text:
    John N. Fulham, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103252.
    Promulgated August 6, 1941.

      Lawrence E. Green, Esq., for the petitioner.

      E. M. Woolf, Esq., for the respondent.
   OPINION.

Black :

Is the income of the Mary E. Fulham trust for the calendar year 1936 taxable to petitioner under any of the provisions of sections 166, 167, or 22 (a) of the Kevenue Act of 1986? These sections are printed in the margin.

We think the amendment to the trust dated December 27, 1935, which was in full force and effect throughout the taxable year 1936, clearly precludes the taxation to petitioner of any of the income of the trust under either section 166 or 167 of the Kevenue Act of 1936. After that amendment became effective there was vested in no person any “power to revest in the grantor title to any part of the corpus of the trust.” After that amendment there did not exist even a possibility of a reverter to the grantor or his estate. It was thereafter impossible to hold, accumulate, distribute or apply to the payment of premiums upon policies of insurance on the life of the grantor any part of the income of the trust. Furthermore, the trust could never thereafter be amended so as to allow the grantor to receive any benefit from the trust, either directly or indirectly. Although in his amendment to his answer the respondent alleges that he “relies not only on the provisions of section 166 but also on sections 167 and 22 (a) of the Revenue Act of 1936”, in his brief he offers no argument in support of taxing the income of the trust to petitioner under section 166 or 167, but relies entirely upon taxing the income to petitioner under the provisions of section 22 (a), citing as authority therefor the two cases of Helvering v. Clifford, 309 U. S. 331, and Morton Stein, 41 B. T. A. 994. In view of the 1935 amendment to the trust, we hold that petitioner is not taxable on the income of the trust under either section 166 or section 167, supra. Helvering v. Wood, 309 U. S. 344; Commissioner v. Branch, 114 Fed. (2d) 985, affirming 40 B. T. A. 1044.

Is petitioner taxable on the income of the trust under section 22 (a) ? The answer depends upon whether the principles enunciated in Helvering v. Clifford, supra, are applicable. The respondent contends that the powers which petitioner reserved to himself as one of the cotrustees under clause fourth of the trust deed bring this case within the ambit of the Clifford and Stein cases. The powers referred to in clause fourth B of the trust deed, which are set forth fully in our findings of fact, are not such powers as in our opinion the Supreme Court intended would alone be decisive of the determination of ownership in the grantor for purposes of section 22 (a). These powers are no broader than the powers given to the trustees in Commissioner v. Branch, supra, wherein it was held that the grantor was not taxable on the income of the trust there in question although the grantor in that case was one of the trustees capable of exercising those powers. Nor do we think the powers conferred upon the trustees in the instant case were any broader than those conferred upon the trustees in Carleton H. Palmer, 40 B. T. A. 1002; affirmed per curiam in Helvering v. Palmer, 115 Fed. (2d) 368. Of the trustees’ powers in the Palmer case, we said: “Those powers which petitioner as grantor reserved to himself as one of the trustees relate to the management of the trust corpus and do not vest in the grantor any control as an individual over the economic benefits or enjoyment of the trust property. [Citing cases.]”

The Supreme Court in the Clifford case particularly pointed out that no one fact was normally decisive of the question. In the instant proceeding it is hard to see in what way the grantor remained the owner after the 1935 amendment. Thereafter the Fulham trust was substantially different from the Clifford trust. The trust in the Clifford case was for a short term of five years, whereas the Ful-ham trust was to continue as long as the rule against perpetuities permitted. Upon termination of the Clifford trust the corpus was to go to the grantor, whereas under the Fulham trust under no possible contingency could either the corpus or income ever revert to or be used for the benefit of the grantor or his estate, either directly or indirectly. In the Clifford case the grantor was the sole trustee, whereas in the case now before us petitioner and another not related to him in any way were trustees. Dorr was the managing trustee. Clause fourth A provided that “While said Dorr is living he shall keep the books of account, and shall be the managing trustee.” Dorr testified at the hearing that he has managed the trust since its inception and that petitioner has done no more than to consent to what Dorr has done.

In the recent case of Commissioner v. Buck, 120 Fed. (2d) 775, the Second Circuit held that the income of the trust there involved was taxable to the grantor under the broad principles of the Clifford case. The Buck case is very much like the Stein case, relied upon by the respondent. Although the trusts in both the Stein and Buck cases were long term trusts, a fact not present in the Clifford case, the controlling circumstance in both the Stein and Buck cases is the extent of the donor’s control to alter or modify the trust in so far as the beneficiaries of income or corpus are concerned. In both those cases the grantor had reserved to himself the power to shift the income or corpus from one beneficiary to another as often as he chose, excluding always himself as a beneficiary. The court in the Buck case said that this was “the outstanding fact” which distinguished that case from Helvering v. Palmer, supra, and Blair v. Commissioner, 300 U. S. 5. The Palmer case, as we have said, was a per curiam opinion by the Second Circuit. It was decided wholly upon the authority of Commissioner v. Branch, supra. The grantor in the Branch case reserved no such powers to alter or amend and neither did petitioner here. At the time petitioner created the trust he, under clause fifth, placed such powers in a committee of three, which committee has since amended the trust deed so as to forever preclude petitioner from receiving or enjoying any benefit therefrom. Under the authority given the committee it could even remove petitioner as one of the trustees.

Taking into consideration all these circumstances, we are of the opinion that the instant case is not controlled by the Clifford case or by the Stein case or by the Buck case. We think the facts in the instant case are more nearly like those involved in Commissioner v. Branch, supra, and Helvering v. Palmer, supra, than the facts in any of the cases cited above. We hold, therefore, petitioner is not taxable on the income of the trust under section 22 (a).

Decision will "be entered u/nder Rule 50.

       SEC. 166. REVOCABLE TRUSTS.
      Where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested—
      (1) in the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, or
      (2) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom;
      then the income of such part of the trust shall be included in computing the net income of the grantor.
      SEC. 167. INCOME FOR BENEFIT OF GRANTOR.
      (a) Where any part of the income of a trust—
      (1) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, held or accumulated for future distribution to the grantor ; or
      (2) may, in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income, be distributed to the grantor; or
      (8) is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be, applied to the payment of premiums upon policies of insurance on the life of the grantor (except policies of insurance irrevocably payable for the purposes and in the manner specified in section 28 (o), relating to the so-called “charitable contribution” deduction) ;
      then such part of the income of the trust shall be included in computing the net income of the grantor.
      (b) As used in this section, the term “in the discretion of the grantor” means “in the discretion of the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of the part of the income in question.”
      SEC. 22. GROSS INCOME.
      (a) General Definition.—“Gross income” includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. In the case of Presidents of the United States and judges of courts of the United States taking office after June 6, 1932, the compensation received as such shall be included in gross income; and all Acts fixing the compensation of such Presidents and judges are hereby amended accordingly.


source: Caselaw Access Project

author: Leech :

license: Public Domain

text:
    Estate of William Childs, Deceased, Morristown Trust Company, Executor, and Victoria Childs, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 102578.
    Promulgated August 6, 1941.

      Sanford D. Beecher, Esq., for the petitioners.

      Albert E. Monacelli, Esq., for the respondent.
   OPINION.

Leech :

Respondent has determined a deficiency of $1,837.64 in income tax of the decedent, William Childs, for the calendar year 1936. The decedent died a resident of Bernardsville, New Jersey. He and his wife filed a joint income tax return for that year with the collector of internal revenue for the fifth district of New Jersey, at Newark, New Jersey. This deficiency arises as a result of respondent’s increasing the income reported on that return by the amount of a gain realized from the sale of certain securities comprising a portion of the corpus of a trust created by the decedent. The only issue is whether this gain received in 1936 by the trust is taxable to decedent as grantor.

We find the facts as submitted by stipulation and two formal exhibits. Briefly, they are summarized as follows:

William Childs executed a deed of trust under date of February 7, 1929, naming himself, the Morristown Trust Co., and Victoria Childs, his wife (now his widow), as cotrustees, and transferred to the trustees certain property owned by him at that time.

The purpose as expressed in the trust was to make immediate and independent provision for the grantor’s wife, since the grantor had sufficient other assets for his own personal needs.

Pertinent provisions of the uses and purposes of the trust were as follows:

