entitled to 231 shares of the stock dividend distributed to and received by him. The charge against petitioner’s personal account as of June 3, 1935, to cover payment of the $50 per share for the stock was apparently only a belated entry to cover a transaction regarded by all of the interested parties as having been previously concluded. The respondent’s determination that the stock was acquired by the petitioner in the taxable year is supported by the acts of the parties themselves, their attitude with respect to the ownership of the stock, and the statements contained in the affidavits previously submitted to the respondent by the petitioner and his father. We accordingly conclude that the stock was acquired in the taxable year and sustain the respondent’s determination.

Decision will be entered for the resyondent.


author: Van Fossan:

text:
    Jessie W. Donahue, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92980.
    Promulgated April 29, 1941.

      Paul L. Peyton, Esq., for the petitioner.

      L. A. Spalding, Jr., Esq., for the respondent.
   OPINION.

Van Fossan:

The single issue for our determination is whether or not the income of certain trusts created by petitioner is taxable to her.

Petitioner contends that section 166 of the Revenue Act of 1934 is not applicable since she possessed no power to revest the corpora of the trusts. She maintains that the trusts had substance and that their income can not be taxed to her under the doctrine of Helvering v. Clifford, 309 U. S. 331. Petitioner further contends that the income of the trusts did not discharge a legal obligation of petitioner, so that the income is not taxable to her under Douglas v. Willcuts, 296 U. S. 1, and Helvering v. Leonard, 310 U. S. 80. Finally, petitioner urges that the rule of Lucas v. Earl, 281 U. S. 111, as delineated in Helvering v. Horst, 311 U. S. 112, does not apply.

Respondent makes no contention that the trusts are revocable or that section 166 applies. He argues that, since the trust instrument was under seal, the seal is to be given presumptive effect, binding petitioner to her promise to make up deficiencies in the trust income payable to the named beneficiaries. He asserts that this promise brings petitioner within the scope of Helvering v. Leonard, supra, and Weir v. Commissioner, 109 Fed. (2d) 996. He also contends that the trusts lack substance and that their income is taxable to petitioner under section 22 (a) of the Revenue Act of 1934. Finally, respondent relies on Helvering v. Horst, supra, and Huber v. Helvering, 117 Fed. (2d) 782, arguing that the trust agreement effected a mere assignment of income.

The effect of the last sentence in the quoted paragraph numbered 4 in our findings was to make the trusts irrevocable for the lives of the beneficiaries. Section 166, therefore, is not applicable. Helvering v. Wood, 309 U. S. 344. Consequently, we must consider respondent’s contentions concerning the applicability of section 22 (a) of the Revenue Act of 1934.

We are of the opinion that the instant case differs substantially from Helvering v. Clifford, supra. There the trust was for a five-year period, the beneficiary was a member of the grantor’s immediate family group, and the grantor was also the trustee. Here, the trusts were to endure for the lives of their respective beneficiaries, the beneficiaries were relatives of petitioner’s deceased husband and had never been members of petitioner’s household, and petitioner was not the trustee. The fact that petitioner retained the right to direct investments is not enough, by itself, to cause the application of the Cliford doctrine. Commissioner v. Branch, 114 Fed. (2d) 985. The trusts created by the agreement of May 1, 1931, were real trusts and their income may not be treated as that of petitioner on the ground that she retained the major incidence of ownership and control of the corpora.

Eespondent’s next contention is that the income of the trusts discharged a legal obligation of petitioner and was taxable to her under Douglas v. Willcuts, supra. The evidence presented clearly shows that these trusts differ from those considered in the “legal obligation” cases of Douglas v. Willcuts, supra; Helvering v. Coxey, 297 U. S. 694; and Helvering v. Stokes, 296 U. S. 551, in that here the income can not be said to be in discharge of any legal enforceable obligation existing prior to the time of the creation of the trusts. Petitioner had no obligation to support the beneficiaries of the trusts. See New York Code of Criminal Procedure, sec. 914; New York Public Welfare Law, sec. 125; Dunlevy Milbank, 41 B. T. A. 1014. The record indicates that she created the trusts out of pure benevolence and humane feeling for decedent’s relatives.

Eespondent asserts further, however, that the provision in the trust agreement by which petitioner agreed to make up deficiencies in trust income payable to the beneficiaries was a. legally enforceable obligation and consequently the income of the trusts must be taxed to petitioner, citing Helvering v. Leonard, supra; Weir v. Commissioner, supra. Eespondent also asserts that at the time the trust agreement was executed the law of New York provided that a seal was presumptive evidence of sufficient consideration.

The Weir case was preceded by Dixon v. Commissioner, 109 Fed. (2d) 984, decided a few days prior, in which case the same court discussed the instant question at length. Addressing itself to the law as laid down in Douglas v. Willcuts, supra; Helvering v. Fitch, 103 Fed. (2d) 702; and Helvering v. Leonard, 105 Fed. (2d) 900, the court observed:

* * * However, we think an accurate demarcation in the instant cause may be accomplished by testing our peculiar circumstance against the two main factors which pervade the controlling decisions.
The first is the nature of the “obligation” ruled upon. In all cases it has been “pre-existing”, i. e., alimony decreeable by court, Douglas v. Willcuts, above cited, the support of minor children, Helvering v. Schweitzer, 296 U. S. 550, a pre-existing debt. Helvering v. Blumenthal, 296 U. S. 552. The second, cognate to the first, is the element of tax avoidance.
As Professor Magill puts it:
“* * * the debtor has created a trust, the income of which is to be used to pay off thé principal and interest of his obligations, remainder to himself or persons of his choice. If he paid off the debts directly out of his own income, he would have no deduction for the sums paid in discharge of principal. By use of the trust device he seeks to reduce his own taxable income by the amount of the income from the corpus of the trust; and thus in effect to obtain a partial deduction from his income for the amounts used to discharge his debts.
* * * * * * *
Had the husband been required to pay the same amount of alimony directly, he would have been taxable upon the total amount of his net income with no deduction therefor. His income tax liability should not be changed by his creation of a trust to take care of his obligation for him.” Magill, above cited, pp. 213, 243.
A like possibility of sidestepping the nondeductibility of a capital outlay inheres, of course, in the- application of trust income to the support of wives and minor children. What, therefore, is the “obligation,” if any, and the avoidance, if any, implicit in the case at bar?

