author: Littleton: Sternhagen,

text:
    Appeal of LIBERTY LIGHT & POWER CO.
    Docket No. 3760.
    Submitted July 27, 1925.
    Decided June 21, 1926.
    In conformity with the statutes of the States of Indiana and Ohio, certain citizens desiring to obtain electric service constructed certain transmission lines at a cost of $10,500 and transferred the same to the taxpayer which was required, by statute and regulations of the Public Utilities Commission, thereafter to maintain said lines and to furnish electrical current to the subscribers to the cost of constructing said line, and, to such other subscribers for electrical service upon the payment of the cost of equipment necessary to make connection with said lines, at rates to be prescribed by the Public Utilities Commission. Held, that the transmission lines, which became the property of the taxpayer upon being transferred to it by the constructors, did- not constitute taxable income within the meaning of the Sixteenth Amendment to the Constitution and the Revenue Act of 1921.

      John D. Van Wagoner, Esq., for the petitioner.

      M. N. Fisher, Esq., for the Commissioner.

      Before James, Littleton, Smith, and Trussell.
    This is an appeal from the determination of a deficiency in income and profits tax in the amount of $2,770.40 for the calendar year 1921, arising from the decision of the Commissioner that certain property, consisting of rural electric power lines constructed and paid for by citizens of the States of Indiana and Ohio, which lines upon completion were conveyed to the taxpayer and became its property, constituted taxable income.
    BINDINGS OP FACT.
    The taxpayer is an' Indiana corporation with principal office at Richmond, engaged in the transportation and sale of electricity in Indiana and Ohio. It was subject to the rules and regulations prescribed by the Indiana and Ohio Public Utilities Commissions. The taxpayer was required to furnish all applicants within its territory, to the capacity of its facilities, with adequate service at just and reasonable rates. It was under no obligation to extend its service into territory which it had not entered and as to which it had assumed no franchise obligations.
    Service could not be extended by the taxpayer to rural communities on a paying basis, and it was not required to do so except when transmission lines were constructed through contributions by prospective consumers. In the event residents of rural communities contributed an amount necessary to construct transmission lines, the taxpayer was required to receive and maintain such lines and furnish service at the rates prescribed by the Public Utilities Commission.
    During the year 1921 the taxpayer became a party to four contracts entered into between certain individuals, designated as unit holders, and a constructor. These contracts provided for the construction, through contributions by the unit holders, of two rural transmission lines, one in Wayne County, Indiana, known as the Centerville Line, and the other in Ohio, known as the Campbells-town Line. The lines were completed and delivered to the taxpayer within the year 1921. The provisions of each of the contracts material to this appeal, except as to a variation in the amount to be contributed by each unit holder, were the same and were as follows:
    Whereas, said Constructor is in position to and can upon suitable plans and specifications construct said line, and said Power Company is in position to render, continue and maintain electrical service thereby after completion, and shall and does further agree that upon the [sio] all of the said transmission line being conveyed to it to thereafter maintain the same suitable to provide therefor efficient and continuous service to the users of electric current along such line; and

      Whereas, Unit Holders in order to encourage such construction, do and have agreed as hereinafter set forth, to provide part of the necessary funds by and with which to meet the costs of" construction of such line, and do and have further agreed that upon completion of the same, same shall be and is the sole property of said Power Company,
    Now, therefore, upon the premises, and for and in consideration of the mutual benefits to accrue to the parties hereto, it is by them respectively agreed and contracted as follows, to-wit:
    (1) Said Constructor contracts and agrees that following the consummation of this agreement and contract by the Unit Holders as hereinafter set forth, he shall and will effect:
    (a) The construction * * * ■ of a transmission line, * * *.
    (2) Said Unit Holders each to constitute such fund as shall be necessary to be provided hereunder, individually and severally subscribe for and agree to pay for such number of units as may be set opposite their names respectively, the maximum of such liability per unit however being and to be the sum of Two Hundred Thirty-four and 25/100 Dollars ($234.25), and respective units payable on demand, fifty per cent thereof when material is delivered, and balance when line is completed. The maximum of aggregate units shall be the sum of an amount which equals the total lineal footage of transmission line at twelve and nine-tenths cents (12.90) per lineal foot therefor, or the sum of $681.81 per mile; and altho not herein finally definitely determined, estimated length is some five and one-half miles.
    Such total cost of such unit at said price of twelve and nine-tenths cents (12.90) per ft. shall be and is a contribution made by the Unit Holders to encourage the construction of such line. As paid in and as accumulated, same shall be and is a contribution upon and as an inducement the construction of such transmission line, and payment being made and gross sum paid to Constructor, Unit Holders have and claim no further right, title and interest in and to such transmission line.
    (3) Said The Liberty Light and Power Company as inducement to this contract and agreement, contracts and agrees that upon the completion of such transmission line, it shall and will at the Northern terminus thereof make due, proper and suitable connection with its power line, and then and thereafter and continuously afford proper and reasonable service by and through such transmission and power lines.
    Said The Liberty Light and Power Company further contracts and agrees that it shall and will accept said line from said Constructor as completed, and shall and will further thereafterwards maintain the same in condition proper in the premises, and without further cost or charge for such maintenance to either said Constructor or to said Unit Plolders; it being always however understood that should said The Liberty Light and Power Company desire or determine to render service to others than Unit Plolders, or to make extensions to said transmission line, it shall be and always is entitled so to do, conditioned always however that such additions and extensions shall not be calculated to render to Unit Plolders as may be consumers of current less efficient service by reason of such additions and extensions.
    The unit holders contributed a total sum of $10,500, and the taxpayer contributed $739.98 in cash and equipment of the value of $1,026.77 toward the construction of the Centerville Line, and equipment of the value of $2,482.60 toward the construction of the Camp-bellstown Line. Upon completion the transmission lines were turned over to the taxpayer and became its property. Their value was entered as an asset in its plant account and as a liability in its balance sheet account “ Donations in Aid of Construction.”
    The Principles and Regulations of the Indiana Public Utilities Commission covering extension of facilities to supply rural electric service provides as follows:
    The term “ Rural Customer ” as herein used refers to the consumer of electrical energy who is located outside of the corporate limits of any city or village or beyond the limits of the local distribution system of any city or village when the same extends beyond the actual corporate limits.
    The term “ Rural Extension ” relates to extensions made primarily to serve rural customers.
    *******
    The customers to be served from any rural extension shall collectively deposit with the company an amount equal to the estimated cost of the general equipment to be furnished and, in addition thereto, each individual customer shall deposit with the company the estimated cost of the local equipment necessary to serve him. The customers to be served shall allocate the distribution of costs of general equipment among themselves.
    Upon the deposit of the funds provided for in the preceding paragraph, the construction work will be completed and service supplied as soon as practicable.
    Notwithstanding any payments made by customers to the company covering the cost of general or local equipment the title to the same shall be and remain in the company.
    ****** *
    The rates for rural service shall be the sum of the regular rates for any class of service as supplied to customers in municipality, suburb or village from which the extension is made, including all minimum and demand charges, and any difference of opinion in the application of this schedule shall be submitted to this Commission for interpretation.
    And, in addition thereto, a rural charge, which, upon the annual basis, shall be equal to ten per cent of the total cost of the general and local equipment included in each separate extension.
    The annual charge will be prorated to each customer served from each rural extension, in proportion to the transformer capacity provided for his use based upon the application for service made by him.
    The annual rural charge applicable to each customer shall be payable in monthly installments as nearly equal as may be, for the period covered by each customer’s application and or so long as such rural charge shall remain on file with the Public Service Commission of Indiana.
    Payment of the rural charge is not based or contingent upon the use of energy during any month or longer period but will be required in addition to any minimum included in the municipal rate upon which the charge for energy is based and is compensation for the excess cost of serving rural customers.
    Accounting procedure to be followed when any part of the property or plant of any public utility is paid for by the patrons or consumers:
    In the instance when any additions, extensions, improvements or better-ments to the property or plant of any public utility are paid for by the patrons thereof, the ownership of which passes to the utility, such as- the rural extensions covered by the foregoing, the following accounting procedure shall be followed.

      Cash shall be charged with amount of money so paid in by said patrons and a balance sheet (liability) account “Donations in Aid of Construction” shall be concurrently credited. As the wort of construction progresses, the proper capital account of the utility shall be charged and the cash account (or accounts payable) concurrently credited.
    Note. — If the addition, extension, improvement, or betterments are first constructed by the patrons and then given to the ownership of the utility, the proper capital account shall be charged and the balance sheet (liability) account “ Donations in Aid of Construction ” shall be concurrently credited with the actual cost (estimated if not known) of said property.
    Said balance sheet account “ Donations in Aid of Construction ” shall be carried permanently and all entries to said account shall be made with sufficient clarity and detail so that the analysis thereof, which will be called for by the Commission, may be readily obtainable.
    Upon the audit of the return the Commissioner held that the property received by the taxpayer constituted taxable income within that year to the extent of $10,500 contributed by the unit holders.

