author: Goodeich: Smith,

text:
    Edith R. Wood, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 47766.
    Promulgated April 27, 1933.

      James A. Tillinghast, Esq., for the petitioner.

      O. O. Holmes, Esq., for the respondent.
   OPINION.

Goodeich:

Respondent determined a deficiency in income tax for the year 1926 of $3,097.02, all of which is in controversy. The case was put in upon agreed statements of fact which we adopt as our findings, together with the exhibits. For the purposes of this report the issue may be presented by a brief statement.

The will of petitioner’s deceased husband established a trust of the residue of his estate, which included stock of Edington & Co., Inc. Petitioner was named life beneficiary of the income of the trust and her two children, of whom she was duly appointed guardian, were the remaindermen. The trustees feared that the business of the Edington Company might be subject to fluctuation and therefore the security of the investment therein uncertain, to the detriment of the remaindermen, and therefore proposed to sell the stock of that company owned by the trust and reinvest the proceeds in more stable securities, which probably would yield less income. Petitioner, that she might enjoy the larger income, desired that the stock be retained by the trust and, in order to compensate the remaindermen for their risk, agreed to share with them the dividends received upon the stock.

Accordingly, on November 29,1922, petitioner entered into a written agreement with the trustees, undertaking to establish trusts for each, of her children and to pay over to the trustees thereof one-half of all money paid to her from the trust established by the will of her deceased husband, “ which is in any way derived from said Edington & Co., Inc.; said payments by me to be made simultaneously with the receipt by me, from time to time, of any income derived from the investment * * * in said Edington & Co., Inc.” The intention of the agreement was further elucidated by a provision authorizing the trustees to retain one-half the income derived from the investment of the Edington Company and pay it equally to the trusts created for the children. As consideration, the agreement recited, inter alia, “ that the investment * * * in Edington & Co., Inc., shall not be immediately liquidated.”

Thereafter, petitioner was appointed as one of the trustees of the trust of which she was life beneficiary and in that capacity, on January 1, 1926, entered into another agreement with herself, individually, and as guardian of her children, respecting the income from the Edington stock. This agreement, which was in a way an enlargement of the first, was motivated by considerations similar to those upon which the first was based, although the trustees were not bound to hold the stock beyond such time as they deemed it beneficial so to do. The principal change in provision here material from that of the first agreement was as follows:

* * * in consideration tiiat the said trustees will not immediately liquidate the said investment but will hold said investment under the terms of this agreement, said Edith R. Wood, (petitioner) individually, does hereby release all claim to one half (%) of the net income received by the trustees from said investment, and the said trustees agree to pay over one-half (%) of said net income from said investment to said Edith R. Wood, and to pay over the other one-half (%) of said net income to the trustees of the trusts created for the children.

In 1926 the trustees received $41,600 as dividends from the Eding-ton Company. Of this amount they paid over to petitioner $41,500. Of the dividend received on September 15, 1926, the trustees retained one-half, or $6,100, and paid over that amount to the children’s trusts. In determining the deficiency, respondent has included in petitioner’s income the whole of the dividends received from the Edington Company. Before this proceeding was brought, petitioner remarried and is now a resident of St. Matthews, Kentucky.

The sole issue here is, Who is the taxable recipient of the dividends paid by the Edington Company upon the stock held by the trust? Petitioner contends that, while one-half belonged to her, the other half, because of her assignments, belonged to the trusts established for her children. Respondent has determined that the dividends were taxable wholly to petitioner because her assignments were invalid and, further, whether effective or not, they transferred, not a property right from which income might arise, but income only, the tax upon which falls against the original rightful recipient, irrespective of agreements, however binding, respecting subsequent disposition. Petitioner argues further that the assignments, the second being but an expression of the intent of the first, transferred all she had which was, she contends, a property right — the right to receive income — created by will and subject to no restrictions upon alienation and that, having assigned that right, the income thereafter arising under it belonged not to her, but to her assignees.

We sustain respondent’s determination without passing upon the questions raised as to the validity of the assignments. The earlier assignment was fully considered by the United States Court of Claims in a proceeding brought before it by petitioner, involving, with respect to 1924 income, the identical issue now before us for the year 1926. The court held that the assignment of income as it is received does not relieve from tax thereon the person to whom the income was payable in the first instance, and that the agreement of November 29, 1922, entered into by this petitioner, did not effect a shifting of the tax burden. Edith R. Porter v. United States, 52 Fed. (2d) 1056. We agree with that decision and therefore we need consider only whether the agreement of January 1, 1926, either as an expression of the intention of the prior instrument or as an enlargement of it, served to relieve petitioner of tax upon the trust income.

In our opinion, it did not. Petitioner’s only right was to receive the net income of the trust. Relying upon O’Malley-Keyes v. Eaton, 24 Fed. (2d) 436; Young v. Gnichtel, 28 Fed. (2d) 789; Shellabarger v. Commissioner, 38 Fed. (2d) 566, and other cases, she contends that she could assign her right to a fixed and determined part of that income so that it would belong and be taxable thereafter not to her, but to her assignees. But, even assuming that she had that power, she did not here exercise it. She did not assign her right to a fixed and determined part of the income of the trust; she released an assumed claim to a part of certain dividends which might be received by the trustees upon stock owned by the trust. Beyond her equitable interest as a beneficiary, she had no ownership in or control of the stock upon which dividends might be paid in the future, nor had she a claim of ownership to the dividends themselves, or the right to receive them as such. She owned only the right to receive the net income of the trust. That right, or a definite part of it, she might alien, but not by the relinquishment of a claim, which she did not legally possess, to one of the component items, indefinite both as to receipt and amount, which if and when received, went to make up the income of the trust. Elongated assumption at most could make no more from this agreement than an assignment of dividends which, without the complete divestiture of petitioner’s interest to the stock upon which they are paid, will not relieve her of the tax upon them. Rosenwald v. Commissioner, 38 Fed. (2d) 423; Bing v. Bowers, 26 Fed. (2d) 1017.

We conclude that petitioner did not effect an assignment of any interest which she had in the trust established under her husband’s will, such as would relieve her of tax upon the income. Cf. Elizabeth D. Smith et al., Executors, 25 B. T. A. 291; William Ernest Seatree, 25 B. T. A. 396.

Eeviewed by the Board.

Judgment will be entered for the respondent.

Smith,

dissenting: The petitioner’s only property in the trust fund involved in this proceeding was a right to receive the income thereof during her life. For a valuable consideration she released all claim to one-half of the dividends received on an investment of the fund so long as the investment was held by the trustees in favor of her children. This constituted an assignment of an interest in the property which she owned. In Chase Nat. Bank v. Sayles, 11 Fed. (2d) 948, 955, the court said:

It has long been recognized that equitable interests in property may be assigned by way of gift, that the assignment may be of the whole or a part of the assignor’s interest, and that the only material question is whether the circumstances show a completed transaction — an intention to pass a present interest and such delivery of the subject matter as its nature permits, and that, if they do, the gift is irrevocable. [Citing many cases.]

It is elementary that the incidence of the income tax is upon the one who receives and has the unfettered control and use of income and not upon the one who acts as a conduit to pass the income on to another. The burden of the tax is upon the one who receives the income out of which the income tax may be paid. There are exceptions such as those which make the grantor of a revocable trust liable to tax upon the income of the trust. But none of those exceptions apply here.

The language used by Judge Thomas in O'Malley-Keyes v. Eaton, 24 Fed. (2d) 436; is equally applicable here.

After all, the stark fact is that the plaintiff did not receive this income, and cannot receive this income. To say that she did receive it is to indulge in a deliberate fiction. Suppose that she had never assigned her interest, and suppose, further, that she deliberately declined to accept any income from her greatgrandfather’s estate; could we say that the income was received by her and tax her accordingly, in spite of the fact that we concede that she did not receive it at all? Are we to inject into the law some doctrine of constructive income? If Congress legislated to this effect, the question of its constitutional power might well be raised.

To the same effect see Young v. Gnitchel, 28 Fed. (2d) 789; Shellabarger v. Commissioner, 38 Fed. (2d) 566; Copland v. Commissioner, 41 Fed. (2d) 501; Bettendorf v. Commissioner, 49 Fed. (2d) 173; Nelson v. Ferguson, 56 Fed. (2d) 121.

Van Foss an and McMahon agree with this dissent.


source: Caselaw Access Project

author: Van Fossan :

license: Public Domain

text:
    T. Pierre Champion, Petitioner, v. Commissioner of Internal Revenue, Respondent. David J. Champion, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 55568, 55569, 63818.
    Promulgated April 27, 1933.

      Walter 8. Gordon, Esq., and A. B. Charpie, C. P. A., for the petitioners.

      Dean Kimball, Esq., and E. C. Adams, Esq., for the respondent.
   OPINION.