Relating the case under consideration to the above stated concepts, the court found no obligation.

In the Dixon case, the trust contained a contingent obligation to make good income deficiencies by adding securities to the corpus. In considering this phase of the case the court states:

* * * Where the trust is set up to meet the debt, he must be taxed to prevent him, as we have seen, from circumventing the non-deductibility of debt payments. Where, on the other hand, the trust antedates a true guaranty, there is no circumvention of non-deductibility, even if the guaranty ripens into a debt. However, if trust and guaranty are roughly contemporaneous in origin, it does not seem unduly cynical to unravel the whole transaction into a continuing obligation to pay a stated amount at future intervals to which payment trust income is applied. So the circumstance is brought within the preexisting debt criterion, and the settlor is taxed.

The court absolved the grantor from tax on the trust income involved in the Dixon case.

In the Weir case, the court, after referring to the principles discussed in the Dixon case, held the grantor taxable on the trust income, stating that the presence of a promise to pay by way of guaranty “affords the sole, yet a valid, ground for taxing the income of the instant trust to the petitioner.”

The case at bar presents certain aspects of both the Dixon case and the Wéir case and certain other aspects not found in either. In both of the cited cases there was a preexisting marital community, with such rights and obligations as adhered thereto under local law. In the case before us there is no such situation. The trust now before us had no background of unhappy marital relations. Grantor was under no legal obligation to support the beneficiaries of the trust. In the Dixon case the trust and settlement agreement recited that the husband “in recognition of his legal liability to support his wife, and pursuant to her demands, has agreed to make provision for her support.” By its terms the wife released grantor from all right of dower or any right under intestate laws or any right to take against the will of grantor. The grantor released Ms right of curtesy. The agreement was executed three weeks before filing of a divorce action by the wife. In the Weir case the trust was likewise in consideration of the release of the right of dower and other marital rights and was executed two days prior to the filing of a divorce action by the wife. In both cases there was real consideration on either side and the discharge of a preexisting legal obligation. In the case presently before us, there was no release of any rights or any recited consideration other than the nominal one of “one dollar and other good and valuable considerations.” There was no preexisting obligation of any kind.

In the Dixon case the grantor undertook to supplement the trust corpus so that it would yield the income requisite to make the stipulated payments. In the Weir case there was an unconditional guaranty of the payment of the stipulated payments. In the instant case there was a substantially similar guaranty.

When all the facts are marshaled and compared with those in the various cited cases, we are of the opinion that the present case falls outside the category of those where the income should be held taxable to the grantor. There was no marital background. There was no preexisting obligation. There is no evidence that tax avoidance was in the grantor’s mind. Nothing in the nature of consideration was parted with by the beneficiaries. The undertaking to make good the deficiencies in income existed only by virtue of the terms of the trust instrument. It was in the nature of a unilateral commitment by the donor of the gifts. The fact that the agreement was under seal is only presumptive evidence of consideration. New. York Civil Practice Act, § 342. It ■ does not follow that the undertaking constitutes an obligation enforceable by the beneficiaries. Farmers Loan & Trust Co. v. Winthrop, 207 App. Div. 356, 363; Alexander v. Equitable Life Assurance Society, 233 N. Y. 300, 307. In our opinion the payment of the trust income discharged no enforceable legal obligation of the grantor.

Finally, we are not impressed by respondent’s argument that tMs case comes within the doctrine of Helvering v. Horst, supra. We do not believe that the Supreme Court intended, by the cited decision, to sweep aside as futile gestures all trusts and gifts. Petitioner did not merely assign income. She placed the legal title to the trust corpus in the trustee beyond recall for the lives of the several beneficiaries.

Under the facts here present, we are impelled to the conclusion that the trust income is not taxable to petitioner.

Decision will be entered under Rule 50.


author: Arnold :

text:
    William Swindells and Irene G. Swindells, Husband and Wife, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97172.
    Promulgated April 29, 1941.

      Gliarles E. McCulloch, Esq., for the petitioners.

      John H. Pigg, Esq., for the respondent.
   OPINION.

Arnold :

The petitioners contend that the amount of gain realized by them from the redemption in 1935 and 1936 of the 53 shares and 17 shares of class B preferred stock of the Willamette Valley Lumber Co. must be determined in accordance with the provisions of section 214 (e) of the Revenue Act of 1939.

The stock dividend distributed in 1934 by the Willamette Valley Lumber Co. was not taxable to the recipients thereof. Sec. 115 (f), Revenue Act of 1934; Helvering v. Gowran, 302 U. S. 238.

The petitioners must prevail (Kelly's Trust v. Commissioner, 106 Fed. (2d) 1002; 38 B. T. A. 1014; Gerlinger v. Commissioner, 106 Fed. (2d) 997; and Smith v. Commissioner, 107 Fed. (2d) 1020; 39 B. T. A. 80, each remanded to the Board for further proceedings in accordance with the provisions of section 214 of the Revenue Act of 1939) unless the proceeds received upon redemption are taxable under section 115 (g) of tlie Revenue Acts of 1934 and 1936, as contended by the respondent.

In determining the gain realized by the petitioners on the redemption of the stock involved the respondent applied a zero basis and held that the period for which the dividend stock was held did not include the period for which the common stock was held. This would be correct, Helvering v. Gowran, supra; and Koshland v. Helvering, 298 U. S. 441, were it not for the provisions of section 214 of the Revenue Act of 1939. In his amended answer the respondent affirmatively alleges that the redemption and retirement of the 53 shares of class B preferred stock in 1935 and of the 17 shares of class B preferred stock in 1936 by the Willamette Valley Lumber Co. was essentially equivalent to the distribution of a taxable dividend under section 115 (g), supra, that the amounts of $5,300 and $1,700 constituted taxable dividends to petitioners in 1935 and 1936, respectively, and that the deficiencies in tax would therefore be no less than $100.06 for 1935 and $148.92 for 1936. He made claim for the increased deficiency for 1936 of $148.92 instead of $80.92.