       This decision was prepared during Mr. James’ term of office.

   OPINION.

Littleton:

The issue presented in this appeal is similar to that before the court in the case of Edwards v. Cuba R. R. Co., 268 U. S. 628, and is whether certain electric power lines constructed by the citizens of Indiana and Ohio and transferred upon completion to the taxpayer, becoming its property under the provisions of the statutes of Indiana and Ohio, constituted taxable income within the meaning of the Sixteenth Amendment to the Constitution and the Revenue Act of 1921.

The question of what constitutes income within the meaning of the Sixteenth Amendment and the various revenue acts has been considered and decided by the courts in a number of cases, in which the courts have given the word “income” a settled and definite meaning.

The Board is without information from the Commissioner as to the theory upon which he predicated his decision that this property constituted taxable income. We presume that his reason for holding it to be taxable income was that the taxpayer became the owner thereof without cost to it, or, that it constituted an advance payment by the citizens for services to be rendered in the future by the taxpayer. The facts show, however, that the citizens who constructed and transferred these lines to the taxpayer were required, by statute and regulations prescribed by the Public Utilities Commissions of Indiana and Ohio, to pay for electricity furnished by the taxpayer at the regular rates paid by consumers in municipalities who contributed nothing toward the construction of the taxpayer’s lines over which such service was furnished, plus an additional rural charge. The most that can be said in respect of these transmission lines is that they were contributed by the citizens to the capital of the taxpayer. They were certainly not j>ayments for services rendered or to be rendered.

In the case of Southern Pacific Co. v. Lowe, 238 Fed. 847, the court said, at page 850:

X do not think that “ income,” as used in the statute, [Income Tax Act October 3, 1913] should be given a meaning so as to include everything that comes in. The true function of the words “ gains ” and “ profits ” is to limit the meaning of the word “ income ” and to show its use only in the sense of receipts which constituted an accretion to capital. So the function of the word “ income ” should be to limit the meaning of the words “ gains ” and “ profits.” The increased value of capital as such constitutes in one sense a gain or profit, but not income. Hence such gain or profit is not taxable, but only such profits and gains as constitute income are taxable. This in substance was what the court held in Gray v. Darlington, 15 Wall. 63, 21 L. Ed. 45, and in Gauley Mt. Coal Co. v. Hays, 230 Fed. 110, 144 C. C. A. 408.
In the early case of People v. Davenport, 30 Hun (N. Y.) 177, it was said that “ income is that which capital earns remaining itself intact.” This definition was recently adopted in Mitchell v. Doyle (D. C.) 225 Fed. 437.

In the case of Stratton's Independence, Ltd. v. Howbert, 231 U. S. 399, the court, at page 415, said:

And, however the operation shall be described, the transaction is indubitably “ business ” within the fair meaning of the act of 1909; and the gains derived from it are properly and strictly the income from that business ; for “ income ” may be defined as the gain derived from capital, from labor, or from both combined, and here we have combined operations of capital and labor.

In the case of Doyle v. Mitchell Brothers Co., 247 U. S. 179, the court said, at page 185:

Whatever difficulty there may be about a precise and scientific definition of “ income,” it imports, as used here, [Act of August 5, 1909] something entirely distinct from principal or capital either as a subject of taxation or as a measure of the tax; conveying rather the idea of gain or increase arising from corporate activities. As was said in Stratton’s Independence v. Howbert, 231, U. S. 399, 415 [34 Sup. Ct. 136, 58 L. Ed. 285]: “ Income may be defined as the gain derived from capital, from labor, or from both combined.”

In the case of Southern Pacific Co. v. Lowe, 247 U. S. 330, under the Act of October 3, 1913, the court said:

We must reject in this case, as we have rejected in cases arising under the Corporation Excise Tax Act of 1909 (Doyle v. Mitchell Brothers Co., [247 U. S. 179, 38 Sup. Ct. 467, 62 L. Ed. 1054] and Hays v. Gauley Mountain Coal Co., [247 U. S. 189, 38 Sup. Ct. 470, 62 L. Ed. 1061, decided March 20, 1918]) the broad contention submitted in behalf of the Government that all receipts— everything that comes in — are income within the proper definition of the term “gross income,” * * *. Certainly the term “income” has no broader meaning- in the 1913 Act than in that of 1909 (see Stratton’s Independence v. Howbert, 231 U. S. 399, 416, 417 [34 Sup. Ct. 136, 58 L. Ed. 285]), and for the present purpose we assume there is no difference in its meaning as used in the two acts.

In Eisner v. Macomber, 252 U. S. 189, in considering the scope of the word “ income,” as used in the Sixteenth Amendment and the Revenue Act of September 8, 1916, the court said, at pages 206-208:

In order, therefore, that the clauses cited from Article I of the Constitution may have proper force and effect, save only as modified by the Amendment, and that the latter also may have proper effect, it becomes essential to distinguish between what is and what is not “ income,” as the term is there used; and to apply the distinction, as cases arise, according to truth and substance, without regard to form. Congress cannot by any definition it may adopt conclude the matter, since it cannot by legislation alter the Constitution, from which alone it derives its power to legislate, and within whose limitations alone that power can be lawfully exercised.
The fundamental relation of “ capital ” to “ income ” has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time. Eor the present purpose we require only clear definition of the term “ income,” as used in common speech, in order to determine its meaning in the Amendment; and, having formed also a correct judgment as to the nature of a stock dividend, we shall find it easy to decide the matter at issue.
After examining dictionaries in common use (Bouv. L. D.; Standard Diet.; Webster’s Internat. Diet.; Century Diet.), we find little to add to the succinct definition adopted in two cases arising under the Corporation Tax Act of 1909 (Stratton’s Independence v. Howbert, 231 U. S. 399, 415; Doyle v. Mitchell Bros. Co., 247 U. S. 179, 185) — “Income may be defined as the gain derived from capital, .from labor, or from both combined,” provided it be understood to include profit gained through a sale or conversion of capital assets, to which it was applied in the Doyle Case (pp. 183, 185).
Brief as it is, it indicates the characteristic and distinguishing attribute of income essential for a correct solution of the present controversy. The Government, although basing its argument upon the definition as quoted, placed chief emphasis upon the word “ gain,” which was extended to include a variety of meanings; while the significance of the next three words was either overlooked or misconceived. “Derived — from—capital—“the gain — derived — from—capital,’’ etc. Here we have the essential matter; not a gain accruing to capital, not a growth, or in&'ement of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being “derived,’’ that is, received or drawn by the recipient (the taxpayer)' for his separate use, benefit and disposal; — -that is income derived from property. Nothing else answers the description.
The same fundamental conception is clearly set forth in the Sixteenth Amendment — “ incomes, from whatever source derived ” — the essential thought being expressed with a conciseness and lucidity entirely in harmony with the form and style of the Constitution.

This definition was followed in the case of United States v. Phellis, 257 U. S. 156, and Weiss v. Stearn, 265 U. S. 242; Bowers v. Kerbaugh-Empire Co., 271 U. S. 170.

In the case of Cuba R. R. Co. v. Edwards, 298 Fed. 664, which involved a tax for the years 1911 to 1916, inclusive, the District Court for the Southern District of New York stated, in respect to the question whether contributions by the Government of Cuba constituted income to the Railroad Company, at pages 665 and 666, as follows :

