author: Sternhagen :

text:
    Domestic Management Bureau, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 77693, 87586.
    Promulgated September 28, 1938.

      Albert S. Lisenby, Esq., for the petitioner.

      Eugene G. Smith, Esq., for the respondent.
   OPINION.

Sternhagen :

1. The petitioner on its return deducted as a loss the $17,915.28 charged off on its furniture and fixtures account. The Commissioner disallowed the deduction:

* * * f0r tlie reason that it is considered that the payment made therefor to the National Cash Credit Association was in the nature of a payment for good will and not for tangible assets.

It appears from the evidence that, when petitioner paid the Na-national Cash Credit Association an amount equal to its book value of furniture and fixtures, it was not merely buying furniture and fixtures, even at an exorbitant price, but was paying also for a promise of management contracts and to repress complaint or litigation by dissatisfied shareholders. How much is even approximately allocable to furniture and fixtures is impossible to say. Groves’ statement that petitioner used “about a third” of the furniture in its Philadelphia office and abandoned the rest affords no basis for apportioning the $18,996.27 paid. The only identifiable item is the $1,525.82 which was accounted for as the cost of a check writer which was charged off. How the $17,915.28 was computed is not clear, but it can not be brought to check with the $18,996.27.

It is not impossible or in the least unreasonable to believe from the evidence, as the Commissioner has held, that $17,915.28 was paid for an intangible asset, call it good will or an assurance of future contracts or “to avoid trouble” or what not. Such a payment is not deductibe either as a loss or as an expense. (Public Opinion Publishing Co. v. Jensen, 76 Fed. (2d) 494; First National Bank of Omaha v. Commissioner, 49 Fed. (2d) 70; Clark Thread Co. v. Commissioner, 100 Fed. (2d) 257). Nor is it the subject of exhaustion, since there is no evidence of a determinable life of the investment. Norwich Pharmacol Co., 30 B. T. A. 326. There is also no evidence to support the idea that there was any subject of obsolescence or any process of obsolescence of whatever the subject matter may be thought to be. Therefore, except for the unidentified lot of abandoned furniture, which was useless and apparently valueless when acquired, petitioner still has all that it paid for and has lost nothing. To establish a loss it should have proven the destruction, abandonment, or utter worthlessness of specific property which had been acquired at an identified cost and not merely the abandonment of some property which had been acquired as a minor incident in a composite transaction. Saline Motor Co., 22 B. T. A. 874; Columbus Brick & Tile Co., 26 B. T. A. 794.

There is some analogy to the purchase of land with an old house upon it which is to be removed to make way for a new structure. The destruction or abandonment of the old building has been held to be no ground for a deduction. Liberty Baking Co. v. Heiner, 37 Fed. (2d) 703; Lansburgh & Brother, Inc., 23 B. T. A. 66; Robert B. Griffin, 17 B. T. A. 255.

The Commissioner’s disallowance of the deduction of $17,915.28 is sustained, as is his denial of any deduction for depreciation in excess of $495.78, being 10 percent of the balance of $4,957.81 in the furniture and fixtures account.

2. The Commissioner disallowed the deduction both of the $25,000 paid to Wallace Groves and of the $2,600 paid for printing, saying “The cost of preparing the manual and printing of same is held to be a capital expenditure.” The evidence can not be said to establish any error in this determination. By extended testimony of George and Wallace Groves, an attempt was made to show that the amount was to a substantial extent, say two-thirds, paid as compensation for the services of Wallace Groves, and hence deductible as ordinary and necessary expenses of carrying on the business, and, failing that, to show that the manual was of a useful life of not more than two and a half years and that its cost was the subject of deductible exhaustion on that basis. But it is hard to get a foothold in this highly rationalized testimony and these “very complex” corporate operations upon which one can stand to make an assured finding of fact at variance with the Commissioner’s determination. That Wallace Groves, out of Ms active experience in the small loan business, devised the manual of instructions is shown. Apparently he also gave some further attention to the petitioner’s business which might be called services, although what they were and when performed the witnesses found it hard to say. After carefully hearing and considering the evidence, we have found that the entire amount of $25,000 was paid to Wallace Groves as the cost of the manual. The manual was a capital asset and its cost is therefore not properly deductible. The $2,600 paid for its printing was part of its cost and is therefore likewise not deductible.

The respondent now concedes that the cost of the manual may be amortized and that 1/56 of its cost is deductible as exhaustion in the fiscal year 1932. Petitioner, however, is not content with exhaustion measured by the life of the copyright, but claims that the period of exhaustion shall be taken as 2½ years. George Groves testified that changing business conditions required frequent changes in the manual; “it was continually changing from the day it came off the press”; and that he was sure when the manual was first completed that changes would result in “an entirely new manual” in 2½ years. TMs testimony does not establish that the copyrighted manual in which the original investment was made was in process of exhaustion. Taylor v. Commissioner, 51 Fed. (2d) 915; certiorari denied, 284 U. S. 689. It does not appear whether the cost of the new and substituted pages has been deducted in the later years when paid; but the depreciable life of a depreciable asset is not ordinarily treated as lessened by the substitution of new and improved parts for old.

The respondent’s concession of a deduction of 1/56 of $27,600, or $494.62, during the fiscal year 1932 is as much as petitioner may have.

