author: Van Fossan:

text:
    Fred Eberlin Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 6827.
    Promulgated October 31, 1927.
    1. Good wiil paid in to a corporation for capital stock can not be included in invested capital in the absence of proof of its actual cash value at the time paid in.
    2. No deduction from gross income for the obsolescence of good will can be allowed.

      Fred 0. Scofield, Esg., for the petitioner.

      John D. Foley, Esg., for the respondent.

      This is a proceeding for the redetermination of a deficiency of $4,769.61 in income and excess-profits taxes for the fiscal year ended January 31, 1920. It is alleged that the Commissioner erred in (1) disallowing a value for the good will (within the limitation of section 326, Revenue Act of 1918) of a predecessor business, for which $180,000 par value capital stock was issued; and (2) disallowing a deduction for the obsolescence of the good will of a wine and liquor business lost through the operation of Federal prohibition.
    FINDINGS OF FACT.
    The petitioner was incorporated in 1902 under the laws of New York and has conducted a cafe and restaurant business at Nos. 9-11 New Street, New York City, across the street from the New York Stock Exchange. Petitioner commenced its occupancy of the premises on May 1, 1902. Upon incorporation, the petitioner took over the cafe and restaurant business of the late Fred C. Eberlin, who had conducted the same as an individual enterprise for many years prior thereto, and issued $180,000 par value of its capital stock for the good will of said business. In addition to' its public place of business, and about four blocks distant therefrom, the petitioner maintained a storeroom at which it made its own blends of liquors. Prior to national prohibition it was licensed as a rectifier of liquors and a retail and wholesale liquor dealer. It possessed and dealt in its own brands of liquors in addition to the standard brands, had its own trade-marks and labels, and, as rectifiers, prepared and dealt in its own blends of liquor. The total receipts from the restaurant, liquor, and cigar businesses were kept in separate accounts.
    Prior to national prohibition the cafe and restaurant was open for business from 7 a. m. to 7 p. m. and approximately 25 days of the month. The bulk of the restaurant business was done between the hours of 11.30 a. m. and 2.30 p. m., while the liquor business continued throughout the day to the closing hour. Some of the petitioner’s customers patronized only the bar, some patronized only the restaurant, and some patronized both the bar and restaurant. Its liquor patrons often ordered petitioner’s own brands by name. It had some liquor customers who purchased only for delivery outside of the place of business, and deliveries of bottled liquors were made not only in and around New York City, but also over practically the entire eastern United States where not prohibited. The charge accounts in the liquor business averaged about $800 per month. Soft drinks were also carried and sold, but were used principally in the preparation of mixed drinks. Through national prohibition the liquor business was lost and since then petitioner has continued the restaurant and cigar business and the sale of soft drinks. The bar has been used as a lunch counter and for the dispensing of soft drinks.
    Prior to national prohibition the petitioner employed in its liquor business four regular bartenders at an aggregate annual wage of $7,000, one extra bar boy, who devoted his time partly to the restaurant and partly to the liquor business, at a total annual wage of $780, and one man for its storeroom at an annual wage of $1,300. For the storeroom it paid an annual rental of $600 and for the cafe and restaurant premises it paid an annual rental of $10,000. The latter premises consisted of an oblong room, 100 feet by 40 feet, the rear 20 feet being devoted to the kitchen. The bar was 80 feet long, of which approximately 6 feet was used for serving oysters.
    The sales, inventories, purchases and gross profits of the wine and liquor business for the years 1909 to 1913, inclusive, were:

    The total sales for the year ended January 31, 1909, in the restaurant business amounted to $87,139.34 and in the cigar business they amounted to $17,660.21. The total expenses for the entire business (restaurant, cigar, and liquor) for the years 1909 to 1911, inclusive, were:

    The restaurant and cigar inventories for the years 1908 to 1913, inclusive, were:

      The net profits of the entire business for the years 1902 to 1906, inclusive, were:
    July 31, 1902. $4,250.07
    Jan. 31, 1903. 4,305.60
    July 31, 1903. 4,640.27
    Jan. 31, 1904. 5, 090.73
    July 31, 1904. 6,795.56
    Jan. 31, 1905. 5.772.29
    July 31, 1905. 1.772.29
    Jan. 31, 1906. 2,231.86
   OPINION.

Van Fossan:

The petitioner seeks (1) an allowance (within the limitations of section 326, Revenue Act of 1918), for invested capital purposes, of good will paid in for stock, and (2) a deduction from gross income for the obsolescence of good will lost through the operation of national prohibition.

The actual cash value of good will and other intangibles paid into a corporation for stock, not exceeding 25 per cent of the par value of the total stock outstanding, may be included in invested capital. (Section 326(a)(4) and (5), Revenue Act of 1918.) The actual cash value of good will at the time paid in must, however, be definitely established. Appeal of Richmond Dairy Lunch, 1 B. T. A. 876. The petitioner submits no evidence of the operation of the business prior to incorporation, and, at the best, only meager evidence of essential facts relative to the business subsequent to incorporation. There is not sufficient evidence in this record to enable us to determine the actual cash value, if any, of the good will at the date of incorporation. Appeal of Saenger Amusement Co., 1 B. T. A. 96, and Appeal of W. E. Marshall & Co., 1 B. T. A. 175; see also Camden v. Stuart, 144 U. S. 104. Accordingly, the action of respondent excluding good will from invested capital must be approved.

The evidence is likewise insufficient to establish any value for good will either at March 1, 1913, or at the date when it is alleged to have become obsolete. However, if value were proved no deduction for the obsolescence of good will could be allowed, as good will is not a depreciable asset, subject to obsolescence, within the meaning of section 234(a) (7) of the Revenue Act of 1918, for which a deduction from gross income may be allowed. Red Wing Malting Co. v. Willcuts, 15 Fed. (2d) 626; Manhattan Brewing Co. v. Commissioner, 6 B. T. A. 952.

Judgment will be entered for the respondent.

Considered by MaRquette, Phillips, and Milliken.


source: Caselaw Access Project

author: Van Fossan :

license: Public Domain

text:
    Simon L. Steefel, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 18708.
    Promulgated October 31, 1927.
    Sections 1200 and 1201 of the Revenue Act of 1924 do not authorize a 25 per cent reduction of tax on 1924 income reported in 1925 but taxable at 1923 rates. Appeal of Charles Colip, 5 B. T. A. 123.

      Kendall B. Castle, Esq., for the petitioner.

      Joseph K. Moyer, Esq., for the respondent.
    This is an appeal from the determination by the respondent of deficiencies in income taxes for the years 1923 and 1924 in the respective amounts of $18.29 and $721.16.
    It is alleged that the respondent erred in refusing to allow a reduction of 25 per cent of the tax imposed on that portion of the petitioner’s income reported in his return for the year 1924 and taxable at the 1923 rates. The deficiency asserted for the year 1924 alone is in issue, the petitioner raising no question in regard to the deficiency for the year 1923. This appeal is submitted, upon an agreed statement of facts.
    FINDINGS OF FACT.
    The petitioner is a resident of Rochester, N. Y., and was such a resident during the entire year 1924. During that year the petitioner was a member of the partnership of L. Griesheimer, Steefel & Co., Rochester, 1ST. Y., whose fiscal year ended January 31, of each year.
    Petitioner included in his income-tax return for the calendar year 1924, filed with the collector of internal revenue at Buffalo, N. Y., his share of the profits of said partnership for its fiscal year ended January 31,1924, in accordance with the provisions of section 218(a) of the Revenue Act of 1924. Eleven-twelfths of said profits are taxable at 1923 income-tax rates, and one-twelfth thereof at 1924 rates, in accordance with the law and regulations.
    The respondent refused to allow a 25 per cent reduction, under sections 1200 and 1201 of the Revenue Act of 1924, in the tax due upon that portion of the petitioner’s profits from said partnership for the fiscal year ended January 31,1924, and taxable at 1923 rates.
   opinion.

