author: Van Fossan :

text:
    Seatrain Lines, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102561.
    Promulgated May 6, 1942.

      H. Mcmrice Fridhmd, Esq., and James Bagan Boberts, Esq., for the petitioner.

      Ellyne E. Strickland, Esq., for the respondent.
   OPINION.

Van Fossan :

The Commissioner determined a deficiency of $834.30 in the petitioner’s income tax for the year 1936. The petitioner claims an overpayment of $11,117.51 for that year.

The sole issue is whether or not the petitioner is entitled to a credit under section 131 (a) (1) of the Revenue Act of 1936 for a tax of 3 percent of the gross income obtained for freight and passenger transportation, paid under Cuban law.

The facts were stipulated and we adopt them as our findings of fact. Based on such stipulation and the translations of Cuban law attached thereto, the facts material to the issue may be summarized as follows;

The petitioner is a domestic corporation, with its office in New Orleans, Louisiana. Its income tax return for 1936 was filed with the collector of internal revenue for the district of Louisiana, and was made on the accrual basis.

The petitioner is a steamship company engaged in the business of carrying freight and passengers from ports in the United States to ports in the United States and in the Republic of Cuba, and from ports in Cuba to ports in the United States.

The Republic of Cuba imposes a tax of 3 percent on the freights and passage money received by foreign shipping companies for cargoes and passengers taken aboard in Cuban ports. This tax is imposed by reason of certain provisions in the Law of July 6, 1928, which amended article III of the Cuban Law known as “Military Order No. 463 of 1900”, hereinafter referred to as Order No. 463.

Order No. 463 provided that certain “entities” should pay to the state “8 per cent tax on their profits” and that companies engaged in navigation should contribute 6 percent to the state (article III, b). Article X is as follows:

X. There shall be considered as net profits ior the collection of the Tax that balance which may result after reduction of the proven expense of operation and maintenance of the business in which the Banks, Companies and enterprises are engaged.
There shall be credited the amount of industrial and territorial taxes that may be paid for the assessable industries which they may exercise and the properties which they may own. (Tb!e amount of these taxes is not to be deducted from the quota to be paid to the State, but shall be accredited or included among the expense of the Companies in accordance to resolutions [Bulings] made or taken in the matter.)

Prior to July 6, 1928, continual controversy arose between the shipping companies and the tax authorities of the Cuban Government on the’ question of what proportion of expenses should be allowed against revenues derived from Cuban sources in determining “net profits.” The taxpayers and the Cuban Government were never able to reach an agreement on the apportionment of expenses. Ultimately, however, the Cuban Government offered to compromise the difficult question by a decrease of 50 percent in the rate of the tax, making it 3 percent, and applicable to gross income from Cuban sources rather than on “net profits.”

The Law of July 6, 1928, in article XV, amended Order No. 463 as follows:

“Ajkticee III. The following shall pay six per cent of their net profits as Tax to the State:
“a) General service railroads, that is, those engaged in public exploitation oí transport of passengers and merchandise, that belong either to companies or tc individuals, in accordance with those laws which are in force governing same.
“b) National shipping companies and those foreign ones authorized to engage in coastwise traffic.
“Foreign shipping companies which engaged in transporting freight and passengers between national and foreign ports shall be exempt from the Tax on Profits and shall, in lieu thereof, pay a tax of 3% of the gross income obtained for freight and passengers which they may ship in national ports, without prejudice of their continuing to pay tax for other reasons (conceptos) according to the legislation in force.
“The tax is to be paid precisely by said shipping companies or their Agents; and they shall not charge same to the shippers nor passengers.”
The Tax due according to Paragraph (b) of Article III of Order No. 463 of 1900 by the Companies which, according to that Article, are subject to tax in accordance with their income, is remitted.

and in article XXI it also amended article X of Order No. 468, as follows:

“Article X: For the purpose of determining the net profits on which the individuals or companies obligated to pay the-tax on profits must pay the corresponding proportion of tax, the following shall be deducted from the gross income which they may obtain, whatever their source:
“a) The amount of all ordinary and necessary expenses paid or incurred during the year in the exploitation of the business; and
“b) The amount of the ordinary losses suffered by the Company during the normal course of business.
“For the purposesi of application of this Law, income shall be understood to be everything received, whether in cash, in securities or in credits, which modify the wealth of the taxpayer and of which he may freely dispose of without restoring their amount.
“There shall be accepted as ordinary expense of exploitation of the business the amount of contributions and taxes paid to the State, to the Province or to the Municipalities, with exception of those paid as tax on profits.”

Pursuant to the above laws, during tbe calendar year 1936 there were accrued and the petitioner duly paid to the Eepublic of Cuba as and for taxes on freight revenues the amounts hereinbelow set forth for each of the three-month periods indicated:

In its Federal income tax return for the calendar year 1936, the petitioner signified its desire to have the benefit of section 131 of the Revenue Act of 1936.

For the period here involved, the Republic of Cuba also imposed a tax of iy2 percent (subsequently increased to 2 percent) on sales and gross receipts. The material parts of the law, known as Decree-Law No. 393, imposing such tax, are substantially as follows:

The Decree-Law recited prior laws establishing a tax on the sale, exchange, or transfer of merchandise and gross receipts, and stated that such taxes henceforth would be governed by the present Decree-Law. It then provided that all merchants, manufacturers, or industrialists, not expressly exempt, should pay a tax equivalent to 1% percent of the price or value of the articles sold, exchanged, or transferred. Article IX is as follows:

Ajuicie IX: To the effects of this Decree-Law, the following natural or juridical persons shall be considered as merchants and therefore subject to the payment of the 1% percent tax on gross receipts:
* * % * & * *
12. Those who directly or indirectly transport passengers or freight in any manner, whether by land, sea, or air, it being understood that in case of transportation by sea or air that the tax shall be paid on freight, whether collected in Cuba or abroad, on that portion of the transportation which begins in Cuban territory, which act shall be determined by the fact of loading, in whole or in part, a vessel or an aeroplane.
In regard to the transportation of passengers by sea or air, tax shall be paid on the amount of the passages, whether collected in Cuba or abroad, covering the transportation which begins in Cuban territory, which act shall be determined by the fact of the departure of the passenger from same.
* * * * s?s * #
[The article specifies 18 other classes of merchants.]

