text:
    Trust No. 5522 and Trust No. 5644, Bellehurst Syndicate, Security-First National Bank of Los Angeles, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.

      Docket No. 58311.
    Promulgated April 26, 1933.

      George G. Witter, Esq., and M. F. Mitchell, Esq., for the petitioner.

      Lloyd W. Greason, Esq., and J. M. Leinenkugel, Esq., for the respondent.
   OPINION.

Smith :

The petitioner first alleges that:

(a) Tiie Commissioner iias erroneously treated tlie Petitioner as an association and proposes to tax it as sucli, whereas the Petitioner is a Trust with no taxable income.

On brief, the petitioner states: “1. The first issue we submit without argument.”

The facts of record do not distinguish this trust from others that the Board and courts have held to be associations taxable as corporations. The Circuit Court of Appeals for the Ninth Circuit held a similar real estate subdivision trust to be an association in Trust No. 5833, Security-First Nat. Bank of Los Angeles v. Welch, 54 Fed. (2d) 323. See also Merchants Trust Co. v. Welch, 59 Fed. (2d) 630; Lloyd M. Willis et al., Trustees, 22 B. T. A. 564; affd., 58 Fed. (2d) 121; G. F. Sloan, 24 B. T. A. 61; Adelaide Park Land, 25 B. T. A. 211.

The second and principal issue is raised by the following allegation of error:

(b) The Commissioner has erroneously placed a value of only fifty per cent of face value upon the agreements for payment of balance owing for properties sold by this Petitioner in the years 1923, 1924, 1925 and 1926, whereas said agreements had a fair market value of 85% to 100% of their face value.

Neither party contends that the Bellehurst property was sold and the income therefrom reported on the installment sales basis. Both are in apparent agreement that lots were sold for cash and deferred payments, the latter covered by the sales contracts, and that the income at the time of the sales and at the time of the collections is determinable from the fair market value of the sales contracts at the time of the sales. Such contracts may or may not have a fair market value, as the evidence adduced in each particular case warrants. Cf. Ravlin Corp., 19 B. T. A. 1112; Rapid Transit Land Sales Co., 20 B. T. A. 608.

To support its contentions upon this point the petitioner submitted the testimony of several witnesses, all of whom testified that in their opinion the 50 per cent valuation used by the respondent in the determination of deficiencies was entirely too low. They testified, generally, that in their opinion the contracts had a fair market value of from 90 to 100 per cent of their unpaid balances. The respondent, on the other hand, submitted the testimony of several witnesses, well qualified to express an opinion upon the value of such contracts, who testified that in their opinion the contracts had no fair market value at the date of their receipt. This was predicated, in part, upon the fact that the selling agent was entitled to receive a commission of 25 per cent of the sales price, whereas the down payment by the lot purchaser ranged generally from 20 to 30 per cent and in some cases less than 20 per cent; also upon the fact that it was not customary to sell contracts of this sort and that there was no established market for them.

From a consideration of all of the evidence we are of opinion that the fair market value, if any, of the contracts was not in excess of 50 per cent of the unpaid balances upon the contracts. That is the amount used by the Commissioner in the computation of deficiencies. Whether the fair market value at the date of the receipt of the contracts was less than the amount determined by the respondent is not necessary for us to determine. The petitioner’s contention upon this point is not sustained.

The next issue is raised by the following allegation:

(e) In each of the years 1928 and 1929 the Commissioner has erroneously included in Petitioner’s income moneys placed in the hands of the Petitioner by purchasers for the payment of city and county taxes, to which the Petitioner still held title for security purposes. Said moneys were in no sense income to the Petitioner. The Petitioner was merely a conduit through which purchasers who still owed balances on the purchase price of their properties paid their city and county taxes.

By motion duly granted, the respondent moved to amend the pleadings to conform to the proof and affirmatively alleges that:

(g) In the alternative, the respondent erred in allowing as deductions county and city taxes paid in the amount of $12,879.46 and $9,086.71 for the years 1928 and 1929, respectively, or any amounts. ’

There is no dispute as to the amounts received by the petitioner from the lot purchasers or as to the amounts of taxes paid by the petitioner. It appears from the evidence that the petitioner paid the taxes upon the lots standing in its name at the date the assessment was made and then collected from the lot purchasers the amount of tax assessed against or allocated to the lot covered by the contract of purchase. The petitioner kept no separate records of the funds thus collected from the lot purchasers. Collections from this source were commingled with the general funds of the trust. The difference between the amount received by the petitioner and the amount paid for taxes in the years 1928 and 1929 is unexplained, unless it be that some of the collections were for taxes paid by the petitioner in prior years. In the determination of the deficiencies the petitioner has been allowed the deduction for all taxes paid by it, and since the amounts received from the lot purchasers were not segregated on the petitioner’s books of account or treated as trust funds, and since we have no knowledge of the taxes, if any, paid by the petitioner on lots repossessed and owned by it, we have no basis for disturbing the respondent’s determination. His action in including the amounts received in the petitioner’s gross income is sustained. It will be unnecessary to discuss the alternative allegation of the respondent.

The remaining allegation of error in Docket No. 58311 is that:

(d) The Commissioner has erroneously failed and neglected to allow as deductions to the Petitioner certain amounts paid out in each of the years 1928 and 1929 for services rendered in the successful operation of said Trust.

The petitioner claims as an ordinary and necessary expense deductions of $92,500 in 1928 and $51,700 in 1929, which it contends are reasonable allowances for compensation for services actually rendered by Thom, Leimert, Bates, Borland, Cotton-, and Cooper. There is no evidence to show that these amounts were actually paid by the trust or that these parties received such amounts as compensation, or to show that if paid the respondent has disallowed them as deductions from gross income in the computation of the deficiencies. The record discloses that the 50 per cent of the profits specified in Article VII of the trust agreement was payable to Thom, after the beneficiaries had received 200 per cent on their investment and 50 per cent of the balance of the profits. Pursuant to this provision certain amounts were paid to Thom. All of the parties sharing in these sums were beneficiaries of the trust. Leimert was sales agent and as such received a commission of 25 per cent of the selling price of each lot. Bates and Borland were the improvement contractors and as such were paid the contract price for their work. The services of these several individuals were doubtless valuable and may not have been adequately compensated for otherwise, yet the plain language of the trust instrument does not show that these payments were made as compensation. It is reasonable to infer from the terms of the trust and the activities of these persons (as shown by the record) in the interest of the Bellehurst property, that provision was made for them to have a greater share in the profits than those beneficiaries who were not as active. While under the terms of the trust agreement there was a liability to Thom for the 50 per cent of the profits, there was no provision for compensating him and his associates for any services to be rendered. The petitioner has not even attempted to prove that the trust was liable for such compensation to these individuals. But in any event, we have not been shown the reasonableness of the claimed deductions. In the circumstances we leave the parties as we found them.

Reviewed by the Board.

Judgment will be entered for the respondent.


source: Caselaw Access Project

author: Muedock:

license: Public Domain

text:
    United States Trust Company of New York, Executor of the Estate of John Watson Dwight, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 45860.
    Promulgated April 26, 1933.

      H. J. Campaign, Esq.-, for the petitioner.

      O. J. Tall, Esq., for the respondent.
   OPINION.

Muedock:

The Commissioner determined the following deficiencies in the tax liability of John Watson Dwight:

1925_$23. 28
1926 _881. 98
1927_ 930.03

Three errors are assigned: (1) That for each year certain.sums were erroneously included in income since they represented amounts “ paid to an attorney for services rendered in connection with a will contest and pursuant to an agreement to assign said amounts to said attorney in the event of success ”; (2) the refusal to allow deduction of the amounts paid to the attorney; and (3) the disallowance of a deduction of $2,500, representing a debt ascertained to be worthless and charged off in 1927.

John Watson Dwight died on December 24, 1931. The United States Trust Company is the executor of his estate. It is a New York corporation which has its principal place of business in New York City. The returns for the years in question were filed with the collector for the second district of New York.

On July 1, 1926, Dwight loaned $2,500 to R. H. Kinloch on the latter’s demand note due three months after date. This note made no mention of interest. The debtor never paid anything on account of this loan. He was an employee of a bank in Albany. Dwight thought very highly of him. While making up his income tax return for the calendar year 1927, which return was filed on March 12, 1928, Dwight told the person assisting him that Kinloch had declined to pay the note and he was afraid he was never going to get a recovery on it. The person assisting him knew nothing about the loan but advised him to take the deduction. A deduction of $2,500 on account of this loan was claimed on the return for 1927. This deduction was disallowed by the Commissioner in determining the deficiency. The following explanation was given in the notice of deficiency:

Concerning the deduction of $2,500.00 for bad debts, you are advised that it has not been shown that the maker of the note, who was a personal friend, was in any different financial condition in 1927 than at the time of issuance of the note, July 1, 1926, or that there was reasonable expectation that the amount would be returned. The previous action taken has, therefore, been approved.