To hold and invest the same and keep the same.safely invested and collect the rents and profits therefrom and the income therefrom and after deducting all proper charges and expenses, pay over the net income therefrom in quarterly installments, to the said Victoria Childs for life.
Upon the death of the said Victoria Childs, said net income shall be paid in quarterly installments to such person or persons next of kin of William Childs, grantor herein, or grantor himself for such time or times as the said Victoria Childs shall by her last Will and Testament designate and appoint. Should Victoria Childs default in making any appointment of said net income or if she makes such appointment, then upon the termination of the time designated by her for the payment of said net income, this trust shall terminate and the principal or corpus thereof shall be paid or distributed by the Trustees to and among such of the following person or persons in trust for life or otherwise and in such amount or amounts as the said Victoria Childs shall by her last Will and Testament designate and appoint, viz; Ellsworth Childs and/or his wife Dora Childs, Matthew O’Neill, Jack O’Neill, Annie Mealy, Basking Ridge Presbyterian Church, the children of Luther Childs, brother of the grantor, and the children of Maggie Pratt, sister of the grantor, also children of his brother Heman Childs, Chester C. Brown, Trustee under Deeds of Trust of September 11, 1923, and January 2, 1926.
In default of appointment of the corpus or principal of this trust, the Trustees shall, upon the death of Victoria Childs, pay and distribute the corpus or principal of this trust as follows:
(1) To the Morristown Trust Company, One hundred fifty thousand dollars ($150,000.) in kind or cash as my Trustees shall determine, to have and to hold the same in trust, to collect and receive the income therefrom, and to pay over the income to Ellsworth Childs so long as he shall live, and upon his death, if his wife Dora Childs shall be living, the said Trustees shjall divide said corpus or principal of said One hundred fifty thousand dollars ($150,000.) into two equal parts: hold one part in trust, and collect and receive the income therefrom and pay said income to said Dora Childs so long as she shall live. The other equal part of said corpus or principal shall be paid and distributed to and among the children of Maggie Pratt, Luther Childs, and Heman Childs, sister and brothers of William Childs, and the issue of any of them that may be dead leaving issue surviving, share and share alike, per stirpes and not per capita, said distribution by representation to have reference to said sister and brothers of William Childs. Upon the death of Dora Childs, said equal part held in trust for her shall be paid and distributed by said Trustees to and among said children of Maggie Pratt, Luther Childs and Heman Childs, sister and brothers of William Childs aforesaid, and the issue of any of them that may be dead leaving issue surviving in the same manner as provided above.
(2) To Matthew O’Neill, Ten thousand dollars ($10,000.).
(3) To Jack O’Neill, Ten thousand dollars ($10,000.).
(4) To Annie Mealy, Five thousand dollars ($5,000.).
(5) To Basking Ridge Presbyterian Church, Five thousand Dollars ($5,000.).
(6) The balance to and among the children of Maggie Pratt, Luther Childs, and Heman Childs, sister and brothers of William Childs, and the issue of any of them that may be dead leaving issue surviving, share and share alike, per stirpes and not per capita, said distribution by representation to have reference to said sister and brothers of William Childs.

The trustees were given the further power under the trust indenture:

To return or repay to the grantor, William Childs, or his nominee, any part or all of the corpus or principal composing said trust in kind or cash at such time or times and in such amounts as the Trustees shall determine upon the written request therefor by the said William Childs.

The trust instrument as originally executed carried the following provision:

The grantor, William Childs, has the right at any time or times, if not satisfied with the management of the trust hereby created, or for any or no cause whatever, to remove any one or all of the Trustees named herein or their successor or successors upon five days’ written notice, and to appoint, designate, or select other trustee or trustees. Provided, however, that at no time shall the grantor he sole trustee.

In 1931 the trust sustained a loss from the sale of securities. In connection with the settlement of the tax liability of the grantor for that year the respondent, on the basis of the grantor’s contentions, allowed the loss as a deduction in the grantor’s tax return on the theory that the grantor had power under the trust instrument to revest title to the trust property in himself.

In the following year, by an agreement dated November 2, 1932, executed by all three trustees, the last provision of the trust as set out above was altered and the power of the grantor restricted to the extent that he could only “remove the corporate trustée named herein or its successor or successors.” The grantor never changed or attempted to change any trustee or appoint a successor or substitute an additional trustee at any time; nor did he request at any time the repayment or return of any part of the corpus or principal of the trust, and such repayment or return was never made to him.

The grantor and his wife, Victoria Childs, lived together as man and wife from the time of their marriage on January 28, 1928, to the date of his death. He died on May 22, 1938, and letters testamentary were issued to the Morristown Trust Co. pursuant to his last will and testament, which was duly admitted to probate.

In 1936 a gain was realized from the sale of certain securities comprising a portion of the corpus of the trust. In their income tax return for the calendar year 1936 the trustees reported the sale of these securities and the resulting gains realized therefrom and paid a tax thereon as income of the trust.

The grantor and his wife filed a joint income tax return for 1936 and respondent increased the income reported thereon by the amount of these gains on the ground that such gains constituted income taxable to the grantor of the trust. This resulted in the determination of a deficiency of $1,831.64 in income tax for the calendar year 1936.

A gift tax return for the year 1932 was not filed by William Childs in 1933, but was filed by his executor in 1939.

The sole issue is whether the capital gain of the present trust resulting from its sale of securities in 1936, is taxable to the grantor for that year, under sections 166, 167, or 22 (a) of the Revenue Act of 1936.

Section 166 imposes a tax on the grantor of a trust “Where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested—(1) in the grantor, either alone or in conjunction with any person not having a substantial adverse interest * ⅞ This trust, as it existed during the taxable year 1936 after the amendment of 1932, provided that the grantor,. upon written request, could have returned or repaid to himself or his nominee, “any part or all of the corpus or principal” of the trust, “at such time or times and in such amounts as the Trastees shall determine.” [Emphasis supplied.]

Petitioners contend that no part of the corpus could have been so returned to the grantor without the joinder of Victoria Childs, his wife, one of the trustees, and that she was the holder of “a substantial adverse interest.”

Of course as to whether such a discretionary act may be performed by fewer than all of the trustees rests upon the intent of the grantor of the trust as ascertained from its content. In so determining this intent where there is more than one trustee, and no contrary intent is expressed in the trust instrument, the general rule, as stated in section 194 of the Restatement of the Law of Trusts (1935), is that “action by all of them is necessary to the exercise of the powers conferred upon them as trustees. If one of them refuses to concur in the exercise of a power, the other can not exercise the power * * See also Perry on Trusts and Trustees, vol. 1, p. 687; Bogart on Trusts and Trustees, vol. 3, sec. 554. This rule is followed in New Jersey. Daybill v. Lucas, 187 Atl. 734; 121 N. J. Eq. 143; Carr v. Hertz, 33 Atl. 194; 54 N. J. Eq. 127.

Here the right to determine how much if any of the corpus should be returned to the grantor upon his written request as well as the exercise of the many other powers of the trustees was not conferred by the trust instrument on fewer than all of the trustees. That the absence of such provision was deliberate and intended as requiring joint action of all the trustees, appears clear. The purpose of the trust was “to make immediate and independent provision for Victoria Childs, the wife of the grantor.” She was the sole beneficiary of current income. She was given a very substantial right respecting the corpus and income in her limited power of testamentary appointment of it. Cf. Meta Biddle Robinette, 44 B. T. A. 701. In the original trust instrument the grantor reserved the right to remove any or all the trustees and appoint others, so long as the grantor was not the sole trustee. By amendment, in 1932, this power was denied except as to the corporate trustee. Thus if fewer than all of the trustees could have acted upon the grantor’s request for corpus prior to the amendment of the trust in 1932, there would have been no reason for that amendment since, in such case, the grantor would have had identically the same rights respecting corpus whether or not he removed his wife as trustee. Therefore, aside from the fact that the trust instrument contains no provision enabling fewer than all of the trustees to exercise their authority, including that of determining what part if any of the corpus is to be returned to the grantor, it seems to us that the intention of the grantor evidenced by the 1932 amendment of the trust was that thereafter no part of the corpus could be returned to the grantor without the consent of his wife, Victoria Childs.

Was her interest in the corpus “a substantial adverse interest” to that of the grantor? We think it was.

It may be that more substance is required to include the interest of a wife as within the quoted expression, than that of another. Cf. Helvering v. Clifford, 309 U. S. 331. But, as the Circuit Court for the First Circuit states in Commissioner v. Prouty, 115 Fed. (2d) 331:

* * * we cannot read into the gift tax, any more than into Sections 166 and 167, the proposition that a member of the grantor’s immediate family can never be deemed to have “a substantial adverse interest.”

Here the grantor retained no control over the corpus or income of the trust or its investment. He kept no voting rights of the transferred securities or other indicia of ownership. There was no lack of substance and reality in the interest of Victoria Childs as a beneficiary. She was not only the exclusive beneficiary of current income, but had a limited power of appointment over income as well as trust corpus. As such a beneficiary, we think, she had an interest in the corpus substantially adverse to that of the grantor, even though she was his wife. Estate of Isaac Fish, 42 B. T. A. 260; Commissioner v. Prouty, supra; Jane B. Shiverick, 37 B. T. A. 454. Cf. Altmaier v. Commissioner, 116 Fed. (2d) 162; Fulham v. Commissioner, 110 Fed. (2d) 916; Commissioners v. Caspersen, 119 Fed. (2d) 914, reversing 40 B. T. A. 759. We hold that section 166 is not applicable.

The taxable income of this trust, in the form of capital gains, was to be added to the corpus and thus become distributable as such. On that premise, are they taxable to the grantor under section 167 ? Though respondent properly raised this question at the hearing, he has not touched it on brief and, in any event, we think it must be resolved against him.

Under no possible construction of the trust agreement of which we are aware could the grantor have ever received more than the income from these accumulated capital gains. That alone would conclude the respondent on this issue. Frances S. Willson, 44 B. T. A. 583. Moreover, even that income could not go to the grantor except by the voluntary testamentary act of Victoria Childs, and if she predeceased the grantor. Such an interest, if it may be even so characterized, certainly is not sufficiently substantial upon which to base a tax under section 167. John P. Wilson, 42 B. T. A. 1260.

Was this trust or the transfer thereto so lacking in substance and reality as to warrant the taxing of its capital gains to the grantor under the rule of Helvering v. Clifford, supra?

Respondent supports his position on this issue by the argument that the trustees were granted unusually broad powers and that the grantor was a trustee. But he could not be sole trustee. See George H. Deuble, 42 B. T. A. 277. And, the exercise of any of the powers of the trustees required the joinder of all of them, including Victoria Childs, the wife of the grantor who, as we have seen, had- an interest substantially adverse to that of the grantor. Any power possessed by decedent as trustee was negative only. Cf. Frank E. Wolcott, 42 B. T. A. 1151.

The lack of retained control by the grantor, the substance and reality of his wife’s interest in corpus and income, the fact that this trust was not for a short term but for her life, and other facts disclosed here and already discussed, pointedly distinguish this case from Helvering v. Clifford, supra, and compel the conclusion that the contested capital gains here are not taxable under that rule. Comissioner v. Branch, 114 Fed. (2d) 985; Helvering v. Achelis, 112 Fed. (2d) 929. Cf. Commissioner v. Buck, 120 Fed. (2d) 775.