The petitioner paid to the Eepublic of Cuba various amounts as taxes on sales and gross receipts accrued during 1936. It filed its 1936 Cuban tax returns pursuant to the Law of July 6, 1928, and the Decree-Law No. 393.

The returns filed by the petitioner recite that it is obligated to contribute the “3 per cent tax on the income obtained from cargo and passengers leaving Cuba, created by the Law of July 6, 1928,” and declare that the “income subject to payment” is as set forth. The receipt issued by the Treasurer of Cuba describes the tax as being “3 per cent of $- income received for freights.” The returns of the 1% percent sales tax are made on a different form and under other laws and refer to “gross sales and income.” The returns of the 3 percent tax were made quarterly while the returns of the 1 y2 percent tax were made monthly.

The question presented by the above facts is: Was the 3 percent Cuban tax an income tax or an excise tax? If the former, section 131 (a) (1), Revenue Act of 1936, allowing a credit of the amount paid or accrued, is controlling; if the latter, the petitioner is entitled only to a deduction of the amount so paid or accrued.

We have no doubt that the tax in controversy was considered and treated by the taxing authorities of Cuba as strictly an income tax. The forms for returns, the references to the underlying Law of July 6, 1928, the receipts issued by the Treasurer, and other facts in the record all point unmistakably to this conclusion. The historical setting and development of the tax also confirm this view. In short, the tax originated and remained wholly within the scope of the Cuban income tax legislation.

Contemporaneously, a sales or gross receipts tax, admittedly an excise tax, was in force in Cuba and the petitioner paid taxes under the law establishing it. Eeturns, reports, receipts, and other administrative details of the two types of taxes were kept separate and distinct in the Treasury Department of the Republic of Cuba. The petitioner’s tax payments followed this routine of segregation and differentiation.

The respondent contends that while the answer to the question before us “must depend in considerable part on the Cuban law * * * it is more important that the facts be analysed in the light of our own concepts.” He then argues that it is a well established principle of law that taxes based on gross receipts constitute a tax on business and “are generally held to be an excise tax.” He advances the theory that the modification of Order No. 463 by the provisions of the Law of July 6, 1928, with no further legislation or words of description, transformed the tax from an income tax to an excise tax.

It will be noted that respondent’s contention is directed to a gross receipts tax, not a gross income tax. The two concepts are not synonymous. Paul & Mertens, Law of Federal Income Taxation, vol. 1, § 5.09.

In the cases cited by the respondent to support his theory that a tax based upon gross receipts is an excise tax, the privilege of exercising a franchise or the privilege of doing business is the controlling factor. The 3 percent tax here involved is not levied on the privilege of doing business but on the gross income derived from the petitioner’s functions of carrying passengers and freight. In no provisions of the Cuban Law of July 6, 1928, is the privilege of carrying on the petitioner’s business made the basis of the tax.

The 3 percent by which the original 6 percent rate was reduced was apparently an approximation of the deductions allowed in arriving at net income and was adopted as a compromise measure in order to avoid the complex and vexatious allocation and calculation of the deductible items peculiar to the petitioner’s business. Therefore, it appears that as to petitioner’s business the present 3 percent tax is but the successor of the 6 percent income tax, took its place in the tax structure of Cuba, and preserved its character as an income tax.

Not only is respondent’s position not supported by the Cuban law, it finds no basis in our own tax interpretations. Section 1400 of chapter 9 (entitled “Employment Taxes”), Internal Revenue Code, requires the payment of certain taxes on the wages received by every individual after December 31,1936, (with exceptions named in section 1426 (b)), but section 1402 provides that such tax is not deductible in computing income taxes imposed by chapter 1. The Senate Finance Committee Report states that the deduction was not allowed because the tax is an income tax. Likewise, the optional Form 1040A, used so widely in the current income tax returns, is based on a gross income of $3,000 and less. The respondent has ruled that Canadian dividend taxes, Canadian copyright taxes, French rental value taxes, Mexican interest taxes, and Argentine dividend taxes are all income taxes and are allowable as a credit under section 131. See also Herbert Ide Keen, 15 B. T. A. 1243; and Havana Electric Railway, Light & Power Co., 34 B. T. A. 782.

There can be no doubt of the right of Congress to impose a tax on gross income under the Sixteenth Amendment to the Constitution. The allowance of deductions from gross income in computing the proper income tax due is solely a matter of legislative grace. Deputy v. duPont, 308 U. S. 488. In New Colonial Ice Co. v. Helvering, 292 U. S. 435, the Supreme Court said:

The power to tax income like that of the new corporation is plain and extends to the gross income. Whether and to what extent deductions shall be allowed depends upon legislative grace; and only if there is clear provision therefor can any particular deduction be allowed.

Thus, although deductions may be allowed, the tax remains an income tax because it is levied on income and not on the privilege of doing business. If no deductions were permitted by statute the tax would still be an income tax.

In so far as I. T. 2596, CB X-2, 184 (1931), cited and relied upon by the respondent, is not in accord with our decision, it must be disregarded. Attention is directed to the fact that in the translation of the Cuban statutes quoted in I. T. 2596 the crucial phrase is rendered as “3 per cent on the gross revenues received * * *” while the translation stipulated by the parties in the present case is “3 per cent of the gross income obtained * *

Reviewed by the Board.

Decision will be entered under Rule 50.

       SEC. 131. TAXES OF FOREIGN COUNTRIES AND POSSESSIONS OF UNITED STATES.
      (a) Allowance op Credit. — If tlie taxpayer signifies in his return his desire to have the benefits of this section, the tax imposed by this title shall be credited with:
      (1) Citizen and domestic corporation. — In the case oí a citizen of the united States and of a domestic corporation, the amount of any income, war-profits, and excess-profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the united States; * * *

         74th Cong., 1st sess., S. Rept. No. 628, p. 42.


source: Caselaw Access Project

author: Black :

license: Public Domain

text:
    J. E. Timberlake, Petitioner, v. Commissioner of Internal Revenue, Respondent. Estelle Flintom Timberlake, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 101096, 101097.
    Promulgated May 7, 1942.

      Richard E. Thigpen, Esq., for the petitioners.

      Charles Oliphant, Esq., for the respondent.
   OPINION.