3. The Commissioner disallowed a deduction of $7,500 claimed as ordinary and necessary expense. The petition and the evidence on the issue are jumbled and vague beyond hope of analysis and findings. The accounts indicate a payment of $3,750 to Merchants & Manufacturers Securities Co., controlled by George Groves, and another of “legal fees” without identification. George Groves testified that $3,500 [$3,750] was paid by him to Arthur Green, president of the Merchants & Manufacturers Securities Co. “for cancellation of a certain contract” which has since been lost — a contract to manage the Domestic Finance Co.’s loan offices. Three thousand seven hundred and fifty dollars was paid by George Groves to Arthur Green to pay to “a hostile lawyer who threatened to cancel these contracts by litigation and he wanted a certain sum of money to step out of the picture. Mr. Green finally got him down to accept $3,750 if he wouldn’t take any action.”

The petitioner does not now press the issue, and the Commissioner’s disallowance of the deduction of $7,500 is sustained.

4. The Commissioner disallowed a deduction of $12,000 alleged by petitioner to have been loaned to the Pennsylvania Industrial Banking Corporation and $2,000 alleged to have been loaned to the Grow-art Corporation and ascertained in the fiscal year 1932 to be worthless debts. The substantive evidence to support the deductions is all in the testimony of George Groves. The petitioner’s books account for the alleged items in a manner substantially different from an accounting for loans. Of the $12,000 said to have been advanced to the Pennsylvania Industrial Banking Corporation, it appears from the books that a $5,000 check drawn to George Groves was immediately charged off as “legal fees” and a $2,000 check to one Orth, who was in some way related to the Pennsylvania Co., was immediately charged to miscellaneous expense. There is no item on the books to give the least indication of a receivable as to either of these items or as to any amount from the Pennsylvania Co.

No attempt was made to explain these entries in reconciliation with the alleged loans. The story George Groves told on the witness stand is that the Pennsylvania Co. was organized by the former Superintendent of Banking of Pennsylvania and several others to bring together numerous savings and small loan businesses in the commonwealth, and he said he would “advance” $12,000 to help finance the project, with the understanding that if it succeeded the petitioner would get a contract to manage the resulting small loan business. He says he advanced $10,000 in August, and, as has been said, there is an entry of $5,000 on the petitioner’s books as a check to him for legal fees. The other $5,000 does not appear on the books in any form. Because of the depression, the venture failed in the year it was started, and with it the prospect of any management contract. This, says Groves, was known to him in November 1931. In December $2,000 was given to Orth because Groves had promised $12,000 and the additional amount had been spent in promoting the project. The Pennsylvania Co. was left entirely without assets and the amount of $12,000 was irredeemably lost.

This oral testimony is all there is. There is no corroboration and it must he decided whether the witness is to be entirely believed. As to this, we are by no means free from doubt. The petitioner’s accounts do not support the testimony, and yet the accounting labels used throughout the bookkeeping seem to mean but little in any event. Whether the witness’ oral statement is any more reliable is hard to say; and without it there is no more in this record upon which to base findings than the Commissioner says there was before him. In our opinion, the evidence is too flimsy to be a foundation for the necessary findings of fact. This Board is no more bound than is a jury to believe the statements of the most interested witness, even though there be no direct or affirmative evidence to the contrary. The Board is unable to conclude that there is any basis for the deduction claimed of $12,000 alleged to have been paid to the Pennsylvania Industrial Banking Corporation or the $2,000 alleged to have been paid under similar conditions to the Growart Corporation, and the Commissioner’s determination as to these items is sustained.

5. The Commissioner disallowed deductions of the $5,000 and $3,565 paid for lawyers’ services in the taxable year 1932. The dis-allowance was for lack of evidence submitted to the Commissioner to support them. It is now proved that the amounts were in fact paid for services which were described adequately to support the findings that they were ordinary, and the conclusion that the payments were ordinary and necessary expenses of the taxable year. The amounts are deductible, and the Commissioner’s determination as to them is reversed.

6. The petitioner on its 1932 return deducted $60,000 as salary paid to George Groves, its president. The Commissioner determined $30,-000 as a reasonable salary and disallowed the deduction of the excess of $30,000. The petitioner now admits that no salary was actually paid to Groves for January and February 1932, and that to the extent of $10,000 the deduction was excessive. It contests the disallowance of any part of the $50,000 actually paid. The only question is as to its reasonableness.

The evidence describes the services and also the services and compensation of comparable positions in similar businesses, and in our opinion adequately supports the finding that the salary was reasonable compensation for the services performed. It is, therefore, properly deductible, and the Commissioner’s determination is reversed in so far as it disallows $20,000 of the deduction taken, and sustained as to the disallowance of $10,000.

Docket No. 81586' covers the fiscal year 1933. The petition raises four issues. As to the first issue, which contests a disallowance of a deduction of $9,567.45 bad debts or losses, there is no evidence, and it must be regarded as abandoned. The Commissioner’s determination is sustained. As to the second issue, which claims a deduction for salary to George Groves, its president, there is no evidence to support the claim, and the Commissioner’s determination is sustained. The third issue is a corollary of the claim above considered for a deduction of $17,915.28 in the fiscal year 1932 in respect of furniture bought and abandoned. The Commissioner made no adjustment of the item for 1933, and there is nothing in the record upon which a conclusion can be based that an adjustment is required. The fourth item is likewise a corollary for 1933 of the issue above considered, as to a deduction for amortization of the cost of the manual. The respondent’s concession that the cost of $27,600 is amortizable over the life of the copyright will result in a proportionate annual deduction.