Reviewed by the Board.

Decision will be entered for the fetitioners.

Smith and Opper dissent.

       It is noted that this case was decided four months after the decision of the Supreme Court in the Clifford case, supra, and the Commissioner has acquiesced therein. C. B. 1940-2, p. 4. (1940-52-10529).


author: Sternhagen : Leech,

text:
    Estate of Mary H. Hughes, Ednyfed H. Williams, Administrator, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93139.
    Promulgated August 8, 1941.

      Francis D. Butler, Esq., for the petitioner.

      Franklin F. Korell, Esq., for the respondent.
   OPINION.

Sternhagen :

The decedent died in 1935, and the question is whether her estate was subject to the Revenue Act of 1932, section 803 (a), which was a modification of section 302 (c) of the Revenue Act of 1926. In 1928, at a cost of $945,000, she had made a contract with the insurance company by which she received the company’s promise to pay her $2,625 a month for her life and, after her death, to dispose of $900,000 in a prescribed manner among her children, grandchildren, and great-grandchildren. None of the descendants had possession or enjoyment of any part of the fund or its income during the decedent’s lifetime, although they did have a vested right in a future expectancy. The practical effect upon them of her contract necessarily came after her death. If, instead of making her contract with the insurance company, she had in 1928 given $945,000 to the children, or someone representing them, and had taken their promise not to use it during her lifetime except to pay her $31,500 ,a year until she died, this would certainly have been a gift to take effect in possession or enjoyment at or after her death, even though ownership of the fund vested in the children at once, Helvering v. Tyler, 111 Fed. (2d) 422; affd., 312 U. S. 657.

But this plain understanding has become involved in refinements so that the language has lost its simple meaning. It is said that because the contract was made in 1928 the children acquired their rights then, that the rights were irrevocably vested during the decedent’s life, that her death added nothing to those rights, and, since this was the extant legal conception when the decedent made her transfer, it is the only conception which may be recognized in taxing her estate. The answer is that, although she created rights, the possession or enjoyment of the property did not take effect before she died. There is no need to give serious consideration to the negligible right which she retained to receive back the fund on the infinitesimal chance that she would survive her descendants. Such a remote possibility may properly be disregarded.

May v. Heiner, 281 U. S. 238, supports the petitioner’s contention that the rights which were transferred by the creation of the 1928 contract were vested at that time, and that nothing may be regarded as taking effect in possession or enjoyment at or after the decedent’s death. That decision was immediately devitalized as to the future by Congressional enactment. The resolution of March 3, 1931, provided that a transfer whereby the transferor retained the income from the property for the rest of his life was to be regarded as a taxable transfer, notwithstanding that it effected a vesting of title during his lifetime. But the resolution, which was embodied in the statute by section 803 (a) of the Revenue Act of 1932, was confined to later transfers, the Supreme Court holding that it was not intended to have retroactive application to transfers made during life prior to its enactment, even though the transferor died afterwards, Hassett v. Welch, 303 U. S. 303.

More recently, however, the application of the estate tax has been held by the Supreme Court to be affected not so much by the common law refinements of conveyancing as by the practical effect of the transfer. In Helvering v. Hallock, 309 U. S. 106, the Court, having in mind “the controlling purposes of the estate tax law”, reiterated the broad principle announced in Klein v. United States, 283 U. S. 231, in the following language:

Nothing is to be gained by multiplying words in respect of the various niceties of the art of conveyancing or the law of contingent and vested remainders. It is perfectly plain that the death of the grantor was the indispensable and intended event which brought the larger estate into being for the grantee and effected its transmission from the dead to the living, thus satisfying the terms of the taxing act and justifying the tax imposed.

From the Hallocle case it must be inferred that the divesting of legal title in 1928 when the contract was made is not the determinant of the time when the transfer became effective in possession or enjoyment. Specifically, the Hallock decision overruled only Helvering v. St. Louis Union Trust Co., 296 U. S. 39, and Becker v. St. Louis Union Trust Co., 296 U. S. 48, but the reasoning leads to the belief that May v. Heiner, supra, may no longer be followed. May v. Seiner treated the vesting of title in another during life while retaining the income thereof until death as sufficient to prevent the inclusion of the property in the gross estate, an interpretation whereby the actual possession or enjoyment of the property is subordinate to the bare legal title. It is hard to see how this interpretation can survive the Hallock case. Cf. Van Vranken v. Helvering, 115 Fed. (2d) 709. The effect of Sassett v. Welch, supra, was no more than to reaffirm the doctrine of May v. Seiner, sufra, in respect of any inter vivos transfer of title which occurred before the adoption of the resolution of March 3, 1931; and without May v. Heiner, supra, it has no remaining force.

The inclusion of the value of the present contract in the decedent’s gross estate is supported by Helvering v. Le Gierse, 312 U. S. 531. The Supreme Court, holding that an alleged insurance policy was, in truth, an annuity contract not affected by the $40,000 insurance exemption of section 302 (g), held further that the sums payable to beneficiaries were taxable under section 302 (c)—the section which is in controversy here—as transfers to take effect in possession or enjoyment at or after death.

In view of the reasoning upon which we think this decision must rest, we have refrained from discussion of the elaborate arguments of counsel. If our view of the construction of the language of the statute in the light of the recent opinions of the courts is disapproved, it would seem to follow that the Commissioner’s determination must be reversed; for the earlier decisions clearly pointed to the exclusion from the gross estate of property of which the decedent had before March 3, 1931, made a complete inter vivos transfer, reserving to himself only the income during his life.

Eeviewed by the Board.

Decision will be entered wnder Rule 50.

Leech,

dissenting: In May v. Heiner, 281 U. S. 238, the Supreme Court held that retention by the grantor of the income for life of an irrevocable trust does not justify the inclusion of the corpus of the trust in the estate of the grantor for estate tax purposes. In Hassett v. Welch, 303 U. S. 303, the same Court held that the Joint Resolution of Congress adopted March 3, 1931, which negatived that holding, could not be retroactively applied. Those cases have been leading authorities for many years in a matter of general importance.

The facts in the present case are admittedly identical with those.in May v. Heiner, supra, as supplemented by Hassett v. Welch, supra. Upon the authority of Helvering v. Hallock, 309 U. S. 106, the majority holds that those cases are no longer law. This is the first.pronouncement to that effect. Since the decision in the Hallock case, the courts and the Board, in at least four cases, have held just the opposite. Commissioner v. Flanders, 111 Fed. (2d) 117 (C. C. A., 2d Cir.).; Commissioner v. Kellogg, 119 Fed. (2d) 54 (C. C. A., 3d Cir.) ; Chase National Bank v. Higgins, 38 Fed. Supp. 858 (U. S. Dist. Ct., S. Dist. N. Y.); and Estate of William G. Thompson, 41 B. T. A. 901.

The attitude of the Circuit Court of Appeals for the-Third Circuit is interesting on the point. In the Kellogg case, supra, an estate tax was proposed under section 302 (c) of the Revenue Act of 1926, as amended by section 803 of the Revenue Act of 1932. The question was whether or not the value of the corpus of a trust irrevocably created on March 2,1926, to which all its property had been transferred before October 1, 1929, was includable in the gross éstate of the deceased-grantor for estate tax purposes. The grantor had retained the income of the trust for life and, upon the remote contingency that all the remainder beneficiaries predeceased the survivor of the grantor and his wife, the corpus was then to go to the surviving next of kin of the grantor.

The majority opinion here, as does the court in the Kellogg case, disregards the “remote possibility” of the grantor receiving back the corpus. However, it proceeds to tax the value of the corpus of the present trust to the grantor under the literal wording of section 302 (c) of the Revenue Act of 1926, as amended by section 803 (a) of the Revenue Act of 1932, which is the identical'section considered in both the foregoing cases.

This position, it seems to me, was exactly the argument made by the petitioner in the Kellogg case under his second point there. The Third Circuit, in holding against the Government in that case, unanimously said:

The petitioner iurther contends that even if he is in error in urging that the corpus of the trust is includible in the grantor’s estate under the principles of Helvering v. Halloelc, none the less the transfer was a substitute for the testamentary disposition of the grantor and, in the words of the statute, was “intended to take effect in possession or enjoyment at or after his death.” In short the petitioner relies on the exact language of the statute. His difficulty in sustaining this contention arises also with May v. Heiner and becomes insurmountable, so far as this court is concerned, when we contemplate the decision in Reinecke v. Northern Trust Co., 278 U. S. 339, 347-348. If the words of the statute just quoted are to receive the meaning contended for 6y the petitioner, they must receive it from the Supreme Court. [Emphasis supplied.]

In the face of these authorities, it would seem that the Board of Tax Appeals should certainly be no less hesitant - than the. Third Circuit Court of Appeals. See also Hammond-Knowlton v. United States, 121 Fed. (2d) 192 (C. C. A., 2d Cir). I think the Board should follow May v. Heiner, supra, and Hassett v. Welch, supra.

Aruxdell, Smith, and Black agree with this dissent.


author: Smith: Harron, Disney,

text:
    Mutual Savings and Loan Company, Inc., of Norfolk, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101321.
    Promulgated August 8, 1941.

      James Mami, Esq., for the petitioner.

      Lloyd W. Greason, Esq., for the respondent.
   OPINION.