Van Fossan :

This proceeding is submitted upon the pleadings and stipulation filed, the sole iss’ue for decision being whether or not the petitioner is entitled to a 25 per cent reduction under sections 1200 and 1201 of the Revenue Act of 1924 in the tax due at 1923 rates on that portion of said partnership profits distributable to the petitioner on January 31, 1924, and reported by the petitioner in his income-tax return for the calendar year 1924.

The facts, in all essential respects, and the question involved in this case are identical with those considered in Appeal of Charles Colip, 5 B. T. A. 123, and upon the authority of that decision.

Judgment will be entered for the respondent.

Considered by MaRquette, Phillips, and Milliken.


text:
    Charles Warner Co., Successor to Penn Sand & Gravel Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 5133.
    Promulgated October 31, 1927.
    Discovery value for gravel deposit disallowed.

      William 8. Hammers, Esq., for the petitioner.

      A. G. Bouchard, Esq., and Granville 8. Borden, Esq., for the respondent.
    In this proceeding the petitioner seeks a redetermination of the income and profits-tax liability for the calendar years 1917, 1918, and 1919, for which the Commissioner has determined deficiencies in the amounts of $1,697.37 for 1917; $2,418.26 for 1918; and $568.69 for 1919. The petitioner alleges error on the part of the Commissioner in disallowing a value for discovery of a sand and gravel deposit, and depletion based thereon. It was conceded by counsel for petitioner at the hearing that discovery value does not apply to 1917.
    FINDINGS OF FACT.
    The Penn Sand & Gravel Co. was a Delaware corporation with its principal offices at 207 South Ninth Street, Philadelphia, Pa. The Charles Warner Co. is a Delaware corporation with its principal offices at Wilmington, Del. By purchases made at various times prior to December 30, 1924, the Charles Warner Co. became the sole owner of all of the shares of stock of the Penn Sand & Gravel Co., issued and outstanding. As the owner of such stock the Charles Warner Co. on December 31,1924, acquired and took over all of the assets of the Penn Sand & Gravel Co., assumed the payments of all its outstanding liabilities, and caused the Penn Sand & Gravel Co. to be dissolved by mutual consent, in accordance with the laws of the State of Delaware, the certificate of dissolution being executed by the secretary of the State of Delaware on December 31, 1924.

      In 1913 James A. Mundy inspected a real estate development known as Wlieatsheaf Heights. This project appeared so attractive that he endeavored to purchase this property, known as the Starkey farm, from the promoters. In July, 1913, while negotiations were being carried on, Mundy obtained an option on a farm west of Wheatsheaf Heights, known as the Leland farm. In August, 1913, an option was secured on the Starkey farm. The option on the Leland farm was secured by a cash payment of $50, which applied as part of a first payment of $500 when an agreement of sale was executed. The total purchase price was $10,000, which was based on a price of $125 an acre. The option on the Starkey farm was secured by a cash payment of $100, which applied as part of a first payment of $1,000 payable Avhen an agreement of sale was executed. The contract of sale of the Leland farm was executed August 25,1913, and the contract of sale of the Starkey farm was executed September 13, 1913.
    After securing the options Mundy and an associate visited the property and went to a location where a bungalow was being constructed. A well was being dug near by and Mundy discovered that a bed, or pocket, of gravel was exposed in the well and that the material was about 90 per cent stone and pebbles. Whereupon Mundy and associates proceeded to investigate the possibilities of converting this property into a gravel producer. With this in view a few test holes were put down which showed a good gravel with very little overburden. This exploration was not sufficiently thorough to warrant making a large investment but was considered sufficient to justify the formation of the company and the adoption of its name.
    On September 9, 1913, a certificate of incorporation of the Penn Sand & Gravel Co. was filed in the office of the Secretary of State of the State of Delaware.
    On October 29, 1913, an amended certificate of incorporation was drawn up and filed in the office of the Secretary of State at 11 a. m., October 30, 1913.
    On October 29, 1913, the first meeting of the board of directors was held, and authority was given proper officers to carry out all necessary steps toward the exploitation of the gravel deposit, but such authority was qualified by the following resolution:
    Resolved, that the proper officers be and they hereby are instructed to make a thorough investigation of the properties, before incurring any further liability, as to the class and quantity of material existing in the different properties, either by open pit work, drilling, or any other manner which in their judgment should be done; if it is necessary, to consult experts in this line of business. This is offered with a view of not going too far into it until the amount of material in the deposits is ascertained, before making any larger investments than are now made. The properties are farm properties and investigation- or discovery has not been thoroughly made at the present time.

      Under the authority granted by this resolution steps were taken to further explore the property, and 30 to 40 men were employed there during the winter of 1913 to 1914.
    On November 3, 1913, the Starkey farm was bought by the Penn Sand & Gravel Co. for a consideration of $18,736.25. On December 18, 1913, the Leland farm was bought by the Penn Sand & Gravel Co. for a consideration of $10,000.
    About April 16, 1914, sufficient exploration had been made to warrant the petitioner in entering into the business of producing and selling gravel and sand.
    Prior to 1914 gravel had not been commercially exploited in* this region, although it was known to exist on these and other properties, as it appeared in places on the surface, had been used to repair roads, and had been uncovered by farmers in plowing the land in some sections where only about four inches of loam lay on top of the gravel. Deposits of sand were well known in this region and had been commercially exploited prior to 1914, particularly for molding purposes.
    The petitioner’s deposit of gravel was of exceptional quality in that it contained 90 per cent of gravel; it had very shallow overburden and was well located, both as to railroad facilities and distance from markets.
    On April 16, 1914, the board of directors approved and accepted the subscription of Joseph J. Iiock of Baltimore, Md., to 500 shares of capital stock of the company at par for cash.
    At the time of organization of the Penn Sand & Gravel Co. the Seeley Engineering Co. subscribed for stock of the Penn Sand & Gravel Co. in the amount of $5,000. By August 3, 1914, only $515 had been paid on this subscription. On that date the board of directors of the petitioner met and authorized the issuance of stock to the Seeley Engineering Co. in the amount of $515, and further authorized the sale of $2,500 of the stock subscribed for by the Seeley Engineering Co. to the American Paving & Construction Co.
   OPINION.

Van Fossan:

Petitioner claims a discovery value for a gravel deposit under favor of section 234(a) (9) of the Revenue Act of 1918, which provides for a reasonable allowance for depletion, and—

That in the case of mines, oil and gas wells, discovered by the taxpayer, on or after March 1, 1913, and not acquired as the result of purchase of a proven tract or lease, where the fair market value of the property is materially disproportionate to the cost, the depletion allowance shall be based upon the fair market value of the property at the date of the discovery, or within 30 days thereafter; * * *

After careful consideration of the record in this case we are unable to find evidence sufficient to enable us to determine the fair market value of the gravel deposit or that the same was materially disproportionate to its cost. There is no record of comparable sales at or about the same time or under similar circumstances, nor is the testimony as to royalty rates of any value in the absence of testimony of their relation to the value of the fee. The fair market value of a gravel deposit depends so largely upon the peculiar factors obtaining in each particular case that the value of another deposit more than a hundred miles distant, located immediately adjacent to, or within, a large city where the land has great value for factory sites, facts in no wise comparable to petitioner’s situation, is of little or no evidentiary weight in the instant case. Petitioner has given us no criterion or measure by which we may judge the fair value of the land in question.

Furthermore, the record is silent as to the area of gravel-bearing' land involved or the quantity of the gravel known to exist on the date ■ of discovery or within 30 days thereafter. It is also silent as to the cost of exploration, development, and exploitation of the alleged discovery.

With all of these data lacking it is impossible to determine the fair market value of petitioner’s land or whether such value is in excess of its cost plus development expense. It should be pointed out further that, were the value of the land ascertainable from the record, petitioner has failed to prove any basis for the computation of depletion.

In view of the above decision it is unnecessary to consider whether the gravel deposit was actually discovered by petitioner, as required by the statute, or whether, as a matter of law, a discovery value may ever be allowed on a gravel deposit.

Judgment will be entered for the respondent.