Van Fossan :

The respondent contends that the redemptions of the preferred stock of the Champion Rivet Company in the taxable years were made at such times and in such manner as to be the essential equivalents of taxable dividends and that consequently, in accordance with the provisions of section 115 (g) of the Revenue Act of 1928, the amounts paid are taxable as such. The provisions of section 115 (g) of the Revenue Act of 1928 are the same as those of section 201 (g) of the Revenue Act of 1926.

The facts in the case at bar are strikingly like those appearing in Henry B. Babson, 21 B. T. A. 859. As in that case, there is here no suggestion or indication that the issuance of the stock dividend by the Champion Rivet Company in 1922 was a part of a continuing plan to distribute corporate earnings freed from the tax burden of ordinary dividends. The capitalization of surplus accomplished by that method was in complete accord with the company’s purpose to expand its business along legitimate and necessary lines.

Thus, if the provisions of section 115 (g) are applicable at all to this case, they must relate to the redemptions effected in 1928, 1929, 1930 and 1931. As we said in Annie Watts Hill, 27 B. T. A. 73, “we must also scrutinize the redemption and distribution with respect to the time and the manner when they occur and the circumstances surrounding them at the time.” Henry B. Babson, supra.

Upon examination of the record we find that logically and chronologically the reasons for reducing the company’s capital stock in 1928 and the following years were sound and cogent. Following the recapitalization in 1922 the demand for the company’s product decreased. The development of the electric welding process was materially diminishing the use of rivets. In the spring of that year the company had been forced to reduce the price of its boiler rivets to that of structural rivets, although the production cost of the former remained higher. The contemplated erection of the Pittsburgh plant had been wholly abandoned in 1927. D.ue to the encroachment of electric welding upon the rivet manufacturing industry, the company was compelled to undertake the processing of electric welding rods in order to continue in business. In March, 1930, it sold land adjacent to its Cleveland plant. Thus, by reason of a diminished market, curtailed production, reduced land area (a potential plant facility), and the gradual substitution of electric welding for riveting, the company was confronted with an excess of capital which it found impossible to utilize profitably. Therefore, it proceeded to redeem and cancel portions of its outstanding stock at such times and in such amounts as business exigencies demanded. The diminution of the capital stock of the company was in harmony with the shrinkage of its own business and the lessened market demand for the product which it manufactured.

When we examine the table of dividends declared from 1913 to 1931, inclusive, we are further impressed with the lack of any purpose on the part of the petitioners and their company to distribute corporate earnings by means of an artifice in order to escape the tax. The company was a closely held corporation. From prior to March 1,1913, to January 8,1922, David J. Champion owned approximately one-fourth of its capital stock. From January 8, 1922, to March 14, 1925, he owned almost one-half thereof. Members of his family and intimate business associates owned practically all of the remainder. During the high tax years his company declared large dividends and he and the stockholding associates and members of his family paid their taxes thereon though such dividends had been declared from surplus rather than from operating income. Such a record is not compatible with a studied intent to avoid taxation.

A further issue is the proper basis for computing profit on the shares of stock of each petitioner upon redemption by the company. The petitioners contend that the profit should be computed according to the “ first-acquired, first-sold ” rule as set forth in articles 58 and 600, Regulations 74. See Towne v. McElligott, 274 Fed. 960; David Stewart, 17 B. T. A. 604. The respondent’s theory is that the shares of stock transferred by David J. Champion on March 14,1925, to D. J. Champion and M. P. Mooney, trustees, are the same shares, or their equivalent under the expanded stock issue, as those inherited by him from his wife, Rose Champion, on January 8, 1922.

The material parts of articles 58 and 600 are as follows:

Abt. 58. Sale of stock and rights. — When shares of stock in a corporation are sold from lots purchased at different dates and at different prices and the identity of the lots can not be determined, the stock sold shall be charged against the earliest purchases of such stock. The excess of the amount realized on the sale over the cost or other basis of the stock will constitute gain. In the case of stock in respect of which any stock dividend was paid, the basis for determining gain or loss from a sale of a share of such stock shall be ascertained in accordance with the principles laid down in article 600.
Art. 600. Stock or securities distributed in reorganisation.—
***»*«■*
(4) Where the stock in respect of which a distribution in reorganization is made was purchased at different times and at different prices, and the stock distributed in reorganization can not be identified as having been distributed in respect of any particular lot of such stock, then any sale of the stock distributed in reorganization will be presumed to have been made from the stock distributed in respect of the earliest purchased stock.

The only question, therefore, is whether or not the 1,920 shares of preferred and the 1,920 shares of common stock of the company transferred by David J. Champion on March 14, 1925, to the trustees can be identified as having been distributed to him on December 30, 1922, in respect of the lot of 240 shares acquired by him from his wife’s estate. The evidence before us demonstrates that such identification of the shares is impossible. From prior to March 1, 1913, to January 8, 1922, David J. Champion owned 240 shares of the common stock of the company. On the latter date he acquired 240 additional shares from his wife’s estate. Thus, on December 18, 1922, at the time of the recapitalization, he was the actual owner of 480 shares. On December 30, 1922, pursuant to the order of the board of directors of the company entered on December 27, 1932, he exchanged his 480 shares for 3,840 shares of preferred and 3,840 shares of common stock, representing his original holdings increased by the stock dividend of 8 shares of preferred and 7 shares of common stock for each original share so exchanged. The common stock was issued to David J. Champion in five certificates, three for 1,000 shares each, one for 478 shares and one for 346 shares. The remaining shares were issued to his nominees, P. H. Mooney and W. J. Eeilley, in four certificates, each nominee receiving one certificate for 7 shares and one for one share. The preferred stock was issued to Champion in four certificates, three for 1,000 shares each and one for 824 shares. The remaining shares of that stock were issued to the said nominees in two certificates of 8 shares each.

From this record it is apparent that David J. Champion pooled his original stockholdings, offered them in exchange for the new issue and received certificates for the new stock in amounts that bore no relation to his original stock. It was not until more than two years later that he executed the trust assignment for the benefit of his children. In paragraph 6 of that instrument he sought to indicate the source of the bequest as being the same heritage he had received through his wife’s will. But since his wife’s stock had lost its identity upon the distribution of the stock dividends and the re-issuance of the entire stock interests in the company on December 30, 1922, no descriptive words or acts of his could restore it. The gift to the children was equivalent in number of shares to the bequest from the wife, but they were not the same shares, nor was it possible to effect identification with the original shares.

The values to be used in recomputing the deficiencies are set out in the findings of fact.

Decision will be entered under Rule 50.


author: Smith :

text:
    Investment Trust of Mutual Investment Company, Empire Trust Company, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 54695.
    Promulgated April 28, 1933.

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

      G. A. Ray, Esq., for the respondent.
   OPINION.

Smith :

The question presented by this proceeding is, first, whether the petitioner is an association taxable as a corporation under the provisions of the Revenue Act of 1928; and, second, if so, whether the operations of the Mutual Investment Company, the managing company, should be consolidated with it for the purpose of computing taxable net income.

Section 701 of the Revenue Act of 1928 provides in part as follows:

(a) When used, in this Act—
*******
(2) The term “ corporation ” includes associations, joint-stock companies, and insurance companies.

Articles 1312 and 1314 of Regulations 74 are as follows:

Art. 1312. Association. — Associations and joint-stock companies include associations, common law trusts, and organizations by whatever name known, which act or do business in an organized capacity, whether created under and pursuant to State laws, agreements, declarations of trust, or otherwise, the net income of which, if any, is distributed or distributable among the shareholders on the basis of the capital stock which each holds, or, where there is no capital stock, on the basis of the proportionate share or capital which each has or has invested in the business or property of the organization. A corporation which has ceased to exist in contemplation of law but continues its business in quasi-corporate form is an association or corporation within the meaning of section 701.
Art. 1314. Association distinguished, from trust. — Where trustees merely hold property for the collection of the income and its distribution among the beneficiaries of the trust, and are not engaged, either by themselves or in connection with the beneficiaries, in the carrying on of any business, and the beneficiaries have no control over the trust, although their consent may be required for the filling of a vacancy among the trustees or for a modification of the terms of the trust, no association exists, and the trust and the beneficiaries thereof will be subject to tax as provided by sections 161-170 and by article 861-891. If, however, the beneficiaries have positive control over the trust, whether through the right periodically to elect trustees or otherwise, an association exists within the meaning of section 701. Even in the absence of any control by the beneficiaries, where the trustees are not restricted to the mere collection of funds and their payment to the beneficiaries, but are associated together with similar or greater powers than the directors in a corporation for the purpose of carrying on some business enterprise, the trust is an association within the meaning of the Act.

The line of demarcation between a trust taxable as an association and one taxable under sections 161 to 169 of the Revenue Act of 1928 is not sharply drawn. The situation under the 1928 Act is similar to that which was involved in the case of Hecht v. Malley, 265 U. S. 144, under the Revenue Act of 1918, wherein the Supreme Court stated:

We think that the word “association” as used in the Act clearly includes “ Massachusetts Trusts ” such as those herein involved, having quasi-corporate organizations under which they are engaged in carrying on business enterprises. What other form of “ associations,” if any, it includes, we need not, and do not, determine.