Smith:

The question presented by this proceeding is whether the petitioner is a bank within the purview of section 104 (a) of the Revenue Act of 1936, which provides:

As used in this section the term “hank” means a bank or trust company incorporated and doing business under the laws of the United States (including laws relating to the District of Columbia), of any State, or of any Territory, a substantial part of the business of which consists of receiving deposits and making loans and discounts, or of exercising fiduciary powers similar to those permitted to national banks under section 11 (k) of the Federal Reserve Act, as amended, and which is subject by law to supervision and examination by State or Federal authority having supervision over banking institutions.

In the determination of the deficiencies involved herein the respondent has held that the petitioner does not “qualify as a bank taxable under Section 104 of the Revenue Act of 1936.”

The facts relative to the incorporation of petitioner and to its method of operation are admittedly not materially different from those involved in Staunton Industrial Loan Corporation, 42 B. T. A. 1030. We there held that a Virginia industrial loan association was not a “bank” within the purview of the above quoted section of the 1936 Act. Our decision in that case was reversed by the United States Circuit Court of Appeals for the Fourth Circuit in Staunton Industrial Loan Corporation v. Commissioner, 120 Fed. (2d) 912. It was there held that a Virginia industrial loan association, operated as the petitioner was operated during the taxable years herein involved, was a “bank” within the meaning of section 104 (a), supra. In accordance with the opinion of the court in that case the action of the respondent upon the question presented is reversed.

Reviewed by the Board.

Decision will he entered under Rule 50.

Harron,

concurring: Section 104 (a) of the Revenue Act of 1936 contains and prescribes a standard by which the classification of a type of corporation as a “bank” shall and may be made. The purpose of the classification is to include or exclude institutions from the surtax prescribed by section 14 and for the purpose of normal tax, as is made clear in section 104 (b).

The standard set forth in section 104 (a) is found in the words: “a substantial part of the business of which consists of receiving deposits and making loans and discounts”, etc. In short, the definition of a “bank” contained in section 104 (a) is a definition in a Federal statute, and for purposes of Federal taxation that definition is controlling, not a definition applied by a statute of a state to institutions. Conceivably a state statute may contain a definition of a “bank” which is at variance with the definition of a “bank” in the revenue acts. But in administering a Federal statute, the definition in the Federal statute is the one to be applied. Where the Federal statute does not contain language indicating that the classifications or definitions of local statutes are to be referred to for purposes of administering the Federal statute and the Federal statute itself sets forth a definition and a standard, there can be little doubt that the Federal statute’s standard is determinative. From then on it is a matter of fact whether an institution is or is not the type of institution defined in the Federal statute. Cf. Fidelity Savings & Loan Co., 44 B. T. A. 471.

The above represents roughly the rationale of the Circuit Court’s view expressed in Staunton Industrial Loan Corporation v. Commissioner, 120 Fed. (2d) 912.

The dissenting opinion in this case presents a conflict in the construction to be given to the language of section 104 (a). It is not uncommon to find differences of opinion as to what the words in a statute say. But I doubt the validity of the general view of the author of the dissenting opinion as to the effect to be given the portion which is quoted of the Supreme Court’s decision in United States v. Cambridge Loan & Building Co., 278 U. S. 55, which, of course, considered another question arising under another statutory provision, namely, section 281 (4) of the Eevenue Act of 1918, and section 231 (4) of the Eevenue Act of 1921, which is the same as section 101 (4) of the Eevenue Act of 1936. From the sentences quoted there is drawn a generalization that the Federal statutes are to be read as defining bank as defined by state statutes. The generality demonstrates the dangers which attend the separation of particular language from an entire text. What the Supreme Court said, which is quoted in the dissent, was in answer to the Government’s argument that the taxpayer, the Cambridge Loan & Building Co., used the terminology descriptive of a building and loan association as a “mask” for its real character, which the Government claimed was that of a bank. The Court pointed out that “a State is not likely to be a party to a scheme to enable a private company to avoid Federal taxation by giving it a false name.” Furthermore, in the Cambridge Loan & Building Co. case, the facts showed that the company in the conduct of its business met the requirements of the Federal statute and the holdings of both the trial court, the Court of Claims, and of the appellate court, the Supreme Court, recognize such to be true. See also, Cambridge Loan & Building Co. v. United States, 63 Ct. Cls. 631, where the facts are set forth at length. It should be noted that Congress, in section 231 (4) of the Revenue Act of 1918, made no prescription of a standard to apply in applying the exemption allowed by section 231 (4). The statute referred merely to “Domestic building and loan associations”, and the Court of Claims observed that “The law of the state in which they were created was the only law which described or defined a building and loan association, and Congress was chargeable with a. knowledge of that law. Until the 1921 act Congress accepted these associations as they existed and were operated in the different states; * * * ” Then in the 1921 Act Congress wrote into section 231 (4) a “standard” or a limitation, which provided a basis for classifying such associations so that they came either within or without the provisions of section 231 (4). Thereupon, state law was no longer to be looked to as controlling, and the portion of the Supreme Court’s decision quoted in the dissenting opinion here can not be so interpreted against the background of the facts in the Cambridge case, which were that under the 1921 Act Cambridge met the standard prescribed because “substantially all of its business” in 1921 and after was with “members.” The Supreme Court, over and above any dicta or the implications to be read into the dicta, recognized the Federal statute as controlling first, and found nothing in the state statutes, in addition thereto, to throw any doubt upon the matter under consideration.

I do not find in this case that the question can properly be posed as involving a conflict between state and Federal statutes, however. I think the terms of section 104 (a) are clear and that the court in the Staunton case correctly construed section 104 (a), and that the facts surrounding petitioner’s business compel the conclusion that petitioner must be classified as a “bank” upon application of the standard found in section 104 (a). Therefore, I concur, with the observation that nothing said in Cambridge Loan & Building Co., supra, is in conflict with the result reached here, and that case, anyway, is not in point. I see no error in applying section 104 (a) to find upon facts that “a particular institution falls without the definition of a ‘bank’ as drafted by a state legislature” and still “falls within the clear policy and broad definition stated by Congress.” Staunton Industrial Loan Corporation v. Commissioner, supra.

Disney,

dissenting: I must dissent from the view expressed in the majority opinion that a corporation doing an industrial loan business under the Virginia statute is comprehended within the definition of bank under section 104, Revenue Act of 1936. Staunton Industrial Loan Corporation v. Commissioner, 120 Fed. (2d) 912, so bolds, but witb all respect I point out that the opinion therein is, in effect, based upon only a part of the statutory definition in section 104 in that the court concludes in substance that the industrial loan corporation involved was a bank because it was a corporation “a substantial part of the business of which consists of receiving deposits and making loans and discounts”; whereas although a bank to come within section 104 must so receive deposits and make loans and discounts, it is earlier in the section and primarily defined as follows: “As used in this section the term ‘bank’ means a bank or trust company incorporated and doing business under the laws of * * ⅛ any State * * In other words, section 104 requires a bank to be one under the laws of the state, and not merely any institution a substantial part of the business of which is receiving deposits and making loans and discounts. The requirement that the bank be a bank incorporated and doing business under the laws of the state can not be ignored, and a bank incorporated and doing business under the laws of a state is one incorporated and doing business under the banking laws of the state—which, as the opinion of the court in the Staunton Industrial Loan Corporation, supra, says, is not true of an industrial loan corporation: “The laws of Virginia, for reasons which that State apparently thinks are compelling, draw a definite line between ‘banks’ and ‘industrial loan associations.’” Neither the petitioner in the instant case nor the petitioner in the Staunton Industrial Loan Corporation case was “a bank * * * incorporated and doing business under the laws of * * * any State * ⅜ for the laws of Virginia denied them the status of a bank. To hold that, though not a bank within the meaning of the Virginia statute, the industrial loan corporation is a bank within the meaning of section 104 of the Revenue Act of 1936 is to read the section as saying: “As used in this section the term ‘bank’ mean a corporation incorporated and doing business under the laws of * * * any State * * * a substantial part of the business of which consists of receiving deposits”, etc. Section 104 does not so read, but requires that for the purpose of that section the term- “bank” not only means a bank, and a bank receiving deposits and making loans and discounts, but a bank incorporated and doing business under the laws of the state. A bank can incorporate and do business under the laws of a state only by complying with the banking laws of that state and not under general laws of incorporation. Banking powers are not conferred by a certificate of incorporation under a general corporation act. McCarter v. Imperial Trustee Co., 72 N. J. L. 42;

60 Atl. 223. In my opinion, the definition in section 104 pointedly includes therein the requirements made of a bank by a state, and under the thought of United States v. Pelzer, 312 U. S. 399, “The language or necessary implication of the section involved makes its application dependent on state law.” Unless this is true, I find no reason why section 104 refers to the law of the state. Certainly the language of section 104 does not indicate a definition of “bank” different from that set by state statute, in specifically referring to the state statute; and, since no different definition is furnished, it is plain that the definition furnished by state statute is intended. Nor does reference by section 104 to the banking law of the state militate against a “nation-wide scheme of taxation uniform in its application.” In United States v. Cambridge Loan & Building Co., 278 U. S. 55, the definition of building and loan association was held to be dependent upon the law of the state: “The statutes speak of ‘domestic’ associations, that is, associations sanctioned by the several States. They must be taken to accept with the qualifications expressly stated what the States are content to recognize, unless there is a gross misuse of the name. The State of Ohio has recognized and still recognizes the respondent as belonging to the class which its name indicates.” In other words the Federal statutes are to be read as defining building and loan associations as defined by the state statute. It was therefore held that the association involved was not a mere money-making institution like a bank, but was exempt under the Federal Eevenue Acts of 1918 and 1921, section 231, as a domestic building and loan association, although it had power under state law to borrow money and loan to outsiders. Such was the effect given to a state statute defining the entity sought to be taxed. Similarly in the instant case the scheme of taxation simply conforms to all banks recognized by state or national law, but excludes those institutions not recognized as banks by state or national law, for, having referred to the state statutes just as the building and loan statute did by use of the word “domestic” (and even more clearly), the Federal statute “must be taken to accept * * * what the States are content to recognize.” To do otherwise seems to place on a parity with banks which comply with state or national law, corporations definitely excluded from that category.