The question is whether the installments paid by the Cuban government were principal or income. Certainly they would not seem to be income in the ordinary sense. It is true that the first line of railroad had to be and was completed by the company before the subsidies were paid, and in the case of both lines there was something to be done on the part of the railroad in futuro by the terms of the contract. But can the subsidies be regarded in any proper sense as gains derived from capital or labor? Stratton’s Independence, Ltd., v. Howbert, 231 U. S. 399, 34 Sup. Ct. 136, 58 L. Ed. 285.
The fixing of rates is certainly a common provision in government contracts granting railroad franchises, and the real consideration for the payment of the subsidy was the agreement to build the road and operate it. For that agreement a franchise to operate it on prescribed terms and a subsidy payable in six annual installments was granted. Suppose a subscriber for stock agreed to pay in his subscription in six annual installments after a railroad was completed. The subscriber’s return would consist of a chance to receive dividends in the future. The government’s return in this case was to be secured by the development of the island through the construction and operation of the railroad, the privilege on the part of the government of placing telegraph and telephone wires on the right of way, and of securing the carriage of mails and passengers, produce, and troops upon prescribed terms. The fixing of rates is apparently a proper subject of government regulation. Would a subscription to stock be income because payable after the railroad was completed? I cannot see the merit of such a contention. The purpose seems clear to add to the funds of the railroad company, doubtless for the purpose of providing equipment or repaying obligations incurred in construction. Whatever the purpose of the subsidies, they in no way resemble earnings. They have but the remotest resemblance to a gain from either capital or labor.
The English cases, where annual contributions were made to assist in paying interest charges on construction bonds, are not in point. Such subsidies have been fairly held to be income, because they were intended to relieve the companies from annual charges against income. So far as annual subsidies were required to be used to form a sinking fund to amortize obligations incurred in construction, I think that the English decisions are of doubtful correctness. They are defended in respect to the items to be applied toward a sinking fund upon the ground that the whole sum making up the annual subsidy was paid as income, and that the appropriation of a portion of it to a sinking fund after receipt by the company did not alter its original character. The court said in the case of Blake v. Imperial Brazilian Ry., Great Britain Reports of Income Tax Oases (1S84) vol. 2, p. 58:
“ When once the thing is ascertained as being subject to income tax, it matters not what is done with it afterwards. When once it has come within the grasp of the income tax acts, it is liable to income tax, whatever may be its destination, or whatever use it may be put to.”
Whether the above reasoning be sound or not, no such situation confronts us here, for the payments are not derived from capital and labor, and are not to relieve annual interest charges against capital, but are contributions made within a short period to pay the railroad for constructing its lines and agreeing to run them on prescribed terms. I cannot see how the subsidies are income in any practical business sense.

This decision was affirmed by the Supreme Court in the case of Edwards v. Cuba R. R. Co., 268 U. S. 628, in which the court said, at page 631:

Defendant [collector] insists that the subsidies were merely payments in advance on account of transportation service, later to be performed by the plaintiff for the government, and therefore are to be deemed income and taxable as such.
In respect of these subsidy payments, the meaning of “income” as used in the Corporation Excise Tax Daw of 1909 is not to be distinguished from the meaning of the same word as used in the Income Tax Law of 1913 and the Revenue Act of 1916. Merchants’ Loan 4 Trust Co. v. Smietanka, 255 U. S. 509, 518-519.
The Sixteenth Amendment, like other laws authorizing or imposing taxes, is to be taken as written and is not to be extended beyond the meaning clearly indicated by the language used. The Cuban laws and contracts are similar to legislation and arrangements for the promotion of railroad construction which have been well known in the United States for more than half a century. Such aids, gifts and grants from the government, subordinate political subdivisions or private sources — whether of land, other property, credit or money— in order to induce construction and operation of railroads for the service of the public are not given as mere gratuities. Burke v. Southern Pacific R. R. Co., 234 U. S. 669, 679; Louisville & Nashville R. R. v. United States, 267 U. S. 395. Usually they are given to promote settlement and to provide for the development of the resources in the territory to be served. The things so sought to be attained in the public interest are numerous and varied. There is no support for the view that the Cuban Government gave the subsidy payments, lands, buildings, railroad construction and equipment merely to obtain the specified concessions in respect of rates for government transportation. Other rales were considered. By the first contract, plaintiff agreed to reduce fares for first class passengers and by the second, it agreed to reduce the rates on small produce. Clearly, the value of the lands and other physical property handed over to aid plaintiff in the completion of the railroad from Casilda to Placetas del Sur was not taxable income. These were to be used directly to complete the undertaking. The Commisioner of Internal Revenue in levying the tax did not include their value as income, and defendant does not claim that it was income. Relying on the contract for partial reimbursement, plaintiff found the money necessary to construct the railroad. The subsidy payments were proportionate to mileage completed; and this indicates a purpose to reimburse plaintiff for capital expenditures. All — the physical properties and the money subsidies — were given for the same purposes. It cannot reasonably be held that one was contribution to capital assets, and that the other was profit, gain or income. Neither the laws nor the contracts indicate that the money subsidies were to be used for the payment of dividends, interest or anything else properly chargeable to or payable out of earnings or income. The subsidy payments taxed were not made for services rendered or to be rendered. They were not profits or gains from the use or operation of the railroad, and do not constitute income within the meaning of the Sixteenth Amendment. See Stratton’s Independence v. Howbert, 231 U. S. 399, 415; Eisner v. Macomber, 252 U. S. 189, 207; Merchants’ Loan & Trust Co. v. Smietanka, supra.

Upon the facts in this appeal, and in the light of the foregoing decisions, the Board is of the opinion that the power lines constructed by the citizens of Indiana and Ohio and transferred to the taxpayer can not be held to have constituted taxable income for the calendar year 1921.

Order of redetermination will he entered on 15 days’ notice, wader Rule 50.

Green concurs in the result only.

Sternhagen,

dissenting: It seems to me that the taxpayer, a commercial corporation, in the course of carrying on its business, and as one of the recognized features of its business, received compensation by way of consideration for a contract to perform its ordinary service. There was nothing altruistic in the motive which prompted these prospective customers to finance the extension. They needed service and they were willing to pay for it. If the facilities had been already constructed and available they would have paid a price embodied in the rate, and this would unquestionably have been within the company’s gross income. Since the facilities were not available the company could only be induced to give service by the receipt of something in addition to the rate, namely, contributions sufficient to enable it to construct and furnish both facilities and service. Whatever it received in this way seems to me to be within its gross income from carrying on its business.

I do not understand the Cuba Railroad decision to hold contrariwise. That was a subsidy contributed by the sovereign, and I can not believe that the court intended it to be inferred that a private contribution made in consideration for the performance of one of the corporation’s normal business functions was to be likewise free from tax. Furthermore, I had understood that the reasoning of this Board in the decision of the Appeal of S. E. Overton Co., 2 B. T. A. 1160, proceeded upon the view that such an amount contributed by a municipality for the construction of a taxpayer’s plant was income.


source: Caselaw Access Project

author: MoRRis:

license: Public Domain

text:
    Appeal of RAYMOND R. GOODLATTE.
    Docket No. 4007.
    Submitted July 14, 1925.
    Decided June 21, 1926.
    On the facts, held, that the taxpayer was a member of the partnership of T. R. Goodlatte & Sons until April 1, 1920, but that his partnership interest during the first three months of that year was only his percentage of the quarterly profits which the partners termed “ deferred salary.”

      Chester A. Gwinn, Esq., for the petitioner.

      B. G. Simpioh, Esq., for the Commissioner.
    Before Marquette and MoRRis.
    This appeal is from the determination of a deficiency in income tax for the year 1920 in the amount of $4,729.53. The question involved is whether the taxpayer was a member of the partnership of T. R. Goodlatte & Sons during the first three months of 1920.
    FINDINGS OF FACT.
    The taxpayer is a resident of Warwick, N. Y.
    The partnership of T. R. Goodlatte & Sons was engaged in the business of manufacturing oil cloth in Delawanna, N. J., and was composed of the taxpayer, his brother Robert IL, and their father, Thomas R. Goodlatte, each having a one-third interest. The partnership agreement was not in writing.
    In the summer of 1919 the partnership was approached by the DuPont interests and a tentative offer was made to buy the business at $1,000,000, subject to a physical appraisal and-an audit of the books. Since the taxpayer desired to sell but the other two partners did not, they felt it was but fair to him to purchase his interest. Discussions continued among the three partners with reference to the price to be paid. In the fall of 1919 it was agreed to pay the taxpayer $200,000 for his interest, payable $50,000 in cash, $50,000 in Liberty bonds, and the balance of $100,000 in notes payable over a period of ten years, and to terminate the partnership by the withdrawal of the taxpayer as of December 31,1919.
    Later in 1919 the father decided that he wished to make a trip to Europe prior to the taxpayer’s withdrawal, in order to visit his sister who was ill, and his daughter. The taxpayer attended to the sales end of the business and his brother to the factory end. The taxpayer agreed to continue with the business until the father’s return, which was expected to occur about April 1, 1920.