Considered by Makqtjette, Phillips, and Milliken.


author: Siepkin :

text:
    Trinidad Brick & Tile Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 25035.
    Promulgated October 31, 1927.
    Where petitioner was granted permission to change the basis of valuing its inventories beginning with the closing inventory for 1921, but did not make such change, the use of the new method beginning in 1922 is unauthorized.

      Joseph 0. Bell, Esq., for the petitioner.

      P. J. Bose, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income taxes of $1,561 for the year 1922. The deficiency results from an increase by the respondent of inventory of materials in the amount of $10,487.98 taken by the petitioner as its opening inventory in the year 1922.
    FINDINGS OP PACT.
    The petitioner is a Colorado corporation with its principal office at Trinidad, Colo.
    Prior to December 31,1921, it had valued its inventory at the close of each year by taking an actual count of the articles on hand and had applied an estimated cost value to this account. During the year 1921 petitioner installed a cost system, and on March 8, 1922, applied to the respondent for permission to change its basis for valuing its inventory at the close of the year 1921. By letter dated May 5,1922, this permission was granted. The petitioner, however, did not change its inventory at December 31, 1921, but returned its income for the year 1921 on the old basis’ of inventory valuation. On its return for the year 1922 petitioner computed its net income by adjusting the inventory valuation as at January 1, 1922, thus charging into the cost of operation for the year 1922 an amount of $10,487.98, the difference between the inventory on the old and the new basis. The adjustment to the opening inventory for the year 1922 of $10,487.98 was disallowed by the Commissioner and forms the only issue in the appeal.
   OPINION.

Siepkin :

The petitioner contends that in order to properly reflect income, and in accordance with permission granted by the respondent, it is entitled to start the new basis of inventories with the year 1922. The permission granted by the Commissioner, however, was conditioned upon such change being made in the closing inventory for 1921. Under sections 212, 232, and 203 of the Revenue Act of 1921, inventories must be taken upon such basis as clearly reflects the income. In view of the fact that the petitioner was changing his basis of inventories, it is necessary that he do so in such a manner as not to distort income and, since the permission of the Commissioner allowed petitioner to start such change with the closing inventory of 1921, we can not say that what the petitioner did clearly reflected his income for 1921. The petitioner can not adopt such portion of the permission as is favorable to it and reject the rest without a satisfactory showing that in so doing it clearly reflects income.

Judgment will he entered for the respondent.

Considered by Teammell, Moeeis, and Muedock.


author: Trammell:

text:
    Nansemond Brick Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 9228.
    Promulgated October 31, 1927.
    Value of assets determined for purposes of Invested capital and depreciation.

      B. Palmer Ingram, Esq., and Fred F. Ames, Esq., for the petitioner.

      T. M. Mather, Esq., for the respondent.
    This is a proceeding for the redetermination of a deficiency in income and profits taxes for the calendar year 1920 in the amount of $402.63. Petitioner assigns as error the action of respondent in holding that its invested capital could not be satisfactorily determined. By amendment to the answer, respondent alleges that an excessive allowance for depreciation was included in the computation of the deficiency and prays that the net income of the petitioner be adjusted on the basis of the proper allowance therefor.
    FINDINGS OP PACT.
    Petitioner is a Virginia corporation, with its principal office at Norfolk. It was organized in August, 1917, with an authorized capital stock of $60,000.
    Under date of August 1,1917, J. B. Moss entered into a contract to purchase, for $50,000 cash, all of the physical assets of the Nanse-mond River Brick & Tile Co., consisting of about 600 acres of land, located in Nansemond County, Virginia, together with all of the improvements thereon, and particularly including the buildings, machinery and equipment, constituting a plant for the manufacture of brick. Upon the organization of petitioner, this contract was transferred to it in consideration of the issuance to Moss and his associates of its capital stock of the par value of $60,000. Petitioner carried out the contract of purchase, and on or about August 15, 1917, took over the assets in question, paying therefor $40,000 in cash, and 1,000,000 bricks at an agreed valuation of $10,000. Petitioner obtained the cash, paid as part consideration for the assets, by borrowing the money under a first mortgage on the property acquired. It was unable to float the loan on the security of the mortgage only, and to that end found it necessary to obtain thereon the personal endorsement of Moss & Moss, of which firm J. B. Moss was a member, and Townsend, Scott & Son, associates of Moss. The assets acquired by petitioner included, in addition to the brick manufacturing plant, several hundred acres of larra land, buildings and farm implements, machinery, growing crops, and live stock. The brick plant was constructed in 1901 or 1902 and originally cost, together with the farm land and all equipment, approximately $125,000. At the time of acquisition, petitioner appraised the value of the assets so purchased by it at a total valuation of $119,337. Certain adjustments were made later, and the value of the assets set up on petitioner’s books at $122,898.52.
   OPINION.

Trammell:

The record of this proceeding presents two issues for consideration. The first involves the question of whether the statutory invested capital of petitioner can be satisfactorily determined. Respondent determined a deficiency in tax for the year 1920 in the amount of $402.63 and, in the statement accompanying the deficiency letter, said:

* * * Tlie Bureau holds that the denial of your application for the determination of your profits tax under the provisions of Section 328 of the Revenue Act of 1918 was proper.
The Bureau further holds that in the absence of evidence of value of the capital stock issued, it cannot satisfactorily determine the statutory invested capital. Your profits tax has, however, been computed under the provisions of Section 302 of the Revenue Act of 1918, for the reason that the profits tax computed under the aforesaid Section is not in excess of the average of representative concerns and imposes no hardship on your company.

Petitioner asserts in its pleading that its invested capital at organization was $60,000, and that its invested capital for the year 1920 was the same amount. At the hearing, petitioner offered some evidence in an effort to show that its invested capital at organization was in fact $82,898.52, consisting of the par value of stock in the amount of $60,000, plus the amount paid with brick at a valuation of $10,000 and plus a paid-in surplus of $12,898.52.

The second issue is raised by respondent in an amendment to his original answer, wherein it is alleged that an excessive amount was allowed as depreciation for the year 1920, erroneously based upon an appreciated valuation of approximately $60,000. Respondent prays that petitioner’s net income for the year in question be adjusted to include a proper allowance for depreciation.

With respect to the first issue, the evidence shows that J. B. Moss, an investment banker of Norfolk, Va., and a member of the firm of Moss & Moss, entered into a contract for the purchase of the physical assets of the Nansemond River Brick & Tile Co. for the sum of $50,000 cash. Petitioner was thereupon organized and the contract transferred to it in consideration of the issuance to Moss and his associates of its authorized capital stock in the amount of $60,000. Petitioner promptly carried out the contract and acquired the assets under the terms of the contract, as set out in our findings of fact. Petitioner paid directly to the seller the sum of $50,000 in cash or its equivalent for the assets. Of this amount $40,000 was borrowed money.

The Revenue Act of 1918 provides, in section 326 (a), that the term, “ invested capital ” for any year means, among other things—

(2) Actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, at the time of such payment, but in no case to exceed the par value of the original stock or shares specifically issued therefor, unless the actual cash value of such tangible property at the time paid in is shown to the satisfaction of the Commissioner to have been clearly and substantially in excess of such par value, in which case such excess shall be treated as paid-in surplus: * * *
(3) Paid-in or earned surplus and undivided profits; not including surplus and undivided profits earned during the year.

The contract for which petitioner issued its capital'stock related to rights in tangible property to such an extent that its value, if any, arose chiefly therefrom. The contract itself was, therefore, tangible property. That the contract was bona fide paid in for stock or shares of the petitioner is not disputed. Accordingly, the petitioner is entitled to include in its invested capital the actual cash value of the contract, if any.

Under this contract, the petitioner acquired the right to purchase the tangible assets of the Nansemond River Brick & Tile Co. for the sum of $50,000 cash. If those assets had an actual cash value in excess of $50,000, such excess value would represent the valúe of the contract, and under the statutory provisions above quoted the petitioner would be entitled to include that amount in its invested capital. If the value of the contract exceeded the par value of the stock, the excess must be treated as paid-in surplus, and as such included in invested capital. Appeal of Sphar Brick Co., 2 B. T. A. 946.