Judgment will be entered under Bule 60.

       Testifying to justify his salary in another issue, George Groves said he was general manager of the Pennsylvania Industrial Banking Corporation.


source: Caselaw Access Project

author: Smith :

license: Public Domain

text:
    Equitable Trust Company, a Corporation of the State of Delaware, and James M. Tunnell, Trustees, under the Last Will and Testament of Edward W. Pyle, Deceased, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 85026.
    Promulgated September 29, 1938.

      James M. Tum/nell, Esq., for the petitioners.

      Benjamin W. Brodsky, Esq., for the respondent.
   OPINION.

Smith :

This proceeding is for the redetermination of a deficiency of $831.39 in income tax for 1933 of the trust estate created under the will of Edward W. Pyle, deceased. The sole question in issue is whether certain fixed annual payments which were made to beneficiaries pursuant to provisions in the testator’s will are deductible from gross income of the estate. The respondent has determined that the disputed payments were “annuities” or “bequests” which were chargeable against the corpus as well as the income of the trust estate and accordingly are not deductible from gross income of the trust. The petitioners contend that the distributions were income distributions, deductible by the trust estate and taxable to the beneficiaries.

The answer to this question is to be found in the construction of the testator’s will. The will reads in part as follows:

6.1 order and direct Equitable Trust Company and James M. Tunnell, Trustees as aforesaid, out of tbe said trust estate, to pay annually, from the date of my death, to my wife, Harriet R. Pyle, the sum of Six Thousand Dollars ($6,000.00) for and during the term of her natural life; to pay annually, from the date of my death, to Roger Vandegrift, of Edgemoore, Delaware, the sum of Pour Thousand Dollars ($4,000.00) for and during the term of his natural life; to pay to my nephew, Milton S. Pyle, of Moore, Pennsylvania, One Thousand Dollars ($1,000.00) per year for ten (10) years after my death, provided the said Milton S. Pyle shall live for that length of time; and to the Ladies Aid Society of the Methodist Episcopal Church at St. George’s, in Baltimore Hundred, Sussex County and State of Delaware, the sum of One Thousand Dollars ($1,000.00) per year for ten (10) years, at least one-half (½) of the said fund to be used by said organization for some charitable purposes, and the other one-half (½) to be used for such religious purposes as the said Ladies Aid Society may determine.
6. I direct that the above annuitants shall be paid in convenient periodical payments, and such income in the hands of my Trustees shall not be liable to the debts, contracts or engagements of the said annuitants or to those of any other person, nor shall they be capable of assignment, alienation or pledge, nor liable to attachment, execution or other legal process.
» * * * * * ⅜
8. All income not necessary for the said annual payments shall be added to the estate in the possession of Equitable Trust Company and James M. Tunnell, Trustees as aforesaid.
9. It is my will and desire, and I direct that my Trustees herein named, after providing for an income sufficient to maintain the annuities herein provided for, shall have the authority to erect and maintain in Baltimore Hundred, Sussex County and State of Delaware, or in the vicinity of the same, some charitable institution, and suggest that the same be either a hospital, a home for children, or a home for adults, or any combination of the same.

After directing the trustees to turn over to a corporation which was to be organized to operate the institution mentioned in paragraph 9 an endownment fund of $200,000 to be paid out of the trust estate, the will further provided:

pL6. While I have in this my Will given specific direction with regard to the corpus of my estate, I desire to vest in my said Trustees a broader power than is) herein limited with regard to the application of the residue of my estate after the payment of said annuities, and it being my intention that my estate shall be used for the alleviation of suffering in Baltimore Hundred and vicinity, I authorize and empower my said Trustees, or the survivor of them, in their uncontrolled discretion to establish such institutions as in their judgment will meet my desires in said matter by the establishment of such institution or by the division of my residuary estate among institutions then in existence in Baltimore Hundred, or its immediate vicinity, for such charitable work as I have indicated, and I direct that approximately one-half ( ½) of my estate in a round sum shall be set apart as endowment funds for the institutions which my Trustees may select as beneficiaries.
17. In case by reason of age or illness, any beneficiary under this my Will shall become incapable of receiving and disbursing the income to which he or she is entitled, I authorize and empower my Executors and Trustees to pay and apply such income to the comfortable maintenance and support of such incapacitated beneficiary without being required to apply to any Court for leave to make such payment.
18. I authorize and empower my Executors and Trustees to retain any investments which I may leave at the time of my death, or in their discretion to sell and convert the same, and to invest and re-invest my estate in such securities as to them shall seem proper, not confining them to what are known as legal investments, and without liability for depreciation or loss by reason of the exercise of such discretion or for any cause other than negligence. However, it is my desire, and I do suggest to my said Executors and Trustees that my real estate in the City of Philadelphia, the same being at the Southeast Corner of Arch and 33rd Streets, shall be held a reasonable number of years because of my belief that property in the neighborhood of its location will greatly appreciate in value during the next few years. However, this is not a direction, but a suggestion to said Executors and Trustees for their guidance, subject to their judgment in case of extraordinary circumstances arising.