      Under date of December 5, 1919, the following agreement was executed by the three partners:
    Agreement made this fifth day of December, 1910, by and between Raymond R. Goodlatte, of the City of Passaic, Passaic County, New Jersey, party of the first part, and Thomas R. Goodlatte, and Robert K. Goodlatte, of the City of Passaic, Passaic County, New Jersey, party of the second part;
    Witnesseth: Whereas the partnership of T. R. Goodlatte & Sons is made up of the above-named parties and the said Raymond R. Goodlatte desires to withdraw from the partnership from and after April 1st, 1920.
    Now therefore, in consideration of One Dollar and of the mutual covenants hereof, the said party of the first part for himself, his executors and administrators, does hereby covenant and agree with the party of the second part and their heirs, executors and administrators, that on or about April 1st, 1920, he will enter into an agreement with the party of the second part whereby he will sell and convey to them all of his right, title and interest in and to the said partnership and in and to all of the assets thereof, including the good-will and undivided profits, subject, however, to all of the existing indebtedness and obligations of the partnership, for the price or sum of $200,000.00, Two Hundred Thousand Dollars, which the party of the second part agrees to pay and the party of the first part agrees to receive in the following manner:
    $100,000.00 in cash upon the signing of that agreement and the balance, $100,000.00 in installments of not less than $10,000 per annum, with interest on unpaid balances to be computed and paid semi-annually; the party of the second part having the option at any time during the life of that contract to pay the entire balance of the purchase price at any time remaining due and unpaid with accrued interest.
    It is further understood and agreed that in and by the said contract the party of the second part shall agree to fully indemnify and save harmless the said Raymond R. Goodlatte and his heirs, executors and administrators from all debts and obligations of the partnership, past, present or future, and the obligation of the party of the second part under the said contract of purchase shall be deemed and taken to be an obligation of the partnership, to remain until fully discharged a lien upon the assets of the partnership.
    Subsequent to this agreement, and. prior to the close of 1919, no additional oral or written agreement was entered into. No agreement was executed on or about April 1, 1920.
    Prior to January 1, 1920, it was the practice of the partners to draw fixed salaries and a bonus or so-called “ deferred salary ”, both of which were credited quarterly with the then closing of the books. The “ deferred salary ” consisted of a percentage of the quarterly profits according to the books, the percentage varying with the three individuals. There was a credit balance in that account in the taxpayer’s favor on January 1, 1920, of $28,823.93. During the period from January 1, 1920, to April 1, 1920, the taxpayer was credited with further items totaling $7,563.82. He drew on his account as follows:

      Jan. 2_ $600. 00
    Jan. 7_ 3,750.00
    Feb. 3_ 600. 00
    Mar. 2__ 600.00
    Mar. 17_ 519.16
    Mar. 31_J_ 6,143.18
    Total_12,212.34
    The amount of $200,000 was actually paid to the taxpayer for his interest in the partnership as follows:
    By check March 27, 1920_$35, 000. 00
    “ “ “ 30, 1920_ 10,000.00
    “ “ “ 31, 1920_ 4,026.94
    Liberty Bonds June 26, 1920_ 50, 373. 06
    Stock in a corporation to which the partnership assets were transferred January 1, 1921_ 100, 000. 00
    Total_200, 000. 00
    The profit and loss account of the partnership showed profits in 1920 for the periods as follows:
    April 1-•_$91,699.11
    July 1___ 48,485.35
    Sept. 1- 25,189.79
    For the entire calendar year 1920 the partnership sustained an operating loss of about $158,000. The profit shown on the books as of April 1st was not credited to the partners.
    The Commissioner treated the taxpayer on the basis of being a partner up to April 1, 1920, and included in his income for 1920 one-third of the book profit from January 1, 1920, to April 1, 1920, ($91,699.11) in the amount of $30,566.37.
   OPINION.

MoRRis:

The taxpayer contends that he withdrew from the partnership oh December 31, 1919; 'that he thereafter continued to perform service as an employee until April 1, 1920, although his compensation received during that period was upon the same basis as that received as a partner prior to January 1, 1920; and that the postponement of payment for his partnership interest until April 1, 1920, was solely as a matter of convenience for his father, and not evidence of the dissolution as of that date. He contends further, that if the dissolution did not occur on December 31, 1919, then it did not take place until the final payment of the purchase price by the delivery of $100,000 of stock in the corporation on January 1, 1921, which would entitle him to the full benefit of the loss sustained in the operation of the business during the calendar year 1920.

We can find no evidence, however, supporting the claim that the dissolution occurred on January 1, 1921. It occurred either on December 31, 1919 or on April 1, 1920. The original partnership agreement of the three individuals was not reduced to writing and the provisions thereof were not testified to at the hearing. That a partner may withdraw from a partnership, which is not definite in duration, at any time that he sees .fit, is well settled. Karrick v. Hannaman, 168 U. S. 328; Davis v. Megroz, 55 N. J. L. 427; 26 Atl. 1009. Under the oral agreement entered into in the fall of 1919, it was undoubtedly the intention of the partners that the taxpayer would withdraw from the partnership as of December 31, 1919, but under date of December 5, 1919, a definite written agreement was executed, wherein he expressed the desire to withdraw on April 1, 1920, at which time he would enter into an agreement for the sale of his interest. This written agreement is in direct conflict with the previous oral understanding and the present contention of the taxpayer that he withdrew from the partnership on December 31, 1919. The taxpayer contends that the written contract is merely an agreement to enter into a subsequent agreement to withdraw, and, as no such action was taken, it should be disregarded unless it be held that the withdrawal took place January 1, 1921. We can agree that the contract was not a sale of the partnership interest, but the subsequent events indicate to our minds that the sale and withdrawal of the taxpayer actually took place at the time designated therein without the execution of a formal agreement. He participated in the profits during the three months of 1920 to the extent of the so-called bonus; he drew nothing after April 1, 1920; and he received his first partial payment, on acount of his $200,000 selling price for his interest, on March 27, 1920, which was followed by additional payments during the next four days.

In holding that the taxpayer was a member of the partnership until April 1, 1920, the question arises whether, by the contract of December 5, 1919, and the facts in connection with the liquidation of his interest, the proportionate shares in the partnership earnings were not varied for the three months of 1920 from the equal division existing prior thereto. Under the terms of the written agreement, the taxpayer was to receive $200,000 for his interest, which amount was arrived at not only prior to the closing of the books at the time of his withdrawal, but before an estimate could even be made of the profits which would accrue to the partnership as of April 1, 1920. As it seemed to be the practice of the partners to leave the major part of the profits in the business, this provision of the contract indicates an agreement among the partners for a reapportionment of the partnership profits for the first three months of 1920, which is to our minds definitely established by the subsequent events. Although there was a book profit of $91,699.11 at the time of the taxpayer’s withdrawal, he did not receive, nor was he credited with, any portion thereof. When the partnership assets were transferred to the corporation, final payment of the contract price was made to him through the issuance of stock without any adjustments being made for the losses sustained by the partnership during the calendar year 1920. His only participation in the profits of the partnership for the first three months of 1920 was a percentage of the quarterly profits which the partners termed “ deferred salary.” From these facts we are led to the conclusion that such percentage represented his entire interest in the partnership during such period, and that the Commissioner was in error in including in his income one-third of the book profit from January 1,1920 to April 1, 1920.

Order of redetermination will be entered on 15 days' notice, under Rule 50.


author: SteRnpiagen

text:
    Appeal of CARL MULLER.
    Docket No. 1543.
    Submitted October 1, 1925.
    Decided June 22, 1926.
    Disallowance of the deduction for losses on bad debts sustained upon the evidence.

      Richard 8. Doyle, Esq., and L. Dana Latham, Esq., for the petitioner.

      R. P. Smith, Esq., for the Commissioner.
    Before Gkeen and Lansdon.
    The Commissioner determined a deficiency in income tax for 1918 of $3,575.05, arising by reason of the disallowance of a deduction claimed by the petitioner as his share of a loss alleged to have been suffered by the partnership of Muller Schall & Co. in connection with certain bills of exchange purchased in 1913.
    FINDINGS OF FACT.
    The taxpayer was a partner, having an interest of 31 per cent, in the former partnership of .Muller Schall & Co., foreign bankers dealing, among other things, in international trade and exchange.This firm had carried on business for a substantial period of time. It was composed of William Schall, an American, owning a 40 per cent interest, Carl Muller, the petitioner, an American, owning a 31 per cent interest, E. Pavenstedt, a German national, owning a 19 per cent interest, and Frederick Muller-Schall, a German national, owning a 10 per cent interest.
    In 1913 Muller Schall & Co. purchased through a Hew York broker two bills of exchange drawn by A. Le More & Co., a Hew Orleans manufacturer of barrel staves, upon Gairard Fils, of Marseilles, France, one for 98,706.83 francs and the other for 100,855.38 francs. Both these bills of exchange had bills of lading attached covering shipments of barrel staves. These bills were accepted by Gairard Fils and were sent at once by Muller Schall & Co., with the documents attached, to De Neuflize & Co., Paris bankers. The bills are not in evidence and their maturity does not appear. Gairard Fils went into bankruptcy in 1915. Upon presentation to Gairard Fils the bills of exchange were dishonored and Muller Schall & Co. were immediately called upon to cover them, and did so.
    Some time prior to the bankruptcy of A. Le More & Co. in 1914, Muller Schall & Co. had purchased two checks drawn by Le More, one on the Associated Industrielle Francaise for 50,000 francs and the other on the Banque de Reports du Fonds Public et Depots, Antwerp, for 25,000 francs. The cost equivalent in dollars of the first check of 50,000 francs was $9,626.96, and that of the second check of 25,000 francs was $4,778.97.
    Muller Schall & Co. also purchased a bill of exchange from Le More on the London house of Coulon-Berthoud, but this account is not directly involved in the present proceeding. The cost of the Coulon-Berthoud check was $16,376.30.
    In 1914 Le More & Co. became bankrupt, and thereupon Muller Schall & Co. placed upon its books charges against Le More & Co., as follows:
    Coulon-Berthoud item-$16, 369.12
    Le More check, IncLustrielle, 50,000 francs- 9, 626. 96
    Le More check, Antwerp, 25,000 francs- 4, 778. 97
    Telegrams- 1. 68
    Protest charges, 50,000 francs- 64. 61
    Protest charges, Coulon-Berthoud- 7.18
    Protest charges, 25,000 francs_ 1.16
    Gairard Fils, 98,706.83 francs-^- 19, 243.35
    Protest charges- 122.94
    Gairard Fils, 100,855.38 francs_ 19, 874. 24
    Total_ 70, 090.21
    In April, 1915, a 12 per cent dividend was received by Muller Schall & Co. from Gairard Fils, through the foreign banking house of John Munro & Co., equivalent to $3,960.54, and this was credited to the account as of December 4,1915. The following dividends were received from the representatives of the Le More Co. prior to 1918:
    1915_ 3 per cent— $2,100. 43
    February, 1916_ 4 do- 2, 800.19
    June, 1916_ 2 do_ 1, 402. 40
    April, 1917_ 3 do_ 2,103. 58
    Total_12 do_ 8, 412. 60

