text:
    Estate of Richard E. Traiser, John Abbott, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91958.
    Promulgated January 31, 1940.

      Roger W: Hardy, Esq., for the petitioner.

      Ojiarles P. Reilly, Esq., for the respondent.
   OPINION.

Smith :

This proceeding is for the redetermination of a deficiency in income tax of the petitioner for 1935 in the amount of $1,011.72. The petition alleges that the respondent erred in the determination of the deficiency by disallowing the deduction from gross income of a part of the executor’s compensation paid by the estate during the taxable year and a part of the distributions made to two beneficiaries, and also in disallowing a portion of the credit claimed for dividends received by the estate.

The facts in this case are presented by (1) respondent’s deficiency notice, (2) the pleadings, and (3) a short stipulation of facts. The facts are as follows:

John Abbott was during 1985 and continues to be the executor of the will of Richard E. Traiser, who died a resident of Brookline, Massachusetts, December 16,1984.

On or about March 15, 1936, the petitioner filed with the collector of internal revenue at Boston an income tax return for the estate of Richard E. Traiser for 1935 and paid the tax of $524.71 shown thereby to be due.

During 1935 the estate received gross income as follows:

Taxable interest_$2, 883.19
Dividends — shares of stock of domestic corporations_ 14,904.43
Capital gains-10,641.55
28,429.17
Tax-exempt interest_ 18,377.02
46,806.19

In the return filed there was excluded from the gross income the tax-exempt interest of $18,377.02, and the gross income reported was $28,429.67, whereas it should have been $28,429.17. The net income was determined by deducting from $28,429.67 the following:

Local real estate and personal property taxes_$2, 956.18
Executor’s compensation_ 2, 594. 93
5,551.11
Distributions to beneficiaries_ 8, 600.00
14,151.11

The net income reported on the return was $14,278.56, whereas it should have been $14,278.06.

In the determination of the deficiency the respondent disallowed the deduction from the taxable income of the estate of $4,982.83 of the distributions to the heirs or legatees, upon the ground that that amount represented a distribution of tax-exempt interest which was computed as being the same percentage of $8,600 as the tax-exempt interest was of the income of the estate available for distribution after the payment of expenses.

The respondent did not treat the capital gains of $10,641.55 as being available for distribution. We think that the respondent erred in holding that the capital gains were not available for distribution. We are dealing here with an estate in process of administration or settlement. So far as anything is shown to the contrary, the gains realized from the sale of capital assets were as much available for distribution to the heirs or legatees as any other income of the estate.

The respondent also disallowed the deduction from the gross income of the estate of $1,102.62 of the executor’s compensation. At the hearing of this proceeding the respondent admitted error in such disallowance in accordance with the opinion of the Board in John H. Watson, Jr., et al., Trustees, 35 B. T. A. 706. The correction of this error and of the error of 50 cents in the amount of the dividends received by the estate will change the respondent’s determination with respect to the amount of the tax-exempt interest included in the $8,600 distribution which the respondent contends should be disallowed as a deduction from gross income.

The tax-exempt interest was correctly excluded from the gross income of the estate in accordance with section 22 (a) (4) of the Revenue Act of 1934. The gross income of the estate with the exclusion of the tax-exempt interest for 1935 was as follows:

Taxable interest_$2, 883.19
Dividends_ 14,904. 43
Capital gains_10, 641. 55
Total_ 28,429.17

The total expenses of the estate in the amount of $5,551.11 are deductible from the taxable income of the estate in accordance with the Board’s opinion in John H. Watson, Jr., et al., Trustees, supra. The net income of the estate before the deduction of any part of the $8,600 distribution was $22,878.06 ($28,429.17 minus $5,551.11).

The petitioner contends that the $8,600 distribution is deductible in its entirety from the gross taxable income ($28,429.17) the same as the expenses ($5,551.11) and that its taxable net income is $14,-278.06. The respondent, on the other hand, contends that all of the income of the estate in excess of the amount used for the payment of expenses was available for the $8,600 distribution and that it must be assumed that the distribution came ratably from the taxable income available for distribution and from the tax-exempt interest, namely, $22,878.06 taxable income and $18,377.02 tax-exempt interest (total $41,255.08) ; that the tax-exempt interest was 44.54486 percent of the amount available for distribution and, accordingly, that the same percentage of the $8,600 distribution, or $3,830.86, was made from the tax-exempt interest, which amount may not be deducted from the gross taxable income of the estate under section 162 (c) of the Revenue Act of 1934.

Section 162 of the applicable taxing statute provides in material part as follows:

SEC. 162. NET INCOME.
The net income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that-
* * * * * * *
(c) In the ease of income received by estates of deceased persons during the period of administration or settlement of the estate, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the bene-ñeiary or accumulated, there shall he allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year, which is properly paid or credited during such year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir, or beneficiary.

It will be observed that the amount to be allowed as a deduction under section 162 (c) is the amount “which is properly paid or credited during such year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir, or beneficiary.” Since the tax-exempt interest distributed to a legatee, heir, or beneficiary is not to be included in the distributee’s net income any more than in the income of the estate, we think that it may not be claimed as a deduction from the taxable income of the estate under section 162 (c) of the statute.

There is nothing in the record in this case which tends to show that the distribution to the heirs or legatees of $8,600 was made exclusively from taxable income of the estate. We think that the respondent is correct in his contention that the amount of the tax-exempt interest included in the $8,600 distribution may not be claimed as a deduction from the taxable income of the estate. It is necessary to determine the amount of the tax-exempt interest included in the $8,600 distribution. The respondent contends that the tax-exempt interest included in the $8,600 distribution is the same percentage of the $8,600 as the tax-exempt interest ($18,317.02) bears to the gross income of the estate available for distribution ($41,255.08). A comparable method of proration of earnings has been approved by this Board and the courts in many cases. Cf. Edwards v. Douglas, 269 U. S. 204; Mason v. Routzahn, 275 U. S. 175; Donahue v. United States, 58 Fed. (2d) 463; Peter W. Rouss, 4 B. T. A. 516; Harry A. Moody, 9 B. T. A. 631; Paso Robles Mercantile Co., 12 B. T. A. 750; Norwich Woolen Mills Corporation, 18 B. T. A. 303; Acme Manifolding Co., 24 B. T. A. 429; Elsie Samstag, 26 B. T. A. 957; Minnie L. Wolf, 32 B. T. A. 959; J. Cornelius Rathborne, 37 B. T. A. 607; affd., 103 Fed. (2d) 301.

In the Rathborne case it was held that where the income of a trust was distributable in its entirety to the beneficiary and a part of the income of the trust was from tax-exempt interest the beneficiary was not taxable on the tax-exempt income received, and that the distribution to the beneficiary should be prorated between the taxable income and the nontaxable income.

Since the tax-exempt interest was 44.54486 percent of the total income of the estate available for distribution that percentage of $8,600 must be excluded from the $8,600 distribution in order to obtain the balance which is deductible from the taxable income of tíre estate. That balance is $4,769.14, which we determine to be the correct amount of the deduction under section 162 (c).

The final question for consideration is the amount of the dividend credit to which the estate is entitled. Section 163 of the Revenue Act of 1934 reads as follows:

SEO. 163. CREDITS AGAINST NET INCOME.

(a) Credits or Estate or Trust.- — For the purpose of the normal tax and the surtax the estate or trust shall he allowed the same personal exemption as is allowed to a single person under section 25 (b) (1), and, if no part of the income of the estate or trust is included in computing the net income of any legatee, heir, or beneficiary, then in addition the same credits against net income for dividends and interest as are allowed by section 25 (a).
(b) Credits or Beneficiary. — If any part of the income of an estate or trust is included in computing the net income of any legatee, heir, or beneficiary, such legatee, heir, or beneficiary shall, for the purpose of the normal tax, be allowed as credits against net income, in addition to the credits allowed to him under section 25, his proportionate share of such amounts of dividends and interest specified in section 25 (a) as are, under this Supplement, required to be included in computing his net income. Any remaining portion of such amounts specified in section 25 (a) shall, for the purpose of the normal tax, be allowed as credits to the estate or trust.

The net income of' an estate in process of administration or settlement is to be computed in the same manner and on the same basis as that of an individual. Section 25 of the applicable statute provides that there shall be allowed for the purpose of the normal tax, but not for the surtax, the amount received as dividends from domestic corporations. The petitioner contends that it is entitled to a dividend credit of $14,904.43, that being the amount of the dividends which it received from domestic corporations.

The respondent determined that the dividend credit to which the petitioner is entitled is $9,722.46. He arrived at this amount in the following manner:

Dividend income_ $14,904. 93
Interest income_ $2,883.19
Deductions:
Taxes paid_$2,956.18
Executor’s commissions_ 1,492.31
- 4,448.49
- (1,565.30)
Net dividend income_ 13, 339. 63

The respondent then determined that of the $8,600 distribution $3,617.17 represented a distribution of taxable dividends as to which the distributees were entitled to a dividend credit. He held that the difference between the net dividend income of $13,339.63 and the dividend credit to which the distributees were entitled ($3,617.17) was an available dividend credit to the estate.

It will be observed that the respondent contends that the portion of the dividends used to pay expenses ($1,565.30) conld be availed of neither by the estate nor by the distributees. He relies upon Elsie Samstag, supra, in support of this contention.