George T. Gerlinger, the president of the company, testified that it was found that the capital of $500,000 was not favorable to certain large deals and contracts and in the purchase of timber and that therefore it was decided to increase the capital stock of the company to about 1913 values of approximately $820,000. He also testified that certain of the stockholders were, due to financial reverses, in urgent need of funds or means of obtaining credit and that, since it was not desired that such stockholders dispose of their common stock, which might affect the equal stock control as between the Clark and Ger-linger families, preferred stock was issued which could be used as collateral. He stated: “We could not declare cash dividends and we wanted to preserve at all times the common stock relationship, and we didn’t want them selling [common] stock in order to realize that money if they had to have it, so we put part of it in preferred.” It appears that the increase of the capital stock was motivated by two objectives—one, the improvement of the company’s financial and business standing, and, two, the extension of financial assistance to stockholders in need thereof by distributing to them profits of the company in the form of preferred stock to be used as collateral or redeemed if the need for funds was urgent. The preferred stock was set up as capital and redeemed out of earnings and profits accumulated subsequent to February 28, 1913. It is apparent that the redemption and retirement of the class B preferred stock was made in pursuance of a plan to distribute earnings and profits formed at the time when such stock was issued and hence the amounts received by petitioners on redemption of their class B preferred stock were taxable as dividends under section 115 (g). See Commissioner v. Cordingley, 78 Fed. (2d) 118. That the redemption was not made pro rata among the preferred stockholders is not a controlling factor. Leopold Adler, 30 B. T. A. 897, 906. It does show, however, a consummation of the original plan to assist, by distribution of cash, those who needed such aid most urgently. The fact that a business purpose was associated with the distribution of the stock dividend in 1934 does not make the redemption of the class B preferred stock any the less “essentially equivalent to the distribution of a taxable dividend * * * to the extent it represents a distribution of earnings or profits” under the statute. The question before us is the taxable effect on a stockholder upon the redemption of class B stock. The redemption of the stock pursuant to a plan to distribute earnings and profits formed at the time the stock was issued is the controlling element. The redemption was not for a business purpose of the corporation, but was solely a part of the means adopted for the distribution of earnings and profits of the corporation to its stockholders for their own personal use. In our opinion the evidence shows that the class B preferred stock involved herein was redeemed “at such time and in such manner” as to make the redemption “essentially equivalent to the distribution of a taxable dividend” under section 115 (g). See E. M. Peet, 43 B. T. A. 852. No useful purpose would be served by discussing the many cases cited by both parties, as the solution of each case depends upon its own peculiar facts. McGuire v. Commissioner, 84 Fed. (2d) 431; certiorari denied, 299 U. S. 591.

Decision will be entered under Rule 50.

       SEC. 214. BASIS OP STOCK DIVIDENDS AND STOCK RIGHTS.
      * * * * * * *
      (e) Basis under Prior Acts.—The following rules shall be applied, for the purposes of the Revenue Act of 1938 or any prior revenue Act as if such rules were a part of each such Act when it was enacted, in determining the basis of property acquired .by a shareholder in a corporation which consists of stock in such corporation, or rights to acquire such stock, acquired by him after February 28, 1913, in a distribution by such corporation thereinafter in this subsection called “new stock”), or consisting of stock in respect of which such distribution was made (hereinafter in this subsection called “old stock”) if the new stock was acquired in a taxable year beginning before January 1, 1936, or acquired in a taxable year beginning after December 31, 1935, and its distribution did not constitute income to the shareholder within the meaning of the Sixteenth Amendment to the Constitution:
      (1) The basis of the new stock and of the old stock, respectively, shall, in the shareholder’s hands be determined by allocating between the old stock and the new stock the adjusted basis of the old stock; such allocation to be made under regulations which shall be prescribed by the Commissioner with the approval of the Secretary.
      * * ⅞ * * * *
      (f) Determination Under Prior Acts op Period por Which Held.—For the purposes of the Revenue Act of 1938 or any prior revenue Act, in determining the period for which the taxpayer has- held stock or rights to acquire stock, received upon a distribution, if the basis of such stock or rights is determined under section 214 (e) (1) of the Revenue Act of 1939, there shall (under regulations which shall be prescribed by the Commissioner with the approval of the Secretary) be included the period for which he held the stock in the distributing corporation prior to the receipt of such stock or rights upon such distribution. This subsection shall be applicable as if it were a part of each such Act when such Act was enacted.

       (g) Redemption op Stock.—If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend.


author: Leech:

text:
    Rollin C. Reynolds, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 97718, 98015.
    Promulgated April 29, 1941.

      Hugh Satterlee, Esq., and I. Herman Sher, Esq., for the petitioner.

      J. B. Johnston, Esq., for the respondent.
   OPINION.

Leech:

The following table gives effect to the corrections in the computation of the deficiencies in the deficiency notices which respondent concedes:

The first issue is whether the sums withdrawn by petitioner from R. C. Reynolds, Inc., in 1934,1935, and 1936 were loans or dividends.

Withdrawals by petitioner during 1930 to 1933, inclusive, are treated by respondent as loans, while he seeks to characterize those occurring during the three following years as dividends.

The evidence reveals no reasonable basis for these opposite positions. It is obvious, however, that he is compelled to take such an inconsistent position in order to have any basis at all for his contention that the withdrawals in the taxable years were dividends. If it were admitted that the withdrawals occurring in the earlier years were dividends, his present contention would fall because such dividends would be chargeable against earned surplus and there would be no earned surplus from which dividends could have been paid in the taxable years.

The withdrawals in dispute were treated on the boohs of the company as loans. Petitioner was charged with interest thereon at a rate varying from approximately 2½ to about 4 percent. Considering the period from 1931 to 1934, inclusive, as a whole, and giving effect to all credits reflected on the books of the company, including the item of the consideration for the transfer of petitioner’s stock and contracts to the company in 1935, and properly attributing those credits first to interest (see Helvering v. Drier, 79 Fed. (2d) 501), $41,624.89, the total interest charged to petitioner was paid, together with $141,351.70 on account of his principal indebtedness.

Petitioner had the means of repaying these advances, consisting of ⅜ assets other than this stock in the company. He intended to repay them. These advances bore no determinable relation either to earnings or surplus and no comparable withdrawals were made by other stockholders. In fact, the largest stockholder, Grace S. Reynolds, j had credit balances with the company prior to and during the years ¡ here involved, on which the company paid her interest. Respondent / attempts to discredit the veracity and character of petitioner by point-' ing out that he absented himself from the hearing after the second day; by the introduction of testimony on the part of certain employee-stockholders that they knew nothing of the loans; and by urging that there was no specific authorization by the stockholders or directors for such borrowings on the part of the corporation’s president.