The first issue is thus resolved into the question, what was the actual cash value of the assets acquired by the petitioner on August 15, 1917, under the contract for which it issued its capital stock? If this question can be satisfactorily answered, it is self-evident that the petitioner’s statutory invested capital can be determined.

Petitioner offered the testimony of several witnesses on this question, who expressed their opinions as to the value of the assets. Their opinions, however, are not corroborated by the established facts and circumstances in the case and are not convincing. Petitioner sought to establish by the testimony of its witnesses that the aggregate value of the assets at date of acquisition was $122,898.52, but no reasonable basis for the opinions of the witnesses was disclosed. The evidence as a whole does not convince us that the assets had an actual cash value in excess of the contract price of $50,000, nor does the record before us disclose that the vendor was under any necessity to sacrifice the property. Apparently it was quite willing to accept $50,000 cash therefor. On the other hand, the original tax return filed by the petitioner for the year 1920, contains in Schedule A 18 attached thereto, the following statement: “ This plant was in a state of decay when acquired in 1917. Depreciation was consequently abnormal.”

Considering the evidence as a whole, we are unable to say that the assets, at the date acquired by the petitioner, had any substantial value in excess of the contract price of $50,000. Petitioner having issued its entire capital stock for the contract, and the contract not having been shown to possess any value in excess of the amount required thereunder to be paid for the assets, petitioner is not entitled to include in its statutory invested capital any amount by reason thereof.

It appears'from the record that the respondent admits that the petitioner is entitled to include as a part of invested capital the sum of $10,000, being the amount of the agreed cash value of the manufactured bricks paid as part consideration for the assets in question. Whether this amount constitutes paid-in or earned surplus, we are unable to determine from the evidence before us. However, whether the petitioner has no statutory invested capital, or is entitled to an invested capital of $10,000, it is our opinion that either situation would bring it within the abnormality provisions of section 327, and require the computation of its profits tax under the provisions of section 328 of the Revenue Act of 1918.

It appears from the quotation from the deficiency letter, herein-before set out, that respondent computed the profits tax involved herein under the provisions of section 302, for the reason that the profits tax so computed was not in excess of that computed under the provisions of section 328. Section 302, providing limitations on the amount of the profits tax imposed by section 301, is controlling over section 328 as well as section 301, and if the tax computed under section 328 exceeds the amount of the tax computed under section 302, the computation under the latter section applies. Davis & Andrews Co., 2 B. T. A. 328. It appears that this procedure was substantially followed by the respondent in computing the deficiency herein, and his action to that extent is approved.

Before concluding consideration of the first issue, since it may be affected by the second issue, the latter will be considered. The second issue relates to excessive depreciation, based upon an appreciated valuation of the assets. As indicated above, the petitioner has failed to establish a value of the assets in excess of $50,000, at the time of purchase in 1917. Accordingly, the allowance for depreciation for the year 1920 should be computed upon the basis of that valuation. This will tend to increase the amount of the petitioner’s net income. Accordingly, after computation of the net income on the basis indicated, the profits tax should be recomputed under the provisions of section 328 of the Revenue Act of 1918, subject to the limitations of section 302 of that Act, and the deficiency so computed shall be final.

Judgment will be entered on 15 days’ notice, under Bule 50.

Considered by MoRRis, Murdock, and Sjefkin.


text:
    J. H. G. Wolf, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 2970.
    Promulgated October 31, 1927.
    1. Year in which loss was sustained determined.
    2. The action of the respondent in not delermining petitioner’s tax liability on the community-property basis is approved.

      W. W. Spalding, Esg., for the petitioner.

      L. L. Sight, Esg., for the respondent.
    This is a proceeding for the redetermination of deficiencies in income tax of $2,650.12 and $1,450.11 for the years 1919 and 1920, respectively. The deficiency for 1919 results in part from the action of the respondent in refusing to allow a deduction of $16,702.34 claimed by the petitioner as a loss. For both 1919 and 1920 the respondent refused to determine, the petitioner’s tax liability on the community-property basis.
    FINDINGS OF FACT.
    During the years 1919 and 1920 the petitioner was a resident of California. Since the filing of the petition he has died.
    The petitioner acquired 67% per cent of the stock of the North American Exploration Co., a corporation organized in 1909 under the laws of California, at a cost of $9,810. It was stipulated that the value of the stock on March 1, 1913, was slightly greater than cost. The corporation’s funds were exhausted and it ceased to function in 1910 or 1911. The petitioner advanced to the corporation $12,926.92 of his own money, no part of which was ever recovered by him. On March 4, 1916, the corporate charter was forfeited due to the failure to pay the state license tax and was never revived. The corporation had no liabilities at this time except its liability, if any, to the petitioner for money advanced to it. Neither the corporation nor the trustees filed income-tax returns for the years 1917, 1918, or 1919. It was decided that the corporation should go out of business and that its assets, which consisted of 7,644 shares of the stock of the Defender Development Co., 25,001 shares of the stock of the Exploration Oil Co., and some office furniture of negligible value, should be distributed to the stockholders in proportion to their stock holdings.
    The North American Exploration Co. distributed to its stockholders in proportion to their holdings the stock held by it in the Exploration Oil Co., surrendered the certificate or certificates therefor, and requested that company to issue to the stockholders certificates for the stock distributed to them. This was done about September, 1919.
    Since no one with authority connected with the Defender Development Co. could be found to transfer on the books of that company to the stockholders of the North American Exploration Co. the stock held by that company in the Defender Development Co., the stockholders agreed among themselves that each had an interest in the certificate of stock of the development company held by the Exploration Co. in proportion to his holdings in the Exploration Co.
    Upon liquidation of the assets of the North American Exploration Co. the petitioner received assets which had a value when received of $1,833.33. This constituted the entire amount received by the petitioner on the liquidation of the corporation.
    The directors of the corporation were Wolf, Dorsey Ash, and Mary Meyer. The latter owned only a sufficient amount of the stock to qualify as a director. The stockholders of the corporation were Wolf, Dorsey Ash, Mrs. Andrew Marvell — sister-in-law of Ash, and Mary Meyer.
   OPINION.

Trammell:

The petitioner contends (1) that for the year 1919 he should be allowed a deduction of $16,702.34 representing a loss sustained on the stock of the North American Exploration Co. and (2) that the respondent erred in refusing to compute the petitioner’s tax liability on the community-property basis.

The respondent contends that whatever loss the petitioner sustained was sustained in 1916 and that no error was committed in treating for tax purposes the entire community income as the income of the petitioner.

The petitioner acquired 67% per cent of the stock of the North American Exploration Co. at a cost of $9,810. He also advanced to this company $12,926.92, of which he contends 67% per cent, or $8,725.67, represented an assessment against him and an additional cost of the stock, making a total cost of the stock to him of $18,535.67. Upon liquidation of the company he received assets having a value of $1,833.33 and it is the difference between this amount and $18,535.67 that the petitioner is contending for as a deduction.

With respect to the $12,926.92 advanced by the petitioner to the North American Exploration Co., the record does not disclose when the amount was advanced or the circumstances under which it was advanced. Whether this amount or any part of it represented an assessment against the petitioner on the stock owned by him is a matter of fact to be established by evidence. We can not assume that it did. It was designated by the petitioner as an advance. Is the evidence, taken as a whole, sufficient to establish the fact that the advance was in the nature of an asáessment on the stock? We have the testimony of Dorsey Ash who was one of the directors and secretary and treasurer of the North American Exploration Co. He was asked, “ Do you recall any discussion at any time of any liability of the corporation (the North American Exploration Co.) to Mr. Wolf?” He replied, “That is a pretty hard question to answer. Mr. Wolf carried on operations in connection with the Defender Mine in his own name but the understanding was that they were for the benefit of the Company.” Q. “When? ” A. “I couldn’t give you any details.”

Wolf owned no stock in the Defender Development Co., all of its stock being owned by the North American Exploration Co.