Counsel for the petitioner claims that counsel for the respondent has admitted the worthlessness of the debt in 1927, the only basis for disallowance of the deduction was that the transaction was a gift rather than a loan, and the introduction of the note proved prima facie a loan. We are unable to follow counsel in this reasoning. We know no more about the loan of $2,500 to Kinloch than is set forth in the above paragraph. Counsel for the respondent has not admitted that the debt was worthless in 1927. But if we were to assume for the moment that he did make such an admission, nevertheless, the quotation from the notice of deficiency shows clearly that the disallowance was not based solely on the ground that it was a gift rather than a loan. The Commissioner had never been shown that the financial condition of the maker of the note was any different in 1927 from what it was in 1926 when the note was given and he had not been shown that Dwight, when he made the advance, had any reasonable expectation of repayment. We are in no better position on these matters than was the Commissioner. The latter had a right to demand a satisfactory showing in this connection before allowing the deduction. We see no reason why we should require him to allow the deduction without such showing.

Emily A. Watson died testate on February 1, 1924. By the tenth paragraph of her will she left the residue of her estate to the United States Trust Company of New York in trust to divide the same into as many shares “ as there may be children of my cousin, Harvey A. Dwight, and grandchildren of my cousin, George W. Pratt, surviving at the time of my death, and to invest and keep invested one such share or portion for the benefit of each child of my said cousin, Harvey A. Dwight, and each grandchild of my said cousin, George W. Pratt, then surviving, and to pay over the income and profits therefrom to the child or grandchild ” for life, and after his or her death to pay the principal and all accumulated income to his or her issue, per stirpes, and in default of such issue, to divide the same equally between the surviving children and grandchildren, and the issue of any who may have died, per stirpes. John Watson Dwight was the son of Harvey A. Dwight. He was one of seven similar beneficiaries under the above provision of the will. When the will was offered for probate it was contested by the next of kin of the decedent who were not mentioned in the will.

On March 29, 1924, Dwight entered into an agreement with an attorney named J. Noble Hayes, whereby the latter was to represent him in the will contest. This agreement provided:

* * * Dwiglit will pay or cause to he paid or assigned to the said J. Noble Hayes as a contingent fee for his, the said Hayes, professional services aforesaid, the sum of Seventy-Five Thousand Dollars ($75,000.00) out of any recovery of property or money or value which he may make or receive from the Estate of Emily A. Watson, Deceased, under or by virtue of the said will as the result of the said proceeding or settlement or compromise of the said contest or otherwise, to be paid as follows:
Seventy-five per cent (75%) of any accumulated income upon said Dwight’s share of same which he may receive or become entitled to at the time of the settlement or final determination of the said contest, when same is received and the balance of said Seventy Five Thousand Dollars ($75,000.00) at the rate of fifty per cent (50%) of the annual income of the said Dwight from the trust established by the will for his benefit, in the United States Trust Company, until the said Seventy-Five Thousand Dollars ($75,000.00) is paid in full. It being understood that said sum is to be payable only from monies received from said Estate of Emily A. Watson.

It was further agreed that Hayes should have a lien upon Dwight’s share in the estate for his fee as attorney.

The contest was settled by a payment to the contestants out of the corpus of the estate. A copy of Dwight’s agreement with Hayes was filed with the trustee. The following table shows the amounts received by Hayes from the trustee pursuant to the above agreement, which amounts were deducted by Dwight in his income tax returns for the respective years:

1925_-_$39, 566.55
1926_ 28,411.61
1927_„_'__ 6,700.91

The Commissioner disallowed the deductions. He explained that the fees paid were not ordinary and necessary expenses of any business but were personal legal expenses to protect Dwight’s rights in the income of the trust. He referred to Helen S. Pennell, 4 B. T. A. 1039.

The Commissioner was undoubtedly right in disallowing the deductions claimed. Section 214 (a) (1) of the Revenue Act of 1926 allows as a deduction all of the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. This includes a reasonable allowance for compensation for personal services actually rendered. But the amounts in question were not paid or incurred in carrying on any trade or business. They were personal expenses. Section 215 (a) (1) provides that no deduction shall in any case be allowed in respect of personal expenses. Lindley v. Commissioner, 63 Fed. (2d) 807; affirming 26 B. T. A. 741.

Counsel for the petitioner has abandoned the claim for these deductions and contends only that the decedent never should have included the payments in his gross income, since he had made an assignment of this property before he was entitled to receive the income. The fact is, however, that nothing was assigned on March 29, 1924. There was perhaps an agreement to make an assignment in the future upon the successful completion of the work by Hayes. Furthermore, if Dwight agreed to assign anything, that which he agreed to assign was not then an existing interest in property recognized by the law. He never agreed to part with any part of his interest in the estate or his right to distribution from the trustee. Cf. Commissioner v. Field, 42 Fed. (2d) 820. He merely agreed to pay or assign $75,000. This was to come out of his distributable share of the trust income. If Hayes had an interest in the estate he would need no lien. The petitioner relies upon Shelldbarger v. Commissioner, 38 Fed. (2d) 566, but that case is different and was decided upon its peculiar facts. Sarther Grocery Co. v. Commissioner, 64 Fed. (2d) 1020.

Section 219 of the Revenue Act of 1926 provides for the taxation of the income of estates or of any kind of property held in trust, including income which is to be distributed currently by the fiduciary to the beneficiaries and income received by estates of deceased persons during the period of administration or settlement of the estate. Subsection (b) provides how the net income of the estate or trust shall be computed. Section 219 (b) (2) allows a deduction, in computing the net income of the trust, of the amount of the income of the trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries. It further provides that “ the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not.” Dwight was a beneficiary under the trust created by the will of Emily A. Watson. The deduction allowed the trust under section 219 (b) (2) undoubtedly included the amounts here in controversy, since under the will these amounts were a part of the income of the trust which was to be distributed currently by the fiduciary to Dwight. Therefore, in computing the net income of Dwight, the full amount of his distributable share of the net income of the estate should be included in his gross income. Hayes was not a beneficiary of the trust. No part of the net income of the trust was distributable to him as a beneficiary. It first had to be distributable to Dwight. Hayes was entitled to it, not because of any provision of the trust instrument, but because of services performed for and a contract with Dwight. The amount which he received was compensation to him for personal services rendered to Dwight and should have been reported as income by him. But it should have been included in his gross income, not because of section 219 (b) (2), but because it was income from his profession. Although Dwight never actually had the cash in hand, nevertheless the trustee paid it to Hayes for and on behalf of Dwight. Therefore, if receipt and use were important, there has been the equivalent of receipt and actual use. Grace McBride Crile, 26 B. T. A. 1020; Houston Belt & Terminal Ry. Co. v. United States, 250 Fed. 1; Old Colony Trust Co. v. Commissioner, 279 U. S. 716. But the statute says that the amount shall be included in computing Dwight’s net income whether distributed to him or not. The use to which it is put is important only when considering a deduction. Thus, there is complete statutory authority for including the amounts in question in Dwight’s gross income. Furthermore, it was his income. The petitioner made no mistake in including these amounts in his gross income, and since there is no reason for deducting any portion of them, they are also a part of his net income and subject to tax. Cf. Marion Stone Burt Lansill, 17 B. T. A. 418; affd., 58 Fed. (2d) 512; Grace McBride Crile, supra.

Judgment will be entered for the respondent.


author:
GOODRICH:
      Vak FossaN,

text:
    Lizzie H. Glide, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 47630, 52685.
    Promulgated April 26, 1933.

      F. E. Youngman, Esq., ior the petitioner.

      Homer Hendricks, Esq., filed brief as amicus curiae.

      H. A. Cox, Esq., for the respondent.
   OPINION.

GOODRICH:

In these proceedings, which were consolidated for hearing, petitioner attacks respondent’s determinations of deficiencies in income tax for the years 1926 and 1927 in the amounts of $34,045.12 nnd $8,843.50, respectively.

The issues are: (1) Whether petitioner is entitled to deduct from her income as an allowance for depletion 27% per centum of the amounts received as bonuses for leases of oil lands; (2) whether such bonus payments are taxable as capital gain under the provisions of section 208, Revenue Act of 1926; (3) whether petitioner may deduct from her income amounts paid by her as interest on bonds of a reclamation district.

As our findings of fact we adopt the stipulation of the parties upon which the case was submitted, together with the various exhibits attached thereto. For the purposes of this report only a brief statement is necessary concerning the facts.

Petitioner was the owner of certain lands situate within what is generally known as the Mt. Poso Oil Field in California. During the years 1925, 1926 and 1927 she granted to several individuals and corporations, various oil and gas leases embracing specified portions of her properties. In 1926 petitioner received $577,663 as bonus payments upon such leases, and $2,000 as consideration for extensions of time within which to comply with the drilling requirements of the leases, a total of $579,663, all of which she reported in her return. In 1927 petitioner received $120,000 as bonus payments upon leases and $28,405 as consideration for extensions of time within which to comply with drilling requirements, a total of $148,405, all of which she reported in her return. Upon her returns for each of these years she deducted as a depletion allowance 27% per centum of the total amounts received as above stated. Respondent has disallowed these deductions and that action gives rise to the greater part of the deficiencies herein. During the years 1925, 1926 and 1927 there were no oil or gas wells upon the properties owned by petitioner and covered by the leases. In 1926 oil was discovered in commercial quantities on other properties within the Mt. Poso Field, the distance from petitioner’s lands not being disclosed by the record.

Certain of petitioner’s properties, leased by her for farming purposes, lay within the West Sacramento Keelamation District No. 900, which levied assessments which included interest on its bonds. Both in 1926 and 1927 petitioner paid $805.02 as an assessment to pay such, interest. These amounts respondent has denied as deductions from petitioner’s income for those years.