The facts in the Samstag case were that an estate in process of administration or settlement had a total income of $24,086.58, $24,000 of which consisted of dividends from domestic corporations. The expenses of the estate were $4,039.96. The balance of the income was distributed to the heirs or legatees. The amount receivable by them was $20,046.62. The recipients of this amount claimed a dividend credit of $24,000. The Board held that the respondent correctly determined that the amount of the credits to which the distributees were entitled for the purpose of computing normal tax on account of dividends received by them was the amount of the dividends remaining for distribution to them, after the payment of expenses, and actually distributed to them. That opinion does not stand for the proposition that an estate taxable as an individual is not entitled to a dividend credit equal to the amount of the dividends received by the estate. It stands only for the proposition that a distributee is not entitled to a dividend credit of more than the dividends received or taxable to the distributee. An estate in process of administration or settlement is taxable upon the same basis as an individual. It would be a novel proposition to hold that an individual, receiving income from wages, dividends, interest, etc., is not entitled to a dividend credit of the full amount of the dividends received simply because the individual claims a deduction from his gross income of amounts paid for taxes, interest, contributions, etc. In such a case the statute contemplates a dividend credit equal to the full amount of the dividends received. We think that the same rule holds for an estate, such as the petitioner herein. The estate is entitled to the full dividend credit ($14,904.43) reduced only by the amount of the dividends distributed. The distributees are entitled to a dividend credit in the amount of the dividends distributed to them. Elsie Samstag, supra.

In the proceeding at bar the estate and the distributees are entitled to dividend credits of $14,904.43, the amount of the dividends received by the estate. If the estate had made no distribution to the heirs or legatees during 1935 the estate would be entitled to a dividend credit of the full amount of $14,904.43. In view of the distribution made the dividend credit of the estate must be reduced by the amount of the dividends included in the $8,600 distribution.

We are of the opinion that in the determination of the amount of the dividends included in the $8,600 the same principle of proration which was applied in the determination of the tax-exempt interest included in the $8,600 distribution should be invoked.

We have found above that $4,769.14 of the taxable income of the estate was included in the $8,600 distribution. The gross taxable income of the estate was $28,429.17, including dividends of $14,904.43. Out of the total taxable income there were paid $5,551.11 expenses, and $4,769.14 was distributed to the heirs or legatees. We think it is logical to assume that both the $5,551.11 expenses and the $4,769.14 distribution of taxable income came ratably from the gross taxable income of $28,429.17, and that the dividend credit to which the estate is entitled should be reduced only by the dividend credit to which the distributees are entitled. The estate’s dividend credit should not be reduced by the amount of the dividends assumed to be included in the amount paid for expenses. We think that the respondent erred in so reducing it. The dividend income of $14,904.43 is 52.42654 percent of the gross taxable, income of $28,429.17. Accordingly, 52.42654 percent of the $4,769.14 taxable income distributed, or $2,500.29, came from the dividend income of the estate. The distribu-tees are entitled to dividend credits in the aggregate amount of $2,500.29. The estate is entitled to a dividend credit of the difference between $14,904.43, dividends received by it, and $2,500.29 distributed, or $12,404.14.

Reviewed by the Board.

Decision will ~be entered under Rule 50.


source: Caselaw Access Project

author: Mellott:

license: Public Domain

text:
    Charles F. Grey and Josephine C. Grey (Husband and Wife), Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 90320.
    Promulgated January 31, 1940.

      Hugh N. Smith, Esq., for the petitioner.

      G. W. Brooks, Esq., for the respondent.
   OPINION.

Mellott:

The Commissioner determined a deficiency in the income tax of petitioners for the year 1934 in the amount of $2,049.05. Inasmuch as all controversies concern the income of Charles F. Grey, he will hereinafter be referred to as the petitioner.

The issue raised in the petition was whether or not the Commissioner erred in disallowing the deduction of $10,331.98 as a bad debt. That issue has now been settled by a stipulation of the parties that the petitioner should be allowed a deduction of $9,056.98.

By an amended answer the respondent asks that the Board “redetermine the correct amount of the deficiency in respect of the petitioners’ income tax liability for the year 1934 to be not less than $439.55.” In that connection he avers that in determining the revised net income shown in the statement attached to his notice of deficiency he understated income from fiduciaries by $1.36, dividends, and other income by $1,361.68. He accordingly asks that these amounts be included in petitioner’s income.

All of the facts are found to be as stipulated. We shall set out herein only those necessary for an understanding of the issues to be decided.

Charles F. Grey died testate in Cook County, Illinois, on May 10, 1925. In his will he named his grandsons, petitioner herein, and Newton Fox Grey, executors of said will, and trustees of the trust created in paragraph twenty-three. By this paragraph he gave his residuary estate to his trustees, in trust, to invest and reinvest the same, to pay all costs and expenses, and to pay the net income for twenty years as follows:

* * * one sixth of said net income to my wife, Anna L. Grey; one sixth of said net income to my son, Howard G. Grey, and his wife, Lizzie T. Grey, or the survivor of them, and in case of the death of both of them during said period of twenty years, then their share of said net income shall be paid in equal parts to their lawful issue; one-sixth of said net income to my daughter, Ethel Grey Scott, and her husband, Robert L. Scott, or the survivor of them and in ease of the death of both of them during said period of twenty years, then their share of said net income shall be paid in equal parts to their lawful issue. In case my wife, Anna L. Grey, shall not survive me, or in case she shall survive me but shall die during said period of twenty years, then in either of said events, the one-sixth of said net income hereinabove bequeathed to my said wife shall be added to and made a part of the portions of said net income hereinabove bequeathed to my said son and his wife and to my said daughter and her husband, one-half thereof to my son and his wife, and one-half thereof to my daughter and her husband. The remaining one-half of said net income from said trust estate shall be set aside by my Trustees as a special fund for the following purposes; Out of said special fund I direct my Trustees to pay to James Spencer Dickerson (or in the event of his death, to his successor, to be named by Howard G. Grey and Robert L. Scott) the sum of Eive Hundred Dollars Semi-annually for ten years from the time of my decease, to he distributed by said James Spencer Dickerson in his discretion, among the wives or widows of.clergymen who are, or at the time of their death were, residents of the United States, and not having an income above Two Thousand Dollars per annum; I further direct my Trustees to pay out of said special fund such sums as they may deem advisable, with the approval of said Howard G. Grey and Lizzie T. Grey, his wife, and Robert L. Scott and Ethel Grey Scott, his wife, or the survivors or survivor of them, for (1) the relief of persons of good character in needy circumstances, especially such as are loath to make their needs known or to solicit help from others; for (2) the assistance of young men and women who desire a collegiate education but have insufficient means to obtain it; for (3) the purpose of assisting worthy college students with transportation from their colleges to their homes and return during vacation periods. I direct my said Trustees to set aside out of said special fund sufficient money or property to enable them, in their judgment, to carry out the foregoing objects, and then to pay the remainder of said special fund annually for the period of twenty years from my death, (subject however, to the right of my said Trustees to discontinue such payments to any one or more of the beneficiaries and to substitute other beneficiaries in the place of those specifically named, as hereinafter provided) in the following proportions, to the following named institutions: [Then follows a list of eleven institutions, each of which is to receive fractional interests of 4/27ths, 2/27ths or l/27th “of the remainder of said special fund.”]
It is not my intention that the payments to be made by my Trustees out of the remainder of said special fund to the several institutions as set forth on pages eight and nine hereof shall be absolute and irrevocable gifts to such institutions, since it is possible that at a later time some of the said institutions may cease to exist or may be managed or operated in a manner that would not meet with my approval, if living. I therefore hereby give my said Trustees full power and authority to discontinue such payments to any one or more of the above named institutions at any time or times as they may deem advisable, and to substitute in lieu of any of the above-named institutions such other charitable institution or institutions as they may select as beneficiary or beneficiaries, provided, however, that before my said Trustees shall discontinue any such payments or shall substitute any other charitable institution or institutions for and in place of any of said beneficiaries, they shall first obtain the written approval of such act or acts by said Howard G. Grey and Robert L. Scott, or the survivor of them, if they, or either of them, be then living. In case any such payments shall be discontinued by my said Trustees at any time, as above provided, it shall be obligatory upon them to select some substitute charitable institution or institutions to receive the payments so discontinued, as I desire that all of the remainder of said special fund to be distributed to charitable institutions, and that no part of said special fund be allowed to accumulate as a part of the principal of said trust estate.

The testator further provided in subparagraph (e) of paragraph 23 of the will, with respect to the said trust, as follows:

(e) At the expiration of twenty years from the date of my death, I direct my said Trustees to divide and distribute the said trust estate in the following manner: One-fourth of said trust estate to my son, Howard G. Grey, and Lizzie T. Grey, his wife, or the survivor of them, but if neither of them shall then be living, then said one-fourth of said trust estate shall go to the children of said Howard G. Grey, in equal parts, the issue of any deceased child to have the parent’s share; one-fourth of said trust estate to my daughter, Ethel G-rey Scott, and Robert L. Scott, her husband, or the survivor of them, but if neither of them shall then be living, then said one-fourth of said trust estate shall go to the children of said Robert L. Scott and Ethel Grey Scott, in equal parts, the issue of any deceased child to have the parent’s share; and the remaining one-half of said trust estate shall be divided and distributed in the following manner, subject, however, to such change or changes of legatees as may be made by my Trustees, as hereinafter provided: [Then follows the same eleven institutions named in the will, each of which is to receive 4/27ths, 2/27ths or l/27th “of one-half of said trust estate.”]
The foregoing eleven institutions last above named are the same as the eleven institutions named as beneficiaries of the remainder of a certain special fund on page 4 of this instrument, and I hereby direct that in case any change or substitution of beneficiaries of the remainder of said special fund be made by my Trustees, then in the final distribution of said trust estate my Trustees shall make the same change or substitution with respect to those institutions which are to take the said remaining one-half of said trust estate; that is to say, at the time of the final distribution of said trust estate the institutions which shall take the said remaining one-half share of said trust estate shall he the same, and shall take in the same proportions as the beneficiaries of the said remainder of said special fund named on pages eight and nine hereof, but subject to all changes and substitutions of beneficiaries as shall have been made by my Trustees as aforesaid up to the time of the final distribution of said trust estate.