Section 162 (b) of tbe Revenue Act of 1932 provides that in computing the net income of an estate or trust there shall be allowed as a deduction:

* * * †⅛ amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, * * * but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. * * *

Section 22 (b) (3) of the same act provides for the exclusion from gross income of “the value of property acquired by gift, bequest, devise, or inheritance (but the income from such property shall be included in gross income).”

In Burnet v. Whitehouse, 283 U. S. 148, and also in Helvering v. Pardee, 290 U. S. 365, the Supreme Court held that annuities chargeable against the corpus of a testamentary trust estate are bequests or legacies and are not taxable to the legatees as beneficiaries of the trust nor deductible by the trust estate as distributions of income. In Helvering v. Pardee, supra, the Court said:

The annuity provided by the will for Mrs. Pardee was payable at all events. It did not depend upon income from the trust estate. She elected to accept this in lieu of her statutory rights. She chose to assume the position of an ordinary legatee. Section 213 (b) (3), Revenue Act of 1924, c. 234, 43 Stat. 253, 267, 268 (26 USOA § 954 and note), exempts bequests from the income tax there laid. Payments to Mrs. Pardee by the fiduciary were not necessarily made from income. The charge was upon the estate as a whole; her claim was payable without regard to income received by the fiduciary. Payments to her were not distribution of income; but in discharge of a gift or legacy. The principle applied in Burnet v. Whitehouse, 283 U. S. 148, 51 S. Ct. 374, 75 L. Ed. 916, 73 A. L. R. 1534, is applicable.

The language of the testators will in the instant case leaves little ground for doubt that the payments in dispute were charges against the entire estate and were payable in any event out of either income or corpus of the trust. The language of the will is:

I order and direct Equitable Trust Company and James M. Tunnell, Trustees as aforesaid, out of the said trust estate, to pay annually, from the date of my death, to my wife, Harriet R. Pyle, the sum of Six Thousand Dollars ($6,000.00) for and during the term of her natural life; * * *

There is no expressed or implied direction in paragraph 5 of the will that the payments are to be made only out of income. The word income is not anywhere used. The only suggested source of the payments is “out of the said trust estate.”

In paragraph 6 and also in other parts of the will the persons to whom the payments are to be made are referred to as “annuitants” and in paragraphs 5, 9, and 16 the payments are called “annuities.” The word “annuity” has a definite legal’ meaning. It is a fixed amount to be paid absolutely and without contingency. See Peck v. Kinney, 143 Fed. 76; Ronald De Reuter, 7 B. T. A. 600.

Petitioners make the argument that the wording and provisions found elsewhere in the will show an intention on the testator’s part that the payments to the annuitants should be made only out of the income of the trust estate without encroachment on the corpus. Attention is called in petitioners’ brief to paragraphs 8 and 9, which it is said “suggest very clearly that the testator had in mind only payment from income.” This argument, we think, is unavailing. Paragraph 8 merely provides for the addition to the trust corpus of the income not necessary for payment of the annuities. It indicates, merely, that the testator may have contemplated that there should be sufficient income, and more, for such payments. Paragraph 9 deals primarily with the erection and maintenance of some charitable institution which was to be done “after providing for an income sufficient to maintain the annuities herein provided for.” These provisions are in no sense restrictive of the annuity payments provided for in paragraph 5.

Petitioners further call attention to the reluctance of the courts of the State of Delaware to sanction the sale of real estate to satisfy bequests and legacies. They contend that the payment of the annuities in question would necessitate the sale of the real estate held by the trust. This question, it is said, has been submitted to the Chancellor of the State of Delaware in a petition for a construction of the will. The evidence before us, however, does not show what part of the trust estate consisted of realty and what part personalty. It is stated in petitioners’ brief that at the time of the decedent’s death his estate consisted principally of a large building at Thirty-third and Arch Streets in Philadelphia, against which there was a mortgage of $85,000, and slightly over $100,000 in mortgages and other personal assets. The respondent has determined in his deficiency notice that the net income of the trust for the taxable year 1933 was $12,539.82, while the distributions to beneficiaries or legatees amounted to only $10,899.99.

However that may be, we are of the opinion that the plain wording of the testator’s will requires the yearly payments to be made in any event out of either the income or assets of the trust estate. This being so, the payments are bequests and are not taxable to the recipients nor deductible from the gross income of the trust. Burnet v. Whitehouse, supra; Helvering v. Pardee, supra; Helvering v. Butterworth, 290 U. S. 365.

Judgment will Toe entered for the respondent.


author: Stbiínhagen :

text:
    John H. Cook, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 77140.
    Promulgated September 29, 1938.

      J. Nelson Anderson, Esq., for the petitioner.

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

Stbiínhagen :

1. The Commissioner held that the $15,670.25 received by the petitioner in excess of the cost ($33,261.50) of the $45,000 par value of bonds is taxable as ordinary income. The petitioner urges that the gain was a “capital net gain” as defined in Revenue Act of 1928, section 101 (c) (l). To succeed he must establish that the gain was “from the sale or exchange” of the bonds.

He argues that the bonds did not mature and were not redeemed in 1931; that the payment was received out of the condemnation award, and not from the bond obligor or in accordance with the terms of the bond, and that prior decisions involving such circumstances and denying the use of the capital gain rate are therefore distinguishable. The argument is fallacious. The issue must be stated and met in the statutory language of sale or exchange. If there be no sale or exchange, the question whether there was a redemption is of no significance. It is no avail to a taxpayer that his case is not within the scope of earlier adverse decisions unless by showing this he also brings himself within a permissible interpretation of the words of the statute.