At the onset we observe that the parties apparently make no distinction between the amounts received by petitioner as bonuses and amounts received as consideration for extensions of time within which to comply with the drilling requirements of the leases. We suggest that perhaps a distinction should be made. It may be that amounts received for granting extensions are in the nature of damages for breach of contract, arising under the lease as consideration for the forbearance of enforcement of the forfeiture provisions covering the lessee’s failure to drill within a specified time, and are not to be included as income from the property ” in computing the allowance for depletion. If so, the amounts so received by petitioner, namely, $2,000 in 1926, and $28,405 in 1927, would be removed from the controversy respecting the depletion allowance. We raise the question, but do not decide it for it is unnecessary for us to do so in the view we take of the case.

There is no occasion for extended discussion concerning the nature of the bonus payments received by petitioner in connection with the leases granted upon her lands. Respondent concedes, as petitioner contends and as the decisions hold, that they constitute payment for oil in advance; are a lump sum or down payment of a part of the royalty; may be reduced by an allowance for depletion as are royalties; and are a part of the “ net income from the property ” as that term is used in the statute. Work v. United States ex rel Mosier, 261 U. S. 352; Nelson Land & Oil Co., 3 B. T. A. 315; Murphy Oil Co. v. Burnet, 287 U. S. 299; Samuel Kraemer, 25 B. T. A. 686; Burnet v. Harmel, 287 U. S. 103; Darby-Lynde v. Alexander, 51 Fed. (2d) 56; certiorari denied, 284 U. S. 666; Palmer v. Bender, 287 U. S. 551; United States v. Dakota-Montana Oil Co., 288 U. S. 459; United States v. Ludey, 247 U.S. 295; Burnet v. Thompson Oil & Gas Co., 283 U. S. 301. But respondent does contend, and we agree with him, that where there is no production from the property there can be no depletion allowance in reduction of income from the property.

Minerals, including oil and gas, and, of course, other elements which need not here be mentioned, are wasting assets. By removal or production they are severed from the reserve body in which they are found and the removal reduces both the quantity and the total value of that reserve without opportunity for replacement. For that reason the Congress saw fit to provide for a depletion allowance as a deduction from the income derived from the removal and sale of the asset and, theoretically at least, the allowance will return to the owner his cost of the reserve by the time it is completely exhausted through removals. That deduction is not a matter of right; authority for it must be found in the statute, and, beginning with the Revenue Act of 1913 and continuing through the subsequent revenue acts, provision has been made for some allowance for depletion in the case of operating mines and oil and gas wells. Burnet v. Thompson Oil & Gas Co., supra; Darby-Lynde v. Alexander, supra.

The Revenue Act of 1926 is controlling of the case at bar. Section 214 (a) (9) of that act provides for a deduction from income of a reasonable allowance for depletion, in the case of oil and gas wells, to be made under rules and regulations to be made by the Commissioner. Section 204 (c) (2) provides that “in the case of oil and gas wells the allowance for depletion shall be 27% per centum of the gross income from the property.” It is to be noted that the statute uses the words “oil and gas wells,” and that it makes no provision for an allowance for depletion of “income from the property,” though it uses that phrase in fixing the measure of the gross income upon which the depletion allowance is to be computed.

Under this act the Commissioner issued Regulations 69, containing various instructions respecting the computation of depletion allowances and in particular Article 216, relating to adjustment for bonuses, which, in turn, was further explained in a ruling, I.T. 2384, VI-2 C. B. 22, reading in part as follows:

It will be noted that the above-quoted section of the law operates only in cases of oil and gas wells and that the allowance for depletion at the rate therein provided is expressly limited to the gross income from such property. Accordingly, it must be concluded that the application of article 216 (e) of Regulations 69 is dependent upon whether or not the lease in question is of an oil or gas well, and that article 216 (e) of the regulations does not apply to leases covering properties on which no well is in existence.

We uphold this interpretation as reasonable and correct. Strictly adhering to the clear wording of the statute, an existing well is a prerequisite to an allowance for depletion.

To stretch this unambiguous provision, as petitioner would have us do, to permit that allowance where there is no well on the property, but only a possibility or prospect that a well may be drilled in the future, would not only be contrary to the statute and to the Commissioner’s ruling promulgated thereunder, but would circumvent the motivating principle and reason for such an allowance. Depletion is inseparably related to production; it denotes a consumption of the reserve by means of which income is realized, resulting in a corresponding diminution of the value of the remainder of the asset. Unless there is production, neither the quantity nor value of the recoverable asset is depleted and there is no occasion for an allowance therefor. The reserve is intact, and the owner needs no compensation for its waste, for he has not parted with it.

It is urged that the decisions above cited require that an allowance for depletion be made even where, as here, no well had been drilled on the property. With that we cannot agree. In each of those cases the properties were producing when the issues arose and the language of the several decisions indicates beyond doubt that the courts were fully cognizant of that fact. Consequently, the question whether bonus payments were subject to depletion allowance in the absence of wells upon the properties was not before the courts. Moreover, those cases (except Dakota-Montana Oil Co.) arose under acts prior to that here controlling, which provided for the computation of the depletion allowance upon a unit basis, necessitating an apportionment and adjustment of the depletion allowance between the bonuses and royalties. The 1926 Act provides for depletion, where allowable, at a flat rate and, in our opinion, that change, which made obsolete the Commissioner’s regulations and rulings concerning the determination of the unit rate, requires a further consideration of the matter.

We are aware that the Commissioner recently has issued a ruling which would permit the reduction of a lease bonus by an allowance for depletion, even though there be no well on the property, where production is obtained within the same taxable year in which the bonus was paid, or where future production is practically assured because of nearby wells and geological indications. See G. C. M. 11384, January 16, 1933. We need not pass upon that ruling, for in the case at bar neither of those situations is presented. Here, no well was drilled within the taxable year and, while it is stipulated that oil was discovered within the Mt. Poso Field in 1926, we have no evidence as to the distance of the discovery from petitioner’s properties, the uniformity of the field, or the exploitation plans of petitioner’s lessees, from which we might determine the possibility of development upon her lands.

Concerning petitioner’s claim that the bonus payments should be taxed as capital gain under the provisions of section 208 (a), Revenue Act of 1926, we need only point out that this contention is disposed of adversely to her by the decision of the Supreme Court in Burnet v. Harmel, supra.

Since respondent concedes that the last issue herein is controlled by our prior decisions in Andrew Little, 21 B. T. A. 911, and Lee Wilson & Co., 25 B. T. A. 840, upon authority of those decisions we sustain petitioner’s claim to a deduction of $805.02 paid in each of the taxable years before us.

Reviewed by the Board.

Judgment will be entered under Rule 50.

Vak FossaN,

dissenting: I find it necessary to dissent from the decision of the majority. In considering the right of a taxpayer to depletion, I am unwilling to decide the question on any basis so highly technical and artificial as that employed in the prevailing opinion. Under the reasoning of the majority, the right to depletion depends on the existence of a well on the property. Obviously the production of the well, provided there be a well, need bear no relation to the amount of depletion. The law allows a flat percentage of income from the property (not from the well) as depletion. The Supreme Court has held that a bonus is income. Therefore, if the bonus be paid and there happens to be a well in existence (however inconsequential the production) the taxpayer gets full statutory depletion. If there be no well, regardless of other conditions, the taxpayer gets no depletion. But assume a case where, as frequently happens, a bonus is paid in one year and there is no well completed until the next year. The taxpayer would get no depletion on account of the bonus (or advance royalties, as the Supreme Court has called them) because there was no well on the property though all surrounding property bore productive wells, nor would he get depletion of the bonus in the next year even if a producing well be completed, because the bonus was not income in that year. Variations of this illustration, emphasizing the absurdities of the situation, could easily be multiplied.

I am unable to see any defensible basis for. a distinction that would produce such an inequitable and illogical result. The prevailing-opinion introduces a new concept into the theory of depletion and in many cases sets at naught the intention of Congress as interpreted by the decisions of the Supreme Court so far as depletion of bonuses is concerned. Murphy Oil Co. v. Burnet, 287 U. S. 299. The cited case clearly decides that a bonus is depletable and makes no suggestion that this right should be governed by such a rule as is laid down by the majority. The court clearly suggests the opposite:

A distinction between royalties and bonus, which would allow a depletion deduction on the former but tax the latter in full as income, when received, making no provision for a reasonably anticipated production of oil on the leased premises, would deny the “reasonable allowance for depletion” which the statute provides. * * * [Italics supplied.]

Moreover, I further find myself in disagreement with the majority opinion in the summary manlier in which G. C. M. 11384 is disposed of. That the Commissioner is not now contending for such a rule as proposed by the majority is clear from this memorandum, which provides that depletion should be allowed if future production is practically assured because of nearby wells and geological indications. Whether this interpretation is too narrow it is not necessary to discuss, but certainly it is broad enough to cover the instant case. The facts show that oil was being produced in the some township and in the same oil field. This brings the petitioner squarely within the first of the four situations referred to in the memorandum. The prevailing opinion dismisses the matter on the basis of failure of proof.

In my opinion the majority of the Board throughout this opinion have grasped at a shadow of diction and allowed the substance of the thought and intention of Congress and the Supreme Court to escape them.