Black :

The first question we have to decide in these proceedings is the fair market value of the shares of stock in the Thomas & Howard Co. of Charleston at the time they were transferred by the Thomas & Howard Co. of Columbia to its stockholders, including petitioners, at $100 per share. If these shares had no greater fair market value at the time of the transfer than $100, it is manifest that petitioners received no dividend in the transaction from the Columbia company of which they were stockholders. Where a corporation sells to its stockholders stock which it owns in another corporation at a price which represents its fair vafoie at the time of sale, there is no dividend in the transaction to the stockholder, even though it does turn out that he has made an advantageous purchase. The stockholder will realize his income if and when he sells his stock at a profit. Palmer v. Commissioner, 302 U. S. 63. Petitioners strongly contend that the fair market value of the stock of the Charleston company was $100 per share on November 9, 1936, at the time they allege it was purchased from the Columbia company. We think the facts are against petitioners on this contention and we have found that the stock had a fair market value of $150 per share on the date in question. We are convinced from the evidence that the stock had at least that much fair market value.

Petitioners rely principally for their contention that the stock had a fair market value of only $100 per share upon the testimony of their witness, Erskine E. Boyce. Boyce was a representative of Mrs. Jessie W. Thomas, who was the principal stockholder in the Columbia and Charleston companies. He was executive vice-president of the Charleston company and had charge of its finances and credits. He testified that in his opinion the fair market value of the stock of the Charleston company was $100 per share at the time of the transfer November 9, 1986. He conceded that he was no expert in the valuing of corporate stocks and that his opinion as to the valuation of $100 per share was largely arrived at by capitalizing the earnings of the Charleston company over a period extending from 1928 to 1936, inclusive, at 10 percent and that on this basis he arrived at a figure of $105.75 per share. We think there are other facts and figures in the record which demonstrate that this figure of $100 per share given by Boyce as his opinion of the fair market value of the stock at the time of the purported sale was too low. Among these is the fact that already in January of the taxable year a dividend of $10 per share had been paid on the stock and the company had the best earnings in its history in 1986. There is no reason to believe but that petitioners were fully aware of this latter fact.

On December 31, 1936, the Charleston company paid a dividend of $40 per share to its stockholders, including petitioners, who had acquired their stock on November 9, 1936, in the manner already detailed.

On or about February 8, 1937, C. L. Howard sold to Mrs. Jessie Thomas 68 shares of the capital stock of the Charleston company at the price of $150 per share. This sale was made after the Charleston company had diminished its assets by the payment of a 40 percent cash dividend to its stockholders on December 31, 1936. It is true that the witness testified that Mrs. Thomas was influenced to pay $150 per share for these 68 shares of the stock by the fact that she needed these shares for the control of the Charleston company. However, when we consider the large earnings of the Charleston company in 1936 and that 68 of its shares were sold early in 1937 at $150 per share after a dividend of $40 per share had been paid on December 31,1936, we think it is not unreasonable to conclude that the shares of stock of the Charleston company had a fair market value of at least $150 per share on November 9, 1936, and that the sale of 775 shares of such stock on that date by the Columbia company to its stockholders, including the petitioners herein, for $100 per share was not an arm’s length transaction.

We shall consider next whether the difference between the amounts which petitioners paid the Columbia company for the shares of Charleston company stock and the amounts of the fair market value of the shares at the time they were acquired represented a distribution of earnings and profits of the Columbia company to petitioners that are taxable to them as dividends within the meaning of section 115 of the Revenue Act of 1936. The applicable Treasury regulation is article 22 (a)-l of Regulations 94, as amended by T. D. 4879, which was quoted by the Commissioner in his determination of the deficiencies and has been set out above.

Petitioners, in their contention that this excess if any did not represent a taxable dividend, make point of the fact that the Columbia company carried the shares of stock which it owned in the Charleston company on its books at cost, and therefore when it sold the stock to its shareholders at $100 per share, which was its cost, the earnings and surplus of the Columbia company were not diminished by the sale and, therefore, there was no distribution of a dividend within the meaning of section 115. To this contention we remark that if the stock had been distributed by the Columbia company to its stockholders as a dividend in kind, the stockholders would undoubtedly have been taxable on the fair market value of the stock at the time of the payment of the dividend, rather than on the amount of the cost of the stock to the Columbia company, regardless of the fact that the Columbia company carried the stock on its books at cost.

That was the effect of the court’s decision in Binzel v. Commissioner, 75 Fed. (2d) 989; certiorari denied, 296 U. S. 579, which affirmed the Board’s memorandum opinion in that proceeding. In affirming the Board the court, among other things, said:

As the taxpayer has the burden of proof, we must assume that the stock of the City Bank was purchased out of earnings accrued after March 1, 1913. If so, its increase in value resulted from earnings out of which the stock was originally purchased and pro tanto was added to its surplus available for dividends or for any other purpose. It does not follow, because the United Cork Companies realized, no taxable profit while it held the shares of the National City Bank, that there was no profit in fact, or that the dividend was not subject to taxes based upon a valuation of the stock that included the increment. That the market value at the time of distribution should be the basis for the income tax is evident from the decisions of the Supreme Court in United States v. Phellis, 257 U. S. 156, * * *, Rockefeller v. United States, 257 U. S. 176, * * * as well as under article 627 of Regulations 74.

If tbe unrealized increment of tbe stock of the National City Bank represented a distribution of earnings by tbe United Cork Companies to its stockholders in tbe Binzel case, as the Board and the court held that it did, then we see no reason why the unrealized increment of the stock in the Charleston company did not represent a distribution of earnings by the Columbia company when it transferred the stock of the Charleston company, which had a fair market value of at least $150 per share, to its stockholders for $100 per share. It seems clear to us that such transaction was a distribution by the Columbia company to its stockholders of earnings to the extent of $50 per share of the unrealized increment on the shares of stock of. the Charleston company. Certainly the transaction seems to fall within the ambit of article 22 (a)-l of Regulations 19, as amended by T. D. 4879, referred to by the Commissioner in his deficiency notices.

The petitioners, however, contend that a Treasury regulation can not make income where none is present and that the regulation in question undertakes to do that very thing and is therefore invalid, and cite in support of their contention Palmer v. Commissioner, supra.

We do not think the Supreme Court’s decision in the Palmer case supports the contention of petitioner. The Court in that case took particular pains to point out that at the time Superpower committed itself to the sale of United stock to its stockholders the price which it was to obtain for the stock represented its jaw market value. The Court pointed out that the mere fact that the stock increased in value between the time Superpower had agreed to sell United stock to its stockholders, and the time the stock was actually delivered to them, did not result in the payment of a dividend by Superpower to its stockholders. Among other things, the Court said:

* * * We accept the findings as at least establishing that the plan was adopted by Superpower in good faith as a means of effecting a sale of its assets to stockholders at fair market value. Hence the issue for decision, in so far as the first allotment of stock is concerned, is narrowed to the question of law whether the commitment of Superpower, by formal action of its Board, to the sale of United stock at its then fair market value and the ensuing distribution to stockholders is taken out of the category of sales and placed in that of dividends by the fact that, pending execution of the project, rights to subscribe sold on the exchange at substantial prices, or that the stock itself sold at prices substantially above the stipulated purchase price. [Italics supplied.]

We have already stated above that, if $100 per share had represented the fair market value of the shares of the Charleston company at the time they were transferred to the stockholders by the Columbia company for $100 per share, there would be no ground to hold that there was any distribution of a dividend by the Columbia company. That is the principle we understand the Supreme Court to have laid down in the Palmer case, supra. The Supreme Court did not hold that there is not a taxable dividend in a case where, as here, a corporation transfers stock which it owns in another corporation proportionally to its stockholders for $100 per share, which stock in fact has a fair market value of at least $150 per share at the time of transfer, and the corporation making the transfer has ample earnings to pay a dividend of the amount in question. On the contrary the Court expressed the view that such a transaction would be a taxable dividend to the extent of the excess of the fair market value of the stock over the purported sale price received. In discussing that phase of the subject, the Court said:

On the other hand, such a sale, ii for substantially less than the value of the property sold, may be as effective a means of distributing profits among stockholders as the formal declaration of a dividend. The necessary consequence of the corporate action may be in substance the kind of a distribution to stockholders which it is the purpose of section 115 to tax as present income to stockholders, and such a transaction may appropriately be deemed in effect the declaration of a dividend, taxable to the extent that the value of the distributed property exceeds the stipulated price. But the bare fact that a transaction, on its face a sale, has resulted in a distribution of some of the corporate assets to stockholders, gives rise to no inference that the distribution is a dividend within the meaning of section 115. To transfer it from the one category to the other, it is at least necessary to make some showing that the transaction is in purpose or effect «sed as an implement for the distribution of corporate earnings to stockholders. [Italics supplied.]

In the instant case we think the facts embodied in the stipulation and brought out by other testimony at the hearing make such a showing as is referred to by the Supreme Court in the language which we have emphasized above. We, therefore, sustain the Commissioner in his determination that petitioners received dividends in the manner detailed in the deficiency notices.

We do not sustain the Commissioner in his determination of the amounts of the dividends which petitioners received, for we have held on the facts that the shares of stock of the Charleston company had a fair market value of $150 per share at the time they were transferred to petitioners instead of $200 per share, as the Commissioner determined.

One of the reasons urged by petitioners as to why we should not sustain the Commissioner in his determination that the distributions in the amounts stated were dividends is that the stock of the Charleston company was not transferred to the stockholders of the Columbia company in ratable proportions. In view of the facts stipulated in the record, this contention is not sustained. An examination of the figures in the record shows that, while there was some slight variation in the proportions, it was so small as to be negligible. We hold that the stock in question was distributed by the Columbia company to its stockholders in substantial proportion to the stock which they owned in the company.

One of the cases strongly urged by petitioners in support of their position that there was no dividend distribution in the transaction in question is George W. Van Vorst, Executor, 22 B. T. A. 632; affd., 59 Fed. (2d) 677. We tbink that case is distinguishable on its facts from the instant case. In that case the Board laid emphasis on the fact that there was a disproportionate distribution in that only one stockholder had profited by the advantageous purchases and there was no evidence that the other stockholders had consented to such disproportionate arrangement. In that case,’ among other things, we said:

* * * A taxable distribution may be made without the formal declaration of a dividend. Furthermore, a dividend need not be distributed in proportion to shareholdings if the shareholders consent. But here there has been no declaration of a dividend in any certain amount, in fact no declaration of any dividend which bore any relation to this transaction, and no evidence of the stockholders consenting to a disproportionate distribution. In our opinion the stipulated facts, including the stipulation that the decedent “purchased” the property, made a prima facie case for the petitioner and it was then incumbent upon the respondent to show that although this was in form a sale, nevertheless it occurred under circumstances which indicate that in fact it was a distribution of earnings or profits accumulated since February 28, 1913. In this connection we see no reason to infer that the stockholders ever agreed to an unequal distribution. This majority stockholder undoubtedly purchased at a bargain price and there were stockholders who did not share in the bargain. But bargain purchases do not ipso facto require an explanation by the purchaser to avoid tax. Proof of a prima facie case does not require the elimination of all unfavorable possibilities. * * * [Italics supplied.]

We think the foregoing facts recited by the Board in its opinion in the Van Vorst case make it distinguishable from the instant case, and not authority for the contention urged by petitioners.

Decision will be entered imder Bule 50.


author: Smith :

text:
    Estate of Gertrude Leon Royce, Richard Leon Royce and Louis Royce, Executors, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 105623.
    Promulgated May 7, 1942.

      G. B. Berne, Esq., for the petitioners.

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

Smith :

The issue presented is whether the value of the corpus of the trust created by the decedent’s husband is includable in the decedent’s gross estate under the provisions of section 302 (a) of the Bevenue Act of 1926. The respondent contends that it is, because during her life decedent had complete beneficial ownership of the corpus through her right entirely to withdraw it from the trust. The petitioners contend that any withdrawals of corpus by the decedent were dependent upon the trustee’s discretion and, in the alternative, that if an unlimited right to withdraw did exist the statute does not require the inclusion of the value of the trust corpus in the decedent’s gross estate. Section 302 (a) of the Bevenue Act of 1926 provides as follows:

Sec. 302. Tbe value of tbe gross estate of tbe decedent shall be determined by including the value at tbe time of his death of all property, real or personal, tangible or intangible, wherever situated—
(a) To the extent of the interest therein of the decedent at the time of his death.

There can be no doubt that the trust indenture gave to the decedent the unconditional right to withdraw the entire corpus of the trust. Although the first clause, referring to the privilege of the decedent to withdraw the corpus, is phrased in terms of the power of the trustee to make the payments, a reading of the entire indenture makes it plain that the trustee was given no discretion over the payments to the decedent out of principal. This conclusion is fortified by the fact that in giving the trustee the power to pay sums out of principal to the sons, the trust indenture expressly places the entire matter in the discretion of the trustee.

The basic problem presented in this proceeding is thus brought clearly into focus. Does the absolute right of the decedent under the trust indenture to withdraw the trust corpus warrant the inclusion of the value of the trust corpus in her estate under the authority of section 802 (a) of the Revenue Act of 1926? It may be assumed that Congress has the power to impose the estate tax in a case such as this one. Chase National Bank v. United States, 278 U. S. 827; Tyler v. United States, 281 U. S. 497; Bullen v. State of Wisconsin, 240 U. S. 625. The question is whether Congress has actually exercised that power.

The rights of the decedent to withdraw the trust corpus terminated at her death. Neither the trust property nor her intangible rights therein were subject to distribution as a part of her estate. The interests of the remaindermen as to them passed directly from the settlor of the trust. At no time was the trust corpus actually the property of the decedent.

The original text of the section under consideration was designated as section 202 (a) of the Revenue Act of 1916 and provided:

Seo. 202. That the value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated:
(a) To the extent of the interest therein of the decedent at the time of his death which after his death is subject to the payment of the charges against his estate and the expenses of its administration and is subject to distribution as part of his estate.

In 1926 tbe section was amended to its present form. With respect to the 1926 amendment, the House Ways and Means Committee Report (H. R. No. 1, 69th Cong., 1st sess.), reads in part as follows:

Seo. 302. Under existing law the gross estate is determined by including the interest of the decedent at the time of his death in all classes of property which after his death is subject to the payment of the charges against his estate and the expenses of its administration and is subject to distribution, as part of his estate. In the interest of certainty it is recommended that the limiting language above referred to shall be eliminated in the proposed bill, so that the gross estate shall include the entire interest of the decedent at the time of his death in all the property.

Clearly the trust corpus was not includable in the decedent’s gross estate under the former wording of the section because it was neither subject to the payment of charges against the estate nor to distribution as a part of the estate. Cf. United States v. Field, 255 U. S. 257. There is nothing in the language of H. R. No. 1, supra, to indicate that Congress intended to extend the meaning of section 302 (a) to include interests of a decedent which terminate at death.

A problem similar to the one which we have before us was considered by the District Court for the Southern District of New York in Davis v. United States, 27 Fed. Supp. 698. In that case the Commissioner contended that because the decedent had a life interest in certain property, coupled with a power of sale, the value of the property was includable in the decedent’s gross estate in accordance with section 302 (a) of the Revenue Act of 1926. The court, without deciding whether an absolute power of sale did exist, held that such a power would not be an “interest” within the meaning of section 302 (a). The court stated:

* * * For even if the power of sale were a power over an undivided share outright, such a power is not an “interest” within the meaning of section 302 (a); That provision deals with property owned by a decedent and passing at death by will or intestacy. Subsequent provisions in section 302 deal with property over which a decedent had powers. * * *

The problem of the scope of section 302 (a), was considered in Helvering v. Safe Deposit & Trust Co. of Baltimore, 316 U. S. 56; reversing in part 121 Fed. (2d) 307, which affirmed 42 B. T. A. 145. The decedent in that case, a minor, was the beneficiary of a trust created by his father and was to receive the income until he reached age 28, at which time he was to become the absolute owner of the property. He was given a general testamentary power of appointment over the trust corpus which he attempted to exercise when he still lacked testamentary capacity in the state in which he was domiciled. The Commissioner contended that the decedent had an “interest” in the trust corpus within the meaning of section 302’ (a). With respect to this argument this Board said:

* * * His power of appointment, which gave him a complete power of testamentary disposition during life, did not, as we read the statutes, constitute an “interest” under subsection (a). That a subsequent subsection, (f), should treat it as taxable in certain circumstances we think is immaterial. We conceive that the word “interest,” as used in subsection (a), refers to a transferable estate, and not something which, like a life estate or power, ceases altogether on the donee’s death. If it includes anything which ceases at the decedent’s death, the inclusion must be in express words. * * *

The Supreme Court reached the same result on this point and held that an unexercised general power of appointment is not an “interest” within the meaning of section 302 (a).

The case of Porter v. Commissioner, 288 U. S. 436, involved section 302 (d) of the Revenue Act of 1926, which provides in substance that the value of property which was transferred in trust, or otherwise, by. a decedent during life and is subject at the date of death to any change through the exercise of a power to alter, amend, or revoke retained by the grantor is includable in the decedent’s gross estate. The argument was made that section 302 (d) was limited by the provisions of section 302 (a). The United States Supreme Court said in answer to this argument:

* * * Subsection (a) does not in any way refer to or purport to modify (d) and, in view of tbe familiar rule that tax laws are to be construed liberally in favor of taxpayers, it cannot be said that, if it stood alone, (a) would extend to tbe transfers brought into the gross estate by (d). United States v. Field, supra, 264. Moreover, Congress bas progressively expanded tbe bases for sucb taxation. Comparison of section 302 witb corresponding provisions of earlier Acts warrants the conclusion that (d) is not a mere specification of something covered by (a) but that it covers something not included therein. * * *

Cf. Lehman v. Commissioner (C. C. A., 2d Cir.), 109 Fed. (2d) 99.

The power held during her life by the decedent in the instant proceeding was somewhat similar to those of the decedent in the Porter case. The distinction between the cases is that in the Porter case the decedent had made a transfer of the property and retained the power, whereas here the property never belonged to the decedent. If section 302 (a) does not include the powers specified in section 302 (d), it clearly does not include the power to invade corpus. See also May v. Heiner, 281 U. S. 238.

We hold that this decedent had no “interest” in the trust corpus which permits the inclusion of the value of the corpus in her gross estate. The contention of the petitioner is sustained.

Decision of no deficiency will be entered for the petitioners.


author: Mtjedock:

text:
    H. & G. Amusement Company, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104445.
    Promulgated May 7, 1942.

      Joseph Getz, G. P. A., for the petitioner.

      Charles Oliphant, Esq., for the respondent.
   OPINION.