The age and physical condition of the petitioner, in our judgment, completely explain his absence from the witness stand after the second day of the hearing. We believe he is entirely worthy of credence.

So far as respondent’s other contentions as to the advances are concerned, we find nothing seriously affecting their character as loans. Though it is true no specific authorization for them was made by the directors, the balance sheets of the company, disclosing fully these transactions between the petitioner and the company as loans, were approved by the directors at the close of each year. It is true, as respondent argues, that, under laws of New York passed in aid of creditors of corporations, loans to stockholders are forbidden. See Stock Corporation Law, ¶ 59; Nellis Co. v. Nellis, 16 N. Y. S. 545. But what engages us here is the actual conduct of the parties, not the legality of that conduct. Stock Yards Bank of Cincinnati, 25 B. T. A. 964.

It is our opinion that the advances to petitioner are what they purported to be—loans, and not dividends. See Albert Bettens, 2 B. T. A. 535; Kate C. Ryan, Executrix, 2 B. T. A. 1130; Pictorial Review Co., 5 B. T. A. 416; Comey & Johnson Co., 8 B. T. A. 52; Herman M. Rhodes, 34 B. T. A. 212; reversed on other grounds, 100 Fed. (2d) 966; Moses W. Faitoute, 38 B. T. A. 32; Wiese v. Commissioner, 93 Fed. (2d) 921; certiorari denied, 304 U. S. 562, affirming 35 B. T. A. 701.

The nest question is whether petitioner realized income upon the transfer of shares to R. C. Reynolds, Inc., in 1935 either under section 115 (g) of the 1934 Act or under section 111. Although respondent advances possible liability under section 111 as an alternative position, we consider it first, in order to present more clearly the 1935 transaction. As is noted below, the amount which respondent seeks to tax to petitioner is not the same under both contentions.

Petitioner wanted key employees to own stock in the business. Respondent argues that stock was never sold to the employees, but that they were merely given equities through what were nothing more than conditional sales contracts. Hence, he says, petitioner’s basis for the 1,340 units transferred to the company in 1935 was their original 1920 cost to petitioner, not the price which petitioner paid for them in the alleged “reacquisition” from employees who wished to surrender their rights to stock. This 1920 basis, he contends, was decided to be $92.37 per unit in Reynolds v. Durey, which fact is therefore res judicata in this proceeding. It is thus respondent’s position that petitioner was in receipt of gain in the 1935 transaction measured by the difference between what he received ($100 per unit) for the 1,340 units of stock and the cost basis of $92.37 per unit.

The agreements by which the employees acquired stock in the company provided that the stock should be issued in the name of the purchaser, that dividends declared thereon should be applied toward the purchase price, that interest should be paid to petitioner on the balance due, that the employee should endorse his stock in blank and give it to petitioner as collateral security for full payment of the price, and that each agreement should terminate in five years. As to the last condition it is apparent from the record that neither of the parties to these agreements regarded them as terminated at the end of five years. Petitioner testified without contradiction that he repurchased stock from dissatisfied employees entirely without regard to any contractual obligations in that respect. This course of dealing by the parties to the contracts in effect established new agreements at variance in that particular with the terms of the original understanding. Gibbs-Preyer Trust #1, 39 B. T. A. 492. As to whether the original agreements embodied sales of stock to employees, we are convinced they did. Title passed to each buyer, who thereafter included the dividends on his shares in his tax returns, and pledged his shares to petitioner by way of security. The rule is well stated in 4 Williston on Contracts (Rev. Ed.) ¶1044: “* * * there seems no reason why one should hesitate to say that a pledgee merely has possession of the goods coupled with a power to sell them on default by the pledgor, but the latter retains the ownership subject to a lien to the extent of the debt enforceable by exercise of the power of sale * * See also Lewis v. Mott, 36 N. Y. 395; First Trust & Deposit Co. v. Potter, 278 N. Y. S. 847; Cole v. Manufacturers' Trust Co., 299 N. Y. S. 418.

In view of these considerations, it is our opinion that petitioner sold this stock to employees and repurchased it from some of them for the same price at which it had been sold ($100 per unit). If as respondent well argues alternatively, the reacquisition of this stock by the company in 1935 was a purchase by the company from petitioner, then it follows that petitioner realized no gain under section 111. This result renders it unnecessary to pass on the question of whether Reynolds v. Durey is res judicata of any fact material in this proceeding.

Respondent’s principal contention with respect to petitioner’s 1935 transaction with the company is that it was a cancellation or redemption of stock'essentially equivalent to the distribution of a taxable dividend under section 115 (g) of the Revenue Act of 1934. Respondent charges petitioner with having so received the amount of $176,000. This includes $134,000 which the company paid petitioner for the stock he had repurchased from employees; $12,971.62 which was the unpaid balance on petitioner’s sales of stock to employees under contracts assigned to the company; and $29,028.38 which petitioner had already received from the employees on those contracts..

On brief respondent urges that there was “camouflage” and “manipulation” of the corporation’s books and apparently takes the position that the corporation could neither have “redeemed” nor “purchased” the stock because it did not comply with the provisions of its charter to the effect that the preferred stock was subject to purchase in whole or in part at $110 per share plus accumulated dividends.

We. agree with petitioner that the company might repurchase its stock otherwise than in accordance with the provisions in its charter and that the charter provision was inserted only to force the preferred stockholders to sell on the terms indicated if the company so desired. It is entirely permissible for a corporation to purchase its own stock by mutual agreement with the seller under these circumstances. Laue v. Bethlehem Steel Corporation, 216 N. Y. S. 173.

In order that section 115 (g) may be applied, the company must have (1) canceled or redeemed petitioner’s stock and (2) that cancellation or redemption must have occurred “at such time and in such manner” as to be “essentially equivalent to the distribution of a taxable dividend.” Here, significantly, the reacquired stock was not retired. It was retained as treasury stock. No reduction of authorized stock was ever authorized. The reacquisitions were not pro rata from all stockholders, but were limited to the stock of the employees and that which petitioner had repurchased from them. Cf. James D. Robinson, 27 B. T. A. 1018; affd., 69 Fed. (2d) 972. The corporate resolution under which these reacquisitions occurred does not, in the face of the other facts, characterize them as in redemption or cancellation of stock. In short, it seems doubtful that these reacquisitions were such at all. They may well have been merely sales of stock to the company. William A. Smith, 38 B. T. A. 317; W. C. Robinson, 42 B. T. A. 725. Cf. Benjamin R. Britt, 40 B. T. A. 790; affd., 114 Fed. (2d) 10.