It is impossible to say that petitioner either sold or exchanged his bonds. By sovereign power his right as a bondholder was brought to an end and he was compensated in the specified amount. No one bought his bonds and he had no choice to hold them longer. It is only because he had held them more than two years that there is reason to think about whether the capital gain tax applies; but the thought is ended when it appears that the occasion on which he received his gain was not a “sale or exchange”, Hale v. Helvering, 85 Fed. (2d) 819; Estate of George Herder, 36 B. T. A. 934 (on review D. C. App.).

2. The second issue is badly snarled. The petitioner in 1931 received $48,994.40 from the Passaic Holding Co. in liquidation of the 910 shares which he held as the result of the distribution to him in 1926 by the New Jersey General Security Co., in which he held 280 shares; and the question is, How much of this amount is taxable gam in 1931 ? This question is simple enough, and, as so stated, its answer should not be difficult. But the difficulty is found in trying to adjust the treatment to be applied in 1931 to what has been done in the past.

When in 1926 the 910 shares of the Passaic Holding Co. were received from the General Security Co. this was a dividend and taxable to petitioner as such at the full value at that time of the 910 shares. It was not a “stock dividend”, Peabody v. Eisner, 247 U. S. 347. Such value then became the basis to be thereafter used in lieu of cost when the 910 shares were disposed of. The liquidation which occurred in 1931 was ordained by statute to be treated as the equivalent of a sale, Revenue Act of 1928, section 115 (c); and hence the gain or loss is the difference between the $48,994.40 received and the basic value.

"What that value is can not be ascertained from this record. No attempt has been made by either party to prove it, it indeed its materiality has ever been apprehended. The evidence was submitted in a written stipulation of facts filed at the hearing without much discussion or argument. The pleadings have been several times amended, the latest on both sides being filed by consent after the hearing and after the Board’s memorandum opinion in the case involving 1926 had been entered and served. It can not be said, therefore, that a full hearing has not been had or that either party has had less than an adequate opportunity to prove all the facts or present all the argument necessary to support his position. For the Commissioner no brief has been filed, although by his amended answer filed after the hearing he pleads error in his treatment of the $48,994.40 and prays for an increase in the deficiency “accordingly”, thus assuming the burden of proof as to the increase. The petitioner in a reply demurs. In this state of the record the decision can not be made accurately on the merits but must fall as best it can in accordance with the way it is submitted.

Apparently the income shown on the petitioner’s 1931 return contained no part of the $48,994.40. The Commissioner in determining the present deficiency computed the gain by a complex computation of cost of the 910 shares. From the admitted cost of $39,812 which petitioner had originally paid for his 280 shares of General Security stock, $17,754.80 is subtracted as a nontaxable distribution in 1926 as said to have been then claimed by the taxpayer. The justification for the subtraction does not appear; the deficiency notice shows only that it is the total of 280 shares at $63.41 a share; and the stipulation states only that in his 1926 return petitioner excluded $12,715.42 “on the basis that it represented a nontaxable distribution of cash and bonds” from the General Security Co., the exclusion of which is the subject matter of Docket No. 52074. It does not appear why the $12,715.42 distribution of “cash and bonds” should have any relation to the distribution of Holding Co. shares or to the figure of $17,754.80. Proceeding with the Commissioner’s computation, the remainder of $22,-057.20 is treated as the total cost of the composite 280 shares of General Security and 910 shares of Passaic Holding, and of this, 50.09 percent, or $11,048.45, is allocated to the 910 Holding Co. shares as their cost basis. This may, in the absence of assignment of error and evidence, be taken as the value of the 910 shares when received. This in turn is reduced by “nontaxable distributions” in 1929 and 1930. For the entire 920 shares the “adjusted cost basis” is taken as $6,546.45 and the resulting “gain on liquidation” as $42,986.35.

The fault which the petitioner in his petition found with the Commissioner’s deficiency determination was that $17,754.80 was taken as the amount excluded from income in 1926 to reduce the basis instead of the $12,715.42 which petitioner says he excluded. But, as has been said, the $12,715.42 was not thought to be the value of these 910 shares but the value of some cash and bonds. The Commissioner’s affirmative claim for an increase in the deficiency is based upon a use of a so-called “zero basis” referred to in Helvering v. Gowran, 302 U. S. 238, and Helvering v. Pfeiffer, 302 U. S. 247. But that “zero basis” was applied to a “stock dividend”, that is, a dividend distributed by a corporation in shares of its own stock. It is not shown to have any application to a property dividend such as this.

In such a state of the record, we can do no better than leave the deficiency where the Commissioner originally found it.

There is a third issue as to salary, which the Commissioner concedes.

Thus the determination on the first and second points is sustained, the Commissioner’s affirmative claim for an increase is denied, and the determination on the third point is reversed.

Judgment will be entered under Bule 50.

       (1) “Capital gain” means taxable gain from the sale or exchange of capital assets consummated after December 31, 1921.