If the advance was an assessment on the stock it would appear that it was an assessment on the stock of the Defender Co., which corporation apparently received it. Assessments are made only against stockholders and the stock of the Defender Co. was owned by the Exploration Co. and not by Wolf. It was stipulated, however, that Wolf made the advance to the North American Exploration Co. There is no evidence that any other stockholder made or was called on to make any advances to that company. The fact that no part of the advance was ever recovered by Wolf might indicate that the amount was not considered as a loan. The assets of the corporation would have been liable for the amount before distribution to the stockholders if it had been a loan which was unsatisfied at that time. This is a circumstance and the only evidence from which the conclusion might be drawn that the advance was not a loan but an assessment on the stock, but this is not to our minds sufficient evidence upon which to reach the conclusion that the advance was an assessment. It might have been a gift to the corporation, or it might have been a loan which was satisfied by forgiveness. If it had been an assessment against the stock it would seem that either the petitioner or some witness would have been in a position to testify to the fact or to testify to facts from which we could draw that conclusion. The question, however, is left entirely to inference. We could as well infer tha’t the advance was a loan and that it was satisfied by forgiveness, or that it was intended only as a gift. If it were a loan which had not been satisfied by forgiveness, it is governed by the statutory provision relating to worthless debts. There is no evidence, however, that it was ascertained to be worthless and charged off during the taxable year involved. All the facts relating to the assets of the corporation were apparently fully known prior to the taxable year. In any event, there is no evidence of an ascertainment of worthlessness during the year or that it was charged off at any time.

From a consideration of the evidence, we are not convinced that the so-called advance was an assessment against the stock. It can not, therefore, be added to the cost of the stock in determining the deductible loss.

We have found that on March 4, 1916, the charter of the North American Exploration Co.' was forfeited because of failure to pay the state license tax and was never revived. This forfeiture arose under the statutes of the State of California of 1915. Act 756, approved May 10, 1915, Stats. 1915, p. 422 (Peering, General Laws of California, 1915, p. 208), provides for the payment of an annual license tax (section 4); “At the hour of 6 o’clock p. m., of the Saturday preceding the first Monday in March of each year the charters of all corporations organized under the laws of this state and which have failed to pay the license tax and penalty prescribed by section 4 of this Act shall be forfeited to the State of California ” (section 7); that it is unlawful for any corporation to do business after forfeiture (section 12); that in case of forfeiture the directors “ are deemed to be trustees of the corporation and stockholders or members of the corporation whose power or right to do business is forfeited and have full power to settle the affairs of the corporation ” (section 13).

When a corporation has failed to pay its license tax, and a forfeiture of its charter has been declared, it ceases to be a corporation. Newhall v. Western Zinc Mining Co., 164 Cal. 380; 126 Pac. 1040.

The provision of the statute to the effect that the directors “ are deemed to be trustees of the corporation and stockholders or members of the corporation whose power or right to do business is forfeited and have full power to settle the affairs of the corporation ” was construed in the case of Crystal Pier Co. v. Schneider, 40 Cal. App. 379; 180 Pac. 948. In that case, the court said :

After forfeiture of the charter the situation, then, is this: The title to all property that formerly belonged to the dead corporation is vested in those who were its stockholders at the time of its demise; the trustees to settle the affairs of the corporation have in their possession property belonging to those who were stockholders at the date of the dissolution; they are bound to settle the affairs of the former owner, the defunct corporation; they have all the power to deal with and dispose of the property that is necessary to accomplish that object.
*******
As the court said in Rossi v. Caire, supra [174 Cal. 74; 161 Pac. 1161], speaking of the act that makes the directors in office trustees to settle the affairs of the dead corporation: “ The obvious purpose of this statute * * * is, as was said in the Havemeyer Case [84 Cal. 362, 24 Pac. 121], above cited, ‘ to leave the whole matter of liquidation and distribution to the exclusive control of the directors of the corporation in office at the time of dissolution.’ ”

Since the whole matter of the liquidation and distribution of the assets was left to the exclusive control of the directors of the corporation, the stockholders did not become entitled to possession, use and control of their pro rata share of the assets of the corporation until the directors acting in their capacity as trustees distributed such assets to them. The directors had the right to sell the assets or to distribute them. As the court in the above cited case said:

* * * As donees of such power, the persons referred to by the statute as “ trustees ” are vested with latitudinous discretion in determining whether a sale or other disposition of the corporate assets should be made — a discretion with which, in the absence of fraud or collusion, the courts will not interfere.

In view of the power, control and discretion as to the manner of the exercise thereof vested in the directors of the corporation over the assets, it is our opinion that the stockholders did not receive any gain or loss with respect to the assets until they were distributed by the directors in liquidation. This being true, the petitioner sustained a loss in 1919 when the assets of the corporation were distributed. The loss is the difference between the cost of the stock, that is, $9,810, and the value of the assets received, that is, $1,833.33.

The second assignment of error was the refusal of the Commissioner to recognize and follow the laws of California with respect to community property and income and in treating the entire community income as the income of the taxpayer for each of the years 1919 and 1920. This issue was apparently abandoned as no evidence with respect thereto was introduced and no contention was made at the hearing or in brief. There is no evidence that the petitioner was a married man.

The action' of the respondent, therefore, in treating the entire income of the petitioner for 1919 and 1920 as subject to the tax as his income and not permitting a portion thereof to be included in a separate return of his wife is approved. See United States v. Robbins, 269 U. S. 315; 46 S. Ct. 148, and Appeal of D. Cerruti, et al., 4 B. T. A. 682.

Judgment will be entered on 10 days’ notice, wider Rule 50.

Considered by Mokeis, Murdock, and Sieekin.


author: Maeqtiette:

text:
    Walter P. Coleman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 11753.
    Promulgated October 31, 1927.
    1. On the evidence, held that stock acquired by petitioner was not received in an exchange of property but was earned under a contract and is income to the extent of its fair market value when received.
    2. Deductions for alleged traveling expenses disallowed because of insufficient evidence.
    3. A loss for stock alleged to have become worthless in 1919 disallowed in absence of evidence that the loss was sustained.

      Thomas E. Scott, Esq., for the petitioner.

      W. F. Wattles, Esq., for the respondent.
    This proceeding is for the determination of deficiencies in income tax as stated in a deficiency letter dated December 11, 1925, to be—

    By letter of January 27, 1926, the overassessment for the year 1919 was increased to $184.65. It arises from the partial disallowance of a claim for abatement.
    The petitioner asserts the following errors:
    (1) The inclusion in income for each of the years involved of certain shares of stock alleged to have been received by the petitioner at various times as gifts.
    (2) Failure to allow the deduction, of certain alleged traveling expenses in each of the years involved.
    (3) Denial of the deduction of losses on stock alleged to have become worthless during 1919.
    At the hearing the petitioner abandoned his contention that the stock first mentioned was received as gifts, asserting that it was received in exchange for certain other property.
    FINDINGS OF FACT.
    The petitioner was, during the years involved, a citizen and resident of Atlanta, Ga. For approximately ten years prior to 1918 he had been engaged as a traveling salesman handling merchandise.