During tlie taxable year 1984, the testator’s widow, Anna L. Grey, his son, Howard G. Grey, and his son’s wife, Lizzie T. Grey, were dead. The petitioner, Charles F. Grey, therefore had %2 (% of (i/6 + i/12)) or a 4y6 percent interest in the income, as one of the six surviving children of Howard and Lizzie Grey.

For the taxable year 1934 the trustees filed a fiduciary return (Form 1041) of income, showing a net loss of $29,411.25. In this return they claimed a deduction of $26,744.64 for depreciation of trust property, and a deduction of $39,453.18 for contributions, detailed as follows:

Amount set aside for special charitable objects under paragraph 23 (e) page 8 of the Will--$6,000.00
Y. M. O. A. of Evanston- 5,273.70
Y. M. O. A. of Chicago_ 5,273. 70
Chicago Orphan Asylum_ 5,273.70
Evanston Hospital Association_ 5,273. 70
Home for Destitute Crippled Children_ 2,636. 86
Illinois Children’s Home_ 2, 636.86
Old-People’s Home- 2,626.86 [sic]
Baptist Missionary Training School_ 2, 636.86 .
Chicago Foundling’s Home_ 1,318.44
Chicago Refuge for Girls- 1, 318.44
Florence Crittenden Anchorage-- 1,318.44
Total- 41, 597. 56
Less: Distributed out of tax reserve — corpus_ 2,144,38
Net contributions_ 39,453.18

The trust return also reported a capital loss of $39,352.14. The trust estate had income available for distribution of $80,396.79 but actually distributed $83,195.13, shown as follows:

Dividends-$17,143. 50
Other taxable income_'— 58,995. 21
Exempt interest_ 3, 663. 08
Nontaxable Liberty bond interest_ 595. 00
80, 396. 79
Distributed from corpus- 2, 469. 31
Distributed, from tax reserve- 329. 03
83,195.13
One-half. 41, 597. 75
Reserved for taxes- $2,144. 38
Less special improvement taxes paid_ 1,815. 35
329.03

The trustees in their fiduciary return, reported distribution to taxable beneficiaries, as follows:

Total before depreciation. $41, 597. 57
Depreciation-_$26,744.64
U. S. interest-_ 595.00
Exempt interest — 1-_ 3, 663.08
Dividends-_ 8,125. 54
Corpus_ _ 2,469.31
41,597,57

There is no evidence showing how the exempt income was allocated on the boohs of the trust.

The Commissioner revised the depreciation deduction, downward, to $26,314.78, and in the notice of deficiency, increased dividend income by $35.82, representing the petitioner’s 8% percent interest in the adjustment of $429.86 for revised depreciation in the trust.

The parties have agreed that $26,314.78 is the correct allowance for depreciation; and for the purpose of this case, that the eleven institutions are devoted exclusively to one or more of the purposes specified in section 162 of the Revenue Act of 1934.

The respondent contends that the eleven charitable institutions are beneficiaries within the meaning of section 162 (b) of the Revenue Act of 1934, and that the amounts distributed to them are deductible under this section rather than under section 162 (a). The sections are'set out in the margin. He also contends that the allowable depreciation upon the trust property and the tax-exempt income received by the trust should be allocated equally between the taxable and nontaxable beneficiaries.

The petitioner contends that the payments made to the eleven charitable institutions are allowable in to to and without limitation as a deduction by the trust under section 162 (a); that section 162 (b) is not applicable to contributions made by an estate or trust; and that the tax-exempt interest of a trust is not allocable to any beneficiaries other than taxable beneficiaries.

There is no dispute as to the gross income of the estate or its allowable deductions, with the exception of the proper method of treating depreciation and tax-exempt interest. The controversy may be thus depicted:

Petitioners Respondent
2. Interest-$4, 004. 38 $4, 604. 38
3. Interest, 2% Tax Paid_ 3, 012.50 3,012. 50
6. Rents-63,433.48 63, 433.48
6. Capital Gain-(39, 314. 64) (39, 314. 64)
7. Dividends_ 17,143.50 17,143.50
8. Other Income_ 261. 72 261. 72
Total Gross Taxable Income. 49,140. 94 49,140. 94
11. Taxes Paid_ 1,168.38 1,168. 38
12. Depreciation (corrected)-26,314. 78 26,314.78
14. Contributions-39,453.18
15. Other Deductions_ 11,185. 99 11,185.99
Total Deductions_ 78,122.33 39, 673.15
Taxable Income_ (28,981.39) 9,467.79
Retained by the Trust Estate. 37, 536. 79 39,314. 64
Total Taxable Distributable Income. 8, 555.40 48, 782.43
Petitioners’ share 8%% (a)__ 712.95
Petitioners’ share 4%%_ (b) 2,032.60

[The above schedule is taken from petitioner’s brief. It does not accurately detail respondent’s contention but that will hereinafter be shown.]

The Commissioner originally treated the petitioner as being entitled to receive 4% percent of the total trust income, allowed him the benefit of 8% percent of the exclusion for exempt interest and permitted him to deduct 8y3 percent of the depreciation sustained on the trust property. He now contends that under the stipulated facts, the petitioner’s proper distributive share of the trust income is as follows:

Dividends, 4% percent of $17,143.50- $714.31
Exempt Interest, 4% percent of $3,663.08- 152.63
U. S. Interest, 4% percent of $595.00- 24- 79
Other Income, 4% percent of $58,995.21- 2,458.13

From this, he says, should be deducted 4% percent of the allowable depreciation of $26,314.78, or $1,096.45, and that his net taxable income should be recomputed as follows:

Other income_$2,458.13
Less depreciation- 1, 096. 45
-$1,361.68
Dividends- 714.31
Total_ 2,075.99

Stated simply, the first question is whether the portion of the gross income of the trust created by the grandfather of this petitioner, which was paid to organizations devoted exclusively to the purposes set out in section 162 (a), supra, should “be allowed as a deduction, * * * without limitation,” as provided in said section, or should “be allowed as an additional deduction in computing the net income of” the trust as provided in section 162 (b), supra.

Eespondent, in support of his contention that the deduction should be allowed under (b) rather than (a), refers to a general statement in “Bestatement of the Law, Trusts (1935) ” section 127, to the effect that: “A person is a beneficiary of a trust if the settlor manifests an intention to give him a beneficial interest * * *”, and says that, inasmuch as the organizations come within the general classification of “income beneficiaries”, the amounts paid to them “should be treated as amounts distributed currently to the beneficiaries.” Petitioner contends that both sections can not be applied to the same distributions ; that the distributions in question fall clearly within (a) ; and that (b) can not possibly be applied because it requires the am mint so allowed as a deduction to be included in computing the net income of the beneficiaries and, for income tax purposes, such organizations have neither gross income nor net income as such terms are used in the revenue act.

Both parties cite, upon brief, Continental Illinois Bank & Trust Co. v. United States, 18 Fed. Supp. 229, in which the question lurked but was not directly decided. In that case the will creating the trust directed that the trustees should reserve and set aside a certain percentage of the annual income as a building fund and as a protection against the impairment of the trust estate by accident or otherwise. Upon termination of the trust one-half of the corpus was to go to a hospital and for certain charitable purposes. During the taxable year the trustees credited to the reserve fund $44,000, one-half of which would inure to the benefit of the hospital. The Commissioner conceded that the $22,000 should have been allowed as a deduction under section 219 (b) (1) of the Revenue Act of 1926 which, in all essential particulars, is identical to section 162 (a), sufra. At the trial, however, the Government contended that the Commissioner had made another error in his computation, which allowed a deduction of the entire amount of depreciation sustained on the trust property whereas he should have allowed only that part of the depreciation which was allocable to the income retained by the trust and sustained on property other than that held for the hospital. As to this contention the court said:

We do not feel that it is necessary to enter into a discussion of this offset as presented by the defendant. The section allowing the charitable deduction, section 219 (b) (1) of the Revenue Act of 1928, 44 Stat. 32, provides that the deduction shall be allowed “without limitation.” If an adjustment is to be made which affects that allowance, it must be clearly shown that it does not do violence to that section which allows the deduction without limitation. Suffice it to say the Commissioner never made any determination on this point and it was first made in the trial of the case. The evidence produced is not sufficient to bear the burden which the defendant has of sustaining its contention by the preponderance of the evidence.

In Estate of Edward T. Bedford, 39 B. T. A. 1039 (appeal pending, C. C. A., 2d Cir.), we pointed out that subsection (a) of section 162, supra, was “entirely different in its purpose and effect from subsections (b) and (c) which follow” — a conclusion which is inescapable from a mere reading of the three sections. It may be added that it seems to be obvious that Congress had entirely different situations in mind in enacting them. In enacting (a) it intended to allow as deductions, without limitation, the amounts paid or permanently set aside for the prescribed — benevolent—purposes; but when it came to dealing with income “beneficiaries” generally, it had no such motive. It was merely being fair to the trust and the beneficiaries by making it definite and specific that tax should be paid but once.