In my opinion, section 104 was definitely intended to set the state or national law as to banks as a standard for those escaping, as banks, the surtax imposed by section 14 and the normal tax imposed by section 13 of the Eevenue Act of 1936, and that it was never intended to include corporations unable to comply with statutory banking requirements.

I note that in Magruder v. Safe Deposit & Trust Co. of Baltimore, 121 Fed. (2d) 981, that United States Circuit Court of Appeals for the Fourth Circuit construed section 117 (d), Revenue Act of 1934, as to a “bank or trus| company incorporated under the laws of the United States or of any state or territory, a substantial part of whose business is the receipt of deposits”—in effect the same definition involved in section 104 (a), Revenue Act of 1936, herein involved; and that inter alia the court said: “We entertain no doubt that the taxpayer is a ‘trust company incorporated under the laws’ of Maryland; but we do not think it can qualify under the second and equally essential [italics supplied] clause of the exempting statute : ‘a substantial part of whose business is the receipt of deposits.’ ” This seems to me to be not only a recognition that, as above expressed, both parts of the statute are equally essential, but some recognition of the state statute as criterion.

SterNhagbN, Murdock, Leech, TurNer, Hjll, and Oppek agree with this dissent.


text:
    Kresge Department Stores, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101906.
    Promulgated August 8, 1941.

      Ward J. Herbert, Esq., for the petitioner..

      Dean P. Kimball, Esq., for the respondent.
   OPINION.

Leech :

The ultimate legal question in this case is whether or not the petitioner is subject to the surtax imposed upon personal holding-companies by section 351 of the Eevenue Act of 1934. The answer to that question depends upon whether or not the petitioner was, during the taxable years, a personal holding company as defined in section 351 (b) of that act, and that turns here upon whether or not at least. 80 percent of petitioner’s gross income for either or both of the taxable years, under the cited section, was derived from “royalties, dividends, interest, annuities, and * * ‘ * gains from the sale of stock or securities.” So much is conceded by both parties.

The position of the respondent is that more than 80 percent of petitioner’s gross income was derived from “interest.” This position is premised upon the validity of his contention that items received by the pétitioner for services rendered through its operation of the New York City buying office do not constitute “gross income” either in whole or in a sufficient part to reduce the percentage of gross income from interest below the 80 percent requirement. Petitioner says all such receipts were gross income to it.

Respondent supports his position by the argument that these receipts “represent merely reimbursement for the maintenance of a buying office which was conducted for the direct benefit of various department stores and not for the direct benefit of the petitioner.” He argues that “The only effect the New York office could have upon the petitioner’s taxable income was to indirectly make possible an increase in the amount of dividends that petitioner might receive upon the stock in some of the department stores which it held by increasing the profits of those stores and that would be to simply indirectly increase its purely personal holding company income in the form of dividends and such was the very income section 851 was designed to reach.” It is then argued in the alternative, as we understand it, that the business of the New York buying office should be segregated and some or all of the expenses of that office deducted from the receipts through that office in the determination of the amount of “gross income” therefrom. The case of All Russian Textile Syndicate, Inc., 23 B. T. A. 1392; affd., 62 Fed. (2d) 614, is cited in support of this position. However, the facts, so far as the record there discloses them, are easily distinguishable from those here. The buying was there done by a wholly owned subsidiary in its name, and . for its parent. It was organized for and existed, in substance, only as “a purchasing and exporting agent for its principal, ⅛ Russian organization’ in Russia.”

Here the petitioner was organized to conduct department stores by direct ownership or through subsidiary companies and to act as purchasing agent for thosei and others desiring the service. It proposed to bring the benefit of the resulting mass buying power to those it served, including those stores in which it was directly interested, and thus increase their profits and dividends to it as well as its gains on any sale of its stocks in those stores.

In conformance with this purpose and plan, the petitioner, during the taxable years, through its New York buying office, acted as purchasing agent for several department stores, only one of which it controlled through stock ownership, in one of which it owned less than 50 percent of the stock, and in at least two others owned no stock. It attempted to secure such business from other corporations and, on occasion, the facilities of its New York buying office were so used. Nor were its services limited to those of buying, but included the procurement of desirable executives and desirable merchandise for the several department stores using its New York facilities. Where, as was true in most cases, petitioner purchased goods for a particular store, they were invoiced directly to that storei and so paid.

The argument of the respondent that the dividends it thus sought to increase were the very income which section 351, supra, sought to reach is beside the question, since the surtax there laid was not imposed on dividends or any other form of' income as such, but was levied only “upon the undistributed net income of every personal holding company.” That term is defined by the statute and does not include such a company as we think petitioner was during the taxable years.

In our judgment, the facts in Andrew Jergens Co., 40 B. T. A. 868, present a stronger case for respondent than those here. That case involved section 351 (b) (1) (A) of the Revenue Act of 1934, which is the provision with which we are presently concerned. There the Jergens Co. contracted with Woodbury, a wholly owned manufacturing subsidiary, and Sales, a wholly owned selling subsidiary company, to furnish certain of its facilities and services to them at cost. These costs were merely annually allocated by the parent on the books of the subsidiaries, which it kept, one of which companies had neither funds nor bank account. The amounts thus charged to these subsidiary companies were then used to reduce the deductible expenses of the parent company. The question was whether these allocated expenses were gross income under section 22 (a) of the same revenue act. It was conceded that, if they were, the petitioner was not subject to the contested tax proposed under section 351, supra. The Board held that these expenses were gross income to petitioner, despite the fact that Woodbury and Sales were wholly owned and dominated subsidiaries which the parent -was alone serving. In so holding every argument made here for respondent was answered.

Upon the authority of that case, we conclude petitioner was not subject to the contested surtaxes or penalties.

Decision will be entered for the petitioner.


author: Aeundell:

text:
    Clinton Hotel Realty Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104314.
    Promulgated August 8, 1941.

      Theodore Within, G. P. A., for the petitioner.

      J. Marvin Kelley, Esq., for the respondent.
   OPINION.

Aeundell:

The issue before us is whether $21,000 received by the petitioner on June 3, 1935, under the terms of the lease executed on that date is includable in petitioner’s gross income for the taxable year. The petitioner contends that the sum was a deposit paid as security for fee lessee’s performance and that its repayment might be compelled in certain contingencies. Accordingly, he argues that it was not income. To bolster his position he points to the fact that fee lessor was required to pay interest on the sum deposited.

The respondent’s argument for inclusion of the sum in income is based on the petitioner’s unfettered control in using the $21,000 payment and on the fact that it was to be applied to rentals due under the lease. He therefore contends feat the payment was an advance rental.

The question may be reduced to one of determining whether, on the basis of all the facts adduced, the payment was more nearly an advance rental or a security deposit. Once that determination is made, the applicable legal principles are not to be questioned. Sums paid in advance, to be applied to rentals falling due in later years, are income to the taxpayer at the time of receipt where his control of the funds is unfettered, even though under certain contingencies he may be compelled to refund certain portions of these payments. Edwin B. De Golia, 40 B. T. A. 845; Renwick v. United States 87 Fed. (2d) 128; Commissioner v. Lyon, 97 Fed. (2d) 70; Grand Central Public Market, Inc. v. United States, 22 Fed. Supp. 119. On the other hand, sums deposited solely for purposes of security, which are to be refunded to the lessee on his completion of performance unless appropriated to compensate for specified defaults, do not constitute income and may not be taxed to the lessor. George E. Barker Estate, 13 B. T. A. 562; Warren Service Corporation, 39 B. T. A. 856; modified, 110 Fed. (2d) 723.

The facts in the instant case bring it within the principle first stated. The petitioner here received the payment in question without restriction as to its use, to serve as security for the lessee’s performance up until the last year of the lease, when it was to replace the rental due for that year. In the event of the destruction of the premises, if the lessor elected not to rebuild, the sum was to be refunded. This latter circumstance, however, was in the nature of an intervening' condition which does not disturb the petitioner’s present use of the funds.

The petitioner points to the fact that it was obligated to pay interest on the $21,000 payment. This interest, however, was to be credited on the rent due from the lessee, and in that circumstance it has been held that the nature of the advance payment as rent is not altered by the interest provision. Commissioner v. Lyon, supra. Argument is further made by the petitioner that, since the real estate broker was not to receive his commission on the payment until 1944, it may not be regarded as earned until then. This contention, however, falls beside the point when it is seen that the basis for taxing to the petitioner the payment in question is its receipt of the sum during the taxable year under an unfettered right to retain and use the funds, subject only to the intervention of developments which might cut off that right. Moreover, it is not plain that the commission was not payable until 1944, since the broker received $1,000 at the time of the execution of the agreement.

As we have pointed out, decisions in the present and similar situations must turn largely on an appraisal of all the facts. In these circumstances the answer is to be found in an assembly of all of the circumstances of one case rather than in a comparison of isolated facts in separate cases. Applying this method to the present case, it must be concluded that the payment was advance rental, and accordingly it is to be taxed to the petitioner in the year of its receipt.

The petitioner places his entire reliance on an unpublished memorandum opinion of the Board, Authentic Realty Co. (Aug. 5, 1940). Viewing all of the pertinent facts there, we concluded that the deposit was intended principally as security for the lessee’s performance. It was provided primarily to cure defaults in current rentals and, in the event there were no defaults, a material portion of the deposit was to be refunded to the lessee. The full and unfettered control of the funds which is found in the present case was there lacking. Our conclusion here thus does not conflict with that holding.