Since the pronouncement of the above cited decision in 1924, the courts and this Board have many times had occasion to pass upon the question of whether a given trust is taxable as an association or as a strict trust.

As pointed out in Morriss Realty Co. Trust No. 1, 23 B. T. A. 1076, there are three tests for determining whether an organization is to be classified as one or the other: (1) business purpose; (2) busi-In Ittelson v. Anderson, Feb. 9, 1933, the United States District Court for the Southern District of New York stated:

* * * The Supreme Court of the United States in the case of Seeht v. Halley, 265 U. S. 114, emphasized the test of business purpose and operation rather than that of structure; that is, the control or lack of control exercised by the beneficiaries.

In Ittelson v. Anderson,-Fed. (2d)-, Feb. 9, 1933, the United States District Court for the Southern District of New York stated:

Under the opinion from which the foregoing excerpts have been quoted, there appear to be three elemental requisites to a trust which, under the capital stock tax statutes, is to be regarded as an “ association.” (1) It should have a “ quasi-corporate form(2) its trustees should be “ associated together in much the same manner as the directors in a corporation;” and (3) the trustees must be engaged in carrying on a business.
$*$**#*
* * * trusts have been held to be taxable as “ associations ” wherever they carried on active commercial enterprises. Neal v. United States, 28 F. (2d) 1022 (C. C. A.-1st), cert. den. 273 U. S. 659; Little Four Oil & Gas Co. v. Lewellyn, 35 F. (2d) 149 (C. C. A.-3rd); Trust No. 3833, Security-First National Bank v. Welch, 54 Fed. (2d) 323 (C. C. A.-9th); Tulsa Mortgage Investment Co. v. Commissioner, 21 B. T. A. 735; Mary L. Dutton v. Commissioner, 18 B. T. A. 1151; Rochester Theatre Trust Estate v. Commissioner, 16 B. T. A. 1275; E. A. Landreth Co. v. Commissioner, 11 B. T. A. 1; Anderson Steam Vulcanizer Co. v. Commissioner, 6 B. T. A. 737. The only trusts engaging in business activity, which have not been classified as “ associations ” have been those formed for the liquidation of concerns or estates. (White v. Hornblower, 27 F. (2d) 777, (C. C. A. 1st); Blair v. Wilson Syndicate Trust, 39 F. (2d) 43, (C. C. A. 5th); Gonzolus Creek Oil Co. v. Commissioner, 12 B. T. A. 310), and real estate trusts where it was deemed that the trustees were merely holding property for the collection of income (Lansdowne Realty Trust v. Commissioner, 50 F. (2d) 56, (C. C. A. 1st); Fisk v. United States, 60 F. (2d) 665, and were not actively engaged in managing the property or buying and selling real estate. See C. W. Cowell Co. v. Commissioner, 21 B. T. A. 1274, cf. Tyson v. Commissioner, 54 F. (2d) 29, (C. C. A. 7th). Apparently, the judicial emphasis has been placed upon the third element of the test set forth in the Hecht case,— namely, that the trustees be engaged in carrying on a business, as distinguished from winding up a business or merely holding property and receiving and distributing its income. The question of whether the trust had a “ quasi-corporate form ” or whether the directors were associated together like “ the directors of a corporation ” has been subordinated by the courts to the consideration of whether they should regard the control of the beneficiaries over the trustees, or the business activities of the trustees, as the decisive consideration. Results have been reached on both theories. See, for example, White v. Honiblower, supra, in the First Circuit, where there was no control in the beneficiaries and the purpose of the trust was to liquidate a business. The majority of the court there held that the trust was not an association, because its function was not to carry on a business enterprise, but to bring about its liquidation. Bingham J. concurred on the ground that the organization under analysis was a strict trust under Massachusetts law, and not an association, the beneficiaries having no control over the actions of the trustees. On the whole, it would appear that the weight of authority has regarded the business activity of the trustees as the controlling factor. * * *

The petitioner does not deny that the indenture entered into on April 1, 1926, had behind it a business purpose. It contends, however, that the Mutual Investment Company was the entity which was to transact the business; that the petitioner was simply to hold the legal title to securities and was not to engage in business operations. We are not impressed by this argument. The organization of the petitioner was an integral part of the whole scheme. It held the legal title to the securities and it was the only one that could purchase and sell securities. The income of the entire operation was to be the income of the petitioner in the first instance, and that income was to be derived in part from trading in securities. In a very real sense the petitioner was organized for a business purpose.

We also think that it was engaged in a business operation. The petitioner argues that it was not doing business within the meaning of the decisions of the courts which have held the transaction of business a factor of importance in the classification of an organization of the character of the petitioner. In its brief the petitioner states:

While the buying and selling of securities may become a business, as the Bureau held, such changes in investment as an active trustee reasonably makes in the trust funds in his care to meet the continually changing important economic and financial conditions is investment and not husiness, and we most emphatically maintain we are doing no more than a wide-awake Trustee should do.

We can not agree that the investment of funds by an entity organized for that purpose does not constitute the doing of business. The evidence of record shows that the petitioner intended to take advantage of wide swings in the market and, in point of fact, a large percentage of the petitioner’s net income for 1928 was from profit on the sale of securities. The petitioner was doing the business for which it was organized. The fact that most of the work was performed by the managing company and paid for by that company does not make it that the petitioner was not doing business.

In numerous decisions of the courts one of the criteria for determining whether a trust is taxable as an association is the extent of the authority which the beneficial certificate holders have over the trustees. Here the evidence is to the effect that when 15 per cent of the Class A certificate holders indicate in writing that they are dissatisfied with the trustee it will be removed and a new one appointed. The certificate holders themselves do not have the power of appointment of a new trustee, but the managing company has that power. It is nevertheless the fact that the certificate holders have a measure of control over the trustee.

The form of organization of the petitioner is not that of a corporation, except that its capital is divided into shares. In Twin Bell Oil Syndicate, 26 B. T. A. 172, the Board said:

Quasi-corporate form is not an indispensable element of an “ association.” Sears, Roebuck á Go., etc., Fund v. Commissioner, 45 Fed. (2d) 506. But business purpose and activities are criteria whicli clearly bring the petitioner within the category of associations. Willis v. Commissioner, - Fed. (2d) - (C. C. A., 9th Cir., May 2, 1932), affirming 22 B. T. A. 564. Cf. Russell Tyson et al., Trustees, 25 B. T. A. 520.

The petitioner also makes the point that under the laws of the State of New York and under the provisions of the indenture the certificates of beneficial interest are not transferable. It is to be noted, however, that a certificate holder may assign his right to redeem and the assignee may under the provisions of the indenture turn in the acquired certificate and have reissued to him a certificate in his own name. The provision of the indenture, therefore, that the certificates may not be transferred is of no consequence in the determination of this issue.

It was apparently the intention of Congress to tax as corporations, associations of men, other than copartnerships, organized for the purpose of carrying on a business. We think that where men associate themselves together and contribute money to a common fund to be held by one or more trustees for a business purpose, the profits thereof to inure to them, the entity thus created is properly classifiable as an association, regardless of the power of control held over the trustee by the associates; of their authority freely to transfer their shares of beneficial interests; or of any provision for meetings of the certificate holders. Upon the entire record we are of the opinion that the petitioner was an association taxable as a corporation for 1928.

With respect to the second contention of the petitioner, that if it is held to be an association there should be consolidated with it for the purpose of computing its net income the operations of the Mutual Investment Company, we are of the opinion that there is no authority in the law for such consolidation. The shareholders of the Mutual Investment Company are different from those of the petitioner. The expenses of the Mutual Investment Company are not the expenses of the petitioner. The provision in the indenture that the managing company shall receive a share of the profits of the petitioner to compensate it for its services in furnishing investment advice in no wise affects the net income of the petitioner.

Reviewed by the Board.

Judgment will he entered for the respondent.


author: Matthews:

text:
    Walter Hopkins, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 50984.
    Promulgated April 28, 1933.

      John B. Peery, O. P. A., for the petitioner.

      Philip A. Bayer, Esq., for the respondent.
   OPINION.

Matthews:

The issue between the parties was stipulated as follows:

DM the distribution oí the stock oí the First National Securities Corporation of Baltimore, under the actions of the Board of Directors and stockholders of the Citizens National Bank of Baltimore, and the agreement between the said bank and the trustees herein referred to, constitute a taxable dividend from earnings subsequent to February 28, 1913, or was said distribution the distribution, to the stockholders of said bank, of the stock of a corporation, a party to a reorganization in pursuance of the plan of reorganization?

It is urged upon us by the petitioner that the distribution of the stock in the Securities Corporation was part and parcel of the general plan of reorganization, the Securities Corporation being “ a corporation á party to a reorganization,” and that the transaction was therefore nontaxable in 1928 under the provisions of section 112 (b) (3), (g) and (h) of the Revenue Act of 1928, set out in the margin. The respondent maintains, on the other hand, that the organization of the Securities Corporation was not an integral part of the reorganization within the meaning of section 112 (i), Act of 1928, set out in the margin, and, therefore, that the distribution of stock in the Securities Corporation was the distribution of a taxable dividend within the meaning of section 115 (a), Act of 1928, also set out in the margin.