However, assuming the reacquisition of this stock from petitioner was a redemption or cancellation of his stock, the question remains, did it occu,r “at such time * * * [as to be] essentially equivalent to the distribution of a taxable dividend” ? We think not.

Obviously, there was no connection between the issuance and redemption or cancellation of this stock. Hone of it had been issued as a stock dividend. Though originally issued to petitioner, the affected stock had been sold to key employees to retain their services and had been repurchased from them for their relief for the same price at which it had been sold to them. These repurchases occurred during a period beginning in 1922—long before the reacquisition of the stock by the company at the same prices. This reacquisition was not prorated among the stockholders. . Only the petitioner and such employees as desired were included. And, of emphatic importance, when the company reacquired petitioner’s stock, he owned less than 50 percent of the outstanding stock. Cf. E. M. Peet, 43 B. T. A. 852. No artifice is revealed here. By this transaction, petitioner actually disposed of an interest in the company measured by the percentage of the stock he relinquished. Cf. J. Natwick, 36 B. T. A. 866. The redemption or cancellation, if such it was, was therefore not “at such time * * * [as to be] essentially equivalent to the distribution of a taxable dividend.” Commissioner v. Brown, 69 Fed. (2d) 602; Commissioner v. Babson, 70 Fed. (2d) 304; Commissioner v. Cordingley, 78 Fed. (2d) 118; Commissioners v. Quackenbos, 78 Fed. (2d) 156; Kelly v. Commissioner, 97 Fed. (2d) 915; Patty v. Helvering, 98 Fed. (2d) 717.

This discussion and conclusion have directly to do with the $134,000 item which was the credit petitioner received from the company in 1935 for the stock it then acquired from petitioner.

However, the same result, we think, follows as to the item of $29,028.38 which constituted the sum already received by petitioner on his contracts of sale with employees when those contracts were assigned to the company, and to the item of $12,971.62, the balance unpaid on those contracts, which was credited by the company to petitioner in that year upon his assignment of those contracts to it.

The item of $29,028.38 was received in earlier years, not from the company, but from employees on account of the purchase price of stock which we have already decided was sold by the petitioner to those employees. The title to that stock passed to those purchasers in those prior years. Petitioner did not own this- stock in 1935. It was not then canceled or redeemed. Nor did the company acquire it. All the company then acquired was petitioner’s rights under his contracts with the employees, which included the right to receive that unpaid balance on this stock from the purchasing employees. Obviously, therefore, neither of those items is taxable to petitioner under section 115 (g), supra.

The last issue is whether petitioner may deduct the interest charged by the company on his indebtedness for 1934 and 1935. Petitioner’s books were kept on the cash basis. His salary was not paid to him by check, but was credited to his account on the books of the company. Nevertheless he included it in his taxable income for both years, in the amount of $10,000 for each year. On the books of the company, petitioner’s account was debited with interest charges for those years in the respective amounts of $10,110.09 and $6,445.32. We may assume that his salary was credited directly against these interest charges, for such is the proper practice. Shepard v. City of New York, 216 N. Y. 251; 110 N. E. 435; When Clothing Co., 1 B. T. A. 973. Although it is true that certain entries in Reynolds’ loan account with the company prior to 1931 are not satisfactorily explained, we are satisfied that the account, as to the taxable years, fairly represents the true situation, namely, advances to Eeynolds upon which, interest was charged and upon which he repaid interest and principal from time to time. It is our conclusion that interest in the amounts charged him by the company was paid by petitioner in each year by a method entirely consistent with the cash system of accounting and that the deduction is allowable. Cf. Barto Co., 21 B. T. A. 1197. For 1934, the excess of interest charged over salary credited, $110.09, should be disallowed, there being no showing that payment of this excess was made during the taxable year.

Decision will be entered wider Rule 50.

       SEC. 115. DISTRIBUTIONS BV CORPORATIONS.
      * # * * * * *
      (g) Redemption off Stock.—If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed! in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend.

       SEC. 111. DETERMINATION OF AMOUNT OF, AND RECOGNITION OF, GAIN OR LOSS.
      (a) Computation of Gain on Loss.—The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113 (b) for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized.
      (b) Amount Realized.—The amount realized from the sale or other disposition of property shall be the sum'of any money received plus the fair market value of the property (other than money) received.
      (c) Recoonition off Gain oe Loss.—In the ease of a sale or exchange, the extent to which the gain or loss determined under this section shall be recognized for the purposes of this title, shall be determined under the provisions of section 112.
      (d) Installment Sales.—Nothing in this section shall be construed to prevent (in the case of property sold under contract providing for payment in installments) ths taxation of that portion of any installment payment representing gain or profit in the year in which such payment is received.


author: Leech :

text:
    R. C. Reynolds, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 98014, 98017.
    Promulgated April 29, 1941.

      Hugh Satterlee, Esg., and I. Herman Slier, Esg., for the petitioner.

      J. R. Johnston, Esg., for the respondent.
   OPINION.

Leech :

The first issue is whether petitioner realized gain upon the acquisition of 1,340 units of its own stock from Reynolds on June 1, 1935. Respondent has determined a gain of $72,98.6.40 on this transaction, apparently, under section 22 (a) of the Revenue Act of 1934 and article 22 (a)-16 of Regulations 86; Respondent nowhere indicates how he arrived at the figure of $72,986.40. Presumably, he is taking the position that the fair market value of the stock was considerably higher than the price petitioner paid for it.

Assuming that such was the case, and that the transaction was not a taxable, dividend under section 115 (g) of the same act, and was a purchase by petitioner (see Rollin C. Reynolds, 44 B. T. A. 342, could petitioner have been in receipt of taxable gain on this transaction under the law as it was in 1935 ?