LaNSDoN and Leech agree with this dissent.


author: Matthews:

text:
    American Printing Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 39721.
    Promulgated April 26, 1933.

      James F. Jackson, Esq., Charles W. Mulcahy, Esq., and Robert N. Miller, Esq., for the petitioner.

      F. L. Van Haaften, Esq., and A. E. Fast, Esq., for the respondent.
   OPINION.

Matthews:

The year before us is 1918. The petitioner alleges in the petition that the respondent erred in determining depreciation on assets acquired by it from the Fall River Company on the basis of cost to Fall River Company instead of fair market value at the time the assets were acquired from Fall River Company; that he erred in determining the opening inventory of raw cotton and cotton in process acquired by petitioner from Fall River Company on the basis of cost to Fall River Company in determining net income for excess profits tax purposes; and that he erred in ascertaining and determining the net income of the petitioner for excess and war profits tax purposes upon a different basis from that was used for income tax purposes.

The respondent, by amended answer, alleged that from January 1, 1918, to November 7,1918, the petitioner and Fall River Company were affiliated; averred that he erred in determining the 1918 income for excess and war profits tax purposes and income tax purposes upon different bases; that as a result of such error the income as computed in the deficiency notice for income tax purposes should be increased by the amount of $369,387.03, being the difference between the cost of the raw cotton and cotton in process to Fall River Company and its fair market value at the time acquired, asserting a claim for an increased deficiency, if any should result from such increase in income.

The petitioner in reply to this amended answer denied that it and Fall River Company were affiliated in 1918 and denied that the respondent .erred in the amount used as an opening inventory in determining the tax for income tax purposes.

A third issue, involving the correct closing inventory for the year 1918, has been settled by stipulation as set forth in our findings of fact and effect will be given thereto in the recomputation under Rule 50.

The parties are now agreed that under the 1918 Act net income for income tax and excess and war profits tax purposes should be computed on the same basis. This is in accordance with section 320 (a) (3) of the 1918 Act, which provides that for excess and war profits tax purposes the net income shall be ascertained and returned for the taxable year upon the same basis and in the same manner as is provided for income tax purposes in Title II of the act.

Eespondent’s brief is largely devoted to arguments in support of his contention that the petitioner and Fall River Company were affiliated not only during all of 1917 but also from January 1, 1918, to November 7, 1918, the date of the formal dissolution of the Fall River Company. Being affiliated, he argues that the two companies should have filed a consolidated return for 1918, and, therefore, that the basis for depreciation and determination of the inventory is the cost to the subsidiary, inasmuch as cost to the subsidiary was the basis used in the consolidated return for 1917, in determining depreciation allowable to the subsidiary, and for the further reason that the acquisition of the assets of its subsidiary by petitioner was an intercompany transaction occurring during affiliation, and gave petitioner no new basis.

The petitioner contends that the liquidation of the Fall River Company in 1917 terminated the affiliation; that the petitioner at that time acquired the assets in exchange for stock in the subsidiary, and therefore that the fair market value of such assets at that date, which is cost to petitioner of such assets, should be used as a basis for inventory and depreciation purposes in 1918.

Under the Revenue Act of 1918, the basis for determining depreciation is the same as the basis for determining gain or loss, namely, cost or March 1, 1913, value, and the basis for valuing the inventory is (1) cost, or (2) cost or market, whichever is lower.

The real question to be decided is, What was the cost of the assets to petitioner ? In determining this question, we must first determine .whether the fact that petitioner acquired the assets in liquidation of a wholly owned subsidiary affects the general rule applicable under the statutes in force in 1917 governing the sale or other disposition of property and the basis for computing gain or loss thereon.

Under the Revenue Act of 1916, as amended by the Revenue Act of 1917, which was in force in the year 1917, gross income included the gain derived from the sale or other disposition of property, and in the case of property acquired before March 1, 1913, the fair market value of such property as of that date was the basis to be used in determining the amount of gain derived. Section 2 (a) and (c) of the Revenue Act of 1916, as amended. Section 206 of the Revenue Act of 1917 provides that for the purpose of Title II, War Excess Profits Tax, the net income of a corporation shall be ascertained and returned for the taxable year upon the same basis and in the same manner as is provided in Title I of the Revenue Act of 1916, as amended, except that amounts received by it as dividends from other corporations subject to the tax imposed by the Eevenue Act of 1916 shall be deducted.

The profit realized in 1917 by a corporation upon the sale or other disposition of property was, therefore, subject to both income and profits taxes. And where property was disposed of in exchange for other property, the fair market value of the property received represented the selling price of the property disposed of and in turn was the cost of the property acquired in exchange.

Under the transactions described in our findings of fact, the American Printing Company acquired all the assets of its subsidiary the Fall Eiver Company, on December 31, 1917, in liquidation and thereby realized a profit on the disposition of its stock. There is no dispute as to the amount of profit realized. Eespondent determined it to be the amount by which the fair market value of such assets exceeded the March 1, 1913, value of the stock surrendered. The cost to the American Printing Company of the assets thus acquired from the Fall Eiver Company, therefore, was their fair market value as of December 31, 1917. This cost, then, became the basis for determining gain or loss on the sale of such assets, and the basis for computing depreciation and valuing the opening inventory for 1918.

No question is here raised as to the right of the respondent to have included the profit realized by petitioner in net income of 1917 for income tax purposes. However, in the consolidated return for 1917 which the Commissioner required petitioner and the Fall Eiver Company to file for excess profits tax purposes, the profit was not included for the reason that respondent considered the transaction to be an “ intercompany ” transaction, occurring during affiliation, the results of which should not be reflected in the consolidated return. And it is because of this fact and the further fact that from January 1 to November 7, 1918, petitioner owned all of the stock of Fall Eiver Company, that respondent now claims that the cost to petitioner of the assets can not be used in determining the depreciation allowance and the opening inventory for 1918.

Under the principles enunciated in Burnet v. Aluminum Goods Mfg. Co., 287 U. S. 544, affiliation was not necessarily terminated by liquidation of the subsidiary in 1917, and in any event, the liquidation of the subsidiary in 1917 was' not such an “ intercompany ” transaction under either the regulations or statutes then in force, or under section 1331 of the Eevenue Act of 1921, as was required to be eliminated from the consolidated return required to be filed for excess profits tax purposes. As the liquidation of a subsidiary is a taxable transaction to the parent corporation, the assets acquired in liquidation take a new basis in the hands oí such parent corporation.

We are not called on to decide whether respondent should have included the profit in the consolidated return for 1917 for excess profits tax purposes, but the fact that it was not included can not be availed of by respondent as authority for using cost to the Fall River Company instead of cost to petitioner as the basis for determining the depreciation allowance and opening inventory of petitioner for the year 1918. The assets were acquired by petitioner in 1917 at a cost equal to their fair market value. There is no provision in the 1918 Act authorizing or requiring any other basis than cost to the taxpayer of property acquired after March 1, 1913, to be used in computing gain or loss or depreciation. Section 331 of the act relates only to the value at which assets acquired upon reorganization, consolidation or change of ownership can be included in invested capital.

The District Court of Massachusetts in the case of this petitioner, American Printing Co. v. United States, 53 Fed. (2d) 98, had before it the same question for 1919 as is involved in this case, that is, the correct basis for depreciation of the assets acquired from Fall River Company. The respondent found an overassessment for 1919, although he determined depreciation on these assets on the basis of cost to Fall River Company, and the petitioner brought a suit for recovery of the taxes paid resulting from the use of the lower basis. The District Court held that the basis for depreciation was the fair market value of the assets at the time of the transfer to the petitioner. See also Wilmington Steamboat Co. v. Sturgess, 52 Fed. (2d) 510. Both Wilmington Steamboat Go. v. Sturgess and American Printing Co. v. United States, supra, were cited with approval by the Circuit Court of Appeals in Aluminum Goods Mfg. Co. v. Commissioner, 56 Fed. (2d) 568, which decision was affirmed by the Supreme Court in Burnet v. Aluminum Goods Mfg. Co., supra.

The basis for determining the depreciation allowance for 1918 of the assets acquired by the petitioner from the Fall River Company is the cost of such assets to petitioner, which cost is their fair market value at the date acquired by petitioner, and the correct basis for valuing the opening inventories of raw cotton and cotton in process is also cost to petitioner, which was the fair market value of the raw cotton and cotton in process at the date acquired. The parties have stipulated the amount of the depreciation deduction on such basis and also the amount of the inventories. These figures, as set forth in our findings of fact, will be used in the recomputation under Rule 50.

Reviewed by the Board.

Judgment will be entered under Rule SO.


author: Sternsagen :

text:
    May Oil Burner Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 42772.
    Promulgated April 26, 1933.

      Robert Ash, Esq., for the petitioner.

      Bruce A. Low, Esq., for the respondent.
   OPINION.