Decision will be entered for the respondent.


author: Disney:

text:
    Trinity Corporation (Formerly Trinity Life Building Corp.), Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103957.
    Promulgated August 12, 1941.

      Robert Ash, Esq., for the petitioner.

      Frank B. Schlosser, Esq., for the respondent.
   OPINION.

Disney:

Petitioner’s first contention is that a corporation does not realize taxable gain by a sale of its assets for shares of its own stock. Similar questions under earlier revenue acts have been before this Board and the courts. In Helvering v. Reynolds Tobacco Co., 306 U. S. 110, the Court held that the taxpayer realized no gain under section 22 (a) of the Revenue Act of 1928 upon the sale in 1929 of treasury stock for amounts in excess of cost. The reasoning of the Court was that, as regulations since the 1913 Act had consistently ruled such gain to be free from tax, Congress had, by repeated reenactments of the statutory definition of gross income, given the administrative construction the force of law, and that a change in the regulations by T. D. 4430, C. B. XIII-1, p. 36, on May 2, 1934, taxing gain realized in transactions of that nature, had no retroactive effect. The Court made no ruling on the prospective application of the new regulation. On April 17, 1939, the Commissioner, in view of the Reynolds Tobacco Co. case, revoked T. D. 4430, supra, in so far as it applied to the 1932, 1928, 1926, and 1924 Acts. T. D. 4895, C. B. 1939-1, p. 225. We extended the Reynolds Tobacco Co. case to the 1934 Act in National Home Owners Service Corporation, 39 B. T. A. 753.

Article 22 (a) (16) of Regulations 94, promulgated under the Revenue Act of 1936, to the extent material here, follows T. D. 4430, supra. It provides, in part, as follows:

Whether the acquisition or disposition by a corporation of shares of its own capital stock gives rise to taxable gain or deductible loss depends upon the real nature of the transaction, which is to be ascertained from all its facts and circumstances. * * *
But if a corporation deals in its own shares as it might in the shares of another corporation, the resulting gain or loss is to be computed in the same manner as though the corporation were dealing in the shares of another. So also if the corporation receives its own stock as consideration upon the sale of property by it, or in satisfaction of indebtedness to it, the gain or loss resulting is to be computed in the same manner as though the payment had been made in any other property. * * *

It is evident that the regulation was intended to cover transactions such as the one involved herein, i. e., that shares of petitioner’s capital stock received as consideration in the exchange must be included in the computation of gain or loss at its fair market value. Petitioner took the stock up on its books and reported it in its 1937 return in computing gain or loss on the transaction at a fair market value of $194,365.28. Is the regulation valid without a change in the statute?

The question appears to be answered by Helvering v. Wilshire Oil Co., 308 U. S. 90. The issue there turned upon whether regulations promulgated on February 15, 1929, under the 1928 Act, requiring the deduction of development expenses in computing net income from oil property, were valid as to the years 1929 and 1930, notwithstanding admitted prior practice of the Commissioner to compute income under earlier acts, without regard to development expenditures. It was argued by the taxpayer that, as the practice under earlier acts was known to Congress through repeated reenactments of the statute without change, the rule could not be altered without legislative approval. The Court assumed that the administrative construction under the 1921 Act had received Congressional approval in the 1924 Act. The regulations under the 1926 Act contained no comparable provision, but the Commissioner undertook to follow the practice subsequently incorporated in regulations under the 1928 Act. This change of administrative interpretation had the effect of restoring to the statutory provision its original ambiguity and the phrase in question became susceptible to new administrative construction. Thus in that case the practice of the Commissioner under the 1924 and prior acts was undergoing a change while the 1926 Act was in full force and effect. Notwithstanding this circumstance, the Court held that the changed regulation promulgated under the 1928 Act had prospective application. The Court said: “It [the rule that administrative interpretation of a statute receives legislative approval upon reenactments of the law wthout material change] does not mean that a regulation interpreting a provision of one act becomes frozen into another act merely by reenactment of that provision, so that that administrative interpretation cannot be changed prospectively through exercise of appropriate rule-making powers.” In Helvering v. Reynolds, 313 U. S. 428, the changed regulation was not promulgated until after the transaction in question had been consummated, but the Court held that it was applicable. Here the new regulation was put into effect while the 1934 Act was being considered by Congress and was in operation at the time of the passage of the 1936 Act. Accordingly, there was some legislative recognition of T. D. 4430 in the enactment of the 1936 Act.

In National Manufacture & Stores Corporation v. Allen (U. S. Dist. Ct., Mid. Dist. Ga., Nov. 2, 1940), the court held that the change made in the regulations in 1934 had no application to the 1936 Act, upon the ground that the old regulation had come to have the force and effect of law through reenactments of the statute in the same language and that the meaning could be changed only by Congress. There was no appeal from the decision. The WilsMre Oil Co. case is not discussed in the opinion of the court. We think the court’s conclusion is contrary to the reasoning of the Supreme Court in the Wilshire Oil Co. case and decline to follow it here.

In Helvering v. Janney, 311 U. S. 189, the decision turned primarily upon the meaning of the statute, unaided by- administrative construction, and the amendment to the regulations was not made until after the taxable year. Regulations of the Commissioner did not control the conclusion in Helvering v. Oregon Mutual Life Ins. Co., 311 U. S. 267. Hammond Iron Co., 41 B. T. A. 86, involved tax for 1933 under the 1932 Act and was controlled by the Reynolds Tobacco Co. case.

The transaction is clearly within Regulations 94, article 22 (a) (16), supra. Petitioner and the Commercial Co. were separate taxpayers, notwithstanding the fact that prior to the transfers the latter corporation owned all of the stock of the former. Petitioner received in the deal, as part of the consideration for the property given up, 2,920 shares of its own stock, which stock it could have sold to third parties,’ subject to the restrictions .imposed upon it by the transfer agreement. The Commercial Co. remained the sole stockholder of petitioner only by reason of the failure of petitioner to dispose of the stock received in the exchange.

The liability of the petitioner for a tax on the exchange is not controlled by the- manner in which it recorded the transaction on its books. Doyle v. Mitchell Bros., 247 U. S. 179. The gain, if any, will be determined by including in the computation, as part of the amount realized in the exchange, the 2,920 shares of stock at fair market value thereof.

Petitioner requests us to find- that the stock had no fair market value. ■ Two witnesses presented by petitioner, testifying as experts, in response to hypothetical questions testified that the stock had no value on the basic date. Although the hypothetical questions contained facts in addition to the book earnings and losses of the petitioner, these witnesses based their opinions largely upon lack of earnings of the corporation prior to the basic date. Alleged restrictions on the stock, including voting privileges, were other factors entering into lack of value. One witness attached no significance to the sales in 1935 and 1938 of shares of the stock at $125 and $73 per share, respectively, and that a purchase of 2,920 shares would give the buyer control of the corporation. The other witness acknowledged that the stock, had value if the purchaser had need for a substantial part of the office space in the building. This witness, who was the president of the ■ Commercial Co. and vice president of petitioner, further testified that the price of $125 per share paid for the stock in 1935 was a fair price in view -of the fact that the purchaser needed space in the building for its growing business.

The sale of the stock in question was not impossible, as in Helvering v. Tex-Penn Oil Co., 300 U. S. 481. The stock was pledged as security for the faithful performance of the contract to renew the ground lease, but a sale could have been made subject to the pledge. The other' cases’ cited by the petitioner involved restrictions against the sale of the stock which are not present here. Shares of the stock were sold by the petitioner to the Commercial Co. in 1938 without any proof of alteration in the guaranteeship to permit the transaction. An assumption that the stock could not be voted until 1987 was one of the facte forming one of the hypothetical questions. Petitioner had the right to vote the stock. The Commercial Co. held a controlling interest in petitioner and had a common management with it and therefore was in a position at all times to sell or withhold the stock from sale, if necessary to terminate the escrow agreement. We do not think the evidence establishes that the stock had no fair market value.

The evidence supports the determination of the respondent. There was a sale of all petitioner’s stock in 1935 for $125 per share and this price was regarded by one of petitioner’s witnesses as a fair price, considering the purpose for which the buyer desired the stock. In 1938 the same buyer purchased 320 shares of the stock at a price of $73.34539 per share, an amount equal to its book value, which was the fair market value determined by the respondent. The Commercial Co., the sole stockholder of petitioner, declared in a report to the Treasury Department that the stock had a fair market value of $125 per share in 1937. The Trinity Building, petitioner’s principal asset prior to the exchange, had a depreciated cost of about $600,000 and was appraised as of January 1,1938, at a present worth of about $730,000. The stock in question was entered in petitioner’s books at a value of $194,365.28.

The evidence before us does not warrant a disturbance of the respondent’s finding that the stock had a fair market value of $214,-168.54. Accordingly,

Decision void Toe entered, for the respondent.


author: Black:

text:
    Eastern Gas and Fuel Associates, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100763.
    Promulgated August 12, 1941.

      John E. McGlure, Esq., for the petitioner.

      Davis Hashin, Esq., for the respondent.
   OPINION.

Black:

The petitioner contends that the sums of $101,926.52, $99,801.13, and $95,926.38 paid by it to a trustee and paid by the trustee to the Commonwealth of Massachusetts in the respective years 1934, 1935, and 1936 are deductible as ordinary and necessary expenses or as taxes paid under section 23 of the Revenue Acts of 1934 or 1936. The applicable paragraphs of section 23 are printed in the margin. It contends in the alternative that if the respondent is correct in adding to income for the year 1934 the sum of $101,-926.52, this sum should be added in determining the adjusted declared value of its capital 'stock for excess profits tax purposes for the year 1935.