Petitioner contends that respondent’s present contention is at variance with what he refers to as the “administrative construction for the past 19 years.” It is true that the instructions contained in the fiduciary returns prior to the year 1937 directed that there should be entered on line 14 of the return, under the heading “Contributions”, that “part of the gross income which, pursuant to the terms of the will or deed creating the trust, was during the accounting period paid or permanently set aside for the use of” organizations exempt from tax. This instruction was superseded in 1937 and subsequent years by one directing that Schedule A (Income) be filled out “to include as shares of beneficiaries, amounts of charitable contributions, which pursuant to the terms of the will or deed creating the trust are during the taxable year paid or permanently set aside as provided in Section 162 (a).” The change in the instructions does what the respondent is attempting to do in this proceeding — that is, consider all exempt organizations as “income beneficiaries” for the purpose of applying section 162 (b) which has the effect of denying a portion of the deduction specifically allowed to the trust under subsection (a). We are of the opinion that such a construction is unsound. We, therefore, decide this issue in favor of petitioner and hold that the payments made to the charitable institutions were properly deducted by petitioner from the gross income of the trust.

f We come now to a consideration of the depreciation issue. The ^parties agree that the total allowable depreciation upon the property ¡owned by the trust is $26,314.78. Petitioner contends that the entire 'amount is allocable to the taxable beneficiaries. Since the taxable jbeneficiaries receive one-half of the total income of the trust he ¡contends that he is entitled to 8% percent of the depreciation whereas ■respondent contends that he is entitled to only 4% percent.

The applicable statute is section 23 (1) of the Eevenue Act of 1934. The italicized portion first appeared in the Eevenue Act of 1928. Under prior acts it had been held that if there was no requirement in the trust instrument or the law of the state for setting up a depreciation reserve and the income was currently distributable to the beneficiary, he (the beneficiary) was not entitled to the deduction for depreciation. United States v. Blow, 77 Fed. (2d) 141. In such a case the deduction was allowable to the trustee; but it was useless to him since he had no income against which it could be applied. The sentence was added for the purpose of eliminating this unfairness.

The use of the words “income beneficiaries” in this section is seized upon by the petitioner. He, in his argument upon this phase of the proceeding, would interpret the expression as if it were “tmahle income beneficiaries.” Eespondent, on the other hand, claims to find in the expression used in this section some support for his theory that charitable organizations should be construed to be “income beneficiaries” in every sense of the word so as to allow the deduction under (b) instead of (a). This contention we have found to be unsound; but petitioner’s present contention is equally unsound.

The hearings do not indicate that Congress was attempting to revise the whole theory and concept of taxing trusts and trust income, or in allowing depreciation upon trust property. It was conscious of an inequity which was resulting from the application of the existing law. It, therefore, undertook to remove this inequity by providing, in effect, for apportionment of the allowable deduction between the income beneficiaries and the trustee. But in removing this inequity it did not intend to create another at the expense of the revenue. Yet that, in effect, is what petitioner contends occurred. He would have us construe the statute to mean, not that there should be an equitable apportionment of depreciation between the beneficiaries and the trustee, but an inequitable one between those enjoying the bounty of the settlor. We do not believe that Congress ever intended any such result or expected that any construction of the language used would be made which would have that effect. This petitioner, in effect, says: “Even though I receive but 4% percent of the income I desire to have allocated to me 8% percent of the deduction for depreciation.” While we have refused to classify charitable organizations as income beneficiaries for the purpose of limiting the deduction from gross income by section 162 (b), we feel that they should be so classified under the amendment of 1928 to section 28 (1). After all, the charitable organizations were collectively receiving 50 percent of the income of the trust. The theory of all the revenue acts is that the income of a trust “shall be computed in the same! manner and on the same basis as in the case of an individual” except as otherwise provided in section 162. If, therefore, we take the general rule and apply the amendment of 1928, we compute the income of the trust in the same manner that we would compute the income of an individual, apportioning it between the income beneficiaries (both the taxable ones and the charitable organizations) and the trustee on the basis that the trust income is allocable to each. We, therefore, allow, under the stipulated facts, all of the depreciation to the income beneficiaries, which complies literally with the statute, and the fact that some of them are taxable and some are not is entirely beside the point.

Petitioner argues that the words “without limitation” appearing in section 162 (a) preclude; us from doing what we have indicated we think should be done, but we do not so construe these words. When they are examined in their context it is obvious that they were used merely to direct that a trust, more than 15 percent of the income of which was used for the prescribed — charitable—purposes, should not be limited to “15 percentum of the taxpayer’s net income” as provided in section 23 (o). The parenthetical clause of section 162 (a), we think, clearly justifies this conclusion. We, therefore, sustain the respondent upon this issue and hold that petitioner is entitled to deduct only 4% percent of the depreciation sustained upon the trust property.

The remaining question is whether the tax-exempt income is al-locable between the taxable and nontaxable beneficiaries (the recipients of the contributions) as contended by the respondent or whether, as petitioner contends, all of it must be allocated to the taxable beneficiaries. Petitioner argues that inasmuch as contributions are deductible from gross income while tax-exempt interest is not to be included in gross income, if an allocation is made, the net result is the same as if a portion of the tax-exempt income be included in gross income or the deduction of a portion of the contributions be denied. The construction urged by the respondent seems to be the more reasonable. The trust instrument contains no direction that the exempt income be distributed only to the taxable beneficiaries and there is nothing in the stipulated facts to show even that the trustees attempted to make any allocation. All of the income of the trust was available for distribution and apparently was distributed.

The courts and this Board have approved proration of earnings, Edwards v. Douglas, 269 U. S. 204; Mason v. Routzahn, 275 U. S. 175; Donahue v. United States, 58 Fed. (2d) 463; Peter W. Rouss, 4 B. T. A. 516; affd., 30 Fed. (2d) 628; certiorari denied, 279 U. S. 853; Harry A. Moody, 9 B. T. A. 631; Norwich Woolen Mills Corporation, 18 B. T. A. 303; allocation of cost between two classes of stock, Acme Manifolding Co., 24 B. T. A. 429; and proration of taxes, Paso Robles Mercantile Co., 12 B. T. A. 750; affd., 33 Fed. (2d) 653; certiorari denied, 280 U. S. 595. In Minnie L. Wolf, 32 B. T. A. 959; affd., 84 Fed. (2d) 390, there was included in the gross income of a legatee so much of the interest distributed by the estate as was proportionate to the taxable income of the estate and the same method was followed in connection with the income of a trust in J. Cornelius Rathborne, 37 B. T. A. 607; affd., 103 Fed. (2d) 301.

Under the stipulated facts we hold that the Commissioner must be sustained in allocating the tax-exempt and taxable income between the taxable and nontaxable recipients of it.

Judgment will be entered wnder Bule 50.

       SEC. 162. NET INCOME. '
      The net income of the estate or trust shall be-computed in the same manner and on the same basis as in the case of an individual, except that—
      (a) There shall be allowed as- a deduction (in lieu of the deduction for charitable, etc., contributions authorized by section 23 (o))'any part of the. gross income,..¡without limitation which pursuant to the terms of the will or deed creating the trust, is during the taxable, year paid or permanently set aside for the purposes and in. the manner,specified in section 23 (o), or is to be used'exclusively "for religious,' charitable,' scientific. literary, or educational purposes, or tor the prevention of cruelty to children or animals, or for the establishment, acquisition, maintenance or operation of a public cemetery not operated for profit;
      (b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. Any amount allowed as a deduction under this paragraph shall not be allowed as a deduction under subsection (c) of this section in the same or any succeeding taxable year.

       (1) Depreciation. — A reasonable allowance for the exhaustion, wear and tear of property used in the trade or business, including a reasonable allowance for obsolescence. * * * In the ease of property held in trust the allowable deduction shall be apportioned between the income beneficiaries and the trustee in accordance with the pertinent provisions of the instrument creating the trust, or, in the absence of such provisions, on the basis of the trust income allocable to each. [Italics supplied.]

       Hearings before Ways and Means Committee on Revenue Revision, 1927-1928, p. 476.


author: Leech:

text:
    Walter C. Hill, Petitioner, v. Commissioner of Internal Revenue, Respondent. Helen Hill Macpherson, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 97981, 97982.
    Promulgated February 1, 1940.

      Charles M. Trammell, Esq., Donald McGovern, Esq., and Neil W. Oakes, C. P. A., for the petitioners.

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

Leech:

Section 114 (b) (4) of the Revenue Act of 1934, so far as material, reads as follows:

A taxpayer making Ms first return under this title in respect of a property shall state whether he elects to have the depletion allowance for such property for the taxable year for which the return is made computed with op without regard to percentage depletion, and the depletion allowance in respect of such property for such year shall be computed according to the election thus made. If the taxpayer fails to make such statement in the return, the depletion allowance for such property for such year shall be computed without reference to percentage depletion. The method, determined as above, of computing the depletion allowance shall be applied in the case of the property for all taxable years in which it is in the hands of such taxpayer, or of any other person if the basis of the property (for determining gain) in his hands is, under section 113, determined by reference to the basis in the hands of such taxpayer, either directly or through one or more substituted bases, as defined in that section.

The 1936 Act, in section 114 (b) (4), contains identical language with the addition of the following:

The above right of election shall be subject to the qualification that this paragraph shall, for the purpose of determining whether the method of computing the depletion allowance follows the property, be considered a continuation of section 114 (b) (4) of the Revenue Act of 1934, and as giving no new election in cases where such section would, if applied, give no new election.