The agreement of consolidation between the two banks provides for the merger of the two banks into one, and for the transfer by each bank, before the effective date of the consolidation, of any assets in excess of the $5,000,000 necessary to make up its contribution to the new corporation “ to a trustee or trustees for the ultimate benefit of its stockholders upon whatever terms and under whatever conditions shall be deemed proper.”

The transfer of the surplus assets of the Citizens National Bank, before the effective date of consolidation, to trustees for the ultimate benefit of its stockholders, was carried out by the Citizens National Bank. By proper corporate action, a dividend was declared of all surplus assets, such assets to he transfered to trustees for liquidation and distribution to the stockholders. The stockholders approved the organization of a securities. corporation and authorized the purchase of stock in such corporation with the first $250,000 of the proceeds of the surplus assets, such stock to be distributed to the shareholders according to the stock held, or in the case of a nonassenting stockholder, $1.25 for each share such stockholder would have been entitled to receive. The effect of the declaration of the dividend by the Citizens National Bank of all surplus assets and the subsequent transactions leading to the distribution of the stock of the Securities Corporation was the distribution of a dividend by the Citizens National Bank. There is no evidence that any of the surplus assets were earnings accumulated prior to March 1, 1913.

Neither the two national banks which merged nor the new bank could lawfully have engaged in the business which the Securities Corporation was organized to transact. The agreement of consolidation between the two banks — which is the plan of reorganization— did not provide for the organization of a securities corporation.

While the Securities Corporation was organized during the time the consolidation of the two banks was being effected, it was not a party to such reorganization and is not a corporation resulting from such reorganization. It resulted from the action of the stockholders in authorizing that a part of the surplus assets declared as a dividend should be used in acquiring stock in the Securities Corporation.

The cases of John G. Lonsdale, 11 B. T. A. 659; affd., 32 Fed. (2d) 537; certiorari denied, 280 U. S. 525; William E. Fulton, 15 B. T. A. 1018; affd., 47 Fed. (2d) 436, are quite similar in essential facts and the conclusion here reached is in accord with the conclusions reached in those cases. See also Mrs. Frank Andrews, 26 B. T. A. 642. We hold, therefore, that the distribution of the stock of the First National Securities Corporation of Baltimore to the stockholders of the Citizens National Bank of Baltimore constitutes a taxable dividend from the earnings subsequent to February 28, 1913. The determination of the respondent is approved.

Reviewed by the Board.

Judgment wül be entered for the respondent.

       Sec. 112. (b) (3) Stock tor stock on reorganization. — No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of tbe plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
      *******
      (g) Distribution of stoelc, on reorganization. — If there is distributed, in pursuance of a plan of reorganization, to a shareholder in a corporation a party to the reorganization stock or securities in such corporation or in another corporation a party to the reorganiza, tion, without the surrender by such shareholder of stock or securities in such a corporation, no gain to the distributee from the receipt of such stock or securities shall be recognized.
      (h) Same — effect on future distributions. — The distribution, in pursuance of a plan of reorganization, by or on behalf of a corporation a party to the reorganization, of its Stock or securities or stock or securities in a corporation a party to the reorganization, shall not be considered a distribution of earnings or profits within the meaning of section 115 (b) for the purpose of determining the taxability of subsequent distributions by the corporation.

       Sec. 112. (i) Definition of reorganization. — As used in this section and sections 113 and 115—
      (1) The term “reorganization” means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected.
      (2) The term “ a party to a reorganization ” includes a corporation resulting from a reorganization and includes both corporations in the case of an acquisition by one corporation of at least a majority of the toting stock and at least a majority of the total number of shares of all other classes of stock of another corporation.

       Sec. 115. (a) Definition of dividend. — The term “ dividend ” when used in this title (except in section 203 (a) (4) and section 208 (c) (1), relating to insurance companies) means any distribution made for a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913.


author: Aktjndell :

text:
    Theodate Pope Riddle, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 54421.
    Promulgated April 28, 1933.

      Otto O. Weirum, Esq., for the petitioner.

      Prew Savoy, Esq., for the respondent.
   OPINION.

Aktjndell :

The respondent determined a deficiency in income tax for the year 1928 in the amount of $1,761.40. The controversy arises out of awards made to petitioner for personal injuries suffered and property lost in the sinking of the steamship Lusitania in 1915. The Mixed Claims Commission, United States and Germany, awarded petitioner damages of $4,850 for loss of personal property, with interest from May 7,1915, and $15,000 for personal injuries, with interest from November 1,1923. The sums awarded, with interest, were paid to petitioner in 1928.

The amount of the award for property loss, $4,850, plus the interest thereon of $3,206.18, less expenses of $40.28, was included by respondent in petitioner’s income for 1928. This action of the respondent was assailed as erroneous and was the sole issue framed by the original pleadings. Counsel for respondent now concedes that the award of $4,850 was not in excess of the basis for gain or loss— the March 1, 1913, value — hence it gave rise to no taxable income. Counsel for petitioner concedes that the interest on the property loss award represented taxable income. These concessions, in which we concur, dispose of the original issue.

At the hearing, upon motion granted, counsel for respondent amended his answer to allege error in failing to include in income the interest of $3,422.61 ($3,439.81 less expenses of $17.20 retained by the Mixed Claims Commission) on the. award for personal injuries, and claimed an increased deficiency. There is no controversy as to the award of $15,000, in view of section 22 (a) (5) of the Revenue Act of 1928, which excludes from gross income damages received on account of sickness or injuries. Thus the only question for decision is whether the interest paid on the award should be included in income.

Section 22 of the Revenue Act of 1928, relating to gross income, reads as follows:

(a) General definition. — “ Gross income ” includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever hind 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.

The difference between the parties is whether the amount specifically designated as interest when paid was interest as a matter of law, or whether it was a part of the amount of damages awarded.

One of the rules promulgated by the Mixed Claims Commission (Administrative Decision No. Ill, Consolidated Decision and Opinion, p. 61), reads in part:

There is no basis for awarding damages in the nature of interest where the loss is neither liquidated nor the amount thereof capable of being ascertained by computation merely. In claims of this class no such damages will be awarded, but when the amount of the loss shall have been fixed by this Commission the award will bear interest from its date. To this class belong claims for losses based on personal injuries, death, maltreatment of prisoners of war, or acts injurious to health, capacity to wort, or honor.

This ruling would appear to be in line with that established by the decided cases. In Roberston v. Miller, 286 Fed. 503, 510, it is held:

The rule in this circuit is that no interest can be allowed at law where the damage is uncertain or unascertainable at the time of the commencement of action, or in other words, where the damages are unliquidated.

That case was affirmed in Miller v. Robertson, 266 U. S. 258, the court saying:

Generally, interest is not allowed upon unliquidated damages. Mowry v. Whitney, 14 Wall 620, 653. But when necessary in order to arrive at fair compensation, the court in the exercise of a sound discretion may include interest or its equivalent as an element of damages.

But these cases stop short of the question we have. Although interest, eo nomine, is not allowable in fixing the amount of damages, it does not follow that interest may not be added to the amount of the award, which by the judgment becomes a liquidated sum. The cases that have come to our attention indicate that, in the absence of statute, this may be done. In Arizona & N. M. Ry. Co. v. Clark, 207 Fed. 817, a suit for damages for personal injuries, the Circuit Court of Appeals sustained the District Court’s allowance of “ interest on the amount of the verdict from the date of the judgment.” That case was affirmed by the Supreme Court, 235 U. S. 669, though the matter of interest does not appear to have been in controversy before it. In Ortolano v. Morgan's L. & T. R. & S. S. Co., 109 La. 902; 33 So. 914, the suit was for damages for personal injuries resulting in death. .The trial court awarded damages with interest there-on “ from judicial demand until paid.” The Supreme Court amended the judgment by reducing the amount of damages awarded, and “ making the amount of the judgment bear legal interest from the date of the judgment of the district [trial] court * * * until paid.”

The rule that we draw from the above cases is that interest is properly allowable upon a judgment or award of damages for personal injuries when the amount of the damages has been ascertained and reduced to judgment. Apparently that is what occurred here. The Mixed Claims Commission fixed the measure of damages at $15,000 and allowed interest as such on that amount until paid, and not as a part of the damages. The computations made by officials of the United States Treasury Department in figuring the amount that was paid to petitioner are in evidence, and in these, after stating the amount of the “ principal of the award,” $15,000, the interest is separately computed and specifically designated as interest.

We accordingly hold that the amount of $3,422.61 was paid to and received by petitioner as interest, and as such is includable in income.

Decision will be entered under Bule 50.


author: Murdock :

text:
    Motty Eitingon, Petitioner, v. Commissioner of Internal Revenue, Respondent. Charles Eitingon, Petitioner, v. Commissioner of Internal Revenue, Respondent. Naum Eitingon, Petitioner, v. Commissioner of Internal Revenue, Respondent
    Docket Nos. 58854, 60163, 60610.
    Promulgated April 28, 1933.