      On December 21,1918, Elmer Oliver, as party of the first part, and the petitioner and E. E. Wright, as parties of the second part, entered into a contract relative to the sale of stock in a corporation to be organized by Oliver and known as the Georgia Welding Co.
    The contract recited that Oliver had agreed to subscribe for 450 out of 1,000 shares of stock at $100 par value each, to be issued by the Georgia Welding Co. Oliver’s stock was to be paid for by his license to the company for the use of certain patents and patent applications- held by him. The patent and patent applications related to split demountable automobile rims.
    The contract further recited that Coleman and Wright had agreed to enter into a contract to take charge of and conduct for the Georgia Welding Co. the sale of the remaining 550 shares of its capital stock.
    The contract further recited that upon Coleman’s and Wright’s performance of an agreement therein made that they would sell, 50, 100, and the remaining 400 shares of the company’s stock within two successive 90-day periods and one 6-month period, as specified, Oliver would convey to them out of the stock personally held by him 18, 86, and 146 shares, respectively, for each of the three periods mentioned, the stock so conveyed to be divided equally between the recipients.
    The. sales periods mentioned were to date “from the time said Georgia Welding Co. is in. position to deliver valid certificates of stock in said corporation to purchasers and second parties are given notice thereof.”
    The contract also provided, dependent on certain contingencies, that Coleman and Wright might receive from Oliver additional stock to the amount of 25 shares.
    The license granted the Georgia Welding Co. was to be exclusive and perpetual as to 10 States. In the event of Oliver’s disposition of other territorial rights or his realization in any other way of further compensation or profits, whether in the form of cash, stock of Georgia Welding Co. or of any other corporation, Coleman and Wright were to share in such additional stock, etc., on the same basis of percentage adopted in this contract. Oliver specifically obligated himself to cause the organization of the Georgia Welding Co. within 30 days from date, with charter provisions which would enable the terms of the contract to be made operative.
    Oliver’s interest in the prompt sale by Coleman and Wright of the 550 shares to be held by the Georgia Welding Co. is stated to be the benefits he would derive as a stockholder from the company’s prompt sale of such shares.
    It does not appear that the Georgia Welding Co. ever came into existence.

      Some time prior to May 19, 1919, a corporation known as the Oliver Rim Co. was organized. The Oliver Rim Co. acquired certain patent rights relating to the patent and patent applications above described. The capitalization of this company does not appear. Elmer Oliver was president and manager of the Oliver Rim Co.
    Under date of May 19, 1919, Elmer Oliver wrote petitioner the following letter:
    Olive® Rim Company,
    MANUFACTURERS OF THE OLIVER SPLIT DEMOUNTABLE RlM,

      Umpire Banning, Atlanta, Georgia, May 19, 1919.

    Mr. W. P. Coleman,

      Atlanta, Georgia.

    Dear Sir: In consideration of your surrender to me of a contract made between R. R. Wright, yourself and myself, dated about December 20th, I agree to the following proposition.
    This Company will pay you twenty (20%) per cent on all stock sold by you and paid for. I will pay you an additional ten (10%) per cent in stock on all such business and further agree to give you an extra thirty (30%) per cent in stock on all sales up to $125,000, said $125,000 in stock to be set aside for you to sell subject, however, to prior sale.
    It is understood that the thirty (30%) per cent mentioned above is to be given to you when the sale of the Treasurer’s stock is complete.
    Yours very truly,
    (Signed) Elmer Olive®.
    The contract of December 21, 1918, was surrendered to Oliver by the petitioner.
    On April 1,1920, Oliver, Coleman, and one D. F. O’Connor entered into the following contract:
    This Contract, made and entered into this first day of April, 1920, between Elmer Oliver, party of the first part, and W. P. Coleman and D. E. O’Connor, parties of the second part, provides as follows:
    Parties of the second part agree to use their best efforts to sell the stock of the Oliver Rim Company at ($125.00) One Hundred and Twenty-Five Dollars per share, or such other price as may later be determined by the Board of Directors of the company. In consideration of this service party of the first part agrees to pay to parties of the second part, the following bonus, payable only in stock of the Oliver Rim Company, and computed on the basis of the number of shares sold and paid for in cash or collectible notes:
    Bonus jointly of ten per cent on the sale of Four Hundred Shares, (or Forty Shares).
    If parties of the second part fail to sell Four Hundred Shares, this Bonus shall be only Seven and one-half per cent, provided they sell more than Two Hundred Shares, and only five per cent, if less than Two Hundred shares are sold.
    In the event more than Four Hundred shares are sold by parties of the second part, or their agents, they are to receive a straight ten per cent stock bonus, computed as above.
    This agreement is to remain in force for six months, or until the balance of the stock which the Oliver Rim Company wishes to sell, and any personal stock the party of the first part might have to offer for sale, has been disposed of.

      D. F. O’Connor was a stock salesman who worked with the petitioner in closing certain sales. When the petitioner and O’Connor closed sales together, the commissions earned were divided equally between them. The contract of April 1, 1920, was entered into at the instigation of O’Connor to insure his receiving a share of the commissions.
    Under the contracts above mentioned Elmer Oliver conveyed to the petitioner out of the stock held by him personally, certain shares of stock of the Oliver Rim Co., as follows:
    Year. Number of shares.
    1919_ 31
    1920_108
    1921_231
    Total_370
    The respondent has included the stock so received in the petitioner’s income at a value of $22.22 per share.
    During the years involved the petitioner used an automobile owned by himself while traveling as a salesman. He has claimed the following stated deductions as traveling expenses: 1919, $2,300; 1920, $3,700; 1921, $2,998.32.
    The petitioner during 1919 kept some memoranda of his traveling expenses, consisting of a weekly or monthly “ survey ” based on the number of days on the road and the mileage covered. He spent approximately 300 days on the road during that year. When he married in December, 1919, he moved and failed to carry this memoranda along. His income-tax return for 1919 was executed on March 6, 1920, and filed on March 8, 1920.
    During 1920 the petitioner’s travels were more extensive than during 1919. In 1921 stock sales slackened and the. petitioner devoted part of his time to other lines of business.
    In 1919, shortly after he commenced selling Oliver Rim Co. stock, the petitioner bought a sport model Paige automobile, costing $2,375. He used this car in traveling until some time in 1921, when he traded it in on the purchase of a Davis car subsequently used ip. his travels. In addition to the Paige, the petitioner gave some money and some shares of Oliver Rim stock for the Davis.
    The traveling expenses above mentioned include hotel and garage bills, meals, motor oil, gas, tires, and other items of automobile upkeep, as well as depreciation. The 1921 claim includes an alleged loss upon the sale of an automobile.
    While at home in Atlanta, the petitioner used the automobile for personal purposes.
    Some time prior to the years involved the petitioner bought certain stock in a corporation organized to engage in the conduct of an ostrich farm in Pennsylvania. The enterprise was not successful and a reorganization was effected. The petitioner surrendered his stock in the ostrich farm corporation, and received a certificate for 100 shares of the common stock of the Alta Vista Co., a Delaware corporation. The total cost of this stock to petitioner was $100.
    In May, 1919, the petitioner bought at par one share of $100 par value preferred stock of the Cotton Picker Co. of America.
    Neither the Alta Vista Co. nor the Cotton Picker Co. of America have ever paid dividends on the petitioner’s stock. The petitioner claims a deduction of $200 for 1919, alleging that his stock in both of these corporations became worthless in that year.
   OPINION.

Maeqtiette:

The petitioner contends that the 310 shares of the Oliver Rim Co. stock received by him from Elmer Oliver during the taxable years involved, were given by Oliver solely in exchange for the petitioner’s surrender of the contract of December 21, 1918. Receipt of this stock is alleged to be a tax-free exchange under section 202 of the Revenue Acts of 1918 and 1921.

From a record unsatisfactory in many details, we have drawn conclusions of fact which we believe embody substantially the actual circumstances surrounding the petitioner’s acquisition of the stock from Oliver.

We believe the fallacy of the petitioner’s contention that the stock mentioned was received in an exchange is so obvious as to make extended discussion unwarranted. So far as petitioner’s surrender of the contract of December 21, 1918, in return for Oliver’s agreement of May 19, 1919, was an exchange, it was an exchange of contracts only and the petitioner received no stock thereby.

Epitomized, the stock received by the petitioner from Oliver, so far as it relates to the contract of May 19, 1919, was not received in exchange for a contract but was earned under a contract received in an exchange. The stock so received, as well as such stock as was received under the contract of April T, 1920, was income to the extent of its fair market value, which the respondent has determined to be $22.22 per share.

In passing it may be observed that even if the petitioner had established the receipt of the stock in exchange for the contract, we would be unable on the record to afford him any relief since there was no evidence that the contract of December 21, 1918, had any value or that the stock had no readily realizable market value when received.

It is obvious that the petitioner’s travels while engaged as a salesman required the expenditure of considerable sums. We think it equally evident that his statements of the amounts of such expenditures are purely estimates. He testified that his 1919 expense records, which were the most complete records he kept, consisted of a weekly or monthly “ survey ” calculated on the basis of mileage covered and days involved. These records were lost in December, 1919, when he married and moved.