      These dividends were credited by Muller Schall & Co. in the account of A. Le More & Co., so that at the beginning of 1918 the balance of that account was $57,717.07.
    At the end of the year 1918 Muller Schall & Co. credited this account with “bad debts $40,000,” leaving a balance of $17,717.07. Some time thereafter the bookkeeper of Muller Schall & Co. made an “ allocation ” of the $8,412.60 received from Le More & Co. as liquidating dividends, as follows:
    Gairard Fils account_$4,709. 81
    Coulon-Berthoud account_ 1, 965. 54
    Le More account_ 1,737. 25
    Total_ 8, 412. 60
    By reason of the fact that two of the partners of Muller Schall & Co. were German nationals, the firm was black-listed by England and France and was unable after 1914 to communicate in any way with anyone in those two countries. The 12 per cent dividend which it received in 1915 from Gairard Fils was secured through the friendly efforts of John Munro & Co. Up to the end of 1918 they were unable to learn anything about the status of Gairard Fils or of the likelihood of recovery on their account. Meanwhile, the French Government issued a decree of September 27, 1914, prohibiting commercial relations with Germany or any of its nationals. On October 13 there was issued at Bordeaux a “Ministerial Circular ” by the Secretary, Minister of Justice, to the Presidents of the Courts of Appeal and General Prosecutors to the Aforesaid Courts, directing the attachment and confiscation of all merchandise, income and property belonging to German nationals. On April 10, 1918, the Prosecutor of the French Republic signed the following document:

      To Mr. President of Civil Tribunal of Marseille.

    Tlie undersigned Prosecutor of the Republic begs to state that the Firm Muller Schall & Co., of New York, has been admitted to claim, in the liquidation Gairard Fils a credit of Fes. 200,852.23. That, in April, 1917, Messrs. Pavenstedt and Ferdinand Muller Schall, German subjects, retired from the firm Muller Schall & Co. which was replaced by the new firm Schall, Muller, Hanway, Welty and Paine, solely made up of Americans.
    That the new firm owes a debt of Fes. 200,852.23 to the partners of the old firm who have retired, Messrs. Pavenstedt and Ferdinand Muller Schall.
    That, under these conditions, there is cause to demand the, seizure of the part that could eventually be returned in view of their claim against the new firm, to Messrs. Pavenstedt and Ferdinand Muller Schall in the sum to be recovered by the new firm in the liquidation of Gairard Fils. For this reason' the petitioner demands that it please Mr. President to command that the credit balances above mentioned be confiscated, designate to this effect an administrator, determine the powers given to him and the rules of his administration. Order that the decree shall be announced by the administrative authorities to the administrator of Custodian which will be designated for Messrs. Pavenstedt and Ferdinand Muller Schall as well as all other necessary measures.
    Made at the Court of Justice in Marseille, the 10th of April 1918.
    The Prosecutor of the Republic.
    (Signed) Massot.
    Thereafter, on April 16, 1918, the following decree was made:
    We, President of the Civil Tribunal of Marseille, Chevalier de la Legion d’Honneur, in view of .the request presented by Mr. Prosecutor of the Republic and his motives,
    Whereas the Firm. Muller Schall & Co. of New Xorlr has been permitted to claim in the liquidation Gairard Fils a credit balance of two hundred thousand eight hundred fifty two francs 23 centimes.
    Whereas in April, 1917, Messrs. Pavenstedt and Ferdinand Muller Schall, German citizens retired from the firm Muller Schall & Co., which was replaced by the new firm Schall, Muller, Hanway, Welty and Paine, solely made up of Americans, That the new firm owing a.debt of 200,852 francs 23 centimes to the partners of the old firm, there is cause to demand the seizure of the part that could eventually be returned in view of their claim against the new firm, to Messrs. Pavenstedt and Ferdinand Muller Schall in the amount to recover in the liquidation Gerard Fils
    Bx These Pkesents
    Decree that the credit balances mentioned above be confiscated.
    Name Mr. Roche, Receiver of the Registry in Marseille, sequestrator of the amounts that could.be returned to Messrs. Pavenstedt and Ferdinand Muller Schall in the liquidation Gairard Fils:
    Say that the present decree will be notified by the administration authorities to Mr. Roche, Sequestrator, Messrs. Pavenstedt and Ferdinand Muller Schall and to whom it may concern.
    Order the provisional execution of the present decree at once before registration and its deposit with the Tribunal Civil of Marseille, after execution.
    Made in our office at the Court House In Marseille the sixteenth of April one thousand nine hundred and eighteen.
    (Signed) Pouhle.
    . In 1919 the two American partners of Muller Schall & Co. were permitted by the French Government to institute a proceeding in the French courts to establish their claims, and in 1921 they recovered from the French Government their percentage of the dividends on the Gairard account, equivalent to their 71 per cent interest in Muller Schall & Co. This amounted to $13,037.93.
    In 1920 a 2 per cent dividend was received from Le More & Co., amounting to $1,403.80, and in 1921 a % per cent dividend was received amounting to $280.76.
   OPINION.

SteRnpiagen

: In 1918 Muller Schall & Co. were settling up their affairs after the dissolution of 1917. Pavenstedt and Muller-Schall, who were German nationals, had withdrawn from the business and the firm liad been reorganized without them. They still had an interest in the Le More, Gairard and Coulon-Berthoud transactions.

At that time there appeared on the books (whether of the old firm or the new is in doubt), a debit balance against A. Le More & Co., including the five transactions, of $70,090.21. At the end of 1918 the bookkeeper charged off, or, as he expressed it, “ booked off ” $40,000 of this amount as a “bad debt.” This round figure is now alleged to be an estimate of the loss attributable to all but the Coulon-Ber-thoud transaction. This we can not adopt. The amount of the Coulon-Berthoud account was clearly shown by the boobs to be $16,369.12 plus $7.18 protest charges, or $16,376.30 in all. If the intention were to regard the remaining four items as wholly worthless and lost, this could have been recorded accurately and probably would have been. The writing off of $40,000 was, we think, not accompanied by the ratiocination that counsel would attribute to it. It was merely a general writing down of the account because of the uncertainty which existed in the extent of its recovery.

The statute does not permit the deduction of doubtful debts partly written off, Steele Cotton Mill Co., 1 B. T. A. 299, nor of possible or probable losses. The loss must be actually sustained in the taxable year to be deductible. The petitioner, feeling the difficulty of his original action in calling the charge a bad debt, urged its deductibility as a loss. Finally, he expresses indifference as to the category of the deduction, claiming it on either ground. He is in a dilemma. If he claims a bad debt, it must be proven to be ascertained as wholly worthless and charged off in the taxable year. The fact of worthlessness is perhaps softened by the proof of tona fide and sensible ascertainment. On the other hand, claiming a loss he must prove as a fact that it was actually sustained within the year. The sustained loss and not his ascertainment is the statutory factor.

Aside from being a partial charge-off, we are of opinion that in 1918 the outlook was not dark enough to justfy the view that the debt or any particular item was worthless. Le More & Co. was still in process of liquidation and with a prospect of further dividends. What its financial condition was does not appear. It is merely said that the attorney thought it was worthless, and that he was surprised when a 2 per cent and later a % per cent dividend were paid. The bookkeeper understood that a 2 per cent dividend might be expected. This is not probative of worthlessness. Alemite Die Casting & Mfg. Co., 1 B. T. A. 548.