      I. Graff, Esq., for the respondent.
   OPINION.

Murdock :

The Commissioner determined a deficiency of $2,853.12 and a penalty of $713.28 in the income tax of Charles Eitingon for the calendar year 1928. At Docket No. 60163 the following is assigned as an error in the determination of the Commissioner:

That the petitioner [Charles Eitingon] was liable for tax to the American Government upon an amount of interest of $44,359.98 received by him on an indebtedness on an open account from Motty Eitingon, an American citizen, the transaction out of which the said indebtedness for interest to the petitioner arose having been wholly consummated outside of the United States, the amount of interest in Question having been paid to the petitioner outside of the United States and having no connection with American sources as defined by the law.

The Commissioner determined a deficiency of $975.32 and a penalty of $243.83 in the income tax of Naum Eitingon for the year 1928. At Docket No. 60610 the error assigned was the same as that above quoted from Docket No. 60163, except that the interest received was in the amount of $2,884.36 and was received by Naum Eitingon,.

The Commissioner determined a deficiency of $2,362.22 representing tax which Motty Eitingon should have withheld for 1928 from income paid to Charles Eitingon and Naum Eitingon, nonresident aliens, which income and tax he should have reported on a withholding return.

The cases have been consolidated. When they came on for hearing there was no appearance for the petitioners, but counsel for the respondent filed a stipulation of facts which is as follows:

1. Petitioners Naum Eitingon and Charles Eitingon are and were during the calendar year 1928 non-resident alien individuals, being residents of the City of Lodz, Poland, and petitioner Motty Eitingon is and was during the calendar year 1928 an American citizen, a resident of the City, County and State of New York.
2. Petitioner Motty Eitingon paid an amount of interest in the sum of Two thousand eight hundred eighty four and 36/100 ($2,884.36) Dollars on an indebtedness on an open account to Naum Eitingon, of Lodz,. Poland, during the calendar year 1928, said indebtedness being unsecured by any collateral within the United States.
3. Petitioner Motty Eitingon paid an amount of interest in the sum of Eorty four thousand three hundred fifty nine and 98/100 ($44,359.98) Dollars on an indebtedness on an open account to Charles Eitingon of Lodz, Poland, during the calendar year 1928, said indebtedness being unsecured by any collateral within the United States.
4. On or about November 6, 1930, Motty Eitingon executed and filed individual income tax returns for the calendar year 1928 on behalf of Charles Eitingon and Naum Eitingon. True photostat copies of said returns are attached hereto, marked Exhibits A and B, respectively, and made a part hereof. No other returns for said year were filed by Charles or Naum Eitingon, or by Motty Eitingon on behalf of Charles or Naum Eitingon.
5. Petitioner Motty Eitingon did not withhold tax on the interest so paid to petitioners Naum Eitingon and Charles Eitingon, non-resident aliens, and did not report such income and tax on a withholding return, not having regarded such interest as income from sources within the United States as defined in Section 119 (a) (1) of the Revenue Act of 1928.
6. The interest received by non-resident alien petitioners, Naum Eitingon and Charles Eitingon, from Motty Eitingon, an American citizen, was not included in returns for the said non-resident alien petitioners filed on their behalf for the calendar year 1928, treating such interest as income from sources without the United States as defined by Section 119 (e) (1) of the Revenue Act of 1928.
7. Respondent has treated the amounts of interest paid to Naum Eitingon and Charles Eitingon as income from sources -within the United States and taxable by the American Government and seeks to hold petitioner'Motty Eitingon liable for withholding tax thereon as on income from sources within the United States.
8. If said interest constitutes income to petitioners Naum Eitingon and Charles Eitingon from sources within the United States, then petitioner Motty Eitingon is liable as withholding agent for -the amount of the deficiency determined against him as shown in the notice of deficiency.

The income tax return filed on behalf of Charles Eitingon reported net income of $5,577.50, consisting entirely of dividends on stock of domestic corporations, an exemption of $1,500 was olaimed, and no tax was -shown to be due. The Commissioner added to infcome, as shown on the return, $44,359.98, representing interest received from Motty Eitingon, and computed the deficiency and a delinquency penalty of 25 per cent for failing to file a return within the time prescribed by law.

The income tax return filed on behalf of Naum Eitingon reported net income of $29,422.50, consisting entirely of dividends on stock of domestic corporations, an exemption of $1,500 was claimed and the only tax shown to be due -was surtax in the amount of $838.80. The Commissioner added to income, as shown on the return, $2,884.36, representing interest received from Motty Eitingon, and computed the deficiency and a delinquency penalty of 25 per cent for failing to file a return within the time prescribed by law.

The three petitioners are stockholders in Eitingon-Schild Company, Inc., an American corporation which has branches in many parts of the world. The open accounts above referred to -originated in the course of business dealings between Motty Eitingon and the other two petitioners.

No question has been raised in the petitions in regard to the penalties, and the proof which has been offered does not indicate that the Commissioner erred in this respect. Cf. Cantrell & Cochrane., Ltd., 19 B. T. A. 16. The only question for our decision is whether or not the interest paid by Motty Eitingon to the two other petitioners was income from sources within the United States. If it was not, then there is no deficiency in any of the three Oases, the penalty would have no tax to support it in the case of Charles Eitingon, and the penalty in 'the case of Naum Eitingon would be limited to 25 per cent of the surtax on $29,422:50. There is ho showing that the transaction out of which the obligatio'n for interest arose was consummated outside of fhe United -States or that -the interest in question was paid outside of -the United States. Thus, the quoted assignment of error is not an accurate statement of the issue.

The pertinent provisions of section 119 of the Revenue Act of 1928, under which the question must be decided, are as follows:

(a) Gross income from sources in the United States. — Tbe following items of gross income stall be treated as income from sources within the United States:
(1) Interest — Interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise, not including—
(A) interest on deposits with persons carrying on the banting business paid to persons not engaged in business within the United States and not having an office or place of business therein, or
(B) interest received from a resident alien individual, a resident foreign corporation, or a domestic corporation, when it is shown to the satisfaction of the Commissioner that less than 20 per centum of the gross income of such resident payor or domestic corporation has been derived from sources within the United States, as determined under the provisions of this section, for the three-year period ending with the close of the taxable year of such payor preceding the payment of such interest, or for such part of such period as may be applicable, or
(C) income derived by a foreign central bank of issue from bankers’ acceptances.

Subsection (c) (1) provides that interest other than that derived from sources within the United States, as provided in subsection (a) (1), shall be treated as income from sources without the United States.

Counsel for the petitioners argues that the rule of ejusdem generis should be applied in interpreting the phrase “ other interest-bearing obligations ” in section 119 (a) (1). He would interpret this phrase to mean obligations similar to bonds and notes, that is, formal written agreements or acknowledgments of a liability to pay a certain sum. Even so, it might include the obligations here in question. We rejected a similar contention in Stockholms Enskilda Bank, 25 B. T. A. 1328. See also British-American Tobacco Co., Ltd., 27 B. T. A. 226. Although counsel for the petitioners has not attempted to refute the reasoning of the Board employed in the former case, nevertheless, what we there said on the subject was undoubtedly mere dicta and need not control us here. The rule of ejusdem generis has been evolved as an aid in the search for intent through a consideration of the words used by a writer. It should be used to resolve a doubt, not to create one. There are other valuable rules of interpretation. These frequently conflict one with the other and also with the rule of ejusdem generis. The problems of statutory interpretation are seldom solved by rote. Sound judgment should be exercised to the end that the true intent of the legislators may be determined as accurately as is humanly possible.

In United States v. First National Bank, 190 Fed. 336, at page 343, the court said that the rule of ejusdem generis is not much in favor at the present time. The following was then appropriately quoted from Sutherland on Statutory Construction, sec. 279, as an accurate definition of the limits of the rule:

In cases coming within the reach of the principle just illustrated, general words are read, not according to their natural and usual sense, but are restricted to persons and things of the same kind or genus as those just enumerated. They are construed according to the more explicit context. This rule can be used only as an aid in ascertaining the legislative intent, and not for the purpose of controlling the intention or of confining the operation of a statute within narrower limits than was intended by the lawmaker. It affords a mere suggestion to the judicial mind that, where it clearly appears that the lawmaker was thinking of a particular class of persons or objects, his words of more general description may not have been intended to embrace any other than those within the class. The suggestion is one of common sense. Other rules of construction are equally potent, especially the primary rule which suggests that the intent of the Legislature is to be found in the ordinary meaning of the words of the statute. The sense in which general words, or any words, are intended to be used, furnishes the rule of interpretation, and this is to be collected from the context; and a narrower or more extended meaning will be given, according as the intention is thus indicated. To deny any word or phrase its known and natural meaning in any instance, the court ought to be quite sure that they are following the legislative intention. Hence, though a general term follows specific words, it will not be restricted by them when the object of the act and the intention is that the general words shall be understood in their ordinary sense.