The cases of Riley Investment Co. v. Commissioner, 108 Fed. (2d) 713, and Dorothy Glenn Coal Mining Co., 38 B. T. A. 1154, are fatal to petitioners’ contention. Those cases hold that the failure to make an election of percentage depletion in the first return filed under the new law prevents the taxpayer from thereafter taking a deduction computed with reference to percentage depletion.

Petitioners are not aided, moreover, by Mead Coal Co. v. Commissioner, 106 Fed. (2d) 388, reversing 38 B. T. A. 1163, or by Haggar Co. v. Helvering, 308 U. S. 389. In both of these cases it was held that an amended return would be effective to remedy a failure to elect on the original return, provided the amendment was timely. In the circumstances of the Haggar case, “timely” meant filed before any return was due under the statute. In the Mead Coal Co. case an amendment was held to be timely when filed before returns for the succeeding taxable year became due.

Under the statutory terms (supra), in order to be effective, petitioners’ election of percentage depletion had to be made, certainly, not later than in their returns for 1935, which were due March 15, 1936. Revenue Act of 1934, sec. 53 (a) (1). Mead Coal Co. v. Commissioner, supra. Here, no amendment was attempted until January 11, 1939, when petitioners filed amended returns for 1934, 1935, and 1936. In the original returns for each of those years, no election was made. Obviously, therefore, we think that the amended returns were not “timely.”

It follows that petitioners are not entitled to percentage depletion.

Decisions will be entered for the respondent.


author: SteRnhagen :

text:
    Ben Grote, Petitioner, v. Commissioner of Internal Revenue, Respondent. Bessie D. Grote, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 94442, 94443.
    Promulgated February 1, 1940.

      George W. Roberts, Esq., and Maurice R. McMichen, Esq., for the petitioners.

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

SteRnhagen :

The taxpayers were wheat farmers and as shown by the evidence they bought and sold wheat futures on the Chicago Board of Trade entirely for the purpose of protection against pricei fluctuation. They were not speculators in the grain market as was the taxpayer in Staerker v. United States (U. S. Dist. Ct., N. Dist. of Texas, Sept. 23, 1938), or on the stock exchange as in O. L. Burnett, 40 B. T. A. 605. All of their transactions were related to their business of production and sale. They had books of account which included inventories and apparently the only reason that there were no inventories at the beginning and end of 1935 was that no wheat and no wheat contracts were on hand on those dates. Whether it would be sensible to include in such, an inventory wheat covered by a contract for future delivery, we do not know. See G. C. M. 18658, C. B. XVI-2, p. 77; Paul and Mertens, sec. 13.43; id. 1939 C. S., sec. 13.43.

The Commissioner has interpreted and administered section 117 as excluding hedging transactions, G. C. M. 17322, C. B. XV-2, p. 151, and the evidence shows that petitioners’ transactions were all hedging transactions. The Commissioner seems, as indicated by the deficiency notice, to have thought that petitioners’ transactions were merely speculations in future contracts having no relation to their production business. This being untrue, the determination is reversed.

Reviewed by the Board.

Decision will ~be entered under Rule 50.

Him dissents.

DisNey concurs only in the result.


author: Van Foss an : Leech,

text:
    S. E. & M. E. Bernheimer Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88978.
    Promulgated February 1, 1940.

      Wiíbwr H. Friedman, Esq., for the petitioner.

      F. S. Gettle, Esq., for the respondent.
   OPINION.

Van Foss an :

The statutory provisions covering the liability for the payment of real estate taxes in New York City here involved, as set forth in chapter 17 of the Charter of the City of New York, as amended by the Laws of New York, 1935, chapter 713, appear below.

The first issue in the case is whether certain taxes on real estate owned by the petitioner and situated in New York City are properly accruable on October 1,1935, as asserted by the respondent, or within the petitioner’s fiscal year which ended on September 30, 1935, as contended by the petitioner.

The Board has held in certain cases that taxes accrue on the date when they become a lien on the property. See Minnie M. Coward, 39 B. T. A. 1158, and cases there cited. This is not, however, a test of universal applicability. Henry J. Burchell, Jr., Executor, 41 B. T. A. 55. In the last cited case it was held, under a statute which made no specific provision for a lien but which provided that “all taxes on the tax roll shall be due and payable on the date of the warrant annexed thereto”, that the annexing of the warrant was the event which fixed the amount of the tax and determined the liability of the taxpayer to pay it in accord with the principles announced in United States v. Anderson, 269 U. S. 422. In the Anderson case the Supreme Court observed:

Only a word need be said with, reference to the contention that the tax upon munitions manufactured and sold in 1916 did not accrue until 1917. In a technical legal sense it may he argued that a tax does not accrue until it has been assessed and becomes due; but it is also true that in advance of the assessment of a tax all the events may occur which fix the amount of the tax and determine the liability of the taxpayer to pay it. In this respect, for purposes of accounting and of ascertaining true income for a given accounting period, the munitions tax here in question did not stand on any different footing than other accrued expenses appearing on appellee’s boohs. In the economic and boohkeeping sense with which the statute and Treasury decision were concerned, the taxes had accrued.

The statutes here involved provide for the delivery to the board of aldermen on March 1 of the certified assessment rolls, the fixing by the board of the tax rate, the extension of the amounts to be paid, and the delivery to the city collector on or before March 20 of the assessment rolls, with collection warrants annexed. They further provide that all taxes upon real estate for 1935 and 1936 shall be due and payable in two installments, respectively, April 1 and October 1, and that such taxes shall be and become liens on the respective days when they become due and payable and not earlier, provided, however, that if there be no delinquent taxes a taxpayer may anticipate later payments and pay any subsequently due payment at the time of mating the first payment, or at any time prior to October 1, and receive a discount thereon. It is stipulated as a fact that the tax bills are sent to the taxpayers during the month of March.

In the light of these statutory provisions, certain conclusions emerge. It is obvious that before the end of March when the tax bills are sent out all the events “which fix the amount of the tax and determine the liability of the taxpayer to pay it” have occurred, thereby satisfying the test laid down in United States v. Anderson. It is equally clear that although the second half of the taxes is not technically “due and payable” until October 1, this provision loses all force if the taxpayer elects to anticipate the due date and pay the second half before October 1. From this it'also follows that the fact that a lien for the second half does not attach until October 1, can not in this case be controlling. If a taxpayer paid the second half of his taxes before October 1, no lien would ever attach.

Turning to the facts, we find that the taxes due from petitioner on October 1, for the period July 1 to September 30,-1935, as to property involved in the first issue had been finally fixed and determined in March. Taxpayer had received official notice of the same in the form of a bill from the collector, dated March 26,1935. The tax bill, on its face, carried notices of the right to anticipate payment. Though they were not technically due until October 1, petitioner, in the light of the facts, accrued them on its books prior to that date. This action we believe to have been proper and to have been in accord with the principles of accrual accountancy. See United States v. Anderson, supra. On this point we reverse the Commissioner.

Passing to the second issue involving taxes on the 255 West 88th Street property, we find the facts to argue even more strongly for the taxpayer. The deduction of the taxes here in question was approved by the respondent in his notice of deficiency, claim of error therein being asserted in the amended answer in this proceeding. The facts are that the taxes had been officially determined and notice thereof sent to taxpayer according to the statute. Petitioner, pursuant to an arrangement with the state mortgage commission, had paid the taxes in controversy to the commission during July, August, and September and the mortgage commission had paid the same to the city collector prior to October 1. This payment was authorized by statute and forestalled the attaching of a lien. Clearly, petitioner was justified in accruing such taxes on its books prior to October 1. It was equally justified in claiming a deduction of such taxes as taxes paid or accrued during the period ending September 80, 1935. Only by such a treatment would the taxpayer’s return accurately reflect income for the period in question.

In the light of the facts and the conclusion reached above, it is unnecessary to discuss petitioner’s alternative contention that the taxes so paid were deductible as business expenses.

Reviewed by the Board.

Decision will be entered under Bule 50.

Leech,

dissenting and concurring: On the first point I respectfully dissent. Taxes, like any other obligation, are accruable by a taxpayer on the accrual basis when they become “due and payable.” Any other conclusion would permit the double deduction of taxes by a grantor of real estate on the accrual basis and a grantee on the cash basis — an anomalous and impossible result. The contested taxes did not become “due and payable” until after September 30, 1935. See I. T. 2834 (C. B. XIII-2, p. 189, 1934). It follows that these taxes were not accruable and, therefore, not deductible for the period ending October 1,1935.

I concur with the result the majority reaches on the second point, on the ground that the amounts in controversy, if not deductible as taxes accrued, were so, at least, as ordinary and necessary expenses of the taxpayer.

Black and Offer agree with this dissent.