Sternsagen :

The petitioner, a Maryland corporation, contends that it may compute its net income for 1926, the first year of its existence, by taking as a deduction the alleged statutory net loss of 1924 and 1925 of another corporation, of New York, whose business and shares it acquired immediately upon incorporation. It argues that with a proper regard for “ substance ” and a proper disregard of “ form,” it must be found that a continuing business was operated by the same owner, and that as a taxpayer such owner has the legal right in 1926 to deduct its net losses for 1924 and 1925. This proposition has been considered so many times in the period since the Board was created, resulting each time in an adverse decision, that nothing can be added to the discussion of the Board’s view of the rule. White House Milk Co., 2 B. T. A. 860 (1925); Maytag Co., 17 B. T. A. 182; West Point Marion Coal Co., 19 B. T. A. 945; Plumber’s Supply Co., 20 B. T. A. 459; Standard Silica Co., 22 B. T. A. 97; Athol Mfg. Co., 22 B. T. A. 105; Industrial Cotton Mills Co., 22 B. T. A. 648; Clark Dredging Co., 28 B. T. A. 508; Overbrook Nat. Bank of Philadelphia, 23 B. T. A. 1390; New Colonial Ice Co., 24 B. T. A. 886; Hartford-Empire Co., 26 B. T. A. 134; Elliott-Granite Linen Corp., 26 B. T. A. 936; Farmers’ Cotton Oil Co., 27 B. T. A. 105. The Circuit. Court of Appeals, First Circuit, adopted the rule in Athol Mfg. Co. v. Commissioner, 54 Fed. (2d) 230. As to a continuing business in an affiliated group, the Supreme Court approved the general rule that the deduction for prior net loss was limited to the particular corporate taxpayer sustaining it, Woolford Realty Co. v. Rose, 286 U. S. 319, even when the same person owned the shares of the affiliated corporations, and the practical incidence of the decision was upon him, Planters Cotton Oil Co. v. Hopkins, 286 U. S. 332. The doctrine that corporations are in all but extraordinary cases to be dealt with under the income tax laws as separate taxpayers, irrespective of who or how many hold the shares, is firmly and authoritatively established by the recent decisions in Dalton v. Bowers, 287 U. S. 404; Burnet v. Commonwealth Improvement Co., 287 U. S. 415; and Burnet v. Clark, 287 U. S. 410, in the last of which the court said:

A corporation and its stockholders are generally to be treated as separate entities. Only under exceptional circumstances — not present here — can the difference be disregarded.

But the petitioner urges that these considerations must give way to what it conceives to be a contrary decision of the Circuit Court of Appeals, Fourth Circuit, in Industrial Cotton Mills Co. v. Commissioner, 61 Fed. (2d) 291, the petitioner being within that circuit and hence subject to the jurisdiction of that court on review. Even if this case were quite like the Industrial case, and it appeared that the decisions of the Supreme Court compelled a decision different from that in the Industrial case, this Board, without sacrificing any of its great respect for the Circuit Court of Appeals, would have no alternative to following the rule laid down by the Supreme Court, if the rule seemed to the Board to be clear. But happily we are not called upon to make such a choice. In the Industrial case, the earlier and losing corporation was, by an affiliation and later by a merger, absorbed into the later corporation, which was organized under the laws of the same state and had, so far as appears, the same incidents. Here the old corporation of New York merely sold out to the new corporation of Maryland, whicli had an entirely different capitalization and broader powers. These differences are as great as those which caused the Supreme Court to distinguish Marr v. United States, 268 U. S. 536, from Weiss v. Stearn, 265 U. S. 242. The Blue Buckle and the Industrial filed a consolidated return, while the Maryland corporation, despite its ownership of the shares of the New York corporation, filed a separate return. When it is remembered that in Planters Cotton Oil Co. v. Hopkins, supra, corporations affiliated and filing a consolidated return were required to limit the use of a prior net loss of one of the group to the computation of the net income of that one member alone, the inference may be drawn a fortiori that such prior net loss may not be deducted upon the separate return of another corporation which for its own reason chooses not to file a consolidated return.

Thus we find ourselves compelled to hold, consistently with our understanding of the law as announced by the Supreme Court, that the petitioner may not deduct any of the net loss of the New York corporation. The case is so similar to numerous others, some of which have been dealt with in the several decisions of the Board and the courts which have been cited, that we are unable to say that it involves such exceptional circumstances that the difference between the two corporations can be disregarded, Burnet v. Clark, supra.

If, however, contrary to our view, it could be said that any part of the New York corporation’s net loss was deductible by petitioner, the deduction could not include the $45,000 par value of shares issued by the New York corporation to the three officers. There is not sufficient evidence to establish either the value of the services performed, Botany Worsted Mills v. United States, 278 U. S. 282, or the value of the shares when issued for the services. Obviously, the par value of shares of a continually unsuccessful corporation in need of funds is not evidence of actual value.

It may be added that both parties seemed to assume the facts as to the amounts of net losses of the New York corporation, but since the record lacks either evidence or a clear stipulation thereof, they have been omitted from the findings.

Judgment will be entered for the respondent.


author: McMahon:

text:
    Lettie Snyder, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 46232.
    Promulgated April 26, 1933.

      Jesse I. Miller, Esq., for the petitioner.

      I. Graf, Esq., and Lloyd W. Greason, Esq., for the respondent.
   OPINION.

McMahon:

This is a proceeding for the redetermination of an asserted deficiency in income taxes for the calendar year 1927 in the amount of $2,823.78.

It is alleged that the respondent erred in computing the profit on the sale by petitioner in 1927 of 5,000 shares of stock of the Maytag Company.

The parties entered into the following agreed statement of facts:

It is hereby stipulated and agreed by and between the parties hereto, through their respective attorneys, that the following facts shall be taken as true, provided, however, that this stipulation shall he without prejudice to the right of either party to introduce other and further testimony not inconsistent with the facts herein stipulated to be true:
(1) Petitioner is an individual residing in Newton, Iowa.
(2) On or about April 15, 1927, petitioner’s husband, Howard F. Snyder, in contemplation of death and without consideration in money or money’s worth transferred to the petitioner five thousand (5,000) shares of the common stock of the Maytag Company, a corporation, which on said date had a value of $27,625 per share, or a total value of $138,125.00.
(3) Petitioner’s husband died on September 2, 1927. The petitioner, as executrix, filed a Federal estate tax return on behalf of the estate of Howard F. Snyder in which there was included in the gross estate for the purpose of computing the Federal estate tax said five thousand (5,000) shares of Maytag Company stock for the reason that the conveyance of said stock to the petitioner had been made in contemplation of death.
(4) Upon the date of death of petitioner’s husband said stock had a value of $31.25 per share, or a total value of $156,250.00, at which amount said stock was included in the gross estate in the said Federal estate tax return and the Federal tax paid thereon.
(5) In December 1927 the petitioner sold said five thousand (5,000) shares of stock for the total amount of $164,700.00.
(6) The respondent contends that the basis for determining the gain upon the sale of said stock is the value thereof in April 1927, to wit, $138,125.00, at which time said stock was given to the petitioner by her husband in contemplation of death.
(7) The petitioner contends that the basis for determining the gain on the sale of said stock is the value thereof at the date of death of petitioner’s husband, to wit, $156,250.00.
(8) The petitioner’s husband acquired said five thousand (5,000) shares of stock at a total cost to him of $3,035.00.

We are here called upon to determine the proper basis to be used in the computation of gain or loss upon the sale by the petitioner in 1927 of 5,000 shares of the common stock of the Maytag Company. The applicable provisions of the Revenue Act of 1926 are set forth in the margin.

Under those provisions the basis to be used in the case of property which was acquired by gift made in contemplation of death, and which was included in the gross estate of the donor for estate tax purposes, as it was here, is the value of the property at the time of acquisition. The respondent has held that the time of acquisition was on or about April 15, 1927, the date that the gift was made, and that the proper basis is the value of the property at that time, $138,125. Petitioner, on the other hand, contends that the time of acquisition was the date of the death of her husband, and that the proper basis is its value at that time, $156,250.

The petitioner points out that provisions similar to those of the Revenue Act of 1926 with which we are here concerned are contained in the Revenue Acts of 1921 and 1924 (secs. 202 (a) (3) and 402 (c) of the Revenue Act of 1921 and secs. 204 (a) (5) and 302 (c) of the Revenue Act of 1924), and that under each act the basis in the case of property acquired by gift made in contemplation of death, as well as the basis in the case of property acquired by bequest, devise or inheritance, is its fair market value at the time of acquisition, whereas the basis under each revenue act for property acquired by a gift made after December 31, 1920, but which was not made in contemplation of death is the same as the basis which the property would have in the hands of the donor. (Sec. 202 (a) (2), Revenue Act of 1921, and sec. 204 (a) (2), Revenue Acts of 1924 and 1926.) She further points out that in each act both property acquired by bequest, devise or inheritance, and property acquired by gift made in contemplation of death, are to be included in the gross estate of the donor, for estate tax purposes, at its value at the time of the death of the decedent. She therefore contends that the obvious purpose of Congress was to make the basis for returning gain or loss, in the case of property which was acquired by gift made in contemplation of death, the “ last tax paid value,” that is, its value at the date of the death of the decedent, at which value it was included in the gross estate of the donor.

In support of her contention, she cites the report of the Finance Committee of the Senate on the Eevenue Bill of 1921, where in regard to section 202 (a) (2) of that bill, which deals with the basis in the case of property acquired by gift after December 31, 1920, it was said in part:

This paragraph does not apply to gifts made in contemplation of death or to gifts made to take effect in possession and enjoyment at or after death, but such testamentary gifts are to be treated as bequests or devises.