The following quotation from United States v. Hartwell, 6 Wall. 385, 396, is apposite:

When the words are general, and include various classes of persons, there is no authority which would justify a court in restricting them to one class, and excluding others, where the purpose of the statute is alike applicable to all. The proper course in all cases is to adopt that sense of the words which best harmonizes with the context, and promotes in the fullest manner the policy and objects of the Legislature.

The language used in section 119 (a) (1) is broad if the words used are read according to their natural and usual sense. Thus read they would undoubtedly include the interest here in question. This interest was upon interest-bearing obligations of a resident. It was interest on deposits with a resident individual. It was earned and paid in the United States. The record does not disclose whether or not there was any writing or formal agreement evidencing the donor’s obligation to pay interest and return the principal. The Commissioner’s regulations and rulings indicate that he has always treated interest such as this as income from sources within the United States. See Regulations 45, article 91; Regulations 62, article 317; I. T. 1311, C. B. 1-1, p. 224. Although we have studied the act and the legslative history of the section and its predecessors in earlier acts, no reason occurs to us why Congress might have desired to relieve such income from tax. On the contrary, we would suppose that Congress had intended to tax it as. income from sources within the United States in order to accomplish the object of the act. Cf. Burnet v. Brooks, 288 U. S. 378. There is nothing to indicate that the lawmakers were thinking only of interest of a particular class which would not include the interest in question. The words used should not be narrowly construed, as the petitioners urge, since there is no apparent reason for such a construction. The Commissioner did not err in holding that this interest is income from sources within the United States and subject to tax.

Decision will be entered for the respondent.


author: Arundell:

text:
    Falls City Ice & Beverage Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Polar Ice & Coal Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. B & B Ice & Coal Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Independent Ice & Coal Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Parkland Ice & Cold Storage Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 61435-61439, 67636-67640.
    Promulgated April 28, 1933.

      Ehoood Hamilton, Esq., for the petitioners.

      L. W. Oreason, Esq., for the respondent.
   OPINION.

Arundell:

The petitioners claim a loss for 1929 on the ground that the stock of the American Company became worthless in that year. The respondent resists the allowance of a deduction, arguing that any loss on the sale of the American Company’s assets was the loss of that company alone; that the Louisville Company — and not the petitioners — owned the stock of the American Company; and that in any event the sale of assets was not consummated in 1929 so as to support a loss deduction in that year.

The theory underlying petitioners’ claim is that they were the beneficial owners of the American Company stock and that the Louisville Company was acting merely as their agent in acquiring the stock. There is nothing in the record to establish the creation of an agency except the testimony of one witness that that was the intent. If the Louisville Company was acting only as agent it is not likely that it would have obligated itself to pay $210,195.70 as it did by giving its note in that amount. The fact is that the Louisville Company was the purchaser and owner of the American Company stock and the only interest of petitioners in the stock was the indirect one of stockholders in the Louisville Company.

Furthermore the evidence does not satisfy us that the sale of the American Company’s assets was consummated in 1929. While the company had agreed to sell, and a deposit was made by the purchaser in 1929, title was not transferred until 1930. In this case, as in Lucas v. North Texas Lumber Co., 281 U. S. 11, “the title and right of possession remained ” in the vendor at the close of 1929, and “unconditional liability of vendee for the purchase price was not created in that year.” See also Newaygo Portland Cement Co., 27 B. T. A. 1097. We, accordingly, hold that petitioners are not entitled to a loss deduction in 1929 on the American Company transaction.

It does not follow, however, that the petitioners may not be entitled to a loss in 1930 when the American Company disposed of its assets. True, the petitioners did not own the stock, but they contributed to the Louisville Company to enable it to buy the American Company stock. They therefore had a capital investment in the Louisville Company to the extent of the cost of their stock therein plus the amounts paid in to reimburse that company for its purchase of American Company stock. Consequently, when the American Company disposed of all of its assets that fact would be reflected in the investment of petitioners in the Louisville Company.

The evidence satisfactorily establishes that the stock of both the Louisville and American Companies became worthless in 1930. Both of them disposed of their plants and equipment in that year. It appears from the balance sheets that the Louisville Company retained some receivables, but they were exceeded by the liabilities. Both companies had ceased to exist as operating concerns and there was no hope of the stockholders receiving any return on their investment after 1930. It is our opinion, and we so hold, that petitioners sustained a deductible loss in 1930 in the amount of the original cost to them of the Louisville Company stock and the amounts contributed by them to that company and used by it in the purchase of the American Company stock. The amounts so deductible are not established clearly enough for us to say definitely what they were. For instance, the Parkland Ice & Coal Company was a joint maker of a note with the Independent Ice & Coal Company, but it appears that the Parkland Company never paid anything. If it was released from liability it, of course,- would not be entitled to a deduction. We cannot agree with the contention of petitioners that, because they failed to deduct interest currently, it should be included in the amount of the investment. Interest was deductible in the year of accrual and may not be added to the principal. Cf. Central Real Estate Co., 17 B. T. A. 776; affd., 47 Fed. (2d) 1036. The amount of the capital investment by each petitioner may bo shown by the parties in the recomputation that will need to be made.

Decision will he entered under Bule 50.


text:
    D. C. Bothwell, Petitioner v. Commissioner of Internal Revenue, Respondent. J. F. Darby, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 50491, 52503.
    Promulgated April 28, 1933.

      George E. H. Goodner, Esq., and Frederick C. Bohwerder, C. P. A., for the petitioners.

      Harold Allen, Esq., and Leslie H. BusKbrooh, Esq., for the respondent.
   OPINION.

Smith :

The first question presented by these proceedings is whether the profit realized by each petitioner in 1928 upon the sale of shares of stock of the Brazos Oil Corporation is ordinary income taxable at both normal and surtax rates, or capital gain subject only to the 12% per cent tax. The amount of the profit in the case of each petitioner is not in dispute.

Section 111 (a) of the Revenue Act of 1928 provides that “the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis provided in section 113.” Section 113 (a) of the act provides in part: “The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28,1913, shall be the cost of such property.” Section 101 (a) of the Revenue Act of 1928 provides for a tax of 12% per cent of the amount of the capital net gain. “ Capital gain ” is defined in section 101 (c) (1) of the act as meaning “ taxable gain from the sale or exchange of capital assets consummated after December 31,1921.” “ Capital assets ” are defined in subdivision (8) of section 101 (c) as meaning “ property held by the taxpayer for more than two years.”

Counsel for the petitioners makes an elaborate argument to the effect that the Brazos Oil Corporation stock sold by the petitioners in 1928 was property held by them more than two years. It is not denied, however, that the option for the purchase of the shares of stock sold in 1928 was exercised in December 1927. We think that the contention of the petitioners is entirely devoid of merit. Manifestly, if the petitioners had not exercised their option for the purchase of the shares of stock in question they would never have become the owners of it. As stated by the court in Harper v. Bibb, 47 Ala. 547:

* * * Bat where the contract gives only an option to purchase, the purchaser can not be said to hold the price in trust for the vendor; and before he has elected to become a purchaser, it is contrary to all rules of reason and good sense to accord to him the rights of ownership.

The contention of the respondent that the stock was acquired by the petitioners in December 1927, at the time the option was exercised and the shares of stock purchased is sustained.

The petitioners make an alternative contention that if it be held that the income reported by them in 1928 as the profit upon the sale of the Brazos Oil Corporation shares was not capital gain under section 101 of the Revenue Act of 1928, then the profit was overstated because the petitioners used as cost the option price of the stock and not its fair market value in December 1927, when the option was exercised and the stock received. The.contention of the petitioners upon this point is in short that the cost basis is not the price which the petitioners paid for their stock, but the fair market value thereof at the date of purchase. In support of this contention the petitioners rely upon the opinion of the Board in Albert Russel Erskine, 26 B. T. A. 147. The facts in that case were that the petitioner entered into an agreement to work for a corporation exclusively for a period of between four and five years. Under the contract he was to receive a- cash salary and in addition “ have the right and option to buy and receive ” a certain number of shares of the capital stock of the corporation upon payment to the corporation of a nominal price for the stock. The corporation purchased the shares in the open market at a cost of several times the agreed price to the petitioner and placed them in escrow subject to the terms of the agreement. In the circumstances of the case the Board held that the contract was an employment contract and that each year as the petitioner exercised the option to purchase the shares of stock at a price far below the market the petitioner received income to the extent of the difference between the price which he paid for the stock and the fair market value. The situation in the instant proceedings is far different. There is no evidence here that the option price was less than the fair market price in 1922. In fact when there was a modification of the contract in 1926, the corporation recognized that the option price was in excess of the value of the stock in 1922 and voluntarily reduced the price from $2.56 per share to $2 per share. The ErsMne case is distinguishable upon its facts.