       Sec. 895: Tie taxable status of all real property assessable for taxation in the City of New York shall be fixed for the succeeding fiscal year on the first day of October in each year; * * *.
      Sec. 896: * * * Such deputies [tax commissioners] shall commence to assess real estate on the first day of April in each year, not a Sunday or legal holiday.
      * * # * * * *
      Sec. 908: As soon as such rolls are completed the board shall annex to each of such rolls its certificate that the same is correct in accordance with the entries and corrected entries in the several books of annual record. The rolls so certified must, on the first day in March in each year, not a Saturday, Sunday or a legal holiday, be delivered by the board of taxes and assessment to the board of aldermen, * * *.
      * * * * * * *
      Sec. 921: The board of aldermen shall meet not later than the third day in March which is not a Saturday, Sunday or a legal holiday, to fix the annual tax rate. * * *
      Sec. 922: At such annual meeting the board of aldermen must set down in the assessment-rolls, opposite to the several sums set down as the valuation of real property, the respective sums, in dollars and cents, to be paid as a tax thereon, rejecting the fractions of a cent. * * *
      Sec. 923: Immediately upon the completion of the assessment-rolls, the city clerk shall procure the proper warrants authorizing and requiring the city collector to collect the several sums therein mentioned according to law and to pay the same from time to time, when so collected, to the chamberlain of the city. * * * immediately thereafter and on or before the twentieth day of March, the assessment-rolls * * * shall be delivered by the president of the board to the city collector with the proper warrant or warrants * * * annexed thereto.
      Sec. 924: All taxes upon real estate for each of the years nineteen hundred thirty-five and nineteen hundred thirty-six shall be due .and payable in two equal installments, the first of which shall be due and payable on the first day of April in such year and the second of which shall be due and payable on the first day of October in such year. * * *
      All taxes shall be and become liens on the real estate affected thereby and shall be construed as and deemed to be charges thereon on the respective days when they become due and payable and not earlier and shall remain such liens until paid.
      Any installment of taxes on real estate which is due and payable on any date subsequent to the date upon which the first installment shall become due and payable, may be paid on the date when the first installment becomes due and payable or at any time thereafter provided all prior installments shall have been paid or shall be paid at the same time, and on such payment of such subsequent installment prior to the date upon which it becomes due and payable, a discount shall be allowed from the date of payment to the date when such installment would otherwise be due and payable at the rate of four per centum per annum.


author: Hill:

text:
    Farmers & Ginners Cotton Oil Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93436.
    Promulgated February 6, 1940.

      E. L. All, Esq., A. J. Bowron, Jr., Esq., and Virden Moore, Esq., for the petitioner.

      Stanley B. Anderson, Esq., for the respondent.
   OPINION.

Hill:

The petitioner contends that the losses it sustained in its dealings in refined oil futures were normal business losses. This claim is based primarily upon the broad hypothesis that the initial processing of raw cottonseed is so related to the manufacture of refined cottonseed oil as to make stocks of the latter product invoiceable 'as regular “stock in trade” of the processor. Secondarily, the petitioner contends that, in any event, its dealings in oil futures were transactions entered into for profit and that the resulting losses are deductible under section 23 (f) of the Revenue Act of 1934 as having been sustained during the taxable year and not compensated for by “insurance or otherwise.”

The respondent concedes petitioner’s loss but contends that its investments in refined oil futures were capital assets within the definition set out in paragraph (b) of section 11T, Revenue Act of 1934, as follows:

(b) Definition of Capital Assets. — Por the liurposes of this title, “capital assets” means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.

If the respondent is correct in his classification of these assets, his holding must be sustained since the law limits deductions for losses from sales or exchanges of capital assets to $2,000, plus gains from such transactions. Sec. 117 (d), Revenue Act 1934; Joseph R. Seeds, 37 B. T. A. 705. In this proceeding the burden is upon petitioner to show that respondent’s classification is incorrect. Lightsey v. Commissioner, 63 Fed. (2d) 254.

The definition quoted identifies as “capital assets” property held by a taxpayer “whether or not connected with his trade or business”, except stock in trade, property includable in the inventory of the taxpayer if on hand at the close of the taxable year, or property held “primarily for sale to customers in the ordinary course of his trade or business.” The petitioner claims that the assets here involved were held under these excepted categories, and that its loss resulted from their “sale in the regular course of its business.”

On the first point petitioner sets forth its contention in its brief as follows:

It is the primary contention of tbe taxpayer that its transactions in refined oil futures were essentially a part of a process of production or other acquisition of property for sale to customers in the ordinary course of its trade or business. Correspondingly, we urge that we are not dealing with capital assets, and that losses sustained are not subject to those provisions of the Revenue Act of 1934 relating to capital losses. * * *

On brief the petitioner argues two grounds to justify its claims as a manufacturer of and/or dealer in refined cottonseed oil. The first ground is based upon the theory that the manufacture of crude cottonseed oil, being the initial and first essential step in the manufacture of the refined product, makes the processor of the first a part manufacturer of the latter. It urges in further support of this theory that refined oil is crude oil subjected to further processing and that they are essentially the same commodity in a slightly different form, refined oil being the only commercially usable form, and that, therefore, they may be interchangeably carried as stocks in trade in its invoice. We think it unnecessary to consider the theory upon which this first ground is based, because the record negatives its application to petitioner’s business. The positive proof here shows that the petitioner operated what is known as an “independent cotton seed mill” without connection with or interest in refineries or the business of refining cottonseed oil. Crude oil was but one of the several products of its mill and, as were its other products, was sold for cash. True, extracting the crude oil from the seed is a step in manufacture of refined cottonseed oil and the two processings might properly be carried on as a single business, but they are separate and distinct steps, performed with different equipment and machinery and each may be conducted as a business unto itself, separate and distinct from the other. The record shows that petitioner operates an independent mill and is in no sense a refiner of crude oil, and we so hold. We also hold against petitioner’s view that crude cottonseed oil and the refined product are essentially one and the same commodity. Petitioner cites G. C. M. 1582, (C. B. VI-1, p. Ill) to support its contention that refined products may be carried in the invoice of the producer of the crude from which it was manufactured, in substitution for the latter, but that ruling has no application to our facts. The ruling dealt with the case of a copper mining company which exchanged its mine output of crude ore currently as mined for prices payable in copper metal from a smelting company which bought and refined the ore. The taxpayer (mining company) there derived its income from sales of the metal received for its ore and maintained regular sales agencies for disposal of the same. Being an active dealer in refined copper, upon an accrual basis, the ruling consistently held that that taxpayer should include in its year-end invoice, as accounts receivable for copper “in kind” at then market prices, all undelivered copper owing to it by the smelting company. We agree with that ruling but find no support for petitioner’s position in it. The petitioner next argues that the established custom of its business, as followed by it and other operators of “independent cotton seed mills”, justifies transactions in refined oil futures, as here carried on by it as necessary to a stabilization of marketing its crude oil. Under the facts here petitioner asserts that its purchases of refined oil futures amounted to “the purchase of refined oil” or “a purchase of property for sale to customers in the ordinary course of its business.”

Whatever justification the entering into of these transactions may have had from the standpoint of business necessity or custom, it is clear from the record that petitioner acquired through them no property which it held for sale to customers. It contends that the contracts amounted to purchase of refined oil, but we think otherwise. Such transactions were mere executory contracts to purchase, which it acquired with a positive intent not to close into completed purchases and not to acquire any specific commodity through them. Such conclusion as to petitioner’s intent in the premises is inescapable from explanations made by its manager while testifying at the hearing. Typical is the answer made by the witness to a question asking him to explain the oft-repeated statement to the effect that through these transactions in futures crude oil sold was replaced by refined oil. The question and answer are as follows:

Member : You talked about replacing it with refined oil. Do you take delivery, actual delivery, of the refined oil that you bought on futures?
Witness: No, sir, we did not. That would put us back in about the same position as if we would have the refined. We would have the actual oil on hand, which we would have to buy, and it is cheaper to carry it in the crude than in the refined oil.

That in such transactions the petitioner was speculating on the ultimate liquidation of its contracts, and not on commodities “in kind”, is shown from these further answers of the witness to questions as follows:

Member: You made a settlement of these futures purchases on the basis of the difference in the market price at the effective date of the futures purchased, and the price you paid for it?
Witness: Of course, you have the right to demand delivery, and if you do not want delivery, if at that time there was a satisfactory market on which to sell that contract, we would sell it, but otherwise if it was not, we might transfer it into a forward position which we do at times, still further. At the final date you do take your loss or your profit, whichever it is.
Member: And your losses involved in this proceeding are losses that were sustained by reason of your transactions in these futures?
Witness: That is right.

In such cases it is “intent” which determines the character of transactions. United States v. Amalgamated Sugar Co., 72 Fed. (2d) 755; Marengo Abstract Co. v. Hooper & Co., 174 Ala. 497; 56 So. 580; Shannon v. McClung, 210 Ala. 273; 97 So. 840; Smith et al. v. Odell, 21 Ala. App. 358; 108 So. 400; Willard Pope, 28 B. T. A. 1255. Petitioner cites the latter case and also United States v. Amalgamated Sugar Co., supra, in support of its contention, but in each of those cases the facts differed fundamentally from the facts here and the decisions therein sustain the legal principle respecting “intent” which we here apply. The petitioner at no time during the taxable year acquired or held refined cottonseed oil for sale to customers in the regular course of its business or at all. We hold against it upon that contention.

The petitioner advances another ground for claiming these losses as related to its mill business. It claims that transactions in refined oil futures, as here carried out, supply a needful protection to such business to the same end and purpose that a business “hedge” serves manufacturers and dealers in like situations. The petitioner, in its briefs, disclaims any contention that its transactions in controversy are within all requirements of a technical business hedge, but argues in effect that they fulfill all substantial requirements of hedges, subserve the same purpose, and are as legally applicable to its business, and, therefore, should be treated under the same rule in case of losses. Seduced to its essence petitioner’s contention here is that necessity and custom made transactions in refined oil futures a regular part of its ordinary business. In our opinion the record does not support such claim. True, the evidence shows that in marketing its crude oil the petitioner’s business was in need of protection against fluctuating prices, but it is obvious that transactions entered into after its raw stocks were bought, processed, the crude extracted and sold, and profits or losses attributable to it made determinable, could.serve no such purpose. While the purpose of the transactions in refined, oil futures contracts was to counterbalance the market hazards in relation to crude oil, such transactions were independent of the petitioner’s crude oil marketing operations and involved their own hazard of losses and chance of gain. Petitioner’s “forward” purchases were not made when its raw stocks were acquired and its investment therein put at risk in its business. They were made after such stocks were liquidated and the turn-over in capital invested therein was complete. The transactions in futures contracts were entered into for profit, subject to the risk of loss instead of gain, but the gain or loss realized thereon in no way resulted from or was attributable to petitioner’s operations in buying its raw materials, processing same, and marketing its products. The amount of gain or loss realized by petitioner on the sale of crude oil did not affect and was not affected by the amount of gain or loss realized by it on its transactions in refined oil futures.