In his statement attached to the deficiency notice the respondent explains his action in disallowing the deductions claimed by petitioner as follows: ■

The amount of $101,926.52, $99,801.13 and $95,920.38, claimed as deductions in your returns (Forms 1120) for the calendar years 1934, 1935 and 1936 respectively, representing income taxes imposed by the Commonwealth of Massachusetts upon the shareholders of your association, based upon the dividends received by the shareholders, which are paid by the association without reimbursement from the shareholders, do not constitute allowable deductions from gross income under Section 23" (d) of the Revenue Acts of 1934 and 1936, because the said taxes are based upon the income derived by the said shareholders from their interest as shareholders and are not taxes upon the interest upon which the dividends were paid.

In his brief the respondent argues that the claimed deductions are not allowable either as ordinary and necessary expenses under section 23 (a) or as taxes paid or accrued within the taxable year under section 23 (c), or as taxes of shareholders paid by the corporation under section 23 (d), and contends that the amounts in question represent dividends paid by the corporation in addition to the regular preferred stock dividends and are not deductible from gross income in the respective taxable years. We agree with the respondent.

The payments here in question were amounts paid on behalf of certain shareholders, residents of Massachusetts, in order to induce them to exchange their shares in the Massachusetts Gas Companies for the shares of petitioner. In order to effect the exchange petitioner agreed to pay, in addition to the fixed dividend, an amount equal to the state tax imposed on the dividend in the hands of the shareholder. Payments of this nature are obviously not ordinary and necessary expenses of carrying on a trade or business within the meaning of section 23 (a): They are, in a practical sense, we think, an amount added to the fixed dividend and should be so regarded.

Petitioner contends that the payments in question are not dividends because they were not made pro rata to all shareholders and the petition was obligated to pay them whether it had sufficient earnings to pay them or not. While distributions by a corporation to its shareholders in proportion to their shares is the usual and customary thing and is evidence that such distributions are dividends, a distribution may be a dividend whether made in proportion to stock-holdings or not.

All of petitioner’s prior preference shares contained the same provisions and all shareholders who came within the class of residents of Massachusetts were entitled to reimbursement or its equivalent for state income taxes on the dividends received by them. This we think was a sufficient classification and only operated to make the net dividend of all shareholders equal. Petitioner does not contend that the payments here were not made from earnings or profits.

The statute defines dividends as any distribution made out of earnings or profits accumulated since February 28, 1913, or earnings or profits of the taxable year (sec. 115, Revenue Acts of 1934 and 1936). As we have already stated, there is no contention by the petitioner that the payments involved here were not made out of earnings or profits. We must, therefore, consider them as having been made out of earnings or profits and we think it is immaterial whether the shareholder could have required payment if there had been no earnings or profits.

The petitioner argues that in acquiring the stock of the Massachusetts Gas Companies it transferred two things; One, its stock; the other its obligation to pay the 6 percent state income tax imposed on the dividends of its Massachusetts stockholders; that the agreement to pay the tax imposed on the dividends was an obligation separate and distinct from the relationship of corporation and stockholder and represented an annual charge which the petitioner had to incur and pay out, and the amount so paid is therefore deductible as an ordinary and necessary expense of doing business. We think this contention must be denied.

In Atlantic Coast Line Railroad Co., 31 B. T. A. 730; affd., 81 Fed. (2d) 309, the taxpayer corporation in 1926 acquired all the common capital stock of the A. B. & C. Railroad Co. for $3,600,000, and guaranteed payment of dividends on its preferred stock. The preferred stock had exclusive voting power in case of default in payment of dividends. During the taxable years which were before us the taxpayer had paid to the preferred stockholders, under its guaranty agreement, amounts equal to the dividends. On these facts we held that the payments so made were not deductible as ordinary and necessary business expenses. Cf. Imperial Type Metal Co. v. Commissioner, 106 Fed. (2d) 302.

We shall next discuss petitioner’s contention that such payments are deductible as taxes paid. The general rule is that a taxpayer can not deduct payments made for taxes on behalf of another unless they come within section 23 (d) of the statute. In order to be entitled to a deduction for taxes paid under section 23 (c) of the statute it is necessary for a taxpayer to show, not only that he paid the taxes claimed, but that the taxes were imposed upon him by the taxing authority. See Eugene W. Small, 27 B. T. A. 1219, and cases there cited. The taxes in question were not imposed upon petitioner by the laws of the Commonwealth of Massachusetts and it was under no obligation to the state to pay them. Had it failed to pay them the stockholders upon whom they were imposed would have been liable for their payment. It is true that the stockholders might have proceeded against petitioner for reimbursement under the terms of their stock agreement. But petitioner’s obligation was imposed by the agreement under which it issued its stock in exchange for the stock of the Massachusetts Gas Companies. It was obligated to its stockholders and not to the state. Obviously the payments in question are not deductible under section 23 (c) as taxes paid. Cf. Old Colony Trust Co. v. Commissioner, 279 U. S. 716; United States v. Boston & Maine Railroad Co., 279 U. S. 732.

In the case of taxes of a shareholder paid by a corporation, section 23 (d) furnishes an exception to the general rule that taxes are deductible only by taxpayer upon whom they are imposed, but this exception only extends to cases where a corporation pays taxes imposed upon a shareholder of the corporation upon his interest in the corporation as a shareholder without reimbursement from the shareholder.

The laws of Massachusetts imposed an income tax on a shareholder of certain associations or trusts on dividends received by him. This was not a tax on any interest of the shareholder in the association or trust, but upon moneys which had been separated from the association or trust and paid over to the shareholders. It was not a tax upon his shares or on any property of the association or trust represented by the shares, but a tax on the income from his investment in such shares, and in our opinion does not coma within the purview of section 23 (d). Cf. Wayne County & Home Savings Bank, 26 B. T. A. 761; Bank of Mount Hope, 25 B. T. A. 542.

We now come to consider petitioner’s alternative contention that if the amount of $101,926.52 is not deductible from income for the year 1934, the adjusted declared value of its capital stock should be increased by that amount for excess profits tax purposes for 1935.

Section 701 (f) of the Revenue Act of 1934 expressly provides that, in determining ,the adjusted declared value of capital stock for capital stock and excess profits tax purposes for any subsequent year, the original declared value shall be increased by (among other things) the amount of net income and decreased by the amount of earnings distributed in such subsequent year.

In its capital stock tax return for the fiscal year ended June BO, 1935, petitioner added, among other things, to its original declared value net income in the amount of $92,858.40. The respondent determined . that petitioner’s net. income should be increased in the amount of $101,926.52, and has treated- this amount as earnings distributed during the year. We agree with the respondent that a recomputation of the adjusted declared value of petitioner’s capital stock for the year in question would require an addition of net income in the amount of $101,926.52 and a subtraction of earnings distributed in the same amount. This would result in no change in the adjusted declared value of $30,167.58 as shown on petitioner’s capital stock tax return for the year ended June 30, 1935, which amount was used by the respondent in computing petitioner’s excess profits tax for the year 1935. The action of the respondent is sustained.

Decision will he entered, for the resfondent.

       SEC. 23. deductions FROM GROSS INCOME.
      In computing net income there shall be allowed as deductions:
      (a) Expenses.—All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * *.

        * * # * * ⅜ *
      (c) Taxes Generally.—Taxes paid or accrued within the taxable year * * *.
      (d) Taxes op Shareholder paid by . Corporation.—The deduction for taxes allowed by subsection (c) shall bo allowed to a corporation in the case of taxes imposed upon a shareholder' of the corporation upon his interest as shareholder which are paid by the corporation without reimbursement from the shareholder, but in such cases no deduction shall be allowed the shareholder for the amount of such taxes.


author: Murdock:

text:
    George M. Cox, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 101847.
    Promulgated August 12, 1941.

      H. A. Mihills, G. P. A., for the petitioner.

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

Murdock:

The Commissioner determined a deficiency of $18,303.88 in income tax and a deficiency of $52,942.99 in personal holding company surtax for the fiscal year ended September 30, 1938. Two issues are raised by the pleadings: First, whether the Commissioner erred in disallowing $7,000 of the $10,000 deduction taken for salary paid to George M. Cox as president, and, second, whether the petitioner is entitled to a dividends paid credit of $95,700. The Board adopts as its findings of fact the stipulation of the parties.

The record does not disclose facts which would justify any change in the Commissioner’s disallowance of the salary item.

Tlie outstanding shares of the petitioner were held as follows in 1929:

George M. Cox- 310
Corporations owned by George M. Cox- 181
Thelnia Agnes Goertz- 1
Two directors- 2
Total_ , 500

Cassie J. Cos secured a divorce from George in February 1930, and 158 shares were transferred to her in March 1930 as her share of their community property in Louisiana. George married Thelma Agnes Goertz in that same month. He purchased the 158- shares from Cassie in January 1932, and placed them in his own name. The petitioner acquired 181 shares by merger with the former owners in 1932, and thereafter those shares were no longer outstanding. Thelma sued George for divorce in October 1933, and the decree of divorce was finally sustained in February 1935. Litigation relating to their finances continued until a final settlement at the close of 1939. •

Thelma seized and sold 12 shares standing in the name of George to satisfy her judgment for delinquent alimony. She then bought those shares at the sale. .She alleged in the litigation that George had given her 156 of the shares purchased from Cassie and, in the alternative, that she was the owner in community with George of the 158 shares purchased from Cassie. The court finally decided in May 1939 that no gift had been made, but the 158 shares belonged to the community.