We do not agree, however, with the contentions of the petitioner that the date of acquisition of the property herein involved, which was acquired by gift made in contemplation of death, was the date of death of the petitioner’s husband. The fact that the basis in the case of property acquired either by bequest, devise or inheritance, or by gift made in contemplation of death, and which was included in the gross estate of the donor for estate tax purposes, is, under the revenue act, the value at the time of acquisition, and the fact that the time of acquisition in the case of property acquired by bequest, devise or inheritance has been held to be the date of the death of the donor (see Brewster v. Gage, 280 U. S. 327), does not mean that the time of acquisition in the case of a gift made in contemplation of death is the date of the death of the donor.

In the instant proceeding the stock was acquired by the petitioner at the time the gift was made on or about April 15, 1927. At that time the petitioner acquired absolute title to the stock. The word “ acquire,” from which the word “ acquisition ” is derived, means to obtain “ as one’s own.” City Bank Co., 1 B. T. A. 210. The fact that the gift was made in contemplation of death has no bearing upon the question of the time of acquisition. It might be well to point out that the fact that property has been included in a gross estate for estate tax purposes does not necessarily require that the property shall thereafter take as a basis the value at which it was included in the gross estate. Helen G. Carpenter, 27 B. T. A. 282 and Fannie E. Lang, 23 B. T. A. 854; affirmed in Lang v. Commissioner, 61 Fed. (2d) 280; George D. Widener, 8 B. T. A. 651; and Ernest M. Bull, Executor, 7 B. T. A. 993.

There is no ambiguity in section 204 (a) (5) of the Eevenue Act of 1926. It clearly provides that the basis in the case of property acquired by gift made in contemplation of death and which was included in the gross estate of the donor, shall be the fair market value of such property at the time of such acquisition. The intention of the Congress is to be sought for primarily in the language used, and where this expresses an intention reasonably intelligible and plain, it must be accepted without modification by resort to construction or conjecture. Thompson v. United States, 246 U. S. 547; United) States v. Goldenberg, 168 U. S. 95; and United States v. Lexington Mill & Elevator Co., 232 U. S. 397.

We hold that the respondent did not err in holding that the time of acquisition of the stock by the petitioner was on or about April 15, 1927, the date the gift was made, and that the proper basis is the value of the stock at that time, $138,125.

Reviewed by the Board.

Decision will be entered for the respondent.

       Sec. 204. (a) (5) If the property ivas acquired by bequest, devise, or inheritance, the basis shall be the fair market value of such property at the time of such acquisition. The provisions of this paragraph shall apply to the acquisition of such property interests as are specified in * * * subdivision (c) or (f) of section 302 of this Act.
      Sec. 302. The value of the gross estate of the decedent shall he determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated—
      * * * * * * *
      (c) To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after his death, except in case of a bona fide sale for an adequate and full consideration in money or money’s worth. * * *


author: Van Fossan:

text:
    The East Ninth Euclid Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 32227.
    Promulgated April 26, 1933.

      Oscar I. Kobe, C. P. A., for the petitioner.

      Hartford Allen, Esg., for the respondent.
   OPINION.

Van Fossan:

The report of the Board upon the original hearing of this case, promulgated May 10, 1932 (26 B. T. A. 32), sustained the respondent’s contention in all respects and directed that decision be entered accordingly. On the following day a decision finding a deficiency of $6,300 for the year 1923 was entered. The petitioner moved for a rehearing on June 28, 1932, and the respondent filed a memorandum in support of petitioner’s motion, entirely reversing the position taken by respondent in the notice of deficiency and on brief previously filed in the same case. On July 8, 1932, respondent, for whom decision had been entered on May 11, 1932, filed a separate motion praying that petitioner’s motion for rehearing and reconsideration be granted. In the motion it is asserted that the brief above- referred to and filed by respondent was in conflict with the position then being taken and in conflict with his “ present rulings.”

The motion for rehearing was granted and the rehearing held September 12, 1932, at which time the exhibits originally presented were again submitted. One witness not previously heard was called. His testimony was not such as to require any material change in the findings of fact included in our original report, which findings of fact are herein incorporated by reference.

In the original opinion we held that bond discount is a cost of acquiring capital and he who incurs it is entitled to recover the same by deductions from income, spread over the life of the bonds; further, that on sale of the property the unrecovered cost of financing is not to be added to the cost of property sold to determine gain or loss, but may be charged off and deduction taken from gross income.

It was then decided, on the facts of the case, it appearing that the two bond issues were wholly separate, there being no exchange or substitution of bonds of the new for those of the old issue, petitioner’s right to claim a deduction for unamortized bond discount matured when the old bond issue was retired. Consequently respondent correctly declined to allow the deduction in a subsequent year.

Our former decision in this case was not based on a lack of proof. We specifically held that there was no exchange of bonds or substitution of the new issue for the old, and that accordingly the unamor-tized bond discount applicable to the old issue could not attach to the new bond issue. At the time the general matter of financing was discussed with the bankers, it was deemed advisable to provide temporary or short-term financing which should be superseded by a long-term issue after conditions improved. This plan was followed, as outlined in our previous report. The aggregate amount of the old bond issues was much less than the new issue. The purchasers of the old bonds were not required by the deeds of trust to exchange these bonds for those subsequently to be issued. The fact that some of the holders of the original issues became purchasers of the new bonds did not make the transaction an exchange of bonds. New York, Chicago & St. Louis R. R. Co., 23 B. T. A. 177; affd., 64 Fed. (2d) 152. Nor did the redemption before maturity and retirement of the old bonds work a substitution. There is nothing in the proof submitted at the rehearing that causes us to alter the conclusion stated in our former opinion. Such being the situation presented, it is not necessary to decide what the rights of the taxpayer would be had there been an exchange of bonds pursuant to corporate authorization.

We affirm our previous decision in all respects.

Reviewed by the Board.

Decision will he entered! for the respondent.


author: Smith:

text:
    Kings County Development Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 46759.
    Promulgated April 26, 1933.

      Wallace Sheehan, Esq., T. T. G. Gregory, Esq., and Kenneth N. Logan, G. P. A., for the petitioner.

      W. F. Wattles, Esq., for the respondent.
   OPINION.

Smith:

The Commissioner determined a deficiency of $11,848.17 in the petitioner’s income tax for 1926, and an overassessment of $1,886.52 for 1927. At the hearing, the petitioner conceded that the Board had no jurisdiction of the overassessment and, in so far as the petition relates to the taxable year 1927, it will be dismissed.

The facts set forth in the stipulation of the parties are incorporated herein by reference. The facts necessary to an understanding of the issue for determination have been succinctly stated by the respondent as follows:

Petitioner is a corporation organized under the laws of the State of California in 1905 and engaged in the business of buying large tracts of arid and swamp lands situated in California, developing them for agricultural purposes, and finally selling them in small parcels. In 1905 petitioner acquired extensive areas of land adjacent to Tulare Lake in Kings County, California, which land when acquired was not suitable for agricultural purposes. The petitioner started to reclaim the lands by constructing levees, dykes, pumping plants, irrigation ditches, etc.
During the years 1925 and 1926 there were organized, under and by virtue of the reclamation laws of the State of California, two districts which are known as Delta Lands Reclamation District No. 770 and North Central Reclamation District No. 2071.
In 1926 petitioner sold certain rights of way, levees, etc., which had cost it $30,548.40 to the Delta Lands Reclamation District No. 770 for $95,134.10 in warrants of that district and certain other rights of way, levees, etc., which had cost $41,558.80 to the North Central Reclamation District No. 2071 for $77.-187.75 in warrants of that district. At the time of the sale petitioner owned 78.946 per cent of all the land in District No. 770 and 75.114 per cent of all the land in District No. 2071.
In computing its income for the year 1926 petitioner did not return as taxable income the total difference between cost of the assets sold and the amount received therefor, but returned as taxable income only a certain percentage of the difference between cost and selling price. The percentages used by petitioner, of 21.056 on the sale made to Delta Lands Reclamation District No. 770 and 24,886 on the sale made to the North Central Reclamation District No. 2071, represent the percentage of land in each district owned by other land owners.
There is no dispute as to the petitioner’s cost or the sale price received for the assets sold. The amounts were stipulated. The petitioner has not challenged the Commissioner’s determination that the warrants of the reclamation districts, which the petitioner received upon the two sales in 1926 were worth face value. There was no evidence that the March 1, 1913, value of any of the properties sold varied from their cost to petitioner.

The sale of the petitioner’s property to the reclamation districts may be better visualized by the following computation, based upon the stipulated facts, with respect to the sale to Delta Lands Reclamation District No. 770:

Petitioner sold rights of way containing 311.52 acres of land at $75 per acre, and 717,701 cubic yards in levees in place at 10(S per
cubic yard, for a total cost of-$95,134.10 The cost of these properties was:
Levees_$24,318.00
Rights of way_ 6, 230.40
Total cost_ 30, 548.40
Difference_ 64, 585. 70

Under section 202 (a) of the Revenue Act of 1926 “ the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis provided in subdivision (a) or (b) of section 204.” There is no dispute here as to the cost being the proper basis upon which to compute the gain realized by the taxpayer. But the petitioner contends that it realized no taxable gain from these sales because of its ownership of lands in the respective reclamation districts; for it “in effect so controlled said districts as to make them subsidiaries of the taxpayer.” In support of this contention the petitioner cites Rindge Land & Navigation Co., 2 B. T. A. 1179, and California Delta Farms, Inc., 6 B. T. A. 1301, wherein the Board held that the respective taxpayers realized no taxable gains from similar transactions because the respective reclamation districts consisted solely of lands of the respective taxpayers.