Mtjedock:

The petitioner contends that the statute of limitations has run for both 1935 and 1936. It fails to demonstrate, however, that the statute has run for 1936, and the facts clearly disclose that it has not. The return was due on August 15, 1936, and was filed on July 15, 1936. The petitioner, on May 19, 1939, agreed with the Commissioner to extend the time for assessment to June 30, 1940. The notice of deficiency mailed on June 6, 1940, was thus timely and the statute of limitations has not run for 1936.

The question of most importance to the petitioner is whether the statute of limitations has run as to 1935. The return for that year was due on August 15, 1935, and was filed on July 9, 1935. The period was never extended by agreement. The general rule provided by section 275 (a) of the Eevenue Act of 1934 is that taxes must be assessed within three years after the return was filed. “Filed” here means “was due.” Sec. 275 (d). That three-year period expired in August 1938, whereas the notice of deficiency was not mailed until June 6, 1940.

The notice of deficiency makes no reference to this subject, but the Commissioner alleged in his answers that the petitioner omitted from its return for 1935 gross income properly includible therein in excess of 25 percent of the amount of gross income shown on the return. He thus seeks to make section 275 (c) applicable. That section provides that if a taxpayer omits from gross income an amount properly includible therein which is in excess of 25 percent of the gross income stated in the return, then the period of limitations shall be five years after the return was filed. The petitioner, having made a prima facie showing under the general rule, contends that tbe burden of going forward to show that this exception to the general rule applies was upon the Commissioner. Farmers Feed Co., 10 B. T. A. 1069; Bonwit Teller & Co., 10 B. T. A. 1300. While there may be force to this contention of the petitioner, the point need not be decided here because the record contains all facts necessary for a decision on the merits.

The amount of gross income shown on the return was $27,789.95. The Commissioner contends that $30,000 has been omitted from gross income. This $30,000 is made up of two items, one of $18,000 and one of $12,000. If either item was “properly includible” in gross income, then the five-year period applies and the Commissioner was not too late. It is important to 'note that the statute provides for the five-year period only in case the taxpayer has omitted from gross income an amount “properly includible therein.”'

The $18,000 is a portion of the original $60,000 received by the petitioner in 1921 as advance rental for the theatre. Advance rental is income when received. Sugar Creek Coal & Mining Co., 31 B. T. A. 344; Grauman’s Greater Hollywood Theatre, Inc., 37 B. T. A. 448; C. H. Mead Coal Co., 31 B. T. A. 190; O'Day Investment Co., 13 B. T. A. 1230; Andrew J. Pembroke, 23 B. T. A. 1176; affd., 70 Fed. (2d) 850; Clinton Hotel Realty Corporation, 44 B. T. A. 1215 (on appeal); Renwick v. United States, 87 Fed. (2d) 123. In the last case the court said:

Upon consideration of the facts, however, it is apparent that the advanced rentals were income in the full sense of the word. They were payments of rental upon a lease covering a period of years. Whether amortization should be allowed against them is a question for the Congress. If a taxpayer receives earnings upon property under a claim of right and without restriction as to its disposition, he has received income for which he is required to account, * * *

The taxpayers in some of the above cited cases were using a cash method of reporting income and others were using an accrual method. The $60,000 received by the petitioner in 1921 was clearly designated in the lease as advance rental. It was received as such by the petitioner; there was no restriction as to its disposition or use; and it was not merely a deposit as security for the performance of some provision of the lease. This last circumstance clearly distinguishes the case of Warren Service Corporation v. Commissioner, 110 Fed. (2d) 723, relied upon by the Commissioner. Thus, the $60,000 should have been reported in income for 1921 and it is not “properly in-cludible” in gross income for 1935.

The $12,000 which the Commissioner has included in income for 1935 was a part of the $40,000 paid in equal installments every three months during the eight-year period, beginning in the calendar year 1921 and ending in the calendar year 1929. The entire $40,000 was rent paid for the use of equipment in the motion picture theatre. It was paid long before 1935 and as advance rent was properly in-cludible in gross income for prior years. It did not represent an amount properly includible in gross income for 1935.

The Commissioner makes an alternative argument in regard to the equipment in the theatre. He calls attention to paragraph 4 of the lease in which the $40,000 is described as a payment “for the equipment in the said theatre” instead of for the use of the equipment. He argues from this that the tenant purchased the equipment and the petitioner realized income to the extent of the fair market value of the equipment in 1935, when the equipment was turned back to the petitioner. The lease should be read in its entirety to determine the intention of the parties, and when so read an intention that title was to remain in the petitioner is disclosed. The tenant was not allowed to remove any of the equipment in the theatre “furnished by the landlord.” The equipment was to be turned over to the landlord upon the termination of the lease and was to “remain the property of the landlord.” The original agreement of March 5,1921, between the petitioner and Muller and Schwartz, which provided how the lease should be drawn, stated that the tenant would “pay for the use of the equipment” $40,000 during the first eight years of the term, in equal installments, every three months, together with interest on each installment at the rate of 6 percent. There was no restriction on the use of this money by the petitioner. It was not put up as a pledge, but as advance rental.

No part of the $30,000 which the Commissioner has included in the petitioner’s income for 1935 was “properly includible therein”, and section 275 (c) has no application. The three-year statutory period of limitations provided by section 275 (a) expired before the notice of deficiency was sent and the Commissioner is foreclosed from assessing or collecting the deficiency which he has determined for 1935.

The Commissioner makes one further contention in an effort to show that the five-year period of (c) rather than the three-year period of (a) applies. He points to the fact that the petitioner chose from the beginning to report the $60,000 and the $40,000 ratably over the 20-year period of the lease and he says that on some principle akin to estoppel (although not strictly estoppel) the petitioner should not be heard to deny that the unreported portion of the $100,000 should be included in income for 1935 when the lease was terminated. He admits that he was at all times fully informed of the facts and by the very nature of his contention he admits that the $100,000 is not “properly includible” in the gross income of 1935 under any statutory provision. If the question were fairly presented, we would not suppose that estoppel, or anything akin to estoppel, would suffice for the purpose of making section 275 (c) applicable. It is an exception to the general rule of the statute of limitations, and applies only in accordance with its terms. But the question of whether or not estoppel or something akin to estoppel might be the equivalent of “properly includible” need not be decided here, because the Commissioner has not made out a case. Both parties made an honest mistake of law in deciding how these advance rentals should be reported. Such a mistake will not support estoppel or anything akin to estoppel. Sugar Creek Coal & Mining Co., supra; Estate of William Steele., 34 B. T. A. 173; Tide Water Oil Co., 29 B. T. A. 1208; United States Trust Co. of New York, 13 B. T. A. 1074; Helvering v. Schine Chain Theatres, Inc., 121 Fed. (2d) 948.