        John S. Watson, Jr., 27 B. T. A. 463; Arthur E. Braun, Trustee, 29 B. T. A. 1161; Ernest W. Brown, 36 B. T. A. 178; dismissed, C. C. A., 2d Cir.; see also United Slates v. Fairbanks, 95 Fed. (2d) 794; Felin v. Kyle, 22 Fed. Supp. 556; George A. Hellman, 33 B. T. A. 901; Francis M. Averill, 37 B. T. A. 485. Cf. White v. United States, 21 Fed. Supp. 361; Mary S. Childs, 35 B. T. A. 1125, which consider the redemption of shares of stock in the light of the statutory provision that liquidation shall be treated as payment for the shares.

       An additional 10 shares admittedly bought in 1928 for $650 was included in the com* putation; but since it is not the subject of dispute, it is not important here.


author: Opper :

text:
    M. W. Alworth, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 91345.
    Promulgated September 29, 1938.

      Franje W. Wilson, G. P. A., for the petitioner.

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

Opper :

Petitioner, the sole stockholder of two corporations which are concededly personal holding companies within the meaning of section 351 of the Revenue Act of 1934, in order to obtain for these corporations the benefit of the remission of tax provided by subdivision (d) of that section, returned as his income what purported to be the entire “adjusted net income” of the respective corporations for the year 1934. The dispute here is whether in fact he did so, the item giving rise to that dispute being the amount of Federal income and excess profits tax due from the corporations for the year 1934 and paid in 1985. That is the only issue, the sole error alleged in the petition being respondent’s “Failure to recognize in computing the undistributed adjusted net income under Section 351 (b) (2) of the Revenue Act of 1934 of * * * both personal holding companies * * * the federal income taxes for the year 1934 * * The parties have stipulated that “The only issue in this case is the determination of ‘adjusted net income’ as defined in Section 351” and that “if the Board should sustain the determination of the respondent, there is a deficiency in income tax of $668.53 to be paid by petitioner, plus interest thereon as provided by law.”

Respondent contends that the corporations, being on the cash basis, may not deduct from their net income the amount of Federal taxes paid in the following year. This contention seems to us to be sustained by the plain language of the statute. Subsection (b) (4) of section 351 provides “The terms used in this section shall have the same meaning as when used in Title I.” Section 48 of Title I provides “ (c) * * * The terms * * * ‘paid or accrued’ shall be construed according to the method of accounting upon the basis of which the net income is computed under this Part.” For the purposes of section 351 the “adjusted net income” of the corporation, which petitioner must treat as his to conform with the provisions of subdivision (d), is defined to mean the net income minus Federal income, war profits and excess profits taxes “paid or accrued.” Applying to this term the definition contained in section 48, it is evident that where a corporation computes its net income on the cash basis, as these corporations did, only taxes actually paid may be deducted in computing the adjusted net income. Respondent’s determination is therefore sustained and the deficiency may be determined in accordance with the stipulation of the parties.

Decision will be entered for the respondent.

       SEC. 351. SURTAX ON PERSONAL HOLDING COMPANIES.
      (a) Imposition of Tax. — There shall be levied, collected, and paid, for each taxable year, upon the undistributed adjusted net income of every personal holding company a surtax equal to the sum of the following:
      (1) 30 per centum of the amount thereof not in excess of $100,000 ; plus
      (2) 40 per centum of the amount thereof in excess of $100,000.
      (b) Definitions. — As used in this title—
      (1) The term “personal holding eomimny” means any corporation (other than a corporation exempt from taxation under section 101, and other than a bank or trust company incorporated under the laws of the United States or of any State or Territory, a substantial part of whose business is the receipt of deposits, and other than a life-insurance company or surety company) if — (A) at least 80 per centum of its gross income for the taxable year is derived from royalties, dividends, interest, annuities, and (except in the case of regular dealers in stock or securities) gains from the sale of stock or securities, and (B) at any time during the last half of the taxable year more than 50 per centum in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals. For the purpose of determining the ownership of stock in a personal holding company — (C) stock owned, directly or indirectly, by a corporation, partnership, estate, or trust shall be considered as being owned proportionately by its shareholders, partners, or beneficiaries; (D) an individual shall be considered as owning, to the exclusion of any other individual, the stock owned, directly or indirectly, by his family, and this rule shall be applied in such manner as to produce the smallest possible number of individuals owning, directly or indirectly, more than 50 per centum in value of the outstanding stock; and (E) the family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants.
      (2) The term “undistributed adjusted net income” means the adjusted net income minus the sum of :
      (A) 20 per centum of the excess of the adjusted net income over the amount of dividends received from personal holding companies which are allowable as a deduction for the purposes of the tax imposed by section 13 or 204 ;

        (B) Amounts used or set aside to retire indebtedness incurred prior to January 1. 1934, if sucb amounts are reasonable with reference to the size and terms of such indebtedness; and
      (C) Dividends paid during the taxable year.
      (3) The term “adjusted net income” means the net income computed without the allowance of the dividend deduction otherwise allowable, but minus the sum of:
      (A) Federal income, war-profits, and excess-profits taxes paid to accrued, but not including the tax imposed by this section;
      (B) Contributions or gifts, not otherwise allowed as a deduction, to or for the use of donees described in section 23 (o) for the purposes therein specified; and
      (C) Losses from sales or exchanges of capital assets which are disallowed as a deduction by section 117 (d).
      (4) The terms used in this section shall have the same meaning as when used in Title I.
      (c) Administrative Provisions. — All provisions of law (including penalties) applicable in respect of the taxes imposed by Title I of this Act, shall insofar as not inconsistent with this section, be applicable in respect of the tax imposed by this section, except that the provisions of section 131 of that title shall not be applicable.
      (d) Payment oe Surtax on Pro Rata Shares. — The tax imposed by this section shall not apply if all the shareholders of the corporation include (at the time of filing their returns) in their gross income their entire pro rata shares, whether distributed or not, of the “adjusted net income” of the corporation for such year. Any amount so included in the gross income of a shareholder shall be treated as a dividend received. Any subsequent distribution made by the corporation out of earnings or profits for such taxable year shall, if distributed to any shareholder who has so included in his gross income his pro rata share, be exempt from tax in the amount of the share so included.
      (e) Improper Accumulation oe Surplus. — For surtax on corporations which accumulate surplus to avoid surtax on stockholders, see section 102.