As to recovery, from Gairard Fils on the two bills which they had accepted, we know only that in 1918 they were bankrupt in France, that they had paid a 12 per cent dividend through John Munro & Co , and that rumor had it that France had sequestered or confiscated tho account. What this meant in 1918 no one was certain. It was not to be supposed that France would confiscate the property of American citizens, however it might treat that of enemy nationals. The present petitioner believed this, for subsequently he proceeded m France to assert his right and in 1921 recovered his full claim, although in depreciated francs. Thus at all times his claim was protected, he had the right of recovery, and in 1918, instead of a worthless debt or a substantial loss, he had a reasonable prospect of substantial recovery.

It is argued that this was a partnership matter, and as such it must stand or fall. This is only partly true. The ultimate French allowance was expressly prorated in accordance with the interest of the American partners, and there is no reason given why Muller did not got his full claim except for the drop in the value of the franc. It could not in the face of this be assumed that the partnership as a whole was to be treated as an enemy claimant and its claims wholly wiped out, including the share of allied citizens.

We therefore sustain the Commissioner’s disallowance of the deduction in 1918.

Judgment for the Commissioner.

Qbeen dissents.


text:
    Appeal of W. W. HARRISON CO.
    Docket No. 6672.
    Submitted March 7, 1920.
    Decided June 22, 1926.

      Edgar R. Mead, Esq., for the petitioner.

      B'ruee A. Low, Esq., for the Commissioner.
    Before Phillips and Team:mell.
    Taxpayer appeals from the determination by the Commissioner of a deficiency of $1,136.04 income and profits taxes for the fiscal year ending January 31, 1920, arising from the disallowance of $2,469.65, claimed as a deduction for additional compensation for services rendered to the taxpayer by an employee during 1917 and 1918.
   FINDINGS OF FACT.

The taxpayer is a New York corporation with its principal office in the City of New York. For several years prior to 1920 it was engaged in the manufacture and sale at retail of umbrellas, canes, and luggage. During 1917 its gross sales amounted to approximately $225,000.

During 1917, 1918, and 1920, Walter W. Harrison was the president, David W. Harrison, his son, was vice president and secretary, and Miss C. H. Harrison, his daughter, was treasurer. The policies of the corporation were in charge of Walter W. Harrison and David W. Harrison. Miss Harrison acted as the office manager, attending to correspondence and having supervision over the bookkeeping and records of the company. The office force included one other person, who acted as bookkeeper and cashier. David W. Harrison was in charge of the manufacturing and sales forces. Two other sons of Walter W. Harrison were employed in the business as salesmen.

During 1917 and 1918 Miss Harrison was- paid a weekly salary of between $30 and $35. Two of her brothers received salaries of from $50 to $60 a week, while David W. Harrison, her other brother, was paid from $60 to $75.

Miss Harrison left the employ of the company in Juno, 1918, and shortly thereafter was married. Some months after she left the employ of the company she made demands upon her father for additional compensation for her services, claiming that she had been insufficiently paid. For a period of several months she pressed her demands and was joined in this by some of the other members of the family. The directors of the corporation at a meeting held January 31, 1920, passed the following resolution:

Resolved that the treasurer be and is hereby authorized to pay Mrs. O. H. "Webb [Miss Harrison] out of the company’s funds, $2,469.65, which is due her in payment of back salaries for the period between February 1, 1917 ana July 10, 1918.

This amount was paid Mrs. Webb in March, 1920. The taxpayer claimed it as a deduction upon its income-tax return for the fiscal year ended January 31, 1920. The’deduction was disallowed by the Commissioner.

The deficiency is determined to be $1,136.04-Order will be entered accordingly.


author: Smith:

text:
    Appeal of C. F. HOVEY CO.
    Docket No. 5448.
    Submitted February 11, 1926.
    Decided June 22, 1926.
    The value of good will paid in to a corporation for shares of capital stock determined.

      Frank J. Albus, Esq., for the petitioner.

      F. O. Graves, Esq., for the Commissioner.
    Before Smith, James, LittletoN, and Trussell.
    This appeal is from the determination of a net deficiency of $3,943.95 in income and profits tax for the three years ended January 31, 1917, January 31, 1918, and January 31, 1920, as follows:
    Fiscal year ended— Deflciency Overasses in tax ment
    January 81, 1917. _ $68.92
    January 31, 1918. $1,127. 81 _
    January 31, 1920. 2, 885. 06 _
    Total_ 4, 012. 87 68. 92
    The point in issue is the exclusion from invested capital of $200,000 for good will acquired with shares of stock in 1914.
    FINDINGS OF FACT.
    The taxpayer is one of the oldest, if not the oldest department store in New England. It began business on May 1, 1838. Since 1847 it has occupied its present location on Summer Street, only one or two doors from Washington Street, in Boston, Mass. The store is located in the heart of the retail shopping district of the city.
    It was incorporated in September, 1914, with a capital stock of $1,000,000, $800,000 of which was issued for tangible assets and $200,000 for good will. At the time of incorporation the store dealt in general dry goods, dress goods, wash goods, shoes, ladies’ wear, children’s wear, and men’s goods.
    The average yearly capital and average yearly earnings of the business from 1848 to 1914 were $1,276,361.46 and $184,373.40, respectively ; corresponding figures for the period 1900 to 1914, inclusive, were $1,404,596.44 and $171,951.83, respectively; and for the period 1910 to 1914, inclusive, were $1,199,691.11 and $34,911.35, respectively. The percentage of earnings to average capital for the entire period of sixty-six years was 14.45 per cent. For the years prior to 1909 the percentage earned was on the average considerably in excess of 15 per cent. Percentages for the years 1909 to 1913 were as follows:
    Year:
    Per cent
    1909 8. 59
    1910 8. 39
    1911 __ 2. 45
    1912 __ .97
    1913 __ 1.46
    Operations resulted in a small net loss for the year 1914.
    Although the profits during the period 1909 to 1914 were less than for any corresponding period in the history of the company, there was a steady increase in the number of customers at the store and a steady increase in the number of customers’ accounts.

      There were special reasons for reduced profits during the period 1909 to 1914. During this period the Jordan-Marsh Co. had built an annex with an entrance on Summer Street, which entrance was across the street from the taxpayer’s entrance. During the period also, Filene’s, Inc., had opened a large store on Washington Street in the neighborhood. The entire department store business in the city was, moreover, subject to the keenest competition during this period as the result of the operations of one Henry Siegel and one Butler. The former had built a large store a little farther south on Washington Street than the junction of Summer and Washington Streets, and Butler had gotten possession of Gilchrist’s, another large department store on Washington Street, and had also opened two other stores in the city, one on Tremont Street and one on Winter Street. Both Siegel and Butler carried on extensive advertising programs and conducted a price-slashing campaign that eventually carried them both into bankruptcy. Siegel’s store was in bankruptcy prior to 1914, and Butler, as a result of financial troubles, committed suicide in November, 1912. The stocks of merchandise carried by the stores operated by Siegel and Butler were thrown upon the market in bankruptcy sales, with the result that for a year or two the department stores in Boston made small profits.
    In September, 1914, the outstanding capital stock of the taxpayer was $1,000,000. It stood at the same amount until after January 81, 1919. On January 31, 1920, the total outstanding capital stock was $2,000,000.

       This decision was prepared during Mr. James’ term of office.

   OPINION.

Smith:

The only question presented by this appeal is the value for invested capital purposes of the good will of the C. F. Hovey Co. paid in to the taxpayer corporation in exchange for $200,000 qf its capital stock in September, 1914. The Commissioner has disallowed the claim of the taxpayer for any invested capital in respect of this asset, upon the ground that it has not proven any cash value for it; that for a period of five years prior to 1915 the taxpayer had operated at a small profit and operated at an actual loss in the year 1914. The taxpayer contends on the other hand that the good will of the company paid in for shares of stock had a cash value of at least $200,000 in September, 1914.

We think that the fact that the business of the C. F. Hovey Co. during the period 1909 to 1914 was not particularly profitable does not prove that the good will did not have a cash value. The value of good will may not be indicated by the profits of a business for a short period. In the case of Macfadden v. Jenkins, 40 N. D. 422; 1C9 N. W. 151, it was held that good will may have a value although there have been no past profits. The distinction between “ profits ” and “ good will ” was determined in the case of Nelson v. Hiatt, 38 Neb. 478; 56 N. W. 1029, wherein the court said:

The distinction between the two [.profits and good will] is obvious. Profits are the gains realized from trade; good will is that which brings trade. A favorable location of a mercantile establishment, or the habit of customers to resort to a particular locality, will bring trade. This advantage may he designated by the term “ good will.” What the trader gains from the trade so acquired are “ profits.”