Considering the loss of the records in December, 1919, we are not persuaded that in preparing his 1919 income-tax return, executed March 6, 1920, the petitioner had available his expense memoranda for 1919 from which to compute the deduction claimed.

Evidence as to the traveling and associated expenses for 1920 and 1921, depreciation deductions, and loss upon sale of an automobile, consisted of bare lump-sum statements of the amounts claimed.

The Board has heretofore said in an appeal involving a claim for similar deductions:

The Board is cognizant of the fact that every detail of a traveling expense account is difficult to keep and prove, and for that reason the Board is prone to give considerable latitude in the matter of evidence tending to prove such accounts. However, there must be something more than a bare estimate to support such a deduction. Appeal of Barnett Weiss, 3 B. T. A. 228, 230. See also Appeal of Sam Israel, 3 B. T. A. 663.

In Appeal of Cleveland Home Brewing Co., 1 B. T. A. 87, the Board held that depreciation is a question of fact and must be established by proof. This is equally true when the purpose is to establish an alleged loss upon the sale of an automobile. The record is barren of evidence tending to show that a loss was sustained, and it must, therefore, be disallowed.

The petitioner’s claim for the deduction of $200 as an alleged loss on worthless stock during 1919 must fail, as have his other contentions, for lack of evidence.

Certain evidence that the Alta Vista Co. became nonoperative during 1919 (through nonpayment of taxes), can not of itself be taken to establish that the stock became worthless in that year or that it has ever become worthless. See Appeal of George W. Todd, 3 B. T. A. 327. This is so even though the stock has never paid dividends.

The only evidence relative to the stock of the Cotton Picker Co. of America is that the petitioner held one share purchased at par value of $100 per share, and that this stock has never paid dividends. Such evidence is insufficient to show that a loss was sustained.

Judgment will be entered for the respondent.

Considered by Phillips, MillikeN, and Van Fossan.


author: Milliken :

text:
    Crandall Horse Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7924.
    Promulgated October 31, 1927.
    1. Pair market value of plant and leases as of March 1, 1913, determined.
    2. Due to lack of evidence, the unexhausted value of plant can not be determined for invested capital.
    3. Capital additions made subsequent to March 1, 1913, determined for invested capital purposes. Arbitrary and erroneous write-off of asset value of plant and lease restored for invested capital purposes.

      Benjamin B. Pettus, Esq., and Wilton II. Wallace, Esq., for petitioner.

      Shelby S. Fcmllcner, Esq., for the respondent.
    This proceeding results from the determination by respondent of deficiencies in income and profits taxes for the years 1919, 1920, and 1921, in the respective amounts of $618.97, $295.52, and $1,851.34. The issues involved relate to—
    (1) The amount to be allowed as a deduction for the years 1919, 1920, and 1921 on account of the exhaustion of a lease, and the value of the same property allowable for invested capital purposes.
    (2) The amount to be allowed as a deduction from income for the years 1919, 1920, and 1921 on account of the exhaustion of additions to the plant of petitioner made after March 1, 1913, and the cost of the same property properly allowable in invested capital for said years.
    FINDINGS OF FACT.
    Petitioner is a New York corporation with principal offices at Buffalo, and is engaged in selling horses on a commission basis, and buying and selling horses on its own account. Petitioner was organized prior to 1906, succeeding a partnership known as Crandall & Co. Included in the assets acquired from the partnership were a valuable lease to certain lands located in Buffalo and a number of barns located thereon. The lease which petitioner acquired provided as follows:
    This Indenture, Made this first day of May, One thousand eight hundred and ninety-four between The New York Central and Hudson River Railroad Company, party of the first part, and Adelbert D. Cronk, Margaret I. Cran-dall, both of Buffalo, New York, William Fiss and John B. Doerh, both of New York City, New York, composing the firm of Crandall and Company, parties of the second part.
    Witnesseth: that the said party of the first part, in consideration of the rents, covenants and agreements hereinafter mentioned, reserved and contained on the part of the said parties of the second part, to be paid, kept and performed, has demised and let, and by these presents does demise and let unto the said parties of the second part, the following described premises, viz: *******
    Tosetheb with the appurtenances, for the term of twenty years from the first day of May, One thousand, eight hundred and ninety-four, at the annual rent or sum of One thousand (1,000) Dollars, to be paid in equal quarterly payments in advance, to wit: on the first days of August, November, February and May in each and every year,—
    Provided, that if the yearly rent above reserved, or any part thereof, shall be unpaid on any day of payment whereon the same ought to be paid as aforesaid, or if default shall be made in any of the covenants or agreements herein contained, on the part of the said parties of the second part, then and from thenceforth it shall be lawful for the said party of the first part to reenter upon said demised premises, and the sum to have again as in its first and former estate.
    The premises above described are let and are to be used for the following purposes only: for the purpose of a horse and mule market, and for the erection of proper and suitable buildings and structures thereon for that purpose; the horses and mules sold and handled by said parties of the- second part at said market on said premises which it may be necessary to ship to or from said market, to be shipped over the railroads of the party of the first part so far as possible without loss and inconvenience to said parties of the second part, and to the fullest extent that.said shipping can be controlled or influenced by said parties of the second part by using all their powers and best endeavors to that end.
    The parties of the second part covenant and agree to pay to the said party of the first part the said rent above reserved, on the days and in the manner limited and prescribed as aforesaid for the payment thereof, without any deduction or delay; and further covenant and agree their proper costs and charges to bear, pay and discharge all taxes, duties and assessment which may during the said term hereby granted, be charged, assessed or imposed upon the said demised premises.
    The parties of the second part covenant and agree not to assign this lease or underlet said premises or any portion thereof without the consent in writing of the party of the first part, and further covenant and agree that said premises shall be used only for the purposes hereinbefore specified.
    And the said parties of the second part hereby assume all risk of loss or damage by fire to the premises hereby demised, or to any structures or property which may be thereon during the terms of this lease, or during any extension or renewals thereof, and hereby expressly agree that the said party of the first part shall in no case be liable for any such loss or damage, in whatsoever way or under whatsoever circumstances such fire may be caused, whether by or on account of the negligence of said party of the first part, its agents or servants, or otherwise.
    The said parties of the second part covenant and agree that all buildings and structures erected by them upon the said demised premises shall be built, and at all times maintained during the term hereby granted, in accordance with the plans and in a manner which shall be approved by,' and be satisfactory to, the General Live Stock Agent, for the time being, of the party of the first part, or such other officer or agent of the party of the first part as shall be by the party of the first part designated to examine and approve such buildings and structures, provided always that such buildings and structures, may be such as are, so far as practicable, best adapted to the uses and purposes of said horse and mule market.