author: Van Fossan:

text:
    Susan B. Armstrong, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 82552.
    Promulgated September 29, 1938.

      George A. Wilson, Esq., and Paid L. Peyton, Esq., for the petitioner.

      J. R. Johnston, Esq., for the respondent.
   OPINION.

Van Fossan:

The sole question presented by the above facts is whether the payment of $25,000 of the sum of $88,200.35 received by the trustees on July 30,1932, from the Fajardo Sugar Co., represented a return of capital and, therefore, not income to the trust to be distributed currently to petitioner.

Respondent contends that the transaction of July 31, 1931, transferring the $25,000 Fajardo note and accrued interest thereon to the new firm for $26,522.30 in cash was in fact a purchase and sale of this note. On this premise he urges that the proceedings were highly irregular and totally without the authority of the executors and trustees. He further urges that the restoration of the sum in question by the redemption of the assignment in the taxable year in question does not in any way affect petitioner’s tax liability on the income because the entire amount of the $88,200.35 payment received by the trustee on July 30, 1931, from the Fajardo Sugar Co. was income to the trust distributable to petitioner.

Petitioner’s contention with respect to this phase of the case is that the transaction was entirely regular and unquestionably made the payment by the Fajardo Co. a return or redemption of capital to the extent of $25,000.

The nature of the July 31, 1931, transaction becomes important in determining the status of the subsequent redemption of the assignment of accrued interest in 1932, and a short resumé of the facts will be helpful. A substantial part of the assets of decedent’s estate was comprised of his interest in the partnership and, in turn, the partnership’s largest asset was the account receivable from the Fajardo Sugar Co., for which notes were given in the full amount of the account, plus interest to date. The estate had no desire to become a member of the new partnership and the partnership did not have sufficient cash to liquidate the estate’s interest. An agreement was therefore entered into whereby a group of the Fajardo notes were transferred to the estate and the new partnership agreed that it would pay the estate annually, on account of the interest then accrued and unpaid on the Fajardo notes held by the estate, cash in an amount equal to the face amount of one of the notes ($25,000), plus interest to the time of payment. In return the estate either was to make an assignment to the new partnership of the right to receive the interest thus paid, or, at the option of the new partnership, was to deliver one of the Fajardo notes to it. Upon payment under this agreement on July 31, 1931, the new partnership exercised its option and received one of the notes theretofore held by the estate.

From these facts respondent contends that the transaction between the estate and the new partnership is a purchase and sale; and that the estate has, in effect, sold and distributed a portion of its principal. The argument is that the cash received from the transaction was cash paid for a principal asset of the estate, a Fajardo note, and that it must necessarily be impressed with the same character. If this argument presented the entire picture of the transaction, the above conclusion might follow. There are further considerations, however, which, in our view, alter the situation. In the first instance, the new partnership was, in effect, guaranteeing the partial payment of interest on the notes; and, secondly, by the agreement and the subsequent treatment and disposition thereof, the cash was paid and received as interest on the notes. We believe these facts fixed the character of the transaction. The fact that the partnership exercised its election to take a note in lieu of an assignment of interest does not change the character of the payment to the estate. The cash did not come into the hands of the executors in lieu of their capital asset, the Fajardo note — the cash came to them as interest. What came to them as a capital asset in lieu of the note was the assignment to the principal account from income account of all interest then accrued and unpaid on the Fajardo notes to the extent of $25,000. It was this assignment which took care of the otherwise impaired principal account. The notes were equally secured as to principal and interest, so the assignment in the principal account of accrued and unpaid interest was of equal dignity to a claim for the face amount of the notes themselves, and the estate in no wise was prejudiced by the transaction.

When viewed in the full light of all the facts the entire transaction speaks of neither a purchase and sale, nor of a borrowing with the posting of collateral. It is what it purports to be, i. e., a guarantee and payment thereunder of interest accrued and unpaid.

The assignment of accrued interest stood as much a part of the principal of the estate as any other of its assets and it was the duty of the trustees to apply money received on account of interest to the extent of $25,000 to the redemption of the assignment. Such money had theretofore been impressed with the character of capital and upon its receipt was capital. Under the circumstances it was not and could not be income distributable to petitioner beneficiary.

Recognizing, as we do, the above status for the interest paid in 1932 to the extent of $25,000, we do not find ourselves in accord with the contention by respondent that petitioner possessed the right to receive the interest to the extent of $25,000 and that the redemption in effect was for the benefit of petitioner and in settlement of an obligation on her part to replace the impaired capital.