In determining that the good will of C. F. Hovey Co. had no value in September, 1914, the Commissioner considered the results of operations for a period of five years only. We think that no definite number of years can be made to apply to all cases. In In re Herrmann’s Estate, 180 N. Y. S. 509, it was held that the length of the period to be considered is to be determined in each particular case. The number of years to be considered is not a question of law but one of fact. In re Ball’s Estate, 161 App. Div. 79; 146 N. Y. S. 499; Von Au v. Magenheimer, 126 App. Div. 257; 110 N. Y. S. 629.

It will be noted from the findings of fact that for the period from 1900 to 1914 the average yearly capital of the C. F. Hovey Co. was $1,404,595.44 and the average yearly earnings $171,951.83. If this period be taken as the basis for the computation of the value of the good.will, instead of the five-year period used by the Commissioner, and an 8 per cent return be considered a fair return on tangibles, the excess average annual earnings for the period applicable to good will is $59,584.19, which capitalized upon a five-year purchase basis, as was done in the Appeal of St. Louis Screw Co., 2 B. T. A. 649, gives a value for the good will in excess of $200,000. ■

In this appeal we do not, however, have to rely entirely upon the basis of earnings for the purpose of arriving at a cash value of the good will in 1914. There has been introduced in evidence the deposition of Maurice Wrigley, director and treasurer of the Jordan - Marsh Co. Kelative to the value of the good will of the taxpayer he testified as follows:

Q. Mr. Wrigley, with your experience in the dry goods business, would you state what, in your opinion, is a fair figure for the good will of the Hovey Company as of 1914?
A. Well, of course, I am not familiar with the Hovey Company balance sheets, and I don’t know anything about the Hovey Company' business as of those dates. As I remember, the Hovey Company is one of the oldest establishments of Boston, ranking as high as any in the early days of the 80’s and 90’s; in fact, in the early 90’s, the Hovey Company was a very high-grade store and held at that time high-grade trade. The old Back Bay people of Boston naturally were on tlie Hovey clientele list. It had a good name and a good reputation.
When you go down to 1914, the Hovey Company conducted a wholesale business and a retail business; they stressed, of course, wholesale in the early years. In the later years, from my observation, I would say that in the retail end they did not keep up the same merchandise grades as before, although I believe they held the old clientele. I think to this day they are holding a good part of the clientele of the old Hovey store.
Q. With your experience in the dry goods business, would you be willing to express your opinion as to what the good will might have been worth in 1914 in dollars and cents?
A. Well, you see that is really something you have to get to some extent through financial statements of condition to express an opinion as to the good will of the business, but it seems to me that if anyone wanted to buy Hovey’s store there would be a good will in the name alone of C. F. Hovey Company which would have quite some value. I should think the Jordan-Marsh Company if they were an outsider coming into Boston wanting to buy the store would be willing to pay considerable merely for the name of G. F. Hovey Company with that class of store, because it was a store similar to ours and with a clientele considered to be high grade; and if we were going to come to Boston, to buy a business of' that kind we would be quite willing to pay a good deal just for the Hovey name.
Q. ■ Regardless of any reference to balance sheets that might give you some- ‘ thing concrete upon which to place a valuation for good will, would you be willing to express any opinion as to the value of the good will of Hovey Company in 1914 — that is, in dollars and cents?
A. Well, I could only say that, speaking in connection with ourselves, if we were outsiders, I should think that Jordan-Marsh Company would no doubt be willing to give a quarter of a million dollars for the good will that was there — you know there is a business already established. It is an old concern. It had the cream of the trade of Boston; and Hovey’s reputation had not suffered, to my knowledge, up to 1914. I don’t know anything about their business results. There was the Hovey business with a very high reputation, and it seems to me that to any one coming in, that name was a valuable name and carried under that name Boston’s best clientele. I think if we took the Hovey store we would develop that name and have a very good prestige in the name alone.

We think that the evidence satisfactorily establishes that the good will of the C. F. Hovey Company paid in to the taxpayer corporation in September, 1914, for $200,000 of capital stock had a cash value on that date of $200,000.

Order of redetermination will be entered on 15 days' notice, under Rule 50.


author: Guaupnek:

text:
    Appeal of B. F. BOYER CO.
    Docket No. 5739.
    Submitted February 11, 1926.
    Decided June 22, 1926.
    1. Cost of advertising for promoting sale of Liberty bonds, held to be an ordinary and necessary business expense.
    2. Kates of depreciation determined.
    3. Invested capital adjusted.

      J. Marvin Haynes, Esq., and H. E. Witman, G. P. A., for the petitioner.

      Ellis W. Manning, Esq., for the Commissioner.
    Before Graupner, Trammell, and Phillips.
    This is an appeal from the determination of deficiencies in income and profits taxes for the calendar years 1919 and 1920, in the respective amounts of $1,268.46 and $1,295.71, a total of $2,564.17.
    FINDINGS OP PACT.
    1. The taxpayer is a New Jersey corporation with its principal office at Camden and is engaged in the business of manufacturing woolen yarns.
    2. In 1919, the taxpayer spent $45 for advertising and promoting the sale of Liberty bonds in an advertisement which appeared over its corporate name. The taxpayer sought to deduct this amount in its return for 1919 as a donation for advertising the sale of Liberty bonds. The Commissioner disallowed the deduction.
    3. In April, 1918, the taxpayer was instructed by a branch of the Council of National Defense to use every available spindle for the manufacture of worsted yarn suitable for making O. D. Army uniforms. The yarn required for this purpose was considerably heavier and coarser than that which the taxpayer had theretofore manufactured and for which its machinery was designed. The manufacture of this heavier and coarser yarn, which was commenced in 1918 and carried on through that year, and to some extent in 1919 and 1920, resulted in unrepairable damage to the spinning machines from placing an unduly heavy strain upon them and by wearing grooves in the iron rolls. There is normally a 20 per cent stoppage of machines in the taxpayer’s factory due to necessity for changes in gearing to accommodate varied sizes of yarn which it manufactures for its ordinary trade, and there was stoppage for replenishing machines, but in 1918 the stoppage was only 7y2 per cent, the machines being kept in almost constant operation upon a single size of yarn. Due to this rush of war work, the machines were not stopped with sufficient frequency to permit the making of customary repairs. During at least a part of 1918 the taxpayer was forced to operate its plant with inexperienced employees, due to its experienced operators being attracted by higher wages to work with ship-building companies located in that vicinity. These conditions served to augment the normal depreciation of the plant machinery.
    4. Prior to 1918 the taxpayer computed and entered on its books, depreciation on machinery at the rate of 5 per cent. For 1918, 1919 and 1920, it computed and took deductions for depreciation at the rate of 7% per cent. The Commissioner refused to allow deductions of the increase in rate of depreciation.
    5. A depreciation rate of 7% per cent represents a fair rate for the computation of depreciation of the machinery used by the taxpayer in its plant in the years 1918, 1919, and 1920.
    6. The taxpayer’s plant is composed of three brick buildings and one steel frame building with an exterior covering of sheet iron and interior lining of wood. Adjacent to the taxpayer’s plant is located a chemical plant, the acid fumes from which, beginning in 1918, have had a noticeable effect on the window frames and rain spouts of the taxpayer’s buildings. The vibration resulting from the manufacture of the heavier and coarser yarn required for war purposes served to augment the normal depreciation of the buildings.
    7. Prior to 1919 the taxpayer computed depreciation on its buildings at the composite rate of 2% per cent. Beginning with 1918, and for the years 1919 and 1920, it computed and recorded on its books depreciation at the rate of 3 per cent. The deduction sought for increased depreciation was disallowed by the Commissioner.
    A depreciation allowance computed at the rate of - 3 per cent represents a reasonable allowance for depreciation of taxpayer’s buildings for the years 1918, 1919 and 1920.
    8. The Commissioner, in computing invested capital for the year 1919, deducted $39,981.85 as prorated 1918 Federal income and profits ^axes, which he considered as $94,609.28. The final tax liability for the year 1918 is $85,811.01, as shown by certificate of overassessment number 450241, schedule No. 14327.
    9. The Commissioner in computing invested capital for the year 1920 reduced the surplus account at December 31, 1919, by 1918 Federal income and profits taxes in the amount of $100,399.26. The final tax liability for the year 1918 is $85,811.01, as shown by certificate of overassessment number 450241, schedule No. 14327. The “ capital stock, surplus, reserves and additions per Eevenue Agent’s report, October 16, 1925, $511,726.83,” shown in the Commissioner’s deficiency letter of June 2, 1925, includes a charge of $95,282.02 for 1918 Federal income and profits taxes, as against the final tax liability of $85,811.01 for the year 1918.