      The parties of the second part further covenant and agree to at all times during the said term hereby demised, use the said demised premises and conduct a horse and mule market thereon in a manner which shall be satisfactory in all respects to the party of the first part and the officers thereof, it being the intention of all the parties hereto, and a part of the consideration moving the party of the first part to make this lease, that the said demised premises shall be conducted in the interest of the traffic and business of the party of the first part.
    The parties of the second part further covenant and agree that upon paying the taxes, duties and assessments, which may from time to time be charged, assessed or imposed upon the said demised premises, they will obtain and furnish to the General Counsel of the party of the first part properly receipted bills therefor, and it is understood and agreed by and between the parties hereto, that in case the parties of the second par-t shall at any time fail to pay any such tax, duty or assessment prior to the time when penalties or interest commence to run thereon, then and in any such case the party of the first part may pay such tax, duty or assessment, with any penalty or interest due thereon, and the amount so paid shall thereupon become due and payable by the parties of the second part to the party of the first part, and such payment may be enforced in the same manner as the payment of the rent herein reserved.
    It is understood and agreed by and between the parties hereto that in case at the expiration of the term hereby granted, this lease is not renewed for a further term, the parties of the second part may at any time within thirty (30) days after the expiration or other termination of this lease, remove all buildings and structures erected by them upon the said demised premises, including the buildings and structures now owned by them on said demised premises, provided the said demised premises are left in as good condition as they are now in; but it is expressly understood and agreed by and between the parties hereto, that all buildings and structures erected by the parties of the second part upon the said demised premises, including the buildings and structures now on said demised premises, which are not so removed within thirty (30) days after the expiration or other termination of this lease, shall thereupon become and be absolutely the property of the party of the first part.
    The parties of the second part covenant and agree to surrender the premises hereby demised at the expiration of the said term, or at any time when said lease shall be terminated as aforesaid, in as good state and condition as they are now in reasonable use -and wear thereof and damages by the elements excepted.
    The covenants and agreements herein contained shall inure to the benefit of, and be binding upon the successors, executors, administrators and assigns of the parties hereto respectively.
    Witnesses.
    Prior to February 1, 1906, the authorized and outstanding capital stock of petitioner had a par value of $100,000 and petitioner was the owner of the lease above set forth and nine horse barns located on the leased premises. On February 1, 1906, a combination was effected of the business of petitioner and that of a competing concern known as the Hickock-Aldrich Co., which latter company had been organized and conducted by A. D. Cronk on a site about four blocks from the business of petitioner. The Iiickock-Aldrich Co. had been very successful and, at the time of the combination of the two businesses, was doing a majority of the horse commission business in Buffalo. To bring about the discontinuance of business by Hickock-Aldrich Co. and secure the valuable services of A. D. Cronk, it was arranged to turn over to Cronk one-third of the outstanding capital stock of petitioner and a changed ownership of the remaining two-thirds of the capital stock took place.
    New books of account were opened by petitioner on February 1, 1906, the opening entry on the journal charging to “Bailey Plant” $12,500 and to “Plant and Lease” account $87,500, and crediting capital stock account $100,000. No segregation of separate values of the lease and of the plant has ever been made on the books of account of petitioner and no separate value attaches to either asset. In the years 1918 to 1921, petitioner wrote off on its books of account, $5,000 each year for the exhaustion of its plant and lease asset.
    On February 13, 1913, the lease expiring on May 1, 1914, was renewed for a period of 15 years, or to expire on May 1, 1929. The material provisions of the renewal lease were as follows:
    This Indenture, Made this thirteenth day of February One thousand nine hundred and thirteen, between The New York Central and Hudson River Railroad Company, hereinafter called the Lessor, and the Crandall Horse Company, a corporation duly organized under the laws of the State of New York, hereinafter called the Lessee.
    Witnesseth, That said Lessor in consideration of the rents to be paid and the covenants to be performed by said Lessee as hereinafter recited, hereby leases unto said Lessee, the following described premises, viz: All that parcel of land situate in the City of Buffalo, County of Erie, and State of New York, bounded and described as follows:
    * # * * * * ❖
    Together with the appurtenances, for the term of fifteen (15) years from the first day of May, one thousand nine hundred and fourteen, unless sooner terminated, at the annual rent or sum of One thousand dollars ($1,000).
    The premises above described are let and are to be used for the following purposes only:
    Site for buildings and structures of Lessee, for the purpose of a horse and mule market.
    It is understood and agreed by and between the parties hereto that if said Lessee shall have paid the rent as aforesaid, in full and without default, and shall have faithfully kept and performed every and all the terms and conditions herein by it to be kept and performed, and not otherwise, it may within thirty days after the expiration or other termination of this lease, remove all buildings and structures now on or erected by if upon the said demised premises during the said term of this lease, rent being paid during said time upon the same terms as herein stated, Provided, the said demised premises are left in as good condition as they were in before such buildings and structures were erected thereon; But it is expressly understood and agreed by and between the parties hereto that all buildings and structures now on or erected by said Lessee upon said demised premises which are not so removed shall thereupon become and be absolutely the property of said Lessor, and may be removed by it, and said Lessee hereby conveys the same absolutely to said Lessor, its successors or assigns.

      It is mutually understood and agreed by and between tbe parties hereto, that Lessee shall have and is hereby given the privilege of renewing this lease for an additional term of five years from and after May 1, 1929, provided said lease is in effect at that time and the demised premises or any part thereof are not needed by Lessor for railroad purposes, such renewal term to be upon the same terms and conditions herein contained, except as to any further right of renewal, provided Lessee gives written notice to Lessor of its intention and desire to take such renewal at least six (6) months prior to said first day of May, 1929, and within three months after such notice is served said Lessor will determine whether the demised premises or any part thereof are needed by it for railroad purposes and advise Lessee of such determination, failing which the renewal term shall take effect and commence on the date aforesaid.
    The lease expiring on May 1, 1929, will not be renewed because the general improvements and the erection of a $12,000,000 station by the lessor in the neighborhood where petitioner’s plant is located make it impossible to continue a horse business in that locality. At the expiration of the lease on May 1, 1929, the horse barns of petitioner will possess no salvage value.
    The March 1, 1918, value of the plant and leases was $87,500, and this value is subject to exhaustion ratably over the period from March 1,1918, to May 1, 1929.
    Subsequent to March 1, 1913, the following additions were made to plant and lease:

    The costs of these additions are subject to exhaustion ratably over the remaining life of the lease. The amount of cost remaining unex-hausted at the beginning of each year is properly allowable in invested capital for that year.
    In 1914, petitioner reduced the book value of its plant and lease account from $87,500 to $46,022, by a charge to undivided profits account, the amount of the write-off being $41,478.
   OPINION.

Milliken :

From a consideration of the evidence, we are satisfied that the aggregate fair market value of the leaseholds and of the barns on March 1, 1913, was not less than $87,500, and petitioner is, accordingly, entitled to annual deductions from income for the exhaustion of such value ratably over the remaining life of the combined leaseholds to May 1,1929. Respondent reversed.

Petitioner contends that there was a reorganization in 1906, and the leasehold and barns were then paid in for the capital stock of a new corporation and had a cash value of $87,500 for invested capital purposes. After a careful study of the record, we conclude that the evidence fails to sustain petitioner, for it is evident that petitioner was organized prior to 1906, its full authorized capital stock was outstanding prior to 1906, and it was the owner of the leasehold and barns prior to 1906. Respondent has refused to allow any value for the leasehold and the barns for invested capital purposes, holding that on May 1, 1914 (the date of expiration of the first lease), the original book value of $50,000 had been fully exhausted. Petitioner contends that a renewal of the lease was promised by the lessor and, therefore, for invested capital purposes, the value should be amortized over a life of 85 years, being the sum of 20 years under the first lease and 15 years under the second lease. The first lease is set forth in full in the findings of fact and upon a consideration of it, we are unable to agree with the petitioner that it contains any right of renewal, even by implication. In our opinion, at no time prior to February 13, 1913, when the second lease was executed, was petitioner entitled to the use of the property later than May 1, 1914, save for the short period of days thereafter allowed it under the lease, within which to remove the barns. This fact definitely limited the exhaustion to a period extending from the date of acquisition of the lease by petitioner from the partnership, to the expiration date, May 1, 1914.

Petitioner secured a renewal of the lease on February 13, 1913, without cost to it. The second lease, therefore, represented no outlay of capital and can not be included in invested capital.

We do not know the separate value attaching to the barns, which were used by petitioner until the expiration of the second lease, and which value, to a small extent, existed on February 13, 1913, and should be exhausted over a period ending May 1, 1929. Such facts not being before us, we can not determine the amount of invested capital to which petitioner is entitled, and the respondent, therefore, is sustained.

It is in evidence and uncontroverted, that petitioner decreased the amount of undivided profits on its books in 1914, by an arbitrary write-off amounting to $41,478, to reduce the book value of plant and lease account. We are of the opinion this reduction should be restored to invested capital.

The remaining question relates to capital additions subsequent to March 1, 1913. Our findings of fact dispose of this issue and should be observed in redetermining the deficiency.

Judgment will be entered on 15 days’ notice, under Rule 50.

Considered by Maequette, Phillips, and Van Fossan.