The facts found clearly show that the petitioner is entitled to the deductions which it claimed for depreciation on the building and the theatre equipment for the taxable years. The respondent makes no argument in its brief in regard to depreciation on the building and his chief argument, if not his only argument, in regard to depreciation on equipment is that the equipment was sold prior to 1935 and reacquired in 1935. The petitioner, as has been stated above, did not sell the equipment, but at all times remained the owner of it. It was in use during all of the taxable years and the deductions claimed were proper.

Decision will he entered under Buie 50.


author: Aenold :

text:
    Estate of Henry William Hofferbert, Deceased, Eugene Frederick, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 106182.
    Promulgated May 8, 1942.

      Eugene Frederick, Executor, for the petitioner.

      Charles Oliphant, Esq., for the respondent.
   OPINION.

Aenold :

The Commissioner determined a deficiency in estate tax in the amount of $1,637.52,..The.only question involved.is whether, proceeds from insurance policies in which the wife of decedent was named beneficiary, which policies had been assigned prior to his death by decedent and wife as collateral security for a debt of decedent, are includable in decedent’s gross estate. The record made consists of the pleadings, a written stipulation of facts and exhibits. The stipulation of facts, with exhibits attached, is included herein by reference.

The petitioner is the executor under the will of Henry William Hofferbert, who died November 13, 1936. The petitioner filed an estate tax return for the estate of decedent on February 16, 1938, with the collector of internal revenue for the district of Maryland.

At the time of his death the decedent was indebted to the Union Trust Co. of Maryland in the sum of $108,525, which obligation was that of the decedent alone and no other person was liable for any portion of such indebtedness.

The decedent was insured under five life insurance policies with the New York Life Insurance Co., in three of which the wife of decedent, Paula Hofferbert, was named as beneficiary, with right of revocation reserved to insured. Under the terms of each of the policies the insured had the right to change the beneficiary at any time provided the policy was not then assigned. These policies were assigned in form absolute to the Union Trust Co. of Maryland but were actually assigned as security for the debt of decedent above referred to owing by him to the trust company. The wife of decedent joined in the assignment of the policies in which she was named beneficiary. The dates when the policies were written, the dates of assignment, the beneficiaries, and the amounts due thereunder at date of death of decedent are as follows:

The total proceeds of such policies, $71,040.85, were paid over to the Union Trust Co. of Maryland and credited on the indebtedness of the decedent above referred to.

The assets owned individually by decedent, other than insurance, as determined by respondent, were as follows:

Stocks and; bonds-$38, 940. 62
Mortgages, notes and cash_ 950. 00
Other miscellaneous property- 532.50
Total. 40, 423.12

The jointly owned property, as determined by respondent, amounted to $73,657.50. The total amount of indebtedness determined was $113,095.60.

The inventory and final account of the executor as filed in the probate proceedings in Orphans’ Court of Baltimore City, Maryland, shows that the estate of decedent was valued at $42,338.91, including stocks of the appraised value of $40,995.84 held as collateral security and sold by the Union Trust Co. The inventory did not list the insurance or the property held jointly. From the final account of the executor it appears that the stock held by the trust company was sold at a loss of $16,389.60; that the Union Trust Co. applied to the debt of $108,525 owing to it by decedent the proceeds of $32,293.01 from two policies in which decedent’s estate was named beneficiary, the proceeds of $38,747.84 from the three policies under which the wife was named beneficiary, and the proceeds of $24,606.24 from the sale of the stock, together with an amount of $12,877.91 “advanced” by the widow; and that the widow also “advanced” $890.39 to close the estate, leaving no estate for distribution.

The proceeds of each of the five policies were scheduled in the estate tax return, but the $38,747.84 total value of the three policies under which the wife was beneficiary was deducted as an amount receivable by a beneficiary other than the estate, leaving insurance included in the gross estate in the amount of $32,293.01. The estate tax return showed no net estate subject to tax.

The respondent restored the value of $38,747.84 of the three policies in which the wife was named beneficiary to the value of the gross estate, giving the following explanation:

No exemption on account of insurance receivable by beneficiaries other than the estate is allowed for the reason that the assignment of these policies to secure a loan made by the Union Trust Company of Maryland to decedent was for the benefit of the estate.

Section 302 (g) of the Bevenue Act of 1926, as amended, provides that “the amount receivable by the executor as insurance under policies taken out by the decedent upon his own life” and the “excess over $40,000 of the amount receivable by ali other beneficiaries as insurance under policies taken out by the decedent upon his own life” shall be included in the value of the gross estate of decedent.

The respondent contends that the proceeds of the three insurance policies in which the wife of decedent was named beneficiary are includable under the first clause of section 302 (g) as “the amount receivable by the executor as insurance under policies taken out by the decedent upon his own life.” In Estate of Silas B. Mason, 43 B. T. A. 813 (on appeal C. C. A., 6th Cir.), the Board stated:

* * * Tbe proceeds of policies of insurance taken out by a decedent upon Ms own life wbieb in terms are payable to a beneficiary other than the decedent’s “executor”, but which are required to be used, and are in fact used, to satisfy debts of decedent or his estate, should be treated as being receivable by the decedent’s “executor” within the meaning of subsection (g) and should be included in the decedent’s gross estate. * * * even though decedent irrevocably assigned the policies to the beneficiary, and did not reserve to himself the power to borrow on the policies or to receive the cash surrender value thereof or “to exercise any of the incidents of ownership therein.” Mathilde B. Hooper, Administratrix, supra. [41 B. T. A. 114.]

Herein, as in the above case, the policies involved were payable to a beneficiary other than the executor and were assigned as collateral to secure the payment of an obligation of the decedent.