The petitioners further refer to the case of Boulton v. Heiner, decided by the United States District Court, Western District of Pennsylvania, on November 5, 1932, at paragraph 2017 of the Prentice Hall 1932 Federal Tax Service. It was held by the court that, where a taxpayer obtained an option for the purchase of shares of stock at a given price under an agreement to serve the corporation for a number of years without salary, the cost of the stock to the taxpayer was the price paid for it plus the value of the services rendered by the taxpayer. The facts in the instant case do not show the value, if any, of the services performed by the petitioners to the corporations which they served over the amounts paid to them as salaries for their services.

The statute plainly states that upon the sale of property acquired subsequent to February 28, 1913, the basis for the determination of the gain or loss shall be the cost of such property. We can not determine from the evidence of record that the cost of the shares of the Brazos Oil Corporation stock sold by the petitioners in 1928 was in excess of $2 per share, the price which they actually paid for the stock. It is clear also that the stock was not held by them for as long as two years at the date of sale. The stock was sold in 1928 and acquired by the petitioners in 1927. The profits realized were clearly taxable as ordinary income and not at the rate of 12% per centum provided by section 101 of the Bevenue Act of 1928.

The second question for our determination is whether the petitioners are liable to the negligence penalty provided by section 293 (a) of the Bevenue Act of 1928, which reads:

SEO. 2 93. ADDITIONS TO THE TAX IN CASE OK DEFICIENCY.
(a) Negligence. — If any part of any deficiency is due to negligence or intentional disregard of rules and regulations but without intent to defraud, 5 per centum of the total amount of the deficiency (in addition to such deficiency) shall be assessed, collected, and paid in the same manner as if it were a deficiency, except that the provisions of section 272 (i), relating to the prorating of a deficiency, and of section 292, relating to interest on deficiencies, shall not be applicable.

The respondent makes the claim for the penalty upon the ground that the petitioners clearly had no ownership of the shares of stock which were sold in 1928 until they bought them in 1927; that in their return they did not set forth the circumstances under which they acquired the stock, but reported that they acquired it in 1922; and that there was nothing shown by the returns from which the respondent could have ascertained that the profit was not taxable as a capital net gain. The petitioners claim that their returns were made by certified public accountants and the certified public accountants were fully informed of the circumstances of the transaction and they assumed that the returns were made out in accordance with the law.

We are of the opinion that the petitioners are liable to the negligence penalty claimed by the respondent. As we see it there was no ground for any contention that the petitioners had “ held ” the stock in question for a period of more than two years at the date of sale. Each petitioner is charged with a knowledge of the law and clearly the requirement of the law with respect to capital gain is shown on the return form. In our opinion the petitioners are liable for the negligence penalty provided in section 293 (a) of the Revenue Act of 1928. Cf. Edmond A. Hughes, 27 B. T. A. 1022.


author: Aeundblu :

text:
    Stires Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 43544.
    Promulgated May 4, 1933.

      Arthur B. Brenner, Esq., for the petitioner.

      Mason B. Leming, Esq., for the respondent.
   OPINION.

Aeundblu :

In 1925 and 1926 petitioner sold stock of oil companies that it acquired in 1925 through the exercise of an option, as related in the findings of fact, and the principal question here is the determination of the proper basis for computation of gain or loss on the sales. The parties are agreed that the option must be taken into consideration in determining the basis for gain or loss. The petitioner contends that it should be taken into account at cost and that included in such cost is the amount it paid for the Homad Corporation stock, namely, $1,680,000. The respondent’s position is that the option was acquired in connection with a reorganization and that under the Revenue Act of 1926 petitioner must use the same basis as its transferor, the Homad Corporation.

The essential facts may be briefly restated. Pforzheimer held an option on certain oil stocks. This he turned in to the Homad Corporation for all its stock on October 29,1925. The next day, October 30, 1925, the Satterfield Corporation issued $1,680,000 par value of its stock to Pforzheimer for all of his stock of the Homad Corporation. On the same day, October 30, 1925, Pforzheimer purchased capital stock of the petitioner corporation for $150,000; petitioner in turn purchased from the Satterfield Corporation all the stock of the Homad Corporation for $1,680,000, payable $150,000 in cash and the balance on or before June 30, 1926, evidenced by petitioner’s promissory note. The cash and note were delivered to the Satterfield Corporation and it delivered to petitioner the Homad Corporation stock. Petitioner thereupon dissolved the Homad Corporation, assuming its liabilities, and received the option as an asset in liquidation.

The option was put through the several corporations admittedly for the purpose of stepping up the basis, according to the testimony, as “ a means to an end,” which was to “ legally avoid, if possible, the payment of tax until the whole transaction should be closed.” While devices to avoid taxes should be subjected to the closest scrutiny to see that they are what they purport to be, if they are and if they do not transgress the statute, they may not be condemned because of the motive that prompted resort to them. United States v. Isham, 17 Wall. 496; Bullen v. Wisconsin, 240 U.S. 625.

Considering the several transactions in chronological order, it is clear that the first, the assignment of the option by Pforzheimer to tbe Homad Corporation for stock, would not serve to increase the basis. That transfer comes within section 204 (a) (8), under which the Homad Corporation would be required to use the same basis as Pforzheimer.

The next step was Pforzheimer’s transfer of his Plomad Corporation stock to the Satterfield Corporation for stock of the latter having a par value of $1,680,000. The respondent argues that the intervention of the Satterfield Corporation should be disregarded entirely, but that if it is to be taken into consideration, the cost to it of the Homad stock was nothing. We do not believe that the existence of the Satterfield Corporation can be thus ignored. It was as important a link in the chain of events as the other two corporate participants. If the Satterfield Corporation is to be disregarded, so should the other two, and yet we are asked to recognize the Stires Corporation to the extent of sustaining a deficiency against it.

In Evelyn F. Gregory, 27 B.T.A. 223, the sole stockholder of a corporation caused a second corporation to be organized. The old corporation then transferred certain assets to the new, which issued all its stock therefor to the stockholder in the old corporation. The new corporation then liquidated and distributed its assets to its sole stockholder, who thereupon sold such assets, and reported a gain based apparently upon the value when acquired by the new corporation. The respondent asserted a deficiency based on the view that the creation of the new corporation was without substance and should be disregarded, and that the stockholder should be taxed as upon a dividend consisting of the amount received upon the sale as if such amount had been distributed directly by the old corporation. We refused to subscribe to the respondent’s theory and held that the tax should be predicated upon the statutory recognition of a reorganization, liquidation, and sale. We said in part:

Congress lias not left it to the Commissioner to say, in the absence of fraud or other compelling circumstances, that the corporate form may be ignored in some cases and recognized in others. Whatever can be said of the wisdom of recognizing the corporate device, the taxing statutes have so plainly accepted it and provided the detailed methods of taxing its transactions, that to disregard it in a case like this would vary the time, method and amount c£ tax which the statute imposes.
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It should be remembered, when considering the effects upon tax liability or corporate plans, that the statute has, since the Act of 1918, provided in more or less detail the system of tax determination, and this system unmistakably permits the tona fide use of the corporate device. That its effect may be, as here, to tax a profit piecemeal over several periods is so clearly within the legislative system that it can not be denied. As a result of it, the benefit of one year may be the burden of another; and the incidence of the statute may be as favorable to the Government in one case as it is unfavorable in another. A statute so meticulously drafted must be interpreted as a literal expression of the taxing policy, and leaves only the small interstices for judicial consideration. The general legislative plan apparently was to recognize the corporate entity and, in view of such recognition to specify when the gains or losses would be recognized and upon what basis they should be measured. We may not destroy the effectiveness of this statutory plan by denying recognition to the corporation and thus preventing consideration of its transactions.

In the present case the respondent does not ask us to go so far as to disregard all the corporations, or to treat them as mere agencies of Pforzheimer, but only to ignore the one in which originated the stepped-up basis here claimed. This one, the Satterfield Corporation, existed as long, and was at least as substantial, as the petitioner and we do not see upon what ground we would be warranted in disregarding it while recognizing the others. Cf. Evelyn F. Gregory, supra.

Nor do we think it can be said that the Homad stock had no “ cost ” to the Satterfield Corporation. True, the Satterfield Corporation had no assets when it issued its stock, but in such cases the rule is that cost is determined by the value of the assets acquired. Rouse, Hempstone & Co., 7 B.T.A. 1018. The evidence satisfactorily establishes that on October 30, 1925, the option, which was Homad’s sole asset, was worth $1,680,000 in excess of the obligations it imposed. The real question, in so far as the Satterfield Corporation is concerned, is whether its basis is cost, this being the primary basis under section 204 (a), or whether the basis is limited by one of the several exceptions. The only suggested exception, and the only one which it appears might possibly be designed to apply in this situation, is paragraph (7), which reads:

If the property (other than stock or securities in a corporation a party to the reorganization) was acquired after December 31, 1917, by a corporation in connection with a reorganization, and immediately after the transfer an interest or control in such property of 80 per centum or more remained in the same persons or any of them, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.