Reclamation districts are provided for in sections 3446 to 3493, inclusive, of the Political Code of California (Deering, 1923). In Metcalfe v. Merritt, 14 Cal. A. 244; 111 Pac. 505, the court held that:

A reclamation district is a public, as distinguished from a private, corporation, acting as a state agency invested with limited powers, but it is not a municipal corporation possessing in any degree general powers of government, though, within the limits of the authority granted to it, it exercises public functions.

Under the above provisions of the Political Code of California, reclamation districts, duly organized, as were those involved in this proceeding, are authorized to do all acts necessary to the accomplishment of the purpose for which they are organized. The district acts through its trustees. It may acquire property, as in this case, and levy assessments against the land within its boundaries for its expenses, including the expense of acquiring property such as was purchased from this petitioner. Such districts are separate and distinct legal entities from the land owners within the district, see Metcalfe v. Merritt, supra, and such distinctions may not be ignored. Burnet v. Commonwealth Improvement Co., 287 U. S. 415; Cannon Mfg. Co. v. Cudahy Packing Co., 267 U. S. 333.

The petitioner argues that it returned the warrants received in payment for the rights of way and levees sold to the respective reclamation districts in part payment of the assessments against its lands within the respective districts, and that it could not realize a profit upon the sales in question. It is to be noted that the assessments were not against the property sold, but against the land retained. Under the statute (section 234 (a) (3) of the Revenue Act of 1926) and regulations (article 133, Regulations 69) such payments are not deductible as taxes paid, but are treated as capital expenditures, increasing the cost of the land retained.

The facts in this proceeding are different from those which obtained in the Rindge Land & Navigation Co. and the California Delta Farms, Inc., cases, supra. The petitioner owned less than 80 per cent of the land in the reclamation districts while in those cases the reclamation districts consisted solely of lands of the respective taxpayers. The petitioner contends, however, that the same principle applies here as there.- This is not necessarily so. We are of the opinion that the petitioner is liable to income tax upon the profit made by it, under Burnet v. Commonwealth Improvement Co., supra.

Reviewed by the Board.

Judgment will be entered for the respondent.


author: Marquette :

text:
    Planet Line, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 47487, 55185.
    Promulgated April 27, 1933.

      E. E. Baldwin, Esq., and Frank F. Barns, Esq., for the petitioner.

      'William. E. Davis, Esq., and Paul E. Warmg, Esq., for the respondent.
   OPINION.

Marquette :

The question presented is whether the petitioner is taxable upon all the profits derived from the joint operating account provided for in the agreement of March 23, 1923, or whether it is taxable on only one-half of said profits. The determination of this question rests primarily upon the construction and interpretation of the contract of March 23, 1923.

The respondent contends that this contract was one for the purchase of stock in the Planet Steamship Corporation by the petitioner, as well as a contract chartering vessels, and upon this theory he has held that the $270,000 of profits received by the owner out of the joint operating account was income to the petitioner in the first instance and w;as thereafter paid over to the owner in purchase of stock. The petitioner contends that the contract, when read and considered as a whole, is essentially and primarily concerned with the operation of certain cargo vessels, but provides for an even division of any profits that might accrue. Petitioner urges that the stock-purchase provisions merely gave an option which might provide an added stimulus for successful operation of the vessels, and that the $270,000 paid over to the owner was never income .of the petitioner under the terms of the agreement.

Before turning to the specific terms of the contract of March 23, 1923, we think it advisable to consider the facts that motivated the parties entering into this contract. The bondholders of the Green Star Steamship Corporation were faced with the loss of a large sum of money, in the aggregate, unless some plan could be devised whereby their interests would be protected and their losses minimized. The Planet Steamship Corporation and the petitioner were creatures of the plan devised by the bondholders and Arthur R. Lewis, whereby these mortgaged vessels could be released from claims and libels outstanding against them and put back into operation. The bondholders organized the lessor corporation to acquire the cargo vessels, and Lewis organized the petitioner to lease the vessels from the bondholders’ corporation.

The resulting agreement of March 23, 1923, is a tripartite agreement designed to put the above plan into effect, but the obligations imposed by its terms rest primarily upon the owner and the petitioner. It is these obligations with which we are principally concerned in construing this agreement.

It is a cardinal rule of construction that a written instrument must be considered as a whole and the intention of the parties must be collected from the entire writing, not from detached portions thereof. Individual clauses and particular words must be considered in connection with the rest of the agreement, and effect must be given to all parts of the instrument if possible. 13 Corpus Juris, sec. 486. Following that rule, we cannot here consider only the contract provisions relating to possible acquisition of stock by the petitioner, and ignore the other provisions of the agreement.

Considering the contract as a whole, together with the facts as they existed at the time the contract was entered into, it is our opinion that the construction adopted by the respondent is unjustified, because, fundamentally, the contract is a ship-operating agreement and not a contract to purchase capital stock. It is true that petitioner first received the income resulting from the operation of the vessels, but it was obligated under the terms of the agreement to deposit these receipts in a special account, to cover from these deposits so made the expenses of operation, and at the end of every six-month period to account to the owner for all ship voyages made and pay over to the owner its one-half of the profits remaining in the joint operating account. These things were done and constituted the essence of the agreement.

But the agreement further provided, and it is these provisions that are the basis for the respondent’s contention, that when the owner’s share of profits paid over out of the joint operating account should total the agreed valuation of the seven cargo vessels, viz., $1,880,700, 51 per cent of the owner’s capital stock should be transferred to the petitioner. It further provided that the petitioner could pay all or any part of the purchase price with its own funds, but since no such payments were made, this provision need not be further considered.

Do these stock-purchase provisions change the evident intent and purpose of the parties from an operating agreement for mutual benefits to an agreement for the purchase of 51 per cent of the owner’s capital stock? We think not. The provisions merely give the petitioner the right to acquire, or an option to acquire, that amount of stock, and specify what funds shall be used in computing the total sum to be paid, that is, the agreed valuation of the cargo vessels. The evidence is undisputed that the only funds received by the owner that could be used in the purchase of the capital stock under the above provisions, were the owner’s one-half of the profits in the joint operating account, which totaled approximately $270,000. But under the provisions of paragraph twenty-one, one-half of the profits belonged to the owner in any event, and this is true, regardless of whether these payments were applied against the total payments that were due and payable before petitioner could acquire the stock.

Respondent’s contention is further refuted by the guaranty agreement that was entered into at or about the time of the operating agreement. In the guaranty agreement, given by the Seas Shipping Company, Inc., to the owner, it was specifically stated that one of the considerations for leasing the seven cargo vessels to the petitioner was to furnish the latter with a fleet of steamships for operation, but no mention is made therein that said Seas Shipping Company, Inc., would guarantee the payment of the purchase price of the stock. Furthermore, there is no showing made in the record that upon termination of the operating agreement the owner insisted upon the guarantor making good for the unpaid balance of the purchase price. It is almost inconceivable that the owner would fail to exercise its rights under the guaranty agreement if the contract of March 23,1923, were a contract obligating the petitioner to purchase the stock in question. We think the respondent erred in including the entire profit in petitioner’s income.

Decision will 5e entered under Rule 50.


author: Black:

text:
    Graham-Loftus Oil Company, Petitioner, v. Commissioner of Internal Revenue, Respondent. Italo Oil Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 45276, 51559.
    Promulgated April 27, 1933.

      A. Gadder Machay, Esq., and Thomas R. Dempsey, Esq., for the petitioner.

      R. W. Wilson, Esq., for the respondent.
   OPINION.

Black:

The respondent determined deficiencies in petitioner’s income taxes of $2,377.70 for the year 1924, $1,264.68 for the year 1925, $1,249.27 for the year 1926; and $4,921.24 for the year 1927. The case was submitted entirely upon a stipulation of facts, which stipulation is incorporated herein by reference.

These proceedings have been consolidated for hearing. There is one issue common to all the taxable years involved and that is: Petitioner contends that the entire cost of the oil wells enumerated in the stipulation should be returnable through depreciation deductions, whereas respondent contends that the part of said costs which is represented by physical equipment should be returned through depreciation deductions but that the part represented by intangible development costs should be added to the costs of the leases and be recovered through depletion allowances, and cites article 225, Regulations 65, and article 223, Regulations 69, in support of his contention.

In carrying out his theory, respondent has allocated 40 per cent of the cost of each of the oil wells involved herein to physical equipment, and has allowed depreciation thereon at the same rate used by petitioner, but has disallowed the remaining portion of depreciation claimed by petitioner, on the ground that such costs should be recovered through depletion. For the year 1925 the petitioner assigned an additional allegation of error as follows: (d) The respondent in determining petitioner’s net taxable income for the year 1925 erroneously and illegally failed to allow the sum of $379.84 as a deduction for depletion. No facts were introduced in evidence in support of assignment (d), and inasmuch as respondent’s answer denied all allegations of error and statements of fact contained in said petition, assignment of error (d) in Docket No. 45276 will be considered as abandoned. Petitioner fails on that issue for lack of proof.

The Commissioner in determining the deficiency for 1925 disallowed an item of $16,796.41, designated as excessive depletion claimed by petitioner. Petitioner assigned no error in respect to such disallowance. *

Petitioner did assign as error respondent’s disallowance for 1925 of an item of $16,703.36, designated as excessive depreciation claimed for that year by petitioner, and for 1926 petitioner assigns as error respondent’s disallowance of a similar item amounting to $9,253.84. Petitioner’s assignments of error for these latter disallowances are on the same ground as heretofore stated. The same situation exists as to 1927. Petitioner does not appear to contest respondent’s disal-lowance of $3,379.99 of the depletion claimed by petitioner for that year but does contest, on the ground already stated, respondent’s disallowance of $33,073.59 of the depreciation claimed by petitioner for that year.

Thus the only issue we have to decide is respondent’s disallowance of certain portions of the depreciation deductions claimed by petitioner, said disallowance being based on the allocation of 60 per cent of the costs of the oil wells to intangible development costs to be added to the cost of the leases and recovered through depletion allowances.

Recently the Supreme Court of the United States had a similar question before it and the decision was adverse to the contention made by petitioner in the instant case. United States v. Dakota-Montana Oil Co., 288 U.S. 459; Petroleum Exploration v. Burnet, 288 U.S. 167;; and Burnet v. Jergins Trust, 288 U.S. 508.

In all of these decisions the Supreme Court approved the Commissioner’s regulations, which in substance provide that such incidental expenses as are paid for wages, fuel, repairs, hauling, etc., in connection with the exploration of property, drilling of oil wells, building of pipe lines and development of the property may at the option of the taxpayer be deducted as a development expense or charged to the capital account returnable through depletion. In the instant case the taxpayer exercised the option to charge the cost of drilling its oil wells to capital account, but it now seeks to have such costs returned by way of depreciation instead of depletion deductions.

The Commissioner’s regulations contained in article 227, Regulations 65, and article 225, Regulations 69, further provide that “ Both owners and lessees operating oil and/or gas properties will, in addition to and apart from the deduction allowable for depletion as hereinbefore provided, be permitted to deduct a reasonable allowance for depreciation of physical property, such as machinery, tools, equipment, pipes, etc., so far as not in conflict with the option exercised by the taxpayer under article 225 [article 223 in Regulations 69].”

Petitioner in the instant case paid for the drilling of its oil wells on the turnkey contract system and there appears to have been no segregation on its books between the amounts paid for such incidental expenses as wages, fuel, repairs, hauling, etc., in connection with the drilling of said wells, and the amounts paid for physical property, such as machinery, tools, equipment, pipes, etc., used in connection with said oil wells. However, as we have already stated, the respondent in determining the deficiencies for each of the years involved in this proceeding allocated 40 per cent of the cost of drilling each of said wells as representing the cost of machinery, tools, equipment, pipe, etc., and allowed depreciation thereon at the rates claimed by petitioner. The remaining 60 per cent of the cost of drilling said wells respondent allocated to intangible development costs to be added to the cost of petitioner’s leases and recoverable through depletion allowances and not by way of depreciation. Petitioner has offered no evidence which would establish or tend to establish that this allocation made by respondent of 40 per cent of the cost of the wells to physical property and 60 per cent to intangible costs was unreasonable and unfair.

In the absence of such evidence we must hold respondent’s determination in that respect correct. Petitioner does not contest the depreciation deductions which respondent allowed, but only those which he did not. As to these, respondent appears to have followed his regulations, which, as we have already pointed out, have recently received the approval of the Supreme Court in the cases which we have- cited. As to¡ whether the details of the computation made by respondent, as shown in the statements attached to the deficiency notices, comply in all respects with the rules approved by the Supreme Court in United States v. Dakota-Montana Oil Co.; Petroleum Exploration v. Burnet; and Burnet v. Jergins Trust, supra, we do not express any opinion. If in the computation of the deficiencies, respondent deviated in any respect from his regulations as approved by the Supreme Court, it should be corrected in settlement under Rule 60.

The stipulation, after stating that respondent in the determination of the deficiencies allowed petitioner annual deductions for depreciation on Lightburn Wells #1 and #2 on 40 per cent of the cost thereof, states that “No deduction of either depreciation or depletion has been made for or on account of the remaining 60 per cent of said cost.”

There appears no good reason why this remaining 60 per cent of the cost of Lightburn Wells #1 and #2 should not be added to the cost of petitioner’s Lightburn lease and treated in accordance with the Commissioner’s regulations in determining depletion allowances for all the taxable years in question. It is so ordered.

Petitioner’s contention that, in the event this Board should hold that petitioner is not entitled to a return of its capital cost by way of depreciation, petitioner nevertheless should be allowed as a deduction the total sum determined by the Commissioner to have been expended by petitioner for intangible development costs, appears not to be well founded, in the light of the Supreme Court decisions already cited. Such contention is accordingly denied.

Decision uMl be entered tAnder Rule 50.


author: SteRnhagen:

text:
    William F. Harrah, Petitioner, v. Commissioner of Internal Revenue, Respondent. Marie E. Harrah, Petitioner, v. Commissioner of Internal Revenue, Respondent. L. G. McDonald, Petitioner, v. Commissioner of Internal Revenue, Respondent. Julius C. Kirchner, Petitioner, v. Commissioner of Internal Revenue, Respondent. C. K. Anderson, Petitioner, v. Commissioner of Internal Revenue, Respondent. Frederick A. Hastings, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 21643, 25269, 25427, 25428, 33242, 38864.
    Promulgated April 27, 1933.

      Arnold B. Baar, Esq., Arthur B. Foss, Esq., and Florence L. Siverston, O. P. A., for the petitioners.

      'Elden McFarland, Esq., for the respondent.
   OPINION.

SteRnhagen:

The issues are entirely in the realm of fact, and evidence of widely varying kinds and qualities was taken for three days, ranging from accurate records and accounts, through narrative statements of events, causes, motives and expectations, to categorical personal opinions of value, given by witnesses called by both sides. This evidence has been considered not only with full regard for the impression received at the time of trial as to the witnesses and their testimony, but with regard to subsequent detailed study and analysis of its significance and effect. There has been neither “ slavish adherence to a formula ” nor an escape from the restraints which the record imposes. Without disregarding any of the evidence, we have given it such weight as its significance in the problem seemed to demand. Obviously such weight and significance can not be measured or described, consisting as they do of ponderable and imponderable factors, the appreciation of which is to some extent born of our experience in other cases involving valuation.

The record contains evidence of the history of the corporation’s business and of the corporation, showing the reasons, motives and expectations of its creators, and the terms upon which it was created; the development of the business, together with its production, sales, earnings and dividends, and the trend thereof generally toward improvement; the assets, both tangible and intangible (including its secret process), with their appraisal at one time and another by several methods; the sales at various times of small lots of the shares, the prices and the circumstances in which such sales occurred with regard to their reflection of value; the opinions of several persons, interested and disinterested, whose qualifications were widely diversified as to experience, knowledge of the significant facts, and ability to consider the factors of valuation. This has all been carefully considered.

The petitioners, in their several returns for 1922 used, as the basis for determining the gain derived from the sale of their shares, a value on March 1,1913, for each share held on that date of $421.70 (in one instance, $421.57). The respondent, in determining the deficiencies, held the values on that date to be $193.86 and $185.45. During this proceeding, the respondent claimed that such value was no more than $100, and this he now urges is the value shown by the evidence and upon which a claimed increase in the deficiency should be based. The petitioner contends that the March 1, 1913, value established by the evidence is not less than $350 and is perhaps $500. We have found as a fact that such value was $200 This, it should be said, is not a figure thoughtlessly hit upon as a convenient intermediate figure. It has been arrived at as a fair representation of the evidence, and reflects our opinion of what a seller and a buyer, acting fairly, freely, and with substantial knowledge of the facts and reasonable prospects, would have agreed upon as a price. This figure should be used in a recomputation which will of course take into consideration the later stock dividends and purchases in determining the total gains of the several petitioners. Such other factors of the computation are not in dispute and require no consideration in this report.

Marie E. Harrah acquired her shares originally by gift on July 1, 1919, increased later by a stock dividend. The basis of gain or loss upon their sale by her in 1922 is the value of the shares at the time of the gift. She used in her return a figure representing $225 as such value, which the respondent reduced to $150. This figure the respondent insists is supported by the evidence, while the petitioner now urges that $400 should be used. We think the evidence establishes the fair market value on July 1, 1919, to have been $250 a share and have so found as a fact.

The third question is fraught with the utmost confusion of treatment by all the parties. It grows out of the circumstance that the shareholders all agreed to sell their shares to one buyer, and appointed one of their number to complete the transaction and distribute to each his proper part of the selling price. The corporation at that time had a surplus on hand. Although each knew at the completion of the transaction that in one way or another he had received $238.75 in respect of each share he had held, a failure to make an analysis of the accounting source of this figure resulted in various allocations of it by them on their several returns. Such an analysis is now available from the evidence, and it indicates without much doubt that of the $238.75 received, $20 per share was a dividend out of the corporation’s earnings and profits accumulated since March 1, 1913, and hence subject only to surtax, and $218.75 was sale price. In some instances the respondent has taxed the same amount twice by including it in both categories. This error should be corrected, and it only remains for the respondent in proceeding under Rule 50 to divide the $238.75 into a dividend of $20 and a sale price of $218.75.

Judgment will be entered under Rule 50.