Respondent’s Regulations 86 were approved on September 6, 1934. Article 22 (a)-16 thereof reads as follows:

Acquisition or disposition hy a corporation of its own capital stock.—Whether the acquisition or disposition by a corporation of shares of its own capital stock gives rise to taxable gain or deductible loss depends upon the real nature of the transaction, which is to be ascertained from all its facts and circumstances. The receipt by a corporation of the subscription price of shares of its capital stock upon their original issuance gives rise to neither taxable gain nor deductible loss, whether the subscription or issue price be in excess of, or less than, the par or stated value of such stock.
.But where a corporation deals in its own shares as it might in the shares of another corporation, the resulting gain or loss is to be computed in the same manner as though the corporation were dealing in the shares of another. So also if the corporation receives its own stock as consideration upon the sale of property by it, or in satisfaction of indebtedness to it, the gain or loss resulting is to be computed in the same manner as though the payment had been made in any other property. Any gain derived from such transactions is subject to tax, and any loss sustained is allowable as a deduction where permitted by the provisions of applicable statutes.

Article 22 (a)-16 was taken from T. D. 4430, C. B. XIII-1, p. 36, adopted on May 2,1934.

Prior to this time, respondent’s regulations (typified by Regulations 77, art. 66) bad read as follows: “A corporation realizes no gain or loss from the purchase or sale of its own stock.”

In Helvering v. Reynolds Tobacco Co., 306 U. S. 110, the Court held that the ruling embodied in Regulations 86 could not be retroactively applied to a sale of treasury stock by a corporation in 1929, and used this language:

* * * As the petitioner points out, Congress has, in the Revenue Acts of 1936 and 1938, retained Section 22 (a) of the 1928 Act in haec verha. From this it is argued,that Congress has approved the amended regulation. It may be that by the passage of the Revenue Act of 1936 the Treasury was authorized thereafter to apply the regulation in its amended form. But we have no occasion to decide this question, since we are of opinion that the reenactment of the section, without more, does not amount to sanction of retroactive enforcement of the amendment, in the teeth of the former regulation which received Congressional approval, by the passage of successive Revenue Acts including that of 1928.

Relying on this language, we held, in National Home Owners Service Corporation, 39 B. T. A. 753, that the changed regulations here involved can not be applied to a 1935 transaction, because Congressional approval of the change could not be deemed to have been given in the Revenue Act of 1934, which became law only eight days after the ruling. Congress, we said, had given the older rule the force of law, and it must be applied rather than the later one.

This issue is thus controlled by Helvering v. Reynolds Tobacco Co. and National Home Owners Service Corporation (supra), and decision thereon is for petitioner.

Respondent, by way of an alternative position, contends that petitioner was in receipt of income in 1935 to the extent it was freed from its obligation to declare dividends on the shares of preferred stock then repurchased. Respondent is foreclosed in this contention by Houghton & Dutton Co., 26 B. T. A. 52.

Did petitioner derive income in 1934 through the recoveries on accounts previously charged off as worthless and, if so, in what amount? The record shows that it was petitioner’s practice to split a bad debt recovery into two parts, reporting as income in the year of recovery only such portion of the recovery as represented the profit on the sale in question and deferring inclusion of the balance until the year in which further attempts at recovery were abandoned. It is well settled that bad debt recoveries should be reported in full as accrued income in the year of recovery and not deferred or split up. Hartford Hat & Cap Co., 7 B. T. A. 714; Excelsior Printing Co., 16 B. T. A. 886; First National Bank of Key West, 26 B. T. A. 370; Lake View Trust & Savings Bank, 27 B. T. A. 290; Putnam National Bank v. Commissioner, 50 Fed. (2d) 158; Regulations 86, art. 23 (k)-1. Consequently we do not think petitioner’s unusual accounting practice is warranted.

However, respondent is seeking to throw into one year all the recoveries that have not yet been reported. The rule is that recoveries must be fully reported in' the year they occur. (See authorities last cited.) Our findings are that only $207.79 was recovered in 1934 on worthless debts and not then reported. To add to this amount recoveries which were made in earlier years and properly so reportable would be to correct the mistakes of past years by incorrectly computing the income of the taxable year. This was expressly forbidden in Nicollet Associates, Inc., 37 B. T. A. 350. We hold that petitioner’s 1934 income should be increased on account of recoveries of worthless debts only to the extent of $207.79.

The third question, is whether petitioner is liable for the addition of surtax upon 1935 net income proposed under the provisions of section 102 of the Revenue Act of 1934. Obviously, the petitioner was not organized for the purpose prohibited by that section. Was it availed of for that purpose in 1935 ? It was not “a mere holding or investment company.” Did the “gains and profits” of the company for 1935, which it accumulated and did not distribute, exceed “the reasonable needs of the business” ? These are questions of fact— the first being the ultimate issue.

The findings of fact include our computation of surplus of the petitioner, which gives effect to Rollin, C. Reynolds, supra, and thus treats petitioner’s advances to Reynolds as loans. It also includes all of the presently contested recoveries on account of bad debts charged off. The amomit of this surplus at January' 1, 1935, $357,444.64, is not controlling, but is a circumstance to be considered in determining whether the accumulation of the gains and profits for 1935 was reasonably justified by the needs, of the business. Corporate Investment Co., 40 B. T. A. 1156.

It is true that this surplus was substantial and that all of it was represented by loans to Reynolds. But Reynolds was not the sole stockholder. He was not even a majority stockholder. Cf. Helvering v. National Grocery Co., 304 U. S. 382; Chicago Stock Yards Co., 41 B. T. A. 590. The loans were amply secured and bore interest at a rate of from about 2½ to approximately 4 percent, which was paid. Cecil B. deMille Productions, Inc., 31 B. T. A. 1161; affd., 90 Fed. (2d) 12; certiorari denied, 302 U. S. 713; Dill Manufacturing Co., 39 B. T. A. 1023. See Rollin, C. Reynolds, supra. The surplus had been accumulated in years prior to 1930, during which period dividends were regularly paid.' In each of the years following, until .1935, the petitioner suffered losses. Its business was contracted by the necessary discontinuance of several of its stores. It was a wholesaler and retailer of furniture. In view of that situation, the use of caution was surely warranted in the distribution, at least, of the first earnings after tlie five years of consecutive losses. And what were those earnings for 1935 which were not distributed and which must support the imposition of this tax?