We hold that petitioner’s transactions in refined oil futures contracts were not a part of its business as operator of its cottonseed oil mill.

Referring to the remaining contention of petitioner we agree that its loss here in question resulted from transactions entered into for profit during the taxable year, and that they were not compensated for by insurance or otherwise, but this does not dispose of the issue in its favor. Petitioner’s loss resulted from sale of contracts in futures which respondent contends were capital assets under section 117, supra. Subdivision (b) of that section defines as “capital assets” all property held by a taxpayer except (1) stock in trade of the taxpayer, (2) other property which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, and (3) property held by the taxpayer primarily for sale to customers in the ordinary course of business.

It is readily apparent from the facts here that the futures contracts were neither stock in trade of petitioner nor held by it for sale to customers in the ordinary course of business. This being true, they would not properly be includable in petitioner’s inventory if on hand at the close of the taxable year.

Regardless of whether petitioner’s transactions in such futures contracts constituted a trade or business, such contracts were nevertheless capital assets within the definition of section 117 (b), supra. Such contracts were choses in action bought and sold only on a produce exchange through brokers. Petitioner bought and sold such futures contracts on its own account only and not for customers. It held no oil futures in stock for sale to customers and, therefore, had no right to include them in an inventory. Cf. Francis M. Weld, 31 B. T. A. 600; Adirondack Securities Corporation, 23 B. T. A. 61; Oil Shares, Inc., 29 B. T. A. 664. We sustain respondent’s determination herein.

Decision will he entered for the respondent.


author: Black:

text:
    Charles Pettit, Petitioner, v. Commissioner of Internal Revenue, Respondent. Bertie Pettit, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 94292, 94293, 94799, 94800.
    Promulgated February 6, 1940.

      W. B. Harrell, Esq., Russell Allen, Esq., and Albert G. Moss, G. P. A., for tbe petitioners.

      James H. Yeatman, Esq., M. L. R. Wade, Esq., and James L. Baekstrom, Esq., for tbe respondent.
   OPINION.

Black:

The material provisions of section 117 of the Revenue Acts of 1934 and 1936 are identical and are set out in the margin. Petitioners contend that the rights and estates held by them by virtue of the 31 oil payment contracts are “capital assets” as that term is defined in section 117 (b); that the profits resulting from the sales of oil in connection with these contracts should be taken into account in computing net income at the percentages mentioned in section 117 (a), depending upon the length of time the contracts have been held; and that in computing the profits resulting from the sales of oil, petitioners are entitled to have the gross proceeds received by them reduced by cost or percentage depletion, whichever is greater. The respondent, in determining the deficiencies, has reduced the gross proceeds received by petitioners by cost or percentage depletion, whichever is greater. He contends that petitioners have not sold or exchanged capital assets and are not, therefore, entitled to the benefits of section 117, and that his determinations of the deficiencies are correct. He further contends as an alternative, that if the Board should hold that petitioners are entitled to the benefits of section 117, then the gross proceeds received should only be reduced by a proportionate part of the cost of the contracts, and that the deductions for depletion which he has allowed should be disallowed. The parties are in agreement as to the amount of taxable net income from the sales of oil in connection with the 31 oil payment contracts for each of the taxable years involved under either the petitioners’ contention or the respondent’s alternative contention, which taxable net income, compared with the respondent’s determination, is as follows:

The term “capital assets” is defined by section 117(b) to mean “property held by the taxpayer” exclusive of three classifications of property, namely, (1) stock in trade, (2) property of a kind which would properly be included in the inventory, and (3) property held primarily for sale to customers in the ordinary course of the taxpayer’s trade or business. The respondent does not seriously contend that the “property held by the taxpayer” falls within any of the three classifications specifically excluded, and, under the view which we take, it will not become necessary to decide whether the “property held by the taxpayer” does or does not fall within any of the three classifications specifically excluded from the term capital assets. The respondent contends that the “property held by the taxpayer” consisted of the 31 oil payment contracts, vesting in petitioners an economic interest in a certain amount of oil in the ground, and that no part of this property, as such, was either sold or exchanged by petitioners during the taxable years in question. If any “property” were sold, the property sold was the oil itself, rather than the economic interest in the oil, and although some of the oil was run into storage tanks prior to its sale, it is not petitioners’ contention that any of the oil sold had been held in the storage tanks for more than one year prior to its sale. But as will be explained later in this opinion, we think the proceeds received by petitioners should be classed as “income * * * growing out of the ownership or use of or interest in * * * property” father than “gains” from the sales of property. (Words within quotation marks are taken from section 22(a), Bevenue Acts of 1934 and 1936.)

The respondent says in his brief, “If petitioners had sold their contracts outright, we would then agree that they were entitled to the benefit of the capital gain provisions * * Such a situation would be controlled by Anderson v. Commissioner, 81 Fed. (2d) 457, reversing SO B. T. A. 597. But petitioners did not sell their economic interests in the oil in place. They retained those interests, diminished, of course, from time to time by depletion, and merely enjoyed the income which those interests produced. This, we think, is the deciding factor in the case. We do not think there is any difference in substance between the proceeds which petitioners received by virtue of their ownership of the several economic interests, and the bonus payments which Harmel received in Burnet v. Harmel, 287 U. S. 103. In that case Harmel was the owner in fee of Texas oil lands. He executed oil and gas leases of the lands for a stated period in return for bonus payments, aggregating $57,000 in cash, and stipulated royalties, measured by the production of oil and gas by the lessee. The question there was whether under the Bevenue Act of 1924, the bonus payments of $57,000 were “gain from the sale or exchange of capital assets.” The Supreme Court was of the opinion that the payments (both bonus and royalties) by the lessee to the lessor were not a conversion of capital, as upon a sale of capital assets, but were income to the lessor, like payments of rent. It did not think that the treatment of the payments as income produced the kind of hardship aimed at by the capital gains provision of the taxing act, as the abstraction of the oil from the soil was a time-consuming operation and the payments made to the lessor did not normally become payable as the result of a single transaction within the taxable year, as in the case of a sale of property. It said that the statute speaks of a “sale” and that the leases there in question would not generally be described as a “sale” of the mineral content of the soil, using the term in its technical sense or as it is commonly understood. Finally, the Supreme Court noted that the court below thought that the bonus payments, as distinguished from the royalties, should be treated as capital gain, apparently because it assumed that the statute authorized a depletion allowance upon the royalties alone, an assumption which later proved to be incorrect. Cf. Murphy Oil Co. v. Burnet, 287 U. S. 299. It said it could see no basis for such a distinction, and that:

Bonus and royalties are both consideration for the lease, and are income of the lessor. We cannot say that such payments by the lessee to the lessor, to be retained by him regardless of the production of any oil or gas, are any more to be taxed as capital gains than royalties which are measured by the actual production.

Although the Harmel case was decided under the Revenue Act of 1924, there are no provisions in the Bevenue Acts of 1934 and 1936 which would require any different holding on the same set of facts as were there involved. In the instant proceedings, the proceeds received and to be received by petitioners are as much of a time-consuming operation as was the receipt of income by Harmel from his leases. Pettit testified that it would take from three to thirty years to realize all that he hoped to realize from his contracts. Furthermore, there can be no question as to petitioners’ rights to depletion deductions against the gross proceeds received by them. By virtue of their 31 oil payment contracts, they acquired for a capital outlay such an economic interest in the oil as under Palmer v. Bender, 287 U. S. 551, and Thomas v. Perkins, 301 U. S. 655, entitles them to the statutory depletion allowance. The respondent in his determinations has granted them this allowance and in his brief states, “if income is subject to depletion it cannot be classed as capital gain.” There is merit in this statement, we think. Cf. F. H. E. Oil Co., 41 B. T. A. 130.

In his determination of the deficiencies in these proceedings, respondent has included the entire amount received under the various contracts in gross income and has allowed, as deductions against such gross income, cost or percentage depletion, whichever.is the greater. This is the same method that we directed should be used as to receipts from the Fox lease oil payment contract involved in F. H. E. Oil Co., supra. Depletion is a deduction from gross income. The latí er term includes “gains” from the sales of property and also “income * * * growing out of the ownership or use of or interest in * * * property.” See sections 22 (a) and 23 (m) of the Revenue Acts of 1934 and 1936. The amount of the “gain” from the sale of property is determined under section 111 (a) of the Revenue Acts of 1934 and 1936 and “shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113 (b) * * Congress certainly did not intend to reduce the “amount realized” on a sale by the “adjusted basis’? and then, on top of that, allow the taxpayer a deduction for depletion. Cf. Columbia Oil & Gas Co., 41 B. T. A. 38. So, if it is clearly established, as it has been in these proceedings, that petitioners are entitled to deductions for depletion, then it is our opinion that the proceeds received by petitioners must be classed as “income * * * growing out of the ownership or use of or interest in * * * property” rather than “gains” from the sales of property.

The Circuit Court of Appeals for the Fifth Circuit, in the case of Dearing v. Commissioner (1939), 102 Fed. (2d) 91, affirming Willis R. Dearing, 36 B. T. A. 843, held that an oil well driller who was paid for his services by an assignment of an interest in the oil in place, until he received the amounts of the payments in the contracts, obtains an economic interest in the oil in place and can not deduct the costs of drilling from the payments received by him under his drilling contracts, but he must recover his costs through depletion deductions. The court said the production of oil under the contract is not a sale of the partnership interest in the oil in place, but is an enjoyment of that interest. Its interest in the oil reserve, like the fee owner’s, is not thereby sold, but only depleted. Neither of them can deduct cost in dealing with the income so received, but each may reduce his income by depletion. The statute, of course, provides that a taxpayer who is entitled to deduct depletion may either deduct percentage depletion or depletion based on cost, whichever is the greater.

Counsel for petitioners cite Carroll v. Commissioner, 70 Fed. (2d) 806, and William E. Boeing, 37 B. T. A. 178, and in their briefs say, “We think it unquestionable that under the rulings in these cases, the money received by the Pettits under their contracts is taxable under the capital gains provisions of the Bevenue Acts of 1934 and 1936.” The Garroll case held that, where a partnership engaged in the manufacture and sale of lumber at wholesale was the owner of extensive tracts of standing timber and sold a part of the timber to another company under an agreement that the purchaser cut and pay for the same as cut, such timber, having been held by the taxpayer for more than two years prior to sale, was a capital asset and the gain thereon was a capital gain, under the capital gains provisions of the applicable statutes. We do not think this case throws any particular light on the questions involved in the instant proceedings, as the law relating to timber is quite different from that relating to oil and gas. The Boeing case is also a timber case and was reversed by the Circuit Court of Appeals for the Ninth Circuit at 106 Fed. (2d) 305; certiorari denied, December 11, 1939.

It is our opinion that the instant proceedings are controlled by Burnet v. Harmel, supra, as we can not say that the proceeds received by petitioners are any more to be taxed as capital gains than were the bonus payments which were involved in that case. The respondent’s determination on this issue is sustained.

Decisions will be entered under Rule 50.

       SEC. 117. CAPITAL GAINS AND LOSSES.
      (a) Gbnehal Role. — In the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net income:

        Í0O per centum if the capital asset has been held for not more than 1 year;
      80 per centum if the capital asset has been held for more than 1 year but not for more than 2 years;
      60 per centum if the capital asset has been held for more than 2 years but not for more than 5 years;
      40 percentum if the capital asset has been held for more than 5 years but not for more than 10 years;
      30 per centum if the capital asset has been held for more than'10 years.
      (b) Definition of Capital Assets. — For the purposes of this title, “capital assets” means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sal? to customers in the ordinary course of his trade or business.


author: Murdock:

text:
    Olive H. Prouty, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96164.
    Promulgated February 6, 1940.

      Allison L. H. Newton, Esq., for the petitioner.

      J. T. Haslan, Esq., for the respondent.
   OPINION.

Murdock:

The Commissioner determined a deficiency of $148,-437.32 in gift tax for the year 1935. The only question presented for decision is whether the petitioner made transfers subject to the imposition of the gift tax in this year by reason of amendments to each of three trusts which she made on January 2, 1935. The Board hereby adopts as its findings of fact the facts as stipulated by the parties.

The petitioner created three trusts on October 13, 1923, and named herself trustee of each. She was married at that time to Louis I. Prouty and they had two children, Jane and Richard. All four of the parties were still living at the date of the hearing in this case. The petitioner amended the trusts in various ways up to and including January 1, 1931. No further amendments of any kind were made between January 1,1931, and January 2, 1935.

Trust No. 1 as it existed immediately after the amendment of January 1, 1931, provided generally as follows: $2,500 of the annual net income was to be paid to Louis I. Prouty during his life and the balance of the income was to be added to the principal; all or any part of the principal, including accumulations, could be paid to Louis I. Prouty or to Jane Prouty in the discretion of the trustee if needed for his or her maintenance, support, or welfare; the property remaining in the trust at the time of the death of Louis I. Prouty was to be distributed as he should appoint by his will and, in default of appointment, was to go to the children of the petitioner; and the petitioner, with the written consent of Louis I. Prouty during his life and thereafter alone, had the power to alter, amend, or cancel any of the provisions of the trust. The petitioner resigned as trustee of this trust on December 31, 1935.

Trust No. 2 as it existed immediately after the amendment of January 1, 1931, provided generally as follows: $2,500 of the annual net income was payable to Louis I. Prouty for life and the balance of the income was to be added to the principal; all or any part of the principal, including accumulations, could be paid to Louis I. Prouty in the discretion of the trustee if needed for his maintenance, support, or welfare; the trust property remaining at the death of Louis I. Prouty was to be paid to Jane Prouty or, if she was not then living, as she should appoint; and the petitioner, with the written consent of Louis I. Prouty during his life and thereafter alone, had the power to alter, amend, or cancel any of the provisions of the trust.

Trust No. 3 was exactly like Trust No. 2, substituting the name of Richard for that of Jane.

The petitioner on January 2, 1935, amended each trust by surrendering all rights which she had retained either alone or in conjunction with any person to cancel, alter, or amend the trust.

The question presented is the extent to which Louis I. Prouty had a “substantial adverse interest” prior to 1935. Section 501 (c) of the Revenue Act of 1932 provided that the gift tax “shall not apply to a transfer of property in trust where the power to revest in the donor title to such property is vested in the donor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such property or the income therefrom, but the relinquishment or termination of such power (other than by the donor’s death) shall be considered to be a transfer by the donor by gift of the property subject to such power.” This provision was repealed in the Revenue Act of 1934 (see sec. 511) with the explanation that it was unnecessary in view of the holding of the Supreme Court in Burnet v. Guggenheim, 288 U. S. 280, that the principle stated in the section was a part of the law even in the absence of an express legislative provision. If the petitioner’s husband had a substantial adverse interest in the disposition of all of the trust property or the income therefrom, then, as contended by the petitioner, she made an effective and complete gift of the corpus of each trust prior to 1935 and also prior to the effective date of this gift tax. The present deficiency can be supported only in the event that the transfers were made in 1935. Furthermore, section 501 (b) provides that the tax shall not apply to transfers made prior to the effective date of the act (June 6, 1932).

The Commissioner, in determining the deficiency, conceded that an effective gift of an annuity of $2,500 for the life of the husband in each trust had been made prior to 1935. He subtracted the value of such an annuity and subjected the remaining value of the assets of each trust to the gift tax as transfers made in 1935. His contention is that the petitioner, in conjunction with her husband, could have revoked each trust at any time prior to January 2, 1935, and he contends further that the interest of the husband was an adverse interest only in relation to the annuity of $2,500. The petitioner replies that the interest of the husband prior to 1935 was adverse as to the entire trust property and income in each instance, in Trust No. 1 because he had the power to appoint by will who should receive all the trust property remaining at the date of his death, and as to Trusts 1, 2, and 3 because be bad the right to receive the entire corpus of each trust if its use was necessary or advisable for bis maintenance, support, or welfare.

• The petitioner’s husband, prior to 1935, had a right to receive not only the annuity under the first trust and all or any part of the corpus of the trust necessary for his maintenance, support, or welfare, but also a power to dispose of all of the corpus remaining at the date of his death. Clearly, his interest in this trust was an adverse interest in the disposition of the entire trust property and income adverse to any other use of the funds, and an interest which would naturally prompt him to resist any effort on the part of the grantor of the trust to alter, amend, or revoke the trust so as to revest in the donor title to such property. That gift was complete prior to 1935 and the amendment of January 2, 1935, did not effect a transfer of that trust property.

The husband also had an interest in the entire corpus of Trusts 2 and 3. His interest was twofold. First, he had a right to receive all or a part of the income or corpus of each of those trusts in case it was necessary for his maintenance, support, or welfare. The evidence does not disclose the probabilities in regard to the possible necessity of using the corpus or income for those purposes. His interest in those trusts went further. Any corpus remaining in those trusts at the date of his death was to go to his children. In the case of Raoul H. Fleischmann, 40 B. T. A. 672, the grantor had established a trust for children of his wife by her prior marriage. The trustee was their mother. She had custody of them. We pointed out that it was to her interest to use the income of the trusts to defray the expenses which otherwise might have to be paid from her personal funds, and although she acquired no legal interest in the trust income, nevertheless, from a practical standpoint, she had a very real and substantial interest in the disposition of the income adverse to any possible interest of the grantor in any accumulations. We held that her interest was a substantial adverse interest within the meaning of section 167 (a) (1) of the Eevenue Acts of 1932 and 1934. The same reasoning applies here with equal force. Louis I. Prouty was the father of the two children ultimately to be benefited by Trusts 2 and 3. It is natural to assume that his desire and concern for the support; maintenance, and welfare of his children after his death would prompt him to resist any effort on the part of the grantor of the trust to alter, amend, or revoke that part of the trust so as to revest in her title to such property. These interests which the father had in Trusts 2 and 3, taken together, gave him a substantial adverse interest in the disposition of all of the property or income of those two trusts. Jane B. Shiverick, 37 B. T. A. 454; Paul W. Litchfield, 39 B. T. A. 1017. It thus appears that the transfers in Trusts 2 and 3 were also complete prior to 1935. If there had been a similar taxing statute during all of those prior years, these trusts would not have escaped tax in some prior year. Cf. Hesslein v. Hoey, 91 Fed. (2d) 954; Sanford v. Commissioner, 308 U. S. 39; Rasquin v. Humphreys, 308 U. S. 54.

Decision will he entered for the petitioner.