But this, petitioner argues, is inapplicable because it specifically excepts from its operation “ stock or securities in a corporation a party to the reorganization.” There would seem to be no doubt that the issuance of Satterfield stock for Homad stock was a “ reorganization ” and that each corporation was “ a party to the reorganization ” as those terms are defined in section 203 (h). If petitioner’s argument is sound, it follows that a corporation may issue stock for property other than stock without a recognition of gain or loss and without a changed basis as to such property, but that if stock is issued for stock, while no gain or loss is recognized on such exchange, nevertheless a new basis for gain or loss on the sale of stock so acquired may be created. On this latter proposition counsel for the respondent has specifically so ruled in Gr.C.M. 1285, CB IX-1, p. 181. In that case an individual, A, owning a majority of stock in M company exchanged such stock for all the stock of the N company, which in: turn exchanged the M company stock for stock of the 0 company. It was held that the basis of the M company stock in the hands of both N and 0 companies was cost to them, and they were not limited to the basis of the stock in the hands of A.

The difference under the Revenue Act of 1926 between the basis applicable to stock acquired for stock and other property acquired for stock, does not obtain under the later acts. The corresponding provisions of the Revenue Act of 1928 (section 113 (a), paragraphs 7 and 8) omit the parenthetical phrase which excluded stock or securities from the operation of the limitation under the 1926 Act. In section 113 (a) (7) of the 1928 Act, which corresponds to section 204 (a) (7) of the 1926 Act, the following sentence is added in lieu of the parenthetical phrase:

This paragraph shall not apply if the property acquired consists of stock or securities in a corporation a party to the reorganization, unless acquired by the issuance of stock or securities of the transferee as the consideration in whole or in part for the transfer.

Section 113 (a) (8) of the 1928 Act simply omits the parenthetical phrase without the addition of any new provision to take its place. The reason for these changes is given in the report of the House Committee on Ways and Means accompanying the Revenue Act of 1928. Rept. No. 2, 70th Cong., 1st sess., pp. 18, 19. In that report the Committee, for the purpose of illustrating the operation of section 204 (a) (8), assumes that individuals purchase all the stock of corporation A for $100,000 at a time when the corporate assets are worth that amount. Upon appreciation of the assets to a value of $1,000,000, the stockholders organize corporation B and exchange their stock in A for all the stock of B, and then B sells the A stock for $1,000,000. The report then proceeds as follows:

Obviously tile gain of corporation A should be $900,000 the amount by which the $1,000,000 realized from the sale exceeds $100,000, the cost to A’s stockholders of their stock, since the transfer of their stock to B in exchange for the stock of B was tax-free. It is claimed that section 204 (a) (8) of the 1926-Act does not apply to such a case because it excludes from the rule therein laid down, stock or securities in a corporation a party to the reorganization.
While it is quite possible that the courts, in view of the general purposes of section 204 of the 1924 and 1926 Acts, would not adopt such a construction, nevertheless, to remove any doubt, the new bill in the corresponding paragraph (section 113 (a) (8)) omits these words of limitation, thus making it clear beyond doubt that in the example above, corporation B would have a basis of only $100,000 for the purpose of computing the gain derived from the sale of its stock in corporation A.
A similar change is made in the bill in section 113 (a) (7) (corresponding to section 204 (a) (7) of the 1926 Act).

To the same effect is the report of the Senate Committee on Finance. Rept. No. 960, 70th Cong., 1st sess., pp. 27, 28. See also Miller’s “ Reorganizations and Other Exchanges in Federal Income Taxation,” ch. 18, §192. The provisions of section 113 (a) (7) and (8) are not made retroactive by the 1928 Act and counsel for the respondent in G.C.M. 7285, supra, has refused to apply them as interpretative of the 1926 Act.

The construction that has been placed on section 204 (a) (7) in respondent’s ruling G.C.M. 7285, supra, appears to us to be sound, in view of the wording of that section specifically excluding from its operation stock or securities in a corporation a party to the reorganization. It follows that section 204 (a) (7) does not apply to the Satterfield Corporation’s acquisition of the Homad Corporation stock, and, as none of the other provisions relating to limitation of basis appear to fit the case, the conclusion must be reached that the basis of the Homad stock in the hands of the Satterfield Corporation is not limited to the basis that the transferor, Pforzheimer, would be required to use in computing gain or loss. Consequently, the Satterfield Corporation is required to take as its basis the primary basis laid down by the statute, namely, cost of the stock. It is only where one of the several exceptions listed under section 204 (a) applies that any basis other than cost may be used. Cost to the Satterfield Corporation, in view of its acquisition for stock, is the value of the property acquired, and this value is established to be $1,181,000. This amount, as set out in the findings, is $1,680,000 in excess of the $100,000 cost of the option to Pforzheimer plus the current liabilities of the Homad Corporation which the Satterfield Corporation assumed in an amount not to exceed $1,000.

Our next inquiry is whether, upon petitioner’s acquisition of the Homad stock, the basis to it was any different from the basis to the Satterfield Corporation. The respondent does not contend that in this transaction the basis suffered any change, and we see no reason why it should. The transfer was effected in the form of a purchase and sale and the obligation of the purchaser was in due course completely liquidated. In this transfer neither the stock of the Homad Corporation nor the option suffered any diminution of value. The stock cost petitioner $1,680,000 plus the assumed obligations, and upon liquidation that cost would apply to the asset received, namely, the option. We accordingly hold that petitioner is entitled to include the sum of $1,680,000 as cost in determining gain or loss on the sale of the oil stocks which it obtained under the option.

The next question has to do with the proper treatment of the amount of $362,434.60 paid by petitioner in 1926 to various persons for services performed in connection with Pforzheimer’s acquisition of the option. Petitioner deducted this amount as an expense in 1926, and respondent treated it as a part of the cost of the oil stock obtained under the option and allocated a proportionate part to the years in which the stocks were sold. The evidence is that Pforz-heimer enlisted the services of these individuals to use their influence with the controlling interests of the Franco Wyoming Oil Co. Pforzheimer agreed to compensate them if the deal proved profitable, and his agreement in that respect was assumed by petitioner. In the written offers from Pforzheimer to the Satterfield Corporation and from the Satterfield Corporation to petitioner it was stated that these persons would be entitled to share in the profits if amounts were realized “ in excess of present market values.” When in 1926 it became evident that a profit would be realized petitioner decided to and did discharge the obligation rather than to wait until the sale of the stocks was completed. The payment was not for services rendered in that year and had no more direct relation to business conducted in that year than in the other years over which the sales were spread. In our opinion the sum paid in 1926 was as much a cost of the stocks as was the $100,000 paid for the option, and the respondent properly so treated it. Inasmuch as the payments were to be made only in the event that sales prices were in excess of the values at October 30, 1925, there is no occasion for decreasing that value by reason of the obligation. Petitioner says that so treating the sum in controversy will result in a refund to it for 1925 and a net loss for 1926. Upon the record we cannot tell whether this is so or not, and it is reserved for determination under Kule 50.

Petitioner alleges, and respondent denies, that it paid $31,900 in 1926 to the Satterfield Corporation as interest on its indebtedness. The respondent disallowed a claimed deduction in that amount in petitioner’s return for 1926. The only evidence on this question is the testimony of one witness to the effect that the interest paid to the Satterfield Corporation was disallowed. There is no evidence as to the amount paid. The note of petitioner to the Satterfield Corporation does not provide for the payment of interest. A number of checks of petitioner are in evidence, but none of them are identified as interest payments. Inasmuch as there is an issue as to whether any amount was paid as interest, we must decide against petitioner on the ground that the amount paid, if any, has not been established.

Petitioner claims a deduction from 1926 income in the amount of $75 for capita] stock tax stamps attached to its stock books upon the issuance of its stock. The deduction claimed was disallowed by respondent, with the explanation that it was an “ organization expense.” Under our decisions amounts paid for revenue stamps in connection with the issue of capital stock are deductible as “ taxes paid,” United States Playing Card Co., 15 B.T.A. 975: Borg & Beck Co., 24 B.T.A. 995, and we hold that petitioner is entitled to the deduction sought.

The final question is whether a deduction may be had in 1925 for the amount of $100 paid for one year’s representation service of petitioner in the State of Delaware, where petitioner was incorporated. It is customary for states to require the maintenance of offices within their borders by companies incorporated therein. We are of the opinion that the cost of maintaining such an office is an ordinary and necessary expense and the deduction claimed should be allowed.

Beviewed by the Board.

Decision will be entered under Rule 50.

       [Section 204 (a) (8).] If the property (other than stock or securities in a corporation a party to a reorganization) was acquired after December 31, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in paragraph (4) of subdivision (b) of section 203 (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money in addition to such stock or securities), then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.
      [Section 203 (b) (4).] No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property- prior to the exchange.

       [Section 203 (h).] As used in this section and sections 201 and 204—
      (1) The term “ reorganization ” means (A) a merger or consolidation (including the acquisition hy one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected.
      (2) The term “ a party to a reorganization ” includes a corporation resulting from a reorganization and includes both corporations in the case of an acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation.