author: TTtt.t. :

text:
    Grison Oil Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96132.
    Promulgated October 30, 1940.

      Ohas. H. Garnett, Esq., for the petitioner.

      J. E. Marshall, Esq., for the respondent.
   OPINION.

TTtt.t. :

The question before us in this case is whether or not respondent erred in deducting from gross income the amounts of income tax paid by petitioner to the State of Oklahoma, in order to determine the net income from petitioner’s oil property for depletion purposes, pursuant to section 114 (b) (3) of the Revenue Act of 1936. The statute provides that in the case of oil and gas wells the allowance for depletion shall be 27½ percent of the gross income from the property, but that such allowance shall not exceed 50 percent of the net income of the taxpayer (computed without allowance for depletion) from the property.

Article 23 (m)-l (h) of respondent’s Regulations 94, issued under the above statute, defines “net income of the taxpayer (computed without allowance for depletion) from the property” as meaning the gross income from the property, less the allowable deductions attributable to the mineral property upon which depletion is claimed, “including overhead and operating expense, development costs properly charged to expense, depreciation, taxes, losses sustained, etc., but excluding any allowance for depletion.”

On brief petitioner argues that the state income tax should not be deducted from gross income in computing net income from the property, for the purpose of applying the 50 percent limitation on the depletion allowance, for the reason that such tax is wholly unrelated to the production of income from its oil property, and that a fair interpretation of the word “taxes” as used in respondent’s regulations does not embrace such a tax.

We are unable to agree with this theory. The Oklahoma income tax would appear to be an allowable deduction attributable to the mineral property upon which depletion is claimed, since the amount is an allowable deduction in computing taxable net income under the Federal taxing act, and the parties have stipulated that during the taxable year petitioner was engaged in operating an oil and gas property theretofore acquired, producing and selling oil therefrom, and carried on no other business in 1936.

Petitioner further contends that the income tax paid to the state can not properly be classified as operating expense, because it represents merely the payment of a part of the net profits to the Government, citing and quoting at length from I. T. 3398, construing regulations issued under the Vinson Act (48 Stat. 503), as amended. This ruling in effect held that a state franchise tax measured by income but imposed upon the privilege of doing business as a corporation within the state is includable as an element of the cost of performing a contract under tbe Vinson Act, while a state income tax is not so includable. The argument is that by analogy the reasoning of such ruling is applicable in the present case. In St. Marys Oil & Gas Co., 42 B. T. A. 270, we rejected a similar argument because of the entirely different purposes of the Vinson Act and the Federal revenue act. The discussion there set forth at length need not be repeated here.

In Helvering v. Wilshire Oil Co., 308 U. S. 90, the Supreme Court approved respondent’s regulations under the 1928 Revenue Act, which required that development expense deducted in computing taxable net income should also be deducted in computing net income from the property for the purpose of applying the 50 percent limitation on percentage depletion. The Oklahoma income tax here involved comes within the class of deductions from gross income allowable in determining taxable net income under the Federal revenue acts, and is no less attributable to the oil property upon which the depletion is claimed than development expense. Under generally recognized rules, both items are properly to be taken into account in computing the net operating profits, as well as the taxable net income, derived from the property by petitioner. Any other conclusion, we think, would be incompatible with the rationale of the Supreme Court’s opinion in the Wilshire case. Whether a state income tax based only in part upon income from the mineral property upon which depletion is claimed should be allocated in proportionate part to such property in computing the limitation on the depletion allowance, we need not here decide, since under the facts adduced such question does not arise.

In Montreal Mining Co., 41 B. T. A. 399, we held, on authority of the Wilshire decision, supra, that, in computing the petitioner’s net income for percentage depletion purposes under the 1934 Act, amounts paid in settlement of silicosis claims should be deducted from gross income.

In Mirabel Quicksilver Co., 41 B. T. A. 401, we held, on the same authority, that, in computing the petitioner’s net income for percentage depletion under the 1936 Act, amounts paid as interest on money borrowed for development and equipment expenses and capital stock taxes, should be deducted from gross income.

In St. Marys Oil & Gas Co., supra, we held that interest paid on money borrowed to purchase part of the property from which oil and gas was produced must be deducted from gross income in arriving at the net income from the property for the purpose of computing percentage depletion.

On authority of the decisions above cited, we hold that respondent did not err in deducting the Oklahoma income tax in computing the percentage depletion allowance, and the deficiency determined by him herein is approved.

Decision will Toe entered for respondent.


source: Caselaw Access Project

author:
MtjRDOCK :
      Opper,

license: Public Domain

text:
    American Light & Traction Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97234.
    Promulgated November 1, 1940.

      Floyd, F. Toomey, Esq., and Ellsworth G. Alvord, Esq., for the petitioner.

      Arthur W. Carnduff, Esq., and Broohs Fullerton, Esq., for the respondent.
   OPINION.

MtjRDOCK :

The Commissioner determined a deficiency of $550,227.83 in income tax for 1930 and one of $309,597.44 for 1931. The facts have been stipulated. The petitioner assigned as error the action of the Commissioner in computing a profit to its four subsidiaries from the sale of debentures at face value, by refusing to allow the use of their cost as basis, the cost being equal to the amount realized from the sale. The Commissioner, by amended answer filed at the hearing, raises the issue of whether the petitioner is estopped to deny that a lower basis (cost of property given in 1928 in exchange for the debentures) is proper.

The petitioner was the top holding company of a large group of corporations engaged principally in supplying artificial gas to the public. It owned the entire capital stock of four New Jersey corporations known as Mutual, Waverly, Bexley, and Provident. The four subsidiaries together owned 153,200 shares of the common stock of the Brooklyn Union Gas Co. The four, on July 27, 1928, transferred all of their assets, consisting of the 153,200 Brooklyn Union shares and debentures of Brooklyn Union, to four Delaware corporations in exchange for debentures of the four Delaware corporations of the face amount of $21,321,900. The stock of the four Delaware corporations was owned by others. These exchanges were a part of a larger plan more fully described in United Light & Power Co., 38 B. T. A. 477; affd., 105 Fed. (2d) 866; certiorari denied, 308 U. S. 574. The cost to the four New Jersey corporations of the property transferred by them was less than the fair market value of that property on July 27, 1928. The fair market value of the property, the fair market value of the Delaware debentures, and the face value of the debentures were all the same, $21,321,900, on the date of the exchange. The four New Jersey corporations sold some of the debentures at face value in 1930 and 1931. The petitioner did not report any profit from those sales on its consolidated returns for 1930 and 1931. The Commissioner, in determining the deficiencies, computed a gain by using the basis of the property given in 1928 in exchange for the debentures.

The petitioner contends that the old basis could be used in lieu of cost only in case the 1928 exchanges were statutory reorganizations under section 112 (i) (1) (A) of the Revenue Act of 1928 (see secs. 112 (b) (4) and 113 (a) (6)); they were not such reorganizations since the four New Jersey corporations after the exchange held only debentures of the Delaware corporations, and the Supreme Court has held that the necessary continuity of proprietary interest in the transferred property is lacking where the transferor receives only bonds of the transferee (LeTulle v. Scofield, 308 U. S. 415; cf. United Light & Power Co., supra); and, consequently, the normal basis of the cost of the debentures must be used. Sec. 113 (a). That cost was the same as the selling price and no gain resulted. The Commissioner, in his brief, mildly resists this contention, but assumes that the Board will adopt it as the only correct application of the statutory provisions as interpreted by the Supreme Court. It is the only conclusion possible under the applicable statutory provisions. Consequently, if the provisions of the statute are to be followed, the four subsidiaries of the petitioner had no gain when they sold the Delaware debentures for face value, which was equal to the cost of the debentures to the four subsidiaries.

The Commissioner relies upon his affirmative contention that the petitioner and its subsidiaries are estopped to deny that the use of the old basis is proper since they reported no gain from the 1928 exchanges and resisted when a representative of the Commissioner auditing the return for 1928 suggested that there was a gain at that time. The Commissioner concedes that there is no basis for, what he terms, estoppel in pais, since there was no misrepresentation or withholding by the taxpayers, no intended deception in their conduct or declarations, and no reliance thereon by the Government. He says he relies upon the broad equitable rule that, where one has taken a position and received benefits therefrom, he will not be permitted to act later in an inconsistent manner to the detriment of another. Such a rule has been applied at times by the courts and the Commissioner has cited a number of those cases.

Mr. Justice Cardozo, in Stearns Co. v. United States, 291 U. S. 54, stated the rule to be “that no one shall be permitted to found any claim upon his own inequity, or take advantage of his own wrong. * * * A suit may not be built on an omission induced by him who sues.” But, because the unnamed rule is stated in such general terms, there is extreme difficulty in knowing whether or not to apply it in particular cases. The Commissioner frequently takes inconsistent positions to the sorrow of taxpayers, yet such mistakes are not later adjusted by unlawful deductions. Cf. Fairmount Foundry, Inc., 42 B. T. A. 1087. Since both parties have full opportunity to have the tax liability determined in accordance with the statutes, the statutory test should not be abandoned for a test based upon the ethics or morals of the conduct of one of the parties except under exceptional circumstances. Tide Water Oil Co., 29 B. T. A. 1208. The Board said in James Couzens, 11 B. T. A. 1040, that “such an argument must be treated with the utmost caution, since its sanction in any case would result in having an individual tax liability depend, not upon the factors and measures prescribed by Congress as applicable to all, but upon the statements and conduct of a particular” person.

This general subject was carefully considered and discussed at some length in the Tide Water Oil Co. case, supra. There the taxpayer had believed and had argued to' the Commissioner that it was affiliated with Tidal. The Commissioner came to the same conclusion. Later the Supreme Court held that there was no affiliation under similar circumstances. It was then too late to tax Tidal separately and the Commissioner contended that Tide Water was estopped to deny its affiliation with Tidal. The Board held that there was no right to elect between affiliation and nonaffiliation, no waiver, and no estoppel of any kind, but merely a misunderstanding of the law by both parties as to which each had to take his chances. It pointed out that the Commissioner, upon whom was placed the duty of correctly interpreting the law, could not hold the taxpayer to the consequences of a mutual misinterpretation. The Board refused to depart from the statutory provisions because of any doctrine akin to estoppel, saying:

Whatever doctrine analogous to estoppel the respondent would invoke, it must be founded upon some act or omission of the petitioner for which in equity it should be held to account. The equities must be strong to overshadow the law. There is here no suggestion of fraud, untruthfulness, concealment, misrepresentation, omission, negligence, violation of duty, or unfair conduct on the part of the petitioner. It was no more the author of the misfortune than was the Commissioner. The latter was in as good a position as the former to make all proper decisions. Thus, in this case there is no occasion for applying either the doctrine of estoppel or any doctrine analogous thereto.

That case and the discussion contained therein is in point here, where the facts are substantially similar. Likewise apposite is the case of R. E. Baker, 37 B. T. A. 1135, wherein we said:

If the determination of the respondent of the factors required by law for the ascertainment of the basis to be used for the computation of gain or loss in 1928 is erroneous, estoppel can not be availed of to justify or perpetuate such errors.. Furthermore, the Board stated in Sugar Creek Coal Mining Co., 31 B. T. A. 344, 348, as follows:
* * * As a general proposition, estoppel does not support a belated assessment merely because the taxpayer has omitted the income from his: earlier returns and the statute of limitations has barred the correct assessment.

See also Salvage v. Commissioner, 76 Fed. (2d) 112; affd., 297 U. S. 106.

The facts in the present case are no more favorable to the Commissioner than were those in the Tide Water and Baker cases. Perhaps they are less so. No gain from the 1928 exchanges was reported. A revenue agent, when auditing the 1928 return in 1930, proposed a tax upon the gain. The petitioner protested upon the ground that there was a reorganization. The revenue agent in charge agreed that there was a reorganization. G. C. M. No. 11272, dated November 17, 1932, held that there was a reorganization and no gain to the four New Jersey corporations. The petitioner, on December 8, 1932, consented to a deficiency for 1928 upon other grounds. The period for , assessment of any additional deficiency for 1928 expired on December 31, 1932. Note that 1928 was still open long after the returns for 1930 and 1931 were due and filed, and, although the new basis was claimed on those later returns, the Commissioner did nothing about taxing the gain for 1928. This is particularly surprising and significant in view of the fact that he held in the case of United Light & Power Co. that the 1928 transactions did not result in a nontaxable reorganization. The Board later sustained him in that holding. United Light & Power Co., supra. After the Commissioner had allowed the statute to run as to the 1928 tax of the four New Jersey corporations, the Supreme Court held that transactions similar to the 1928 exchanges were not statutory reorganizations. LeTulle v. Scofield, supra. Cf. United Light & Power Co., supra, and cases therein cited. The Commissioner now attempts to circumvent the applicable statutory provisions and the effect of the statutory period of limitation by pointing to his mistake as to 1928, blaming it upon the taxpayer, saying that it is unconscionable to allow the taxpayer to retain the benefit of that mistake, and asking that the error be offset by collecting now, contrary to statute, a larger amount than was due but unpaid for 1928. He would thus actually penalize the taxpayer for abiding by his determination of its 1928 tax liability. That does not seem equitable and we can do no better than apply the statutory provisions, which allow a cost basis equal to the sales price.

Peviewed by the Board.

Decision will be entered v/nder Pule 50,

Opper,

dissenting: If we state the problem which this case typifies in terms sufficiently broad to describe the species or type of the difficulty common to all such cases, it will appear, I think, that this Board and the courts have laid down inconsistent principles for dealing with it; if this is so, I feel that we are still at liberty to choose from among those principles that which is the most generally satisfactory; and if, as I think, a different formula from that used by the majority will result in a determination fair to the taxpayer and fair to the Government, the consequence should be its adoption in the present case.

The background common to the general problem appears to be that in a previous year now closed by the statute of limitations the taxpayer and the Commissioner have adopted a view as to the taxpayer’s liability to tax which now appears to have been erroneous, but a development in the present tax year directly involving that previous treatment is open and requires our present decision. The problem is: Shall we reach that decision leaving out of consideration entirely the earlier approach which the parties have erroneously adopted, because the statute of limitations bars a readjustment for the prior year; or shall we, precisely because that earlier adjustment is now impossible, shape our present view to conform as nearly as may be to the justice and practical consequence of the entire situation, giving such weight to the previous treatment as is necessary to make the whole result one from which neither taxpayer nor Government may take an'undue advantage?

This general question has, it seems to me, called for consideration on previous occasions. Where, for instance, a deduction has been taken which appeared at the time to be correct, but later circumstances have developed which place the taxpayer in a position to offset the detriment for which the deduction was allowed, it has been the consistent judicial view that then an adjustment of the tax consequences is appropriate. Typical of these cases are those where a tax originally assumed to be due is refunded because the taxing statute was unconstitutional or because there was an overassessment, or, an item siich .as a bad debt, insurance premium, or loss from embezzlement or fire, which appeared to be properly deductible was later recovered or canceled. The same conclusions have been reached in instances where the taxpayer has omitted to include in income an item which it later appears should have been taxed. One and possibly two limitations are imbedded in this view. The taxpayer will not be charged with income in the later year to the extent that he obtained no income tax benefit from the privilege of deduction in the first instance. And perhaps it is only where the statute of limitations has run against the earlier year, precluding adjustment of the original tax liability in accordance with the subsequently discovered actuality, that the rule applies. These results have been reached without resort to strict principles of waiver, estoppel, or election and it seems apparent that only confusion can result from attempting to apply them to such a situation. Beyond the recognition that equitable doctrines similar to unjust enrichment are involved, such technical aspects as whether there was misrepresentation or mutual mistake, error of law or of fact, reliance, detriment, and the like, can advance us little in disposing of a controversy involving elements so “essentially practical.”

It is true that there are authorities, as the prevailing opinion shows, which appear to deny the possibility of the kind of subsequent adjustment which seems to me called for here. But my feeling that there is no tenable distinction in principle among the cases thus reaching divergent results is the justification for the statement made earlier that holdings on the present problem in its larger aspect have been inconsistent. There is as much “right of election” here as there was, for example, in Moran v. Commissioner; as much of an “estoppel” as there was in Stearns Co. v. United States; no more of a “mistake of law” than in Charles W. Nash. And it violates the classic definition, see e. g. Eisner v. Macomber, 252 U. S. 189, 207, at least as much to characterize as income the refund to the taxpayer of his own funds which he should not have paid in the first place, as it does to include as income an amount resulting from reducing an admitted receipt by a basis measured by the cost not of the particular asset but of its predecessor.

If we were to follow here what I think is the principle of the cases first cited we should say that the taxpayer obtained the benefit in 1928 of the payment of a smaller income tax because of an exclusion from its income which now appears to have been incorrect; that in the present year a further development of that situation has occurred raising for our consideration the total amount of taxable income which this taxpayer has received out of the transaction as a whole; and that, notwithstanding, and in fact because, adjustment of the prior year is now made impossible by the bar of the limitations statute, liability to tax shall be determined with respect to the present year by taking into consideration the prior erroneous treatment to the extent and only to the extent that a benefit was obtained by the taxpayer from underpayment of his income tax in a prior year.

It may be said that the present result is necessary to attribute the maximum possible effect to statutes of repose. To this I think it may be answered that the formula suggested does not require, nor indeed sanction, a violation of any principle that controversies must be definitely and finally set at rest. If there were no occasion, because of the events of the present year, for reopening the entire question, there would be no justification for disregarding the statute of limitations. But, because something new has developed which necessarily calls into question the previous transaction, we should not allow a formal provision of limitation to interfere with a consideration of all the facts which are necessary for a just result. It seems to me statutes of limitation were not enacted for this purpose and it may well be that section 820, Revenue Act of 1938, is a broad pronouncement, not intended to be exclusive, of the legislative policy that they should not be so regarded, although, unfortunately, the present case lies outside its specified scope.

On the other hand, such a rule as is here suggested would, it seems to me, eliminate some of the difficulties and delays which are now necessarily inherent in the administration of tax legislation. Otherwise, the respondent is placed in the position where he must at his peril contest the position assumed by the taxpayer even though at the time and in the apparent state of the law that position may appear to be correct. Changes in judicial interpretation from time to time are necessarily to be reckoned with. If we are now in a period where such changes may be even more frequent and probable, that is an added reason for taking them into account. The case at bar is itself the result of a decision which, it is to be assumed, the parties did not originally foresee, Le Tulle v. Scofield, 308 U. S. 415. A rule which would permit readjustment of situations developing as a result of judicial clarification and reexamination would, it seems to me, add rather than detract from the extent to which tax cases could be promptly and, for the most part, permanently closed.

        Charles W. Nash, 34 B. T. A. 675; affd. (C. C. A., 7th Cir.), 88 Fed. (2d) 477; certiorari denied, 301 U. S. 700; Chevy Chase Land Co., 34 B. T. A. 150 ; Universal, Inc. v. Commissioner (C. C. A., 7th Cir.), 109 Fed. (2d) 616. See Cartex Mills, Inc., 42 B. T. A. 894.

         Houbigant, Inc., 31 B. T. A. 954; affd. (C. C. A., 2d Cir.), 80 Fed. (2d) 1012; certiorari denied, 298 U. S. 669; Victoria Paper Mills Co., 32 B. T. A. 666; affd. (C. C. A., 2d Cir.), 83 Fed. (2d) 1022; Walter M. Marston, 41 B. T. A. 847 ; Elsie S. Eckstein, 41 B. T. A. 746; Dixie Margarine Co., 38 B. T. A. 471.

        Jamaica Water Supply Co., 42 B. T. A. 359; Hartford Hat & Cap Co., 7 B. T. A. 714; Chicago, Rock Island & Pacific Ry. Co. v. Commissioner (C. C. A., 7th Cir.), 47 Fed. (2d) 990; certiorari denied, 284 U. S. 618; South Dakota Concrete Products Co., 26 B. T. A. 1429; Cooper v. United States (C. C. A., 8th Cir.), 9 Fed. (2d) 216. See Burnet v. Sanford & Brooks Co., 282 U. S. 359.

        Commissioner v. Farren (C. C. A., 10th Cir.), 82 Fed. (2d) 141; Larkin v. United States (C. C. A., 8th Cir.), 78 Fed. (2d) 951; Moran v. Commissioner (C. C. A., 1st Cir.), 67 Fed. (2d) 601, affirming 26 B. T. A. 1154; Raleigh v. United States (Ct. Cls.), 5 Fed. Supp. 622; Crane v. Commissioner (C. C. A., 1st Cir.), 68 Fed. (2d) 640, affirming 27 B. T. A. 360; Alamo National Bank of San Antonio, Executor, 36 B. T. A. 402; affd. (C. C. A., 5th Cir.), 95 Fed. (2d) 622; certiorari denied, 304 U. S. 577. Contra, Helvering v. Williams (C. C. A., 8th Cir.), 97 Fed. (2d) 810, Salvage v. Commissioner (C. C. A., 2d Cir.), 76 Fed. (2d) 112, the affirmance of which, 297 U. S. 106, is of such ambiguity that “it does not seem that the conflict, if there be one, is resolved.” Commissioner v. Farren, supra, 143.

        Central Loan & Investment Co., 39 B. T. A. 981; National Bank of Commerce of Seattle, 40 B. T. A. 72.

       See Estate of William H. Block, 39 B. T. A. 338; affd. (C. C. A., 7th Cir.), 111 Fed. (2d) 60.

         Cf. Revenue Act of 1936, Title III.

       See Stearns Co. v. United States, 291 U. S. 54

        Tide Water Oil Co., 29 B. T. A. 1208; R. E. Baker, 37 B. T. A. 1135; Salvage v. Commissioner, supra; and cf. Rossin & Sons, Inc. v. Commissioner (C. C. A. 2d Cir.), 113 Fed. (2d) 652, with Maryland Casualty Co. v. United States, 251 U. S. 342.

       Cf. Ilfeld Co. v. Hernandez, 292 U. S. 62.

       See Crane v. Commissioner, supra. Cf. Sugar Creek Coal & Mining Co., 31 B. T. A. 344.

       * * * under existing law, an unfair benefit would have been obtained by assuming an inconsistent position and then taking shelter behind the protective barrier of the statute of limitations. Such resort to the statute of limitations is a plain misuse of its fundamental purpose. The purpose of the statute of limitations to prevent the litigation of stale claims is fully recognized and approved. But it was never intended to sanction active exploitation, by the beneficiary of the statutory bar, of opportunities only open to him if he assumes a position diametrically opposed to that taken prior to the running of the statute. The Federal courts in many somewhat similar tax cases have sought to prevent inequitable results by applying principles variously designated as estoppel,' quasi estoppel, recoupment and set-off. For various reasons, mostly technical, these judicial efforts cannot extend to all problems of this type. Nor can they provide a uniform, systematic solution of these problems. Legislation has long been needed to supplement the equitable principles applied by the courts * * *. [Senate Rept. 1567, 75th Cong., 3d sess., p. 49, (Emphasis added.)]

       Subsection f.


author: Murdock:

text:
    Kansas, Oklahoma and Gulf Railway Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 93526, 93527.
    Promulgated November 1, 1940.

      William B. Spofford, Esq., Charles S. Jacobs, Esq., and Robert S. IngersoTl, Jr., Esq., for the petitioner.

      BrooTcs Fullerton, Esq., for the respondent.
   OPINION.

Murdock:

The petitioner was organized under the laws of Oklahoma in 1919, to take over certain railroad properties pursuant to a plan of reorganization known as the “Hook Plan.” All of the preferred and common stock of the petitioner was placed in trust pursuant to that plan and stock trust receipts were issued to the persons entitled to the stock. Those receipts were issued in bearer form. The properties of the petitioner were placed in receivership in 1924. A further plan for readjusting the capital structure of the petitioner was agreed upon in order to avoid foreclosure. The plan was put into effect in 1926'. The Muskogee Co., hereinafter called Muskogee, had in the meanwhile acquired most of the series A, B, and C bonds of the petitioner, most of the stock trust receipts, and all of the common stock of the petitioner. The common stock was eliminated from the capital structure of the petitioner and most of the preferred stock held by Muskogee through stock trust receipts was also surrendered and canceled pursuant to the plan. Most of the bonds of the petitioner were exchanged pursuant to this plan for series A, B, and C preferred stock. Thus, at the conclusion of the 1926 readjustment, the only stock of the petitioner outstanding was divided into four different classes, namely, series A, series B, series C, and preferred stock, all of which had the same par value and all of which had the same voting privileges. Muskogee owned most of that stock.

The stock trust created under the “Hook Plan,” which held only the nonseries preferred stock after the 1926 readjustment, was terminated on July 8, 1931. The surviving stock trustees sent a circular letter to all of the holders of the stock trust receipts in so far as their names and addresses were known to the trustees. The letter notified them of the termination of the trust and requested that the stock trust receipts be presented at once for exchange into certificates of preferred stock. Stock trust receipts were surrendered and certificates for 25,820 shares of preferred stock were issued prior to the close of 1931. Outstanding stock trust receipts for the remaining 1,180 shares of preferred stock were not surrendered by that time and a certificate for those 1,180 shares of preferred stock was issued to and registered in the name of “C. Jared Ingersoll, Agent” on December 28, 1931. The following table shows the amount of each kind of stock owned by Muskogee on January 1, 1932, and the total amount of that stock issued and outstanding on January 1,1932:

Stock trust receipts for 43 additional shares were presented during 1932 and the early part of 1933, so that the unclaimed shares were reduced to 1,137. There was no material change in stock ownership during the taxable years.

Ingersoll voted the stock in his name as agent on February 2,1932. He gave no particular thought to the wisdom of voting the stock. The vote was not challenged and was not necessary to any of the business transacted at the meeting. The unclaimed shares were never voted thereafter.

All of the nonseries preferred stock, including unclaimed shares, was carried on the books of the petitioner as preferred stock until about March 10,1933. The petitioner and Ingersoll decided at that time that it was improper for him to have a certificate for the unclaimed shares and he surrendered the certificate. Entries were made upon the books of the petitioner at that time, but as of December 31,1932, reducing the preferred stock account by the amount of the par value of the unclaimed shares and crediting that amount to an account entitled “Stock liability for conversion — preferred stock.”

Muskogee, which owns stock of a number of corporations engaged as common carriers by railroad, filed a consolidated return for itself and a number of those companies, including the petitioner, for each of the taxable years. The Commissioner, in determining the deficiencies, has eliminated the petitioner from that affiliated group and has computed its tax separately. He determined that Muskogee owned less than 95 per cent of the stock of the petitioner during the taxable years by including as stock, within the meaning of section 141 (d) of the Revenue Acts of 1932 and 1934, not only the shares of preferred stock issued to persons who deposited their stock trust receipts and received certificates for preferred stock, but also the shares of preferred stock for which the holders of stock trust receipts had not as yet deposited those receipts. The Muskogee Co., by that method of computation, owned less than 95 percent of the stock of the petitioner during each of the taxable years. The petitioner contends that its stock, for the purpose of section 141 (d), includes only the shares of preferred stock issued to persons who had deposited their certificates of preferred stock, and does not include the shares of preferred stock to which the holders of stock trust receipts who had not yet deposited them were entitled. Muskogee, by that method of computation, owned more than 95 percent of the petitioner’s stock during each of the taxable years. Thus, the sole question for decision by the Board is whether or not the stock of the petitioner for the purpose of section 141 (d) includes the preferred shares belonging to persons who had not deposited their stock trust receipts. The decision of this question is important because the petitioner had a substantial amount of income for each year, whereas the affiliated group, exclusive of the petitioner, had a substantial net loss in each year.

There is no definition of the word stock in the Revenue Acts of 1932 and 1934 which is particularly helpful. Of. section 1111 of the Revenue Act of 1932, section 801 of the Revenue Act of 1934, and the statement in section 141 (d) that “the term ‘stock’ does not include nonvoting stock which is limited and preferred as to dividends.” There are a number of decided cases in which stock has been defined for the purpose of the question there involved, but their authority here is limited. The arbitrary amount of 95 percent in the definition of an affiliated group appeared for the first time in section 240 (c) of the Revenue Act of 1924. Congress used it to eliminate, as far as possible, the uncertainty which had existed under the “indefinite and vague language of existing law.” Report of the Ways and Means Committee, 68th Cong., 1st sess.„ H. Rept. 179; Report of the Senate Finance Committee, 68th Cong., 1st sess., S. Rept. 398. The House bill contained the words “85 per centum”, the Senate amended by increasing the percentage to 95, and the House receded. It was suggested in the discussion of this percentage in the Senate that it ought to he even higher than 95 percent. See Congressional Record, vol. 65, p. 7130. However, the percentage was fixed at 95 and has remained at that amount ever since, although the privilege of filing consolidated returns has been limited to railroads under the 1934 Act.

The parties are in dispute only as to what stock is to be included in the 100 percent from -which the 95 percent is to be measured. It may be conceded for present purposes that stock owned by the issuing corporation itself, such as, for example, treasury stock, would not have to be included in the 100 percent. Cf. Borg v. International Silver Co., 11 Fed. (2d) 147; Fletcher Cyclopedia of Corporations, vol. 11, § § 5083, 5088. But all stock owned by others than the issuing corporation would certainly have to be included in the 100 percent (excepting, of course, the nonvoting limited and preferred dividends stock mentioned in section 141 (d), which will be disregarded for the present discussion).

Muskogee owned most of each of the four classes of preferred stock of the petitioner during the taxable years. Others owned and held certificates for a portion of each class of that stock. The parties are in agreement as to all such stock. They differ as to whether there should be included in the 100 percent the shares of preferred stock, somewhat in excess of 1,100, for which stock trust receipts had been issued to persons, not otherwise identified in this record, who had never surrendered those stock trust receipts for certificates of preferred stock of the petitioner. Those persons were entitled to receive certificates for shares of the preferred stock of the petitioner upon surrender of their stock trust receipts. Furthermore, a certificate is only paper evidence of the ownership of a share of stock and those persons were the real and beneficial owners of that portion of the petitioner corporation measured by the eleven hundred and some shares of stock, even though they had failed to exchange their stock trust receipts for certificates. Black Eagle Mining Co., 94 Okla. 199; 221 Pac. 425; Fletcher Cyclopedia of Corporations, vol. 11, § 5092; Richardson v. Shaw, 209 U. S. 365; Pacific National Bank v. Eaton, 141 U. S. 227; Anita Owens Hoffer, 24 B. T. A. 22; Elvira Scatena, 32 B. T. A. 675; affd., 85 Fed. (2d) 729; Mascot Stove Co., 40 B. T. A. 1057, 1065. “A corporation consists of a set of rights and duties between the corporation and the owner of the share.” Winslow v. Fletcher, 53 Conn. 390; 4 Atl. 250. Those rights and duties existed as to the shares here in question. The owners of those shares were the owners of that proportionate interest in the petitioner just the same as Muskogee and the other holders of certificates were the owners of the proportionate share in the petitioner represented by the number of shares belonging to them. All of this particular class of preferred stock of the petitioner was included in the trust under the “Hook Plan” and, obviously, all of that stock was outstanding as stock of the petitioner until the termination of the “Hook Plan” in 1931. If at some time thereafter it ceased to be stock of the petitioner, as the petitioner contends, just when did that occur? Surely some proceeding aside from the mere bookkeeping entries made by the petitioner in March 1933 would be necessary to retire and cancel it. The petitioner had some reason to believe that the owners of the small interest here involved might never appear and claim their property. Perhaps their interests might have been forfeited and canceled by a court proceeding, but they never have been. Those interests during the taxable years belonged to and were owned by someone other than the petitioner, and that proportionate ownership in the petitioner can not be ignored for the purposes of section 141 (d). Therefore, we conclude that the petitioner was not affiliated with Muskogee.

Decision twill be entered wider Rule, 50.

       Definition op “Affiliated Group”. — As used in this section an “affiliated group” means one or more chains of corporations connected through stock ownership with a common parent corporation if—
      (1) At least 95 per centum of the stock of each of the corporations (except the common parent corporation) is owned directly by one or more of the other corporations ; and
      (2) The common parent corporation owns directly at least 95 per centum of the stock of at least one of the other corporations;
      * * * # * * *
      As used in this subsection the term “stock” does not include nonyoting stock which is limited and preferred as to dividends.


author: Hill :

text:
    Titus Oil & Investment Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 91993, 94877.
    Promulgated November 1, 1940.

      Ciarle G. Clinton, Esq., for tlie petitioner.

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

Hill :

In computing the deficiencies involved in these proceedings, respondent disallowed deductions claimed by petitioner for intangible drilling and development costs, holding that petitioner, in its original return for 1933, made a binding election, effective for subsequent years, to capitalize such expenditures. The deficiencies involved result in part from the adjustments to income so made by respondent. The sole issue for decision is whether petitioner, in its original return for 1933, made a final and deliberate choice to capitalize the controverted amounts, or whether it made a binding election in its amended, return for 19B3 to charge them to expense.

Kespondent defends his action specifically on the ground that at December 31, 1933, petitioner was in possession of all facts essential to the exercise of its right of election, and that by including the intangible drilling and development expenditures made in 1933 in the asset account entitled “Incomplete Wells” it thereby elected to capitalize such items and recover the amount through depletion allowances.

Petitioner contends that at the end of 1933 the facts necessary to enable it to make an election were not known and could not then have been known; that the asset item “Incomplete Wells” shown on its balance sheet was in effect merely a suspense account, and that by the filing of its original return for 1933 it did not intend to and did not in fact make an election to capitalize intangible drilling expenditures. Under the circumstances shown, we think petitioner’s contention must be sustained.

While it is true that at December 31, 1933, petitioner’s books disclosed the amounts expended in that year for intangible drilling expense, as well as the amounts expended for equipment, it was not known whether additional expense would be incurred. The well was in process of being cleaned out, and some oil had been produced, but the ownership of the oil was in controversy. Furthermore, it was not then known whether the well would be a producer or would be abandoned. Obviously, knowledge of these facts was necessary to enable petitioner intelligently to exercise its right of election to charge drilling expenditures either to capital or to expense. In 1934 the well was completed as a producer, and petitioner received proceeds from the sale of oil properly allocable to 1933. This made it necessary to file an amended return for 1933 to report such additional income, and respondent does not question the propriety of that action.

Petitioner filed such amended return prior to filing its income tax return for the subsequent year 1934, and prior to expiration of the time in which it was required to file its 1934 return. It reported in such amended return the additional income for 1933, and also exercised its right to deduct drilling expenditures as expense. This, we think, constituted the first instance of deliberate choice by petitioner. In our opinion it would be unfair to petitioner to hold that it made an irrevocable election prior to completion of its first well and at a time when not all material facts were known.

There is no statute expressly conferring upon taxpayers the right of election under consideration here, but such privilege is accorded by article 23 (m)-16 of respondent’s Regulations 86, issued under the Revenue Act of 1934. Similar regulations have long been in effect under prior acts, and apparently do not require a taxpayer to make an election prior to completion of Ms first well. See article 23 (m)-16 (d) quoted in material part below. Under these regulations, petitioner could not be required to exercise its right of election prior to completion of its first well in 1934, and respondent concedes that in its 1934 return it elected to deduct intangible drilling and development costs as expense.

In Lucas v. Sterling Oil & Gas Co., 62 Fed. (2d) 951, the Circuit Court had before it facts similar in all material respects to the present proceedings, and both the decision and reasoning of the court support the conclusions we reach hereinabove. See also Callie E. Robertson, 28 B. T. A. 635, 639, where we stressed the point that a taxpayer could not be held to have made a deliberate and binding election until adequate knowledge was had upon which judgment could be exercised in respect thereof.

On the issue submitted for decision, respondent’s action is disapproved.

Decisions will be entered wider Rule 50.

       Art. 23 (m)-16 (d). * * * and a taxpayer who has never made expenditures for a nonproductive well prior to the first taxable year beginning after December 31, 1933, must make an election as to the cost of such wells in the return for the first taxable year in which the taxpayer completes such a well.


author: Murdock :

text:
    B. Cohen & Sons Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 97939.
    Promulgated November 1, 1940.

      Sigrmmd E. Steinberg, Esq., for the petitioner.

      Paul E. Waring, Esq., for the respondent.
   OPINION.

Murdock :

Section 112 (b) (5) of the Revenue Act of 1932 provided that no gain or loss should be recognized if property was transferred to a corporation solely in exchange for stock of the corporation and immediately after the exchange the transferor was in control of the corporation, but if there were two or more trans-ferors, the paragraph was to apply only if the amount of stock received by each was substantially in proportion to his interest in the property prior to the exchange. Section 112 (c) (1) of that act provided that if an exchange would be within the provisions of (b) (5), save for the fact that money was received in addition to stock of the corporation, then the gain should be recognized, but in an amount not in excess of the money received. Section 113 (a) (8) provided for. the retention of the old basis where (b) (5) applies. The Commissioner has apparently determined the petitioner’s bases under those provisions, although it is not clear how he arrived at the total basis of $7,363.55. He has regarded the payment of the cash by Anne and Polish as a separate transaction. He erred in so doing. The word property used in section 112 (b) (5) includes money. Halliburton v. Commissioner, 78 Fed. (2d) 265; Claude Neon Lights, Inc., 35 B. T. A. 424; Cyrus S. Eaton, 37 B. T. A. 715; Columbia Oil & Gas Co., 41 B. T. A. 38. Florence, Anne, and Polish, transferred property to the petitioner in exchange for all of its stock. The transfer of property by Florence and the purchase of stock for cash by Anne and Polish were parts of a single plan. The control mentioned in the statute is determined at the completion of all of the inseparable steps in that plan. Wilbur F. Burns, 30 B. T. A. 163; affd., 85 Fed. (2d) 8; certiorari denied, 299 U. S. 592. Florence was not in control of the petitioner within the meaning of section 112 (b) (5).

However, Florence, Anne, and Polish, who transferred property to the petitioner in exchange for all of its stock, were in control of the petitioner immediately after the transfer. The respondent did not determine that the stock received by those three people was substantially in proportion to their interests in the property prior to the exchange and makes no such argument now. Furthermore, it is apparent that the value of the share of each transferor in the total assets before the exchange is not substantially in proportion to the amount of stock received by him. Cf. Cyrus S. Eaton, supra; United Carbon Co. v. Commissioner, 90 Fed. (2d) 43. The petitioner received $1,500 in cash and about $19,460 worth of assets and paid out $1,300 in cash, so that the net value of its assets was about $19,660. Florence, who contributed over 92 percent of that property, received only 15 percent of the stock, whereas Anne and Polish, who contributed less than 8 percent of the property, received 25 percent of the stock. Section 112 (b) (5) has no application whatsoever. It is not suggested that there is any other provision of the statute which would require the petitioner to take as its basis for the property transferred to it the same basis which the property had in the hands of Florence. The petitioner’s basis is the cost of the property to it.

The petitioner paid for the property with 45 shares of its own stock and $1,300 in cash. Thus, the cost of those assets was $16,045 (45 shares, or 75 percent of its own stock, would be worth 75 percent of $19,660, the total value of its assets, or $14,745). A proper allocation of that cost under the facts of this case is as follows: To accounts receivable, $11,376.84; to merchandise, $4,207.87; to furniture and fixtures, $460.29.

The Commissioner did not make a determination of the fair market value of the assets at the time they were transferred to the petitioner. The evidence in the case shows clearly that Florence purchased those assets at much less than their true value. Witnesses, familiar with the value of accounts receivable and merchandise similar to these, testified that the accounts receivable upon which recent payments had been made were worth a large percentage of face value and the merchandise was worth from 90 to 100 percent of its cost. There was no opinion evidence of the value of the furniture and fixtures. There is other evidence, however, which tends to show that the values of the accounts receivable and the merchandise were less than the percentages stated by the witnesses. Some of that evidence as, for example, the bankruptcy appraisal, is not entitled to much weight. The bankruptcy sale was rather inconclusive as to value. The circumstances of the formation of the petitioner in connection with which Florence turned in the assets for 45 shares, whereas $1,500 in cash was paid for the remaining 15 shares is not determinative. Cf. Gillette Rubber Co., 31 B. T. A. 483. The business done by the store during the bankruptcy proceeding is also evidence. Nor may we overlook the fact that the exact amount of accounts receivable and merchandise transferred to the petitioner is not shown. We have endeavored to fix a value from all of the evidence, after giving due weight to the various kinds of evidence. Subsequent events give some corroboration to the values which we have determined. Others might fix the values differently, but we have determined values which we think the evidence warrants.

The legal fee is not deductible under section 23 (a) of the Revenue Act of 1932. The services were rendered in connection with the acquisition of title to the property. Such expenditures are capital expenditures and are not deductible from income. Vernor v. United States, 23 Fed. Supp. 532.

Decision will be entered umder Rule 50.


author: Mellott : Haeeon,

text:
    (Patrick) P. T. Clary, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96496.
    Promulgated November 5, 1940.

      John J. Dougherty, G. P. A., for the petitioner.

      B. D. Daniels, Esq., for the respondent.
   OPINION.

Mellott :

Respondent contends that the royalties applied during the taxable years by Swanson Brothers to the payment of the Dukane indebtedness “were royalties from the taxpayer’s property — constructively received by him and appropriated to the use of another.” He argues that the question is simply: To whom is the income from proceeds arising and derived from patents at the initial stage attributable — not whose income it may be after other steps are taken. He urges that, even if it be assumed, for the purpose of discussion, that Swanson Brothers would not have entered into the contract without the agreement to liquidate the account of the Dukane Coffee Corporation, still the royalties accrued to the taxpayer first before they could be applied to other purposes, and hence that the income (royalties) was not divested until after it (they) had been earned. He also denies petitioner’s various contentions, hereinafter set out.

Petitioner contends that he never had the unrestricted choice of taking, or refraining from taking, possession of the income in question, and, therefore, that he never constructively received it; that the instrument which created the income destroyed it as far as he was concerned; that he waived the right to receive it as part of the consideration for the contract; that the contract would never have been executed if he had not consented to the waiver; and that, if the waiver can he considered to be an assignment, it constituted an assignment of a property right, and any income accruing thereunder was taxable to the assignee.

The question is a difficult one and the right answer is elusive. Petitioner assumed the burden of attempting to overturn the presumptive correctness of the respondent’s determination and, for reasons which will be pointed out, we think he has succeeded in doing so.

The facts set out in the findings need not be repeated. Suffice it to note at this juncture that petitioner acceded to what appears to have been rather harsh terms — in the language of our findings— “because he felt it was the best arrangement that he could make and that the royalties to be received by him after the indebtedness was liquidated would adequately compensate him for the use of his; patent.” He testified that it was merely a question of giving “something to get something bigger. * * ⅛ I had to do it to get them for the whole term of the patent.” “That was just for a bargain; the best I could take.” Under cross-examination he expressed the same idea when he likened the transaction to giving “a sardine for a salmon.” Eespondent, upon brief, points out that it was a rather large “sardine” which he gave up, since it amounted to more than $50,000. It can not be gainsaid that there is considerable substance to this argument; but in this connection reference may appropriately be made to the fact that petitioner anticipated that the royalties would be sufficient to liquidate the Dukane obligation' in approximately two and one-half years, leaving him free to collect royalties at an estimated rate of $20,000 a year for approximately fifteen years. When these facts are kept in mind the terms of the contract are not so shockingly harsh as they first appear to be.

No attempt will be made to summarize all of the evidence. It indicates, however, that the Dukane Corporation was having financial difficulties. One faction of its management was urging that it be placed in bankruptcy, while petitioner and his nephew — the latter owning about 20 percent of its stock — wished to save it, if possible. Swanson Brothers naturally wanted to collect the account, which was long past due. The situation was such that a hard bargain could be driven. Whether it was a wise one or not, from the standpoint of the petitioner, need not be decided. It is sufficient for the present purposes to advert to the fact, which is amply shown by this record and set out in our findings, that petitioner had not guaranteed the Dukane indebtedness to Swanson Brothers, had not been responsible for the granting of the credit under which it had been created, and was not personally liable for the payment of any part of it. He, therefore, was not discharging any personal obligation of his own in consenting that a portion of the royalties be applied upon the Dukane indebtedness. He was not a stockholder or financially interested in the Dukane Coffee Co.

This Board and the courts have held that an owner of property who contracts to sell it or lease it to another can not escape tax on the income resulting from the sale or lease by designating in the contract that the selling price or rental shall be paid to a third party. Samuel V. Woods, 5 B. T. A. 413; J. T. Browning, 16 B. T. A. 485; John Shirley Ward et al., Executors, 22 B. T. A. 352; affd., 58 Fed. (2d) 757; certiorari denied, 287 U. S. 656; rehearing denied, Dec. 5, 1932; W. L. Shore, 26 B. T. A. 389. The reason for this holding is well stated in Samuel V. Woods, supra, relied upon by the respondent. There an owner leased property and in the lease agreement directed that the lessee pay to his wife and daughter portions of the rents and royalties as they became due. In holding that the amounts paid to the wife and daughter constituted income of the lessor, this Board said:

The petitioner, the parties agree, was the owner of the property from which the income was derived. As such owner he had the right to the income or the right to dispose of it. In the enjoyment of this right, he ordered it paid directly to another until otherwise ordered. He might have taken it, or he might have ordered it sent to his hank, paid directly to a creditor, or held by the lessee. Whichever of these courses he took was an exercise of his enjoyment of the fruits of his ownership inherent in such ownership. * * * Such a voluntary act in anticipation of actual receipt and before the income exists can only affect the income when it actually arises, and in our opinion it may properly be treated as coming to him and immediately disposed of. See Ormsby McKnight Mitchel, 1 B. T. A. 143.

In our opinion the facts relating to the royalties applied by Swanson Brothers during the taxable years to the payment of the indebtedness of the Dukane Coffee Corporation call for the application of a different rule than that applied in Samuel V. Woods, supra, and related cases. Petitioner, as has been pointed out above, never had the right to acquire this income or to dispose of it as he saw fit. It can not be said, therefore, that he ever, either actually or constructively, received it. Moreover, the agreement did not provide that it be paid to a third party, although it is true that its application to the indebtedness of the Dukane Coffee Corporation did unquestionably benefit that corporation, which was not a party to the agreement. However, the primary purpose of the provision was not so much to benefit Dukane as it was to benefit Swanson Brothers; and it had its inception in the desire of that concern to liquidate one of its bad accounts. It was inserted at the insistence of Swanson Brothers and to induce it to enter into the contract.

It is apparent from what has been said that we are of the opinion the Commissioner erred in including the amounts in controversy in petitioner’s income. But such holding need not be predicated entirely upon the ground discussed. Under the contract Swanson Brothers acquired not only an interest in petitioner’s patent — the exclusive right to use it in a specified territory, which vested “pro tanto title to the patent itself in the grantee” (Claude Neon Lights, Inc., 35 B. T. A. 424, 427, and cases cited) — hut also the right to the income from such property to the extent of the Dukane indebtedness. Swanson Brothers thus acquired two valuable property rights in exchange for its promise to pay petitioner all royalties accruing after the Dukane debt had been liquidated. A taxpayer may transfer or assign property or property rights and any income subsequently arising therefrom is not taxable to him, as transferor or assignor. Nelson v. Ferguson, 56 Fed. (2d) 121; certiorari denied, 296 U. S. 555; Blair v. Commissioner, 300 U. S. 5; Hall v. Burnet, 54 Fed. (2d) 443; certiorari denied, 285 U. S. 552; Commissioner v. O'Donnell, 90 Fed. (2d) 907.

We are of the opinion and hold that the respondent erred in including the amounts in controversy in petitioner’s gross income.

Reviewed by the Board.

Judgment will ~be entered for the petitioner.

Haeeon,

dissenting: The main facts in this case were stipulated and the license agreement between petitioner and Swanson Brothers was introduced in evidence. Petitioner called three witnesses — petitioner, S. R. Rudolph, treasurer of Dukane Coffee Corporation and a nephew of petitioner, and B. J. Wells, a member of the partnership known as Swanson Brothers. These witnesses were called by petitioner to testify concerning the circumstances under which it was agreed that the first royalties were to be applied to liquidate Dukane’s debt to Swanson Brothers. Respondent objected to certain testimony being given which might have the effect of modifying the terms of the written agreement. In the interests of learning all the facts pertinent the objections were overruled. There is no ambiguity in. the terms of the license agreement. Hereinafter comment will be made upon the oral testimony.

Petitioner contends that he did not constructively receive the royalties which accrued in the taxable years, that the royalties were assigned to another as part of the agreement made with Swanson Brothers under compulsion in order to get Swanson Brothers to enter into the agreement and that, therefore, the assignment of the first royalties, or the “waiver” of them, constituted consideration from petitioner to Swanson Brothers. Petitioner makes a further contention that the rule of Nelson v. Ferguson, supra, and Julius E. Lilienfeld, 85 B. T. A. 391, applies here. The applicability of the rule in those cases, and similar cases, to this case is not clearly argued, but it appears that petitioner contends that petitioner assigned a property right to Dukane in Ms license agreement and that the royalties in question issued from the assigned property right so as to relieve petitioner, the assignor, from taxation on the royalties.

First, attention must be given to the terms of the license agreement. The only parties to the agreement are petitioner, as “patentee”, and Swanson Brothers, as “licensee.” The agreement is written in the form of an ordinary license agreement. No consideration is recited for the agreement in any specific terms. The licensee is given the exclusive use of the process developed by petitioner witMn a territory and it agrees to pay royalties for the use of the process. The provisions of paragraph II of the agreement are quoted in part in the findings of fact. A fuller quotation is helpful in understanding the terms of the agreement.

II. Licensee agrees to pay to the Patentee a royalty for the use of the said method of processing coffee on each and every bag of coffee roasted by the said Licensee during the continuance of this agreement, * * *. The royalty shall be in an amount equal to one-half of the cost price to the licensee of the number of pounds of coffee saved by the reduction of shrinkage due to the use of this process. * * * [See quotation in findings of fact for the rest of the material provisions of paragraph II.]

The provision for termination of the license agreement is as follows:

V. Upon failure of the licensee to make returns or to make full payments of the license fees or royalties, as herein provided for the period of thirty (30) days from the date above provided for such returns and payment or upon any other default or violation by the licensee of this agreement, the patentee shall have the right and option to terminate this license on thirty (30) days written notice to that effect mailed to the licensee at his last known business address; otherwise this license shall extend for a period of seventeen years from the date hereof.

A complete reading of the license agreement shows that the only consideration was the granting of the license by petitioner. The petitioner had the exclusive right to charge royalties. The grant of a license is adequate consideration for a promise to pay royalties, 48 C. J. 276, par. 447, and ordinarily it is the only consideration moving from a licensor to the licensee. The latter part of paragraph II of the agreement is no more than a provision for the method of payment of the royalties, and it is a direction to the licensee, first, to apply royalties to the liquidation of a debt of another, for wMch petitioner was in no respect liable at law, and, second, to pay royalties thereafter to petitioner, the licensor. Under such terms, and since petitioner was in no way obligated to pay the Dukane debt, Dukane was no more than a donee beneficiary of the agreement. The contention; made by petitioner that he “waived” the receipt of the first royalties as an inducement to obtain the agreement from Swanson Brothers must be carefully scrutinized, first, because it goes outside the terms of a written contract and, second, because of petitioner’s close relation to the Dukane Coffee Corporation, and one of its stockholders. Petitioner was president of that company and his nephew owned about 20 percent of the stock of the company. Petitioner was not married and his nephew may have been his next of kin.

Some of petitioner’s testimony has been referred to already. But all of petitioner’s testimony, taken as a whole, does not strongly support the contention that petitioner was subject to compulsion in the matter of providing that the royalties should first be applied to reduce the Dukane debt. On direct examination his testimony is that, while he did not originally suggest that royalties be used to pay the Dukane debt, that feature was part of what he considered a good bargain. On cross-examination he testified that he was interested in the matter because “one faction was putting us [Dukane] into bankruptcy, and, in my feeling, bankruptcy was a disgrace, and so that ⅛ the only reason I got into it; not to make money for me. That was not the purpose. It was just because this one faction was bringing it [Dukane] into bankruptcy.” The above testimony, with other testimony, shows clearly that, while petitioner was not very active or interested in the success of the business of Dukane, he wanted to help prevent that company from being forced into bankruptcy. Such evidence, in my opinion, demolishes the petitioner’s contention that he “waived” the first royalties as consideration to induce Swanson Brothers to enter into the license agreement. Petitioner’s testimony indicates strongly that he wanted very much to help Dukane continue in business without going through bankruptcy and that he was willing to contribute to reduction of the Dukane debt because he believed it could be liquidated in about two and one-half years and, since his license agreement had seventeen years to run, the arrangement would be profitable to him in the end, anyway.

On the record in the case, I am of the opinion that the question must be decided solely upon the terms of the license agreement of October 19,1938, and, so considered, I believe it is error to hold that petitioner is not taxable upon the royalties which accrued in the taxable years under the license agreement, for the following reason: There was no assignment to Dukane of any property rights in the license agreement whatsoever. That being true, as I believe is entirely clear, it can not be held that the royalties in the taxable years accrued to Dukane under any property rights transferred to it. Unless such can be concluded, the benefit derived by Dukane was no more than a gift to it from petitioner. In fact, Dukane was Clary’s donee of the royalties or income which accrued under the license agreement between petitioner and Swanson Brothers.

The majority view states that “Petitioner * ⅝ * never had the right to acquire this income or to dispose of it as he saw fit.” This view appears to be dictated by a conclusion that the evidence shows that Swanson Brothers insisted that the provision be inserted in the license agreement. The evidence is, at best, extremely weak upon that point. There is a question whether or not it is material in deciding the question. Quite naturally, Swanson Brothers were interested in receiving payment of an account receivable. But petitioner was under no legal obligation to pay Dukane’s debt. Passing from that to the part quoted from the majority opinion, I believe the conclusion stated is erroneous as a matter of law. Petitioner was the owner of property rights in a process for which patents were pending and were granted. He alone could grant a license to use the process. He made such grant by the license agreement and the royalties were derived thereform. As the only party to the license agreement and the sole owner of the process licensed, petitioner had the right from the date of the agreement to all royalties provided for in the agreement and to have them applied as provided for therein. Petitioner directed in the license agreement that royalties be applied to reduce the Dukane debt to Swanson Brothers. Nevertheless the royalties first accrued under the license agreement to petitioner under his property rights in that agreement, none of which were assigned to Du-kane. The royalties were earned and were accrued under the terms of the agreement. I am unable to agree that petitioner never had the right to acquire the royalties accruing db initio, but I believe, rather, that petitioner at all times had the right to acquire the royalties and that he disposed of them by his direction, or consent, to have them applied to the Dukane debt. Certainly the royalties did not accrue to Swanson Brothers, which could not be both the obligee and the obligor of royalties, and Dukane was not assigned any property rights in the property which produced the royalties. It is, of course, not determinative that petitioner did not first receive the royalties. An assignment of income in anticipation of payment thereof does not relieve the assignor from, tax thereon.

I believe this is a clear case of an anticipatory direction to apply future income of property, voluntarily, to the use or benefit of another whose status is that of a donee, and that the rule of Samuel V. Woods, 5 B. T. A. 413; Ward v. Commissioner, 58 Fed. (2d) 757; 287 U. S. 656, and like cases is controlling, and that respondent properly-included in petitioner’s income the royalties which accrued in the taxable years. I respectfully dissent.

Black, Arhold, Hill, and Opper agree with this dissent.


author: Leech:

text:
    Frank E. Wolcott, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100008.
    Promulgated November 5, 1940.

      Thomas Hewes, Esq., E. Barrett Prettyman, Esq., F. Gloyd Await, Esq., and Charles L. Smiddy, Esq., for the petitioner.

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

Leech:

Respondent’s specifically pleaded theory is that petitioner is taxable on the income of the four trusts under sections 166 and 167 of the Revenue Act of 1936. The issues, admittedly, for decision are whether, under sections 166 and 167, (1) petitioner is taxable on the income of the two trusts created for the children who were minors during the taxable year to the extent such income exceeded the amounts paid over for their suitable support, maintenance, and education, and (2) petitioner is taxable to any extent on the income of the two trusts created for the children who were adults during the taxable year.

All of the trusts were irrevocable. At the time of their creation, the trust of shortest duration, i. e., the one for Frank, had nine years to run. In the taxable year, that particular trust had only one more year to run. Nevertheless, there is no legal basis for taxing petitioner on any of the trusts under section 166, since no power of revocation was retained, and since the trusts were to end automatically and their corpora to revert by their terms upon contingencies beyond the grantor’s control, namely, the lapse of time and the survival of the grantor. Helvering v. Wood, 309 U. S. 344.

Respondent builds a labored argument to the effect that because the trustee, a nonadverse interest, was given the power to invade corpus for the purpose of fulfilling the obligations of the grantor, petitioner was in legal effect vested with a power to revest the entire corpus in himself within the meaning of section 166 (2). He is concluded in this position by the case of Lewis Hunt Mills, Administrator, 39 B. T. A. 798. In that case the Board held that the power to revest the corpus in the settlor could not vest until the contingency upon which it was exercisable occurred. Decision went against the taxpayer only because he had failed to disprove the occurrence of the contingency. Here, it has been shown that the trust income was ample to support, maintain, and educate suitably the two minor children in the taxable year, and that no invasion of corpus took place. As to the two adult children, petitioner was under no obligation, and no invasion of corpus took place. The nonoccurrence of the contingency vesting the power having been proved, petitioner must be sustained so far as his liability under section 166 is concerned. Lewis Hunt Mills, Administrator, supra; Percy M. Chandler, 41 B. T. A. 165, 175; Lolita S. Armour, 41 B. T. A. 777; Katherine Boyd Morehead, 42 B. T. A. 851.

Petitioner admits that he is taxable on the income of the trusts to the extent it was actually paid over in discharge of his duties to support, educate, and maintain those of his children who were minors in the taxable year, i. e., Janet and Richard. The 1936 net income of the trust for Richard was less than the amounts paid over during 1936 for his support, maintenance, and education; so the real question arises only as to the trust for Janet. Respondent contends that petitioner is taxable on the entire 1936 income of the trust for Janet, under both Douglas v. Willcuts, 296 U. S. 1, and section 167 of the Revenue Act of 1936.

Respondent’s invocation of Douglas v. Willcuts rests upon the premise that the trust instrument provided for mandatory distributions of all the trust income to the beneficiary, and that whether the trustee distributed all, none, or only part of the income to Janet does not affect petitioner’s liability. See J. S. Pyeatt, 39 B. T. A. 774.

We do not so read the indenture. It authorizes the trustee to apply the net income of the corpus for “the suitable support, maintenance and education of Janet M. Wolcott.” Webster’s New International Dictionary defines “suitable” as “fitting, proper, becoming.” It lists as synonyms “proper, fitting, becoming, accordant, agreeable, competenjt, coprrespondent, compatible, consonant, congruous, consistent.” In law, the word “suitable” has been held to involve an element of discretion. Appeal of Bainbridge, 79 Pa. 482, 485; City of Worcester v. Board of Railroad Commissioners, 113 Mass. 161, 171. Our construction of this indenture is that it authorizes the trustee in the exercise of its discretion to pay over such amounts of income as are necessary, in the judgment and discretion of the trustee, for the support, maintenance, and education of Janet and directs the trustee to accumulate the superfluous balance. Since here the trustee was a bank and not the grantor, the Douglas case thus may be applied only to the extent of taxing to petitioner the amounts actually paid over for Janet’s support, maintenance, and education. Percy M. Chandler, supra; Alfred C. Berolzheimer, 40 B. T. A. 645; Martin F. Tiernan, Trustee, 37 B. T. A. 1048; dismissed, C. C. A., 3d Cir., June 29, 1940; Hudson v. Jones, 22 Fed. Supp. 938; E. E. Black, 36 B. T. A. 346; George H. Deuble, 42 B. T. A. 277; Herbert W. Hoover, 42 B. T. A. 289; J. S. Pyeatt, supra; George H. Whiteley, Jr., 42 B. T. A. 402.

Respondent’s next contention is that petitioner must be taxed on all the income of all four trusts because the trustee was directed to accumulate such income for petitioner’s future benefit within the meaning of section 167 of the Revenue Act of 1936.

Considering these four identical trust instruments, as entireties, each in itself, as is proper (Ellsworth B. Buck, 41 B. T. A. 99; on appeal, C. C. A., 2d Cir.), we note that a careful distinction has been drawn throughout between principal and income. For instance, if the income is not sufficient for the purposes of the trust, the principal is to be invaded. If a beneficiary should die before reaching 25, the principal and any unexpended income was to be divided among the other three trusts. The trustee is given the power, if it buys securities at a premium, to charge the premium against principad or against income, or partly against one and partly against the other. If securities are sold at a profit, the proceeds are to be added “to the corpus of this trust.”

The deeds in their first alternative limitation provide that the particular trust is to terminate when the beneficiary reaches 25, and the trust corpus is then to be paid over to petitioner, if living. That is the only contingency upon which petitioner can receive the corpus. There is nothing said as to the disposition of accumulated income. Nevertheless, we think that the language, both in this instance and throughout the trust indenture, is so carefully chosen as to indicate an intent in petitioner that the unexpended income should be paid over to the beneficiary on termination. This is borne out by the acts of the parties, to which we may resort for evidence of intention. Gibbs-Preyer Trust #1, 39 B. T. A. 492; on appeal, C. C. A., 6th Cir. When the trusts for Frank and William subsequently terminated (after the taxable year), the corpus was returned to petitioner, but all of the unexpended income was paid over to them. In the circumstances, such a disposition of principal and income was wholly proper for the trustee to make. New Haven Bank v. Hubinger, 117 Conn. 417; 167 Atl. 914; Brown v. Mead, 121 Conn. 1; 183 Atl. 27; 4 Bogert on Trusts, sec. 811. The trust incomes in the taxable year were derived wholly from note interest and dividends; and there were no sales of corpus, the profits from which would have to be added to corpus. See Antoinette K. Brown, 42 B. T. A. 693. It follows, in our opinion, that the incomes of the trusts were not held for future distribution to the grantor, and that he can not be taxed thereon under section 167. Higgins v. White, 93 Fed. (2d) 357; Commissioner v. Waterbury, 97 Fed. (2d) 383; certiorari denied, 305 U. S. 638.