      10. The Commissioner reduced the 1919- and 1920 invested capital by $982.73, net additional taxes for 1916 and 1917 assessed and paid during the years 1920 and 1921.
    The payments made on account of these taxes are as follows: Additional taxes paid and charged to surplus account:
    1920 -December 22-1917 taxes_$947. IS
    Less 191G taxes overpaid_ 14. 62
    932. 51
    1921 --- May, 1928 - 1917 taxes_ 50.00

      Tliis decision was prepared by Mr. Graupner during bis term of office.

   OPINION.

Guaupnek:

The issues in this appeal, briefly, are': (1) The right of the taxpayer to deduct the amount spent in 1919 for advertising and promoting the sale of Liberty bonds. (2) The amount allowable as deductions for depreciation for 1919 and 1920. (3) Loss on sale of capital assets in 1920. (4) Adjustment of invested capital for 1919 and 1920 on account of depreciation deductions and charges to depreciation reserves on assets sold or discarded. (5) Reduction of invested capital for 1919 and 1920 on account of taxes for prior years.

On the first of these questions the parties stipulated that the expenditures of $45 in 1919 for advertising and promoting the sale of Liberty bonds was for an advertisement over the corporation’s name. This advertisement was made in accordance with the custom of the time. Such an advertisement was a combination of patriotic endeavor and business publicity, and received the recognition of the Commissioner in article 562 of Regulations 45. A corporation of the cliaracter of the taxpayer is entitled to deduct amounts spent in advertising as a part of its ordinary and necessary business expense and, as the particular form of advertising to be employed is, of necessity, within the judgment of the officers of such a corporation as the taxpayer, we believe that the Commissioner improperly disallowed (die deduction.

With respect to the question of depreciation, we found as facts that allowances computed at 7% per cent on machinery and 3 per cent on buildings represented reasonable amounts to be allowed for depreciation sustained in 1919 and 1920. The amounts to be allowed as deductions for depreciation should be computed at these rates and the tax recomputed accordingly.

With respect to claimed loss on the sale of capital assets in 1920, the taxpayer sets forth as the facts upon which it relies that—

Tlie loss oil the sale or discard of capital assets treated as a deduction from income by the taxpayer in the year 1920 is $6,956.53, whereas the Commissioner has allowed a loss of $6,843.20. This difference is due to the change in depreciation rates for the years 1918 and 1919 as made by the Commissioner.

These allegations of fact are admitted by the Commissioner in his answer. These allegations and the Commissioner’s answer thereto require us, under section 274(g) of the Eevenue Act of 1926, to consider the depreciation to be allowed for 1918. The rates at which depreciation of assets is to be computed for 1918, 1919, and 1920, are set forth above, and any loss sustained upon the sale of assets in 1920 should be determined after making allowance for depreciation by the application of those rates. Section 274(g), however, prohibits our ■ redetermining the correctness of the tax for the year 1918.

. As to the fourth question, the rates as set forth in the findings of fact should be applied for the years 1918, 1919, and 1920, in determining the amount of the reserves for depreciation to be taken into account in computing the invested capital for those years.

With respect to the last question the taxpayer contends that surplus at the beginning of any taxable year may not be reduced on account of taxes for a preceding year. The principle here involved is settled by section 1207 of the Eevenue Act of 1926. There is nothing in the record to show that the Commissioner’s method is not in accordance with the regulations, and under section 1207 we must approve the method used.

The invested capital for 1919 and 1920 should be adjusted in ac- ' cordance with findings 8 and 9. As the payments of additional taxes for 1916 and 1917 mentioned in findings 10 were not made until after the beginning of 1920, the taxpayer’s invested capital for 1919 and 1920 was properly determined by a reduction of the amount of such taxes.

Order of redetermination will he entered on 15 days' notice, under Bule 50.


author: Smith

text:
    Appeal of GREENVILLE COALING & EXPORT CORPORATION.
    Docket No. 5403.
    Submitted March 9, 1926.
    Decided June 22, 1926.
    The taxpayer and the Maryland Coal & Coke Co. were not affiliated during the calendar year 1920.

      O. E. Marvin, O. P. A., for the petitioner.

      P. J. Bose, Esq., for the Commissioner.
    Before Smith, James, Littleton, and Tkhssell.
    This is a proceeding for the redetermination of a deficiency in income and profits tax for the year 1920, in the amount of $1,471.43. The point in issue is whether the taxpayer was affiliated with the Maryland Coal & Coke Co. during the calendar year 1920.
    FINDINGS OF FACT.
    The taxpayer was incorporated under the laws of Delaware, November 12, 1918, and is engaged in the retail sale of bituminous coal. During 1920 it had a capital stock of $10,000, divided into 100 shares of a par value of $100 each, only 20 of which were issued and outstanding. The Maryland Coal & Coke Co. was incorporated under the laws of West Virginia, on January 3, 1905, and is engaged in the wholesale bituminous coal business. During 1920 its authorized capital stock was 2,000 shares of a par value of $100 each, of which only 94-9 shares were outstanding. The stock of the two corporations was owned during the taxable year as follows:

    M. Evelyn Brown is the wife of Medford J. Brown, and Clara C. Taylor is the wife of Frank A. Taylor. George P. Spates was the original incorporator of the Maryland Coal & Coke Co. and was its president up to 1919. During the year 1920 he was not an officer of that company or of the taxpayer. Brown and Taylor, who together owned more than 50 per cent of the stock of the Maryland Coal & Coke Co., directed the operations of that company and also those of the taxpayer.
    The taxpayer was organized for the purpose of handling the retail business of the Maryland Coal & Coke Co. in New York Harbor, viz., supplying bunker coal for tugs. During the year 1920 it supplied coal from the yard of the Maryland Coal & Coke Co.; it had no boats or barges of its own, furnished no capital for the purchase of coal, and handled no business for any concern other than the Maryland Coal & Coke Co. Its officers were the same as the officers of the Maryland Coal & Coke Co. It had no office or place of business separate from that of the Maryland Coal & Coke Co, and was in all respects operated in conjunction therewith,

       This decision was prepared during Mr. James’ term of office.

   OPINION.

Smith

: The claim of the taxpayer in this appeal is that it and the Maryland Coal & Coke Co. were affiliated in 1920. The basis of the claim is that Brown and Taylor were owners of 90 per cent of the capital stock of the taxpayer and 65% per cent of the capital stock of the Maryland Coal & Coke Co., and that they, together with their wives, owned 66% per cent of the capital stock of that company.

Section 240 of the Revenue Act of 1918 declares that, for the purpose of imposing the tax, certain corporations shall be deemed to be affiliated. In subdivision (b) it is provided that “ For the purpose of this section two or more domestic corporations shall be deemed to be affiliated * * * (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests.” At the hearing of this appeal the taxpayer made no claim that it or its stockholders owned or controlled more than two-thirds of the shares of stock of the Maryland Coal & Coke Co. The only witness who testified for the taxpayer at the hearing knew of no control which either the taxpayer or its officers had over the shares of stock of the Maryland Coal & Coke Co. owned by George P. Spates. The claim for affiliation is based solely upon the proposition that the corporations are operated to a large extent as a business unit and that the stockholders of the taxpayer own 66% per cent of the shares of stock of the Maryland Coal & Coke Co. We are of the opinion that “ substantially all ” the stock of the two corporations is not owned or controlled by the same interests, yet this is the criterion of affiliation laid down by the taxing statute. The fact of intercompany relations, or the absence of them, without the necessary stock ownership or control as provided in the statute, is not sufficient to permit or require affiliation. Appeal of Schloss Brothers Co., 1 B. T. A. 581; Appeal of Rowe Transfer & Coal Co., 1 B. T. A. 593; Appeal of Canyon Lumber Co., 1 B. T. A. 473. See also Appeal of Madera Yosemite Big Tree Auto Co., 2 B. T. A. 346, in which it was held that the ownership or control of only 65 per cent of the shares of stock of a corporation was not substantially all the shares of stock; and Appeal of United Metal Spinning Co., 2 B. T. A. 520, in which it was held that 66% per cent of the stock was not substantially all the stock of the corporation within the meaning of the statute.

By reason of the fact that the taxpayer was required to furnish no capital for the purchase of coal, there was manifestly an abnormality in its invested capital for the year 1920, and it is entitled to be taxed under the provisions of section 328 of the Act. The taxpayer has, however, furnished no comparatives for the determination of its tax liability. The selection of comparatives which may be made by the Commissioner and tbe determination of tax liability made by him from tbe use of such comparatives will be accepted as final. Appeal of H. T. Cushman Mfg. Co., 2 B. T. A. 39.

Order of redetermination will be entered on 15 days’ notice^ under Rule 50.