In the deficiency notice the respondent determined the net income of petitioner for that year, on which the surtax was there proposed, to be $98,491.16. The computation of that income there disclosed was as follows:

Adjustments to Net Income.
Net income as disclosed by return-_$20,380.53
Unallowable deductions and additional income:
(a) Bad accounts collected-$2, 833. 24
(b) Repairs-1,228. 88
(c) Excessive depreciation-3, Oil. 82 ,
(d) Capital gain-72,986.40 80,060.34
Total_$100,440.87
Nontaxable income and additional deductions:
(e) Installment profits_$1,037.41
(f) Treasury bond interest_ 162. 30
(g) Capital stock tax- 750.00 1,949.71
Net income adjusted_$98,491.16

There is apparently no controversy as to any other item appearing in this computation except capital gain in the amount of $72,986.40, which the respondent states in his deficiency notice represented “Profit realized on transfer of stock under the provisions of section 22 and article 22 (a)-16 of the Revenue Act of 1934.” But we have already held that petitioner realized no such gain in that transaction. Eliminating that item in the computation of the respondent in his deficiency notice would leave, according to that notice, $25,504.76 as the adjusted net income of the petitioner for 1935. ' This computation, of course, would be reduced by $749.17 if the net profit as shown by the books of the company, and appearing in the findings of fact, were used instead of the net income disclosed in the return of the petitioner.

However, on brief, respondent shifts his position. He contends that there became available for distribution to shareholders in 1935 the following items:

Net income per books-$19,631. 53
Principal amount (interest excluded) of B. O. Reynolds taxes theretofore charged to accumulated surplus!-117,135. 22
Total_ 136,766. 75

Analyzing this statement, $19,444.30 of the “net income per books” consisted of the excess of interest on the tax refund over counsel fees and other expenses of suit.

The tax refund of $117,135.22 was a recovery of part of the cost of capital assets to petitioner. Petitioner had agreed, as part of the consideration for the transfer to it of Eeynolds’ assets, to assume the tax liability imposed on Eeynolds in respect of his conduct of the business prior to incorporation. 'When the recovery of part of the amount thus paid occurred in 1935, it was merely a partial restoration of that capital cost and did not affect surplus. Having been paid out as a capital item, it was not income upon its recovery. See Burnet v. Logan, 283 U. S. 404; Jamieson Associates, Inc., 37 B. T. A. 92. Be-gardless of the manner in which the petitioner treated this item on its books when paid, in our computation of surplus appearing in the findings of fact, neither the payment nor restoration of part of this item is reflected in the surplus account. This, we think, is proper. The entire income for 1935, therefore, as computed in the deficiency notice, is $.25,504.76, upon which the proposed imposition of surtax must rest, and as computed by respondent on brief, by using the net income as shown by the books of the company, it is $749.17 less.

The comparatively little savings to the stockholders to be expected by the accumulation of this relatively small amount of income, contradicts rather than supports the existence of the condemned purpose in failing to distribute it in view of the record here. See Cecil B. de-Mille Productions, Inc., and Bill Manufacturing Co., supra. Particularly is this so, in view of the fact that in 1936 and 1937, when petitioner continued to realize income, and in greater amounts, dividends were promptly declared and paid.

Moreover, of this total income of the petitioner for 1935, approximately $19,400 consisted of the excess of interest on the refund over counsel fees and other expenses of the suit therefor. The balance of about five or six thousand dollars, was all of the operating income.

The policy of the company was not to declare and pay dividends unless currently earned and to conserve surplus to protect its financial position during the periods of depression and the reasonably expected years of prosperity and expansion.to follow. That policy was followed consistently by the company from its inception through 1934. In the face of this record, we will not say that the accumulation of gains and profits for 1935 was an accumulation not reasonably justified. Cf. Trico Securities Co., 41 B. T. A. 306. And if it were unnecessary, we think any presumption that such accumulation was “for the purpose of preventing the imposition of the surtax upon its shareholders” has been definitely overcome. Corporate Investment Co., supra. Respondent- is reversed on this issue.

Decision will be entered under Rule 50.

       Revenue Act of 1 934 was approved May 10, 1934.

       SBC. 102. SURTAX ON CORPORATIONS IMPROPERLY ACCUMULATING! SURPLUS.
      (a) Imposition oh Tax.—There shall be levied, collected, and paid for each taxable year upon the adjusted: net income'of every corporation (other than a personal holding company as defined in section 351) if such' corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders or the shareholders of any other corporation, through the medium of permitting gains and profits to accumulate instead of being divided or distributed, a surtax equal to the sum of the following:
      (1) 25 per centum of the amount of the adjusted net income not in excess of $100,000, plus
      (2) 35 per centum of the amount of the adjusted net income .in excess of $100,000.
      (b) Prima Facie Evidence.—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 avoid surtax.


author: Sternhagen :

text:
    J. Brooks B. Parker, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101676.
    Promulgated April 30, 1941.

      Philip Dechert, Esq., for the petitioner.

      Paul E. Waring, Esq., for the respondent.
   OPINION.

Sternhagen :

The evidence shows that petitioner fulfills all of the qualifications prescribed by the regulations, article 25-4, Regulations 94, of the head of a family, covered by section 25 (b) (1), Revenue Act of 1936. He actually supports and maintains one or more individuals who are closely connected with him by blood, has the right to exercise family control and provide for them, and this is based on a moral or legal obligation. The separation of residence is a matter of necessity under the circumstances. The $2,500 personal exemption should have been allowed, Percival Parrish, 44 B. T. A. 144; Estate of Grace Adams Howard, 42 B. T. A. 449 ; Sidney Williamson Kirtland, 39 B. T. A. 959; William Lee Tracy, 39 B. T. A. 578; Hassard Short, 39 B. T. A. 567; Meier S. Block, 37 B. T. A. 945; Olive Ross, 37 B. T. A. 928.

Decision will be entered vmder Bule 50.


author: SteRNHagen:

text:
    Roland L. Taylor, Trustee for Taylor Hardwick, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 103468, 103469, 103470, 103471, 103472, 103473, 103474.
    Promulgated May 1, 1941.

      James A. Moore, Esq., for the petitioners.

      Bernard D. Darnels, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: Roland L. Taylor, Trustee for Anita Marjory Hardwick; Roland L. Taylor, Trustee for Roland Taylor Ely; Roland L. Taylor, Trustee for Gordon A. Hardwick, Jr.; Roland L. Taylor, Trustee for Donald Ely; Roland L. Taylor, Trustee for William Newbold Ely, III; and Roland L. Taylor, Trustee for Charles A. Hardwick.