The petitioner declared a dividend of $300 per share on July 29, 1938, and the president was authorized to pay it.forthwith. The petitioner was using an accrual method of accounting. The dividend was paid immediately on the two shares held by the two directors. The $3,900 dividend on the 13 undisputed shares held by Thelma was ordered held to apply on her indebtedness to the petitioner in a larger amount. She had taken securities of the petitioner in August 1933, and the amount of her indebtedness to the corporation was not known on July 29,1938. Later, her indebtedness on that date was disclosed as $27,182.37. George owed the petitioner $80,181.46 on July 29, 1938. The dividend on the 146 undisputed shares held by him amounted to $43,800. The situation as it finally developed was as follows on July 29, 1938:

Entries were made on the books of the petitioner, after the decree in May 1939, crediting dividends of $67,500 to the account of George and dividends of $27,600 to the account of Thelma. These dividends had not been previously paid or credited.

George reported $91,200 of the dividend on his own return for 1938, filed June 15, 1939.

The respondent now concedes that the petitioner is entitled to a dividends paid credit of $600 for the dividend paid to the two directors. Section 27 (a) of the Revenue Act of 1936 provides that “the dividends paid credit shall be the amount of dividends paid during the taxable year.” The remaining amount of the $95,700 was not paid by the petitioner during the taxable year. It was not even credited to the account of any stockholder during the taxable year. The corporation deliberately refrained from paying or crediting this amount because of the litigation and until that litigation was terminated and ownership of the shares established. The mere declaration of a dividend is not enough, Cox Motor Sales Co., 42 B. T. A. 192, even though it is to be paid “forthwith.” Obviously, the petitioner did not intend to pay this one forthwith to the two Coxes. It did not even pay or credit the dividend on the undisputed shares during the taxable year. That was done for a purpose, to avoid further litigation. Congress intended the credit only where there was actual payment or the equivalent thereof. Concord Silversmiths Corporation, 32 Fed. Supp. 128; Sanford Corporation, 38 B. T. A. 139; affd., 106 Fed. (2d) 882. There was here no constructive receipt by the shareholders during the taxable year of any part of the $95,100, not even the part applicable to the undisputed shares, since the corporation was deliberately refraining from crediting any part of it until ownership of all shares was finally determined. We hold, upon authority of the cases above cited, that the petitioner is not entitled to credit in excess of $600.

Decision will be entered wnder Rule 50.


author: Sternhagen :

text:
    Estate of W. R. Whitthorne, Deceased, Minnie L. Whitthorne and Eva Whitthorne, Executrices, Petitioners, v. Commissioner of Internal Revenue, Respondent. Sherwood Swan, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 101189, 101190.
    Promulgated August 13, 1941.

      Robert W. MacDonald, Esq., for the petitioners.

      Thomas M. Mather, Esq., for the respondent.
   OPINION.

Sternhagen :

1. The taxpayers were in 1936 jointly indebted to Central Bank for $165,081.32 and Swan separately owed that bank $20,000. They compromised this aggregate indebtedness of $185,-081.32 for $75,000 cash and a new joint note of $20,000, thus relieving themselves of an aggregate of $90,081.32, of which $70,081.32 was attributable to the joint note of $165,081.32 and $20,000 was attributable to Swan’s separate individual note. The Commissioner determined that Whitthorne’s income included the released $35,-040.66, one-half the joint note, and Swan’s income included the released $55,040.66, one-half the joint note and all of his separate note.

The taxpayers were jointly indebted to the Bank of America for $89,066.33 and Swan separately owed that bank $65,000. This aggregate debt was settled by the payment of $100,000 cash and the taking by the debtor of the shares of the Hale Bros. Realty Co., Wasserman-Gattmann Co., and Swan’s. The shares of the last two corporations were worthless and the shares of the Hale Bros. lie alt y Co. were recognized as having a value of $34,564.69. The Commissioner determined that Whitthorne realized no income in the settlement of this indebtedness and that Swan’s income included the $24,968.47 difference between his share ($109,533.16) of the aggregate of $154,066.33 owed and bis share ($50,000) of the amount of cash and the value ($34,564.69) of the Hale shares paid by Swan in the settlement.

When a taxpayer settles a debt for less than the full amount, the saving, as a general rule, is income. United States v. Kirby Lumber Co., 284 U. S. 1; B. F. Avery & Sons, Inc., 26 B. T. A. 1393; Highland Farms Corporation, 42 B. T. A. 1314. The petitioners try to bring themselves within the line of cases holding , that income is not realized if the debtor is insolvent before and after the settlement. Swan claims to have had a net insolvency of $10,500.83 and Whitthorne a net worth of $3,500. In each instance, their shares in the corporation are treated as worth $105,000, arrived at by using a value of $200,000 for the corporation’s land. The evidence does not, in our opinion, establish insolvency of either petitioner.

The value of the petitioners’ shares is not properly fixed by the value of the land on which the corporation operates the market. Other factors must be considered. In view of all the evidence, the opinions of the witnesses as to the value of the land can not be adopted. The earnings of 1935 were over $65,000 and of 1936 over $70,000. The dividends for 1935 were $32,000 and for 1936 were $11,000. The new financing was based upon' a recognition of the book value of the market property. The wholesale price of the class A shares to the dealer was $7 and to thé .public $10. The common shares had commensurate rights which gave them substantial value. It is not necessary to find a definitive value for the corporations’ shares, but it is clear that they were worth more than enough to show that as assets in the hands of petitioners they preclude a finding of insolvency and do not affect the gain realized in the settlement of their debts.

The petitioners argue a new conception of the doctrine of realization of income in connection with a debt settlement. They say the essence of the realization is not the settlement of the debts alone, but the freeing of assets, and that such freeing of assets occurred in 1930 when the pledge of the shares was limited by the banks to $100,000. This can not be adopted as the theory of the rule. A solvent taxpayer realizes a gain by a reduction of his debt irrespective of whether the debt is secured by a pledge or mortgage. The freeing of assets which has been regarded in the decisions as a significant fact is not the release of the pledged security from lien, but the effect of enabling the debtor to use all his assets freed from the incubus of the debt. The obliteration of the offsetting liability for debt is what constitutes the gain. If in 1930 the creditor banks had not only agreed to limit the use of the pledged shares to security for $100,000 of the debt, but had also renounced all claim on the debtor for more than. $100,000, the forgiveness would have been a gain, not because the lien was limited, but because the excess amount of the debt was discharged without payment. Having been realized in 1930 it would have been taxable then and not later. But it was not until 1936 that the debt was finally settled; so the resulting gain is properly taxable then.

The petitioners also make a point that the measure of the gain, according to their theory, is not the value of the assets freed, but the cost of them to the petitioners, which was $50,000 to each. The point, however, falls with the theory. Since the release of the pledged shares from the lien is not the occasion of the gain, their particular value or cost is not determinative of the gain. The relevancy of their -value when the debt is discharged is only as a factor in considering whether the extent of petitioners’ assets demonstrates insolvency; and this, as has been stated, is not-true.

The Commissioner’s determinations of taxable gain resulting from the settlement of debts to the Central National Bank of Oakland and Bank of America are sustained.

2. The petitioners claim that in the computation of gain resulting from the sale of the new shares the basis has been erroneously distributed between the class A preferred and the common shares. The original 1,000 old company shares cost them $100,000. The petitioners exchanged their old shares for new and agreed with Miller & Co. to sell 25,000 class A shares to it for $175,000 on prescribed terms. They say that in computing the gain from this transaction the basis of $100,000 must all be assigned to the class A shares .because the common shares were worthless. By such a computation the basis of the shares sold would be increased and the gain correspondingly reduced, and the unsold common shares would be left with no basis, and any future sale price would be entirely gain. The Commissioner adopted for the distribution of the basis between the two classes of shares the ratio which petitioners used on their returns, viz., 50.84 percent for the preferred and 49.16 percent for the common. This is, in our opinion, the best the petitioners can demand on the evidence.

The corporation’s balance sheet showed a surplus of $97,670.45 after assigning $390,000 to capital stock. The assets included the $618,674.83 book value of the market property. Net income each year was about $65,000. This was more than enough to have enabled the corporation to pay dividends equal to the first 60 cents on the preferred and the corresponding first 60 cents on the common. Additional dividends were to be equal on the two classes of shares. Other rights of the shareholders were very much alike, except the liquidation preference of the class A. The fact that the common abares were not actually sold is no indication of a lack of market or of value, when the preferred were so promptly sold at $10 a share on the open market. The basis used by the Commissioner is sustained.

3. The petitioners contend that in 1936 they sold only 12,500 of the class A shares and that their tax may not be measured by a profit from the sale of 25,000 shares. In this we think they are correct. The contract with Miller & Co. was not a sale of the entire 25,000 shares. In fact only 12,500 were delivered in 1936 and, since this was well within the 90-day period, there was no duty of the dealer to take any more in that year. It fulfilled its contract in 1937 by taking the remaining 12,500 and paying for them in that year. It can not be said that the latter were sold in 1936 or that petitioners in that year derived the profit from their sale. They had made a contract to sell, but there is no evidence that this was intended to be an immediate sale. It is error to treat it as such. Commissioner v. Segall, 114 Fed. (2d) 706; Shillinglaw v. Commissioner, 99 Fed. (2d) 87; Dahlinger v. Commissioner, 51 Fed. (2d) 662; certiorari denied, 284 U. S. 673; Stiver v. Commissioner, 90 Fed. (2d) 505.

The gain in 1936 should be reduced to that applicable to a sale of 12,500 shares.

4. The Commissioner determined a penalty of 5 percent under section 291, Revenue Act of 1936, for failure of petitioners to file their returns on time. The evidence does not establish that the delay was due to reasonable cause and not to willful neglect, and the penalty is therefore sustained.

Decision will be entered under Rule 50.

      . The balance due on tbe face amount of the notes was $212,115.04, but the Commissioner’s determination treats the excess as interest and omits it from the computation. Likewise the excess of the face amount of the Bank of America notes is omitted from the computation.