The petitioner contends, however, that the facts in the Mason case are wholly dissimilar to the facts herein in that the beneficiary and the assignee were the same party, i. e., the divorced wife of decedent, and that the relinquishment by the wife of her dower interest as a consideration for the assignment to her of the insurance enlarged the interests which passed to other persons under decedent’s will. He further contends that the policies were not assigned for the benefit of the estate; that the beneficiary under the policies was a mere surety and entitled to reimbursement by way of subrogation for any part of the jointly owned property and the insurance of which she was beneficiary applied on decedent’s debt; and that insurance written for the benefit of the wife or children is by the laws of Maryland made absolutely free from the claims of the representatives of the husband or his creditors.

Sections 8 and 9, article 45, Flack’s Ann. Code of Maryland, provide that insurance taken out for the benefit of a wife shall inure to her benefit free from the claims of the representatives of the insured or his creditors. However, the right or interest of a wife as beneficiary under an insurance policy in which the insured reserved the right to change the beneficiary attaches only after the death of the insured, her interest as beneficiary under such a policy being a mere expectancy dependent upon the free and unlimited will and acts of the insured. Rullen v. Safe Deposit & Trust Co. of Baltimore, 177 Md. 271; 9 Atl. (2d) 581; Rosman v. Travelers' Insurance Co., 127 Md. 689 ; 96 Atl. 875. During Ms life the insured assigned the policies involved herein to secure the payment of his debt. Although he did not change the beneficiary named in such policies, by his act of assignment he made any rights which might accrue to the named beneficiary upon his death subject to the rights of the assignee to apply any or all of the proceeds of the policies on decedent’s debt, thus, under the circumstances herein, effectually cutting off the potential interest of the wife as though he had actually made a change of beneficiary. The proceeds, by virtue of the assignment, were payable upon the death of the insured to the assignee and not to the beneficiary. The fact that the right of the insured was suspended during the life of the assignment under the terms of the policies did not enlarge the interest of the beneficiary. The only interest she retained in the policies after the assignment thereof was to receive after the death of the insured any part of the proceeds not required to satisfy the claim of the trust company. No excess remained, as the entire proceeds of the policies were applied on the insured’s debt.

The contention of petitioner, that the beneficiary under the three policies was a mere surety and therefore entitled to reimbursement by the estate by way of subrogation for any part of the jointly owned property and the proceeds of the three policies in which she was named beneficiary, is not supported by Farracy v. Perry, 12 S. W. (2d) 651, cited by petitioner. Although the Texas court in that case stated that a beneficiary of life policies, transferred as collateral security, on payment of a debt to protect her interest as beneficiary under the policies became subrogated to all rights of the creditor, it held that the beneficiary’s right to the proceeds of the policies was subject to the rights of such creditor. In that case Perry, the beneficiary’s husband, individually, and a partnership of which he was a member were indebted to a bank in the amounts of $5,467.37 and $18,317.60, respectively, or a total of $23,784.97. Partnership property was assigned to the bank as collateral and Perry also assigned as collateral property of his own, together with two policies on his life under which his wife was beneficiary, with right of revocation. After the death of Perry $20,923 was due on the policies. The wife with borrowed funds paid $23,784.97 to the bank which assigned to her the notes and obligations of the partnership and all collateral held by it together with the two policies. The partnership was adjudged bankrupt after the death of Perry and the trustee in bankruptcy brought suit against the widow of Perry and the bank to recover possession of the collateral given to the bank by the partnership. The court denied the trustee in bankruptcy any relief, holding that the “policies” occupied the position of a surety for the payment of the partnership debt, which had been incurred prior to the transfer of the policies as collateral and that therefore the beneficiary had the right to require the partnership collateral to be applied to the $18,317 partnership debt before any part of the proceeds of the policies were so applied. Herein the collateral consisted of some stocks belonging to decedent, two insurance policies payable to decedent’s estate, and three insurance policies payable to decedent’s wife. In addition, according to the statement of petitioner’s counsel, jointly owned property of a value of $73,657.50, as determined by respondent, was held as collateral by the trust company to obtain the release, of which the widow advanced $12,877.91. Applying the doctrine of the Farraoy case, supra, although the facts are different, the widow of decedent herein had the right at most to have the collateral belonging to decedent and the proceeds from the policies payable to the estate first applied to the debt before resorting to the proceeds of the policies payable to her. This was done. We know of no authority and none has been called to our attention which holds that a beneficiary of a policy with power of revocation assigned by the insured during his .life as security for the payment of his debts may recover from his estate the entire proceeds or so much as were applied to the payment of his debts. The Farraoy case does not so hold.

In Commissioner v. Jones, 62 Fed. (2d) 496, cited by petitioner, it was held that the amount “receivable by the executor” under section 302 of the Revenue Act of 1924 means only such insurance as comes to his hands for distribution as a part of the assets of the estate subject to the claims and charges that such assets are ordinarily subjected to in the administration of an estate. In that case the insurance, although collectible by the executor of the estate, was payable to decedent’s widow or children free from the claims against his estate. Herein the proceeds of the policies were expressly made by the decedent subject to his indebtedness.

Under the rule of the Mason case, supra, insurance proceeds which, although payable to a beneficiary other than the estate, are required to to be used and are used to satisfy debts of the decedent or his estate, are to be treated for the purposes of the Federal estate tax “as receivable by the executor” and are includable in the value of decedent’s gross estate. That case is controlling herein. See also Estate of Waldo Rohnert, 40 B. T. A. 1319, and Pacific National Bank of Seattle, Executor, 40 B. T. A. 128. The action of the respondent in including in the value of the gross estate of decedent the proceeds of $38,747.84 from the policies herein involved is, therefore, approved.

Decision will be entered for the respondent.

       8. Any married woman by herself and in her name or in the name of any third person with his assent as her trustee may insure or cause to be insured for her sole use the life of her husband for any definite period or for the term of his natural life; and any husband may cause his own life to be insured for the sole use of his wife and may also assign any policy of insurance upon his own life to his wife for her sole use; and in case of the wife surviving her husband, the sum or net amount of such insurance becoming due and payable by the terms of the insurance shall be payable to her for her own use, free from the claims of the representatives of her husband, or any of his creditors.
      9. All policies of life insurance upon the life of any person which may hereafter mature, and which have been or shall be taken out for the benefit of or bona, fide assigned to the wife or children or any relative dependent upon such person or any creditor shall be vested in such wife or children or other relative or creditor, free and clear from all claims of the creditors of such insured person.