   OPINION.

SteRNHagen:

1. The petitioners assail the inclusion in their income of any part of the $62,350.17 received by the trustee under the contract because it was all a “return of capital”, the theory being that the $150,000 which petitioners “advanced” was a simple loan and that the $62,350.17 was but a partial collection of the debt. To accept this theory would be contrary to the facts and give an artificial meaning to the contract and to the word “advance” as used in it.

The contract recites that the Gilmort Co. desires to develop its properties and petitioner is willing to advance money for that purpose “for an interest in the property and profits of such business.” The contract gave petitioners a substantial interest in the properties and also in the possible profits. To the prescribed extent, petitioners were to finance operations and the acquisition of new properties, and were assured of a larger part of proceeds from early operations than that to which their 30 percent interest entitled them. There was no fixed debt, but only an expansible interest out of production. Petitioners, to the stated extent, shared the hazard. Such a contract can not be placed in the same class with a mortgage, which, irrespective of personal liability for the Toan, is a lien on the specified property and presupposes a promise to repay the full amount. Petitioners had no simple promise to repay, but only the expectation of a business venturer that he would get back more than he put in. Compare Ortiz Oil Co. v. Commissioner, 102 Fed. (2d) 508; certiorari denied, 308 U. S. 566, which considers the position relative to that of the Gilmort Co. and holds that the amount received from West-brook and Thompson, who were in a position relatively similar to petitioners here, was not a.loan but the price of a sale of oil.

The Commissioner has held that the $62,350.17 was properly to be reduced by deduction for expenses and depletion, and this is as much as petitioners can legally claim. The determination is sustained.

2. The petitioners claim that the commissions paid by their partnership upon the sales and purchases of commodities and the sale of, securities are deductible in determining the taxable net income of the partnership. The commissions on sales of securities have been held deductible in Neuberger v. Commissioner, 104 Fed. (2d) 649, reversed on another point, 311 U. S. 83, and the Commissioner’s determination is reversed as to this item. The separate commissions on purchases and sales of commodities can not be ascertained because the broker’s bills did not show such a break-down. The evidence shows the rate to be the same, and under similar circumstances it was held that one-half of the total amount was properly attributable to each and a deduction allowed as to the one-half attributable to sales, George W. Covington, 42 B. T. A. 601 (on review C. C. A., 5th Cir.). Following that decision, $10,875 is deductible as commissions on commodity sales, and the determination is to that extent reversed.

3. Since no returns were filed by any of the petitioners, the 25 percent penalty is sustained, Noteman v. Welch, 108 Fed. (2d) 206; Kathryn Lammerding, 40 B. T. A. 589, 600 (on review App. D. C.) ; Puritan Mills, 43 B. T. A. 191.

Decisions will be entered wnder Bule 50.


author: Tuenbe :

text:
    Lucian T. Wilcox, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 80393.
    Promulgated May 1, 1941.

      H. Y. Simmons, Esq., and Perry W. Shrader, Esq., for the petitioner.

      Angus B. Shannon, Jr., Esq., for the respondent.
   . OPINION.

Tuenbe :

The petitioner concedes the deficiency as determined by the respondent, but denies that any part thereof was due to fraud with intent to evade tax. The burden is accordingly on the respondent to prove fraud. The notice of deficiency did not state any basis for the determination of fraud. The allegations contained in the respondent’s answer to support his charge of fraud are little if any more revealing. They read as follows:

(a) Petitioner filed a Federal income tax return for the taxable year 1932 with the Collector of Internal Revenue for the District of Iowa on March 15, 1933, and showed no ordinary net income and no capital net gain, whereas his ordinary net loss was $1,450.25 and his capital net gain was $44,170.94.
(b) Petitioner, fraudulently and with intent to evade tax, failed to report the receipt of his capital net gain in the amount of $44,170.94.
(c) Respondent, for further facts in this case, refers to the deficiency letter, a copy of which is affixed to the petition, and the same is hereby adopted in this answer as fully as if incorporated herein.

Apparently the respondent has treated the return of March 15, 1933, as the petitioner’s return herein and rests his claim of fraud upon the failure of the petitioner to disclose in that return the exchange of his interest in the Wilcox Building to his mother for securities, on which exchange it appears that petitioner realized a capital net gain in the amount of $44,170.94. Such a claim on the part of the respondent is clearly without merit. The petitioner’s letter definitely indicates that he did not regard the document filed on the return form on March 15, 1933, as a completed income tax return. He did not give any of the details with respect to items of income or deduction but concluded with statements clearly indicating that a further and complete return was contemplated. It is apparent that the petitioner was and is bitter and resentful over his lot in life, but that alone is not sufficient basis to charge him with fraud. It is true that the amended return in which he did attempt to disclose, so far as this record shows, all items of income and deduction was made, at the office of the collector of internal revenue in Cedar Rapids, upon a visit by petitioner at the request of the deputy collector. It further appears, however, that the petitioner had upon his return from Nevada in November preceding set about the preparation of the schedule showing all of the details concerning the exchange of his interest in the Wilcox Building for securities and the information shown on the amended return so filed was volunteered to the deputy collector by the petitioner. . The record contains nothing whatever to indicate that in making the amended return the petitioner did not offer and give full and complete cooperation to the deputy collector. We accordingly conclude that the respondent has failed to sustain his burden of showing fraud on the part of petitioner.

In the alternative, the respondent has pleaded in his answer that in the event this Board should find that the petitioner was not guilty of fraud, it should find that part of the deficiency was due to negligence or intentional disregard for rules and regulations and that our decision should include the appropriate penalty therefor. In our opinion the record amply shows intentional and more or less willful disregard of the requirements of the income tax statutes and regulations with respect to the time of filing returns and the keeping of the necessary records for properly reflecting income. The respondent is accordingly sustained in his request for the imposition of an appropriate penalty with respect thereto and our decision will include the penalty provided therefor in section 293 (a) of the Revenue Act of 1932; but the computation of said penalty shall be limited to the deficiency of $610.92, as determined by the respondent and agreed to by the petitioner.

Decision will be entered under Rule 50.