Upon the question of the taxability of petitioner upon the income of the four trusts under section 22 (a) of the Revenue Act of 1936, assuming but not deciding that this issue is before us and the burden of proof in respect thereto upon petitioner, we think that the evidence presented, under protest, establishes affirmatively that the rights retained by petitioner in the creation of the trusts fall far short of control or beneficial ownership of the trust properties. The situation as disclosed in no wise resembles that present in Helvering v. Clifford, 309 U. S. 331. Here the trusts are for long terms. They are all irrevocable and no power was reserved to amend or to remove the corporate trustee. Petitioner here reserved no right to vote the stocks transferred, in trust, as in Frank G. Hoover, 42 B. T. A. 786, nor did he, as in that case, reserve the right to direct investments by the corporate trustee. He did reserve the right to disapprove suggested investments, a very reasonable reservation in view of the wide latitude given the trustee in their selection.

The request for a finding of overpayment is granted. The amount of the overpayment will be computed under Bule 50.

Decision will he entered wider Bule 50.


text:
    Estate of Theresa Seagrist, Corn Exchange Bank Trust Company, as Administrator with the Will Annexed, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 96392.
    Promulgated November 5, 1940.

      William H. Amend, Esq., for the petitioner.

      Harold F. Noneman, Esq., for the respondent.
   OPINION.

Murdock :

The Commissioner determined a deficiency of $2,130.05 in estate tax. The issues for decision are (1) whether the Commissioner erred in allowing a deduction of only $40,000 out of $140,600 due on seven mortgages, the lien of which was spread over two properties owned by the decedent and four owned by her husband and (2) whether real estate taxes on properties owned by the decedent, payable in the second half of 1935 after her death, are deductible. The facts have been stipulated and the Board adopts the stipulation as its findings of fact.

Two pieces of real estate, one at 309 and the other at 313 West 42d Street, New York City, were owned by the decedent at all times material hereto. Her husband, Francis K. Seagrist, was the owner of four pieces of real estate known as 317, 319, 321, and 323 West 42d Street, New York City. Each of the six properties was encumbered by a mortgage given by the owner to the Emigrant Industrial Savings Bank. The unpaid principal due as of August 28, 1933, was $35,600 on the mortgages secured by the properties of the decedent and $90,000 on the mortgages secured by the properties of her husband. The decedent and her husband wanted to obtain additional funds with which to pay taxes due on their properties. The Emigrant Industrial Savings Bank agreed to lend an additional $15,000, provided that the lien for the total amount to be owed would be spread over all six of the properties. Counsel for the Seagrists advised them to place the title to all of the properties in the name of either one or the other to facilitate handling the matter. The husband, on August 28, 1933, gave his wife a deed to the four properties owned by him. The decedent, on December 6, 1933, gave to the bank her bond in the amount of $15,000 and a mortgage for the same amount covering all six of the properties. She entered into an agreement with the bank on the same date, consolidating all of the mortgages into one lien, spreading the lien of the consolidated mortgage over all six pieces of real estate, and extending the time for payment. The decedent thereafter on the same day gave her husband a deed to the four properties which he had theretofore conveyed to her.

The $15,000 obtained on the loan, together with an additional amount of about $6,000, was used to pay taxes, penalties, and interest on the properties. $8,351.75 was applied on the properties which originally belonged to the decedent and $12,529.71 was paid on account of properties originally owned by her husband.

A deduction equal to the total amount of the seven mortgages, together with accrued interest thereon, was claimed on the estate tax return for the estate of the decedent. The Commissioner, in determining the deficiency, allowed $40,000 of principal and accrued interest on that amount.

The two properties which had originally belonged to the decedent were included in her gross estate at a value of $212,000. The four properties which originally belonged to her husband were not included in her gross estate.

The decedent died on July 11, 1935, survived by her husband, who was the sole distributee of her estate.

The petitioner contends that $140,600, the entire amount of the seven mortgages mentioned in the agreement of December 6, 1933, between the bank and the decedent, should be allowed' as a deduction in determining the net estate of the decedent. This contention is based upon application to the present case of the following rule of law in New York as stated in Chapman v. West, 17 N. Y. 125:

It is a familiar principle of equity that when mortgaged premises are sold, subsequent to the mortgage, to different purchasers in parcels, the parcels, on foreclosure, are to be sold in the inverse order of their alienation, according to the equities of the respective purchasers in regard to the payment of the mortgage. (Stuyvesant v. Hall, 2 Barb. Ch. 151; Guion v. Knapp, 6 Paige, 35; Howard Ins. Co. v. Halsey, 8 N. Y. 271.) When sufficient is realized by the sale of one or more parcels to pay the mortgage debt and costs, the remaining parcels are, of course, discharged of the lien.

Here the decedent, while record owner of all six of the properties, entered into the agreement of December 6, 1933, spreading the lien of all seven mortgages over the six pieces of real estate. Thereafter she alienated four of the pieces of real estate and retained two which had a value in excess of the total amount of the consolidated mortgages. The petitioner concludes that the mortgages would have to be satisfied out of the two lots belonging to the decedent at the time of her death, her husband’s four lots would be discharged of the lien and, therefore, the entire amount of the mortgage is an unpaid mortgage upon her property deductible under section 303 (a) (1) (D) of the Bevenue Act of 1926, as amended by section 805 of the Bevenue Act of 1932.

The respondent agrees that the above quotation is a correct statement of the law of New York but he argues that it has no application here. He says the rule is an equitable one and would not be applied between this decedent and her husband where inequities would! result from its application. The cases cited by the petitioner do not show that the rule would be applied and we do not believe that the courts of New York would apply the rule under circumstances like those shown here. The benefits of the four loans originally made on the properties of the husband all flowed to him, as did the larger part of the benefit from the $15,000 blanket mortgage. The transfers of the four properties to the decedent and back to her husband were without consideration. We can see no equity in holding her two properties primarily liable for the payment of moneys borrowed and used by him. If the properties of the decedent were ever taken in foreclosure by the mortgagee, rights of subrogation against the husband and his property upon the original bonds and mortgages would accrue to the decedent or her estate. Thus, the actual amount of indebtedness for which her estate was ultimately liable and for which a deduction should be allowed in arriving at the true value of her net estate, was not in excess of the amount used by the Commissioner in determining the deficiency. Cf. John Parrott, Jr., et al., Executors, 7 B. T. A. 134; affd., 30 Fed. (2d) 792; certiorari denied, 279 U. S. 870.

Section 303 (a) (1) (D) allows deductions “for unpaid mortgages upon, or any indebtedness in respect to, property where the value of decedent’s interest therein, undiminished by such mortgage or indebtedness, is included in the value of the gross estate.” Section 303 (a) (1) further provides:

* * * The deduction herein allowed in the case of claims against the estate, unpaid mortgages, or any indebtedness shall, when founded upon a promise or agreement, be limited to the extent that they were contracted bona fide and for an adequate and full consideration in money or money’s worth.

To what extent, from the standpoint of the decedent, did she contract the agreement of December 6, 1933, for an adequate and full consideration in money or money’s worth? She never had any real financial interest in the four properties belonging to her husband. It may fairly be assumed that her agreement to pay the unpaid balance of $35,600, secured by the two mortgages on her own property, was contracted bona fide and for an adequate and full consideration in money or money’s worth. Likewise, to the extent that she benefited from the $15,000 borrowed in 1933, her promise and agreement in connection with that mortgage was contracted for an adequate and full consideration in money or money’s worth. The record does not show who furnished the additional $6,000 used to pay taxes. The petitioner had the burden of proof and we may not assume for its benefit that the $6,000 was not furnished by the decedent. Therefore, this record does not show that the decedent benefited from the $15,000 mortgage in any amount in excess of $2,351.75. Thus, the total adequate and full consideration in money or money’s worth in the agreement of December 6, 1933, measured from the standpoint of the decedent as shown by this record, was $37,951.75. The two quoted portions of the statute, read together, clearly indicate that Congress did not intend to allow any greater deduction, under the circumstances of this case, than has been allowed. Cf. Oreon E. Scott et al., Executors and Trustees, 25 B. T. A. 131; Estate of Herbert A. Schoenfeld, 37 B. T. A. 36; affd., 103 Fed. (2d) 964; Estate of Charles H. Lay, 40 B. T. A. 522.

Real estate taxes for the second half of the calendar year 1935 upon real estate in the city of New York became liens upon the real estate on October 1, 1935, when they also became due and payable. The decedent owned a number of pieces of real estate in; the city of New York. They were included in her gross estate. Taxes on those properties for the second half of the calendar year 1935 were paid after her death in the amount of $7,543.50. The estate claims the right to deduct that amount. The Commissioner has disallowed the deduction. His position is that since the lien for the taxes did not attach until after the death of the decedent, and since the taxes were not payable until that time, they were not debts of the decedent for the purpose of determining her net estate. It has been held that the determining factor in ascertaining the deductibility of taxes from the gross estate under provisions like those in section 303 (a) (1) of the Revenue Act of 1926, is the date upon which a lien for the taxes attaches. Charles B. Shelton et al., Executors, 3 B. T. A. 809; Roy J. O'Neil et al., Administrators, 31 B. T. A. 727; Estate of Henry Friend, 40 B. T. A. 768; Estate of A. S. Klyce, 41 B. T. A. 194; Carter v. United States, 3 Fed. Supp. 782; Thompson v. United States, 8 Fed. (2d) 175. We hold, following those cases, that the Commissioner did not err in disallowing the deduction.

Decision will be entered for the respondent.