If there be any doubt as to the above construction of the facts, there is a further reason why petitioner should prevail. The decrees entered by the Surrogate’s Court are conclusive of the issue presented here.

The stipulated facts show that the Surrogate’s Court for the County of New York, having jurisdiction of the estate and testamentary trust, has twice approved all the transactions involved in this manner of handling the estate and trust.

By court decree the action of the executors in treating the payment of July 31, 1931, as income when received, and in turning over to the trustees as a principal asset the assignment of accrued interest, was approved. And subsequently, by court decree, the intermediate accounting of the trustees determining the payment of $25,000 in 1932 to be a receipt of principal, was also approved. The decrees of that court are final and conclusive of these questions and are binding upon this Board.

It is a well recognized rule that where the question involved is the meaning of a revenue law the will of Congress controls over local law. The obvious reason for this rule is to effect an interpretation of Federal statutes of uniform application to a nation-wide scheme of taxation. Eagan v. Commissioner, 43 Fed. (2d) 881. Where applicable, this principle is controlling, but when the legislative will is dependent upon facts which can be interpreted only in accordance with a state rule of property, the state rule must then prevail. Included in this category of state or local determinations which are controlling in Federal tax matters, are rules governing the construction of wills, and administration of estates and testamentary trusts.

In our opinion the present case is within this last mentioned limitation on the rule and the decrees of the Surrogate’s Court determining the status of the 1932 payment, to the extent of $25,000, are binding upon this Board.

Respondent strongly urges the contrary because no actual contest was presented to the surrogate. There is, however, no evidence of collusion in the present case; all interested and necessary parties were represented and from the nature of the proceeding the court’s approval and decree must conclude the matter. The particular subjects now in issue were directly before the court and were specifically discussed in the report of the special guardian for the infant re-mainderman.

The leading case on the conclusiveness of a determination by a local court concerning the amount distributable to the beneficiaries under a trust, is Freuler v. Helvering, 291 U. S. 35. It was there held that the decree of the state court was binding. The Court said:

* * * <jecigion of that court, until reversed or overruled, establishes the law of California respecting distribution of the trust estate. It is none the less a declaration of the law of the state because not based on a statute, or earlier decisions. The rights of the beneficiaries are property rights and the court has adjudicated them. What the law, as announced by that court, adjudges distributable is, we think, to be so considered in applying section 219 of the Revenue Act of 1921.

In that case it was argued that the proceeding in the state court was a collusive one, but this argument was rejected in view of the record in the state court. The Court said:

* * * The case appears to have been initiated by the filing of a trustee’s account, in the usual way. Notice was given to the interested parties. Objections to the account were presented, and the matter came on for hearing in due course, all parties being represented by counsel. The decree purports to decide issues regularly submitted and not to be in any sense a consent decree.

A case following the principle of Freuler v. Helvering, supra, and possibly closer to the present factual situation, is that of Letts v. Commissioner, 84 Fed. (2d) 270 (C. C. A., 9th Cir.), affirming 30 B. T. A. 800. In that case the trustees filed their account showing therein the sum of over $6,000,000 received by them as trustees during the taxable year and the distribution by them of a sum of over $1,000,000 as net income to the beneficiaries of the trust. The trustees prayed for and obtained from the local court having jurisdiction over the matter an order “approving, allowing, and settling said account.” The Federal court, in arriving at its decision, followed the rule enunciated in the Freuler case, supra, and said:

Whether, under the will, income received by the trust was or was not currently distributable, was to be determined, in the first instance, by the trustees themselves and, finally, by the state court having jurisdiction of the trust. Petitioner and his cotrustees determined that, of the $0,998,888.24 which the trust received from the Holmby Corporation in 1927, $1,185,088.24 was net income currently distributable to the beneficiaries of the trust. They accordingly made such distribution and so reported to the court in their account heretofore referred to. The court, after hearing the matter, made its order approving, allowing, and settling the account, thereby finally determining that the $1,185,088.24 was currently distributable to the beneficiaries of the trust, including petitioner. That order has not been reversed or overruled and is, therefore, conclusive. Freuler v. Helvering, 291 U. S. 35, 43, 45, 54 S. Ct. 308, 78 L. Ed. 634.

The Supreme Court of the United States, in Blair v. Commissioner, 300 U. S. 5, adhered to the rule of the Freuler case, supra, and held that a decision of a state court determining a trust there under consideration not to be a spendthrift trust, and further holding that certain assignments of income were valid, was binding upon the Federal courts. The Court there said:

The question of the validity of the assignments is a question of local law. The donor was a resident of Illinois and his disposition of the property in that State was subject to its law. By that law the character of the trust, the nature and extent of the interest of the beneficiary, and the power of the beneficiary to assign that interest in whole or in part, are to be determined. The decision of the state court upon these questions is final. Spindle v. Shreve, 111 U. S. 542, 547, 548; Uterhart v. United Slates, 240 U. S. 598, 603, Poe v. Seaborn, 282 U. S. 101, 110, Freuler v. Helvering, supra, p. 45. It matters not that the decision was by an intermediate appellate court. Compare Graham v. White-Phillips Co., 296 U. S. 27. In this instance, it is not necessary to go beyond the obvious point that the decision was in a suit between the trustees and the beneficiary and his assignees, and the decree which was entered in pursuance of the decision determined as between these parties the validity of the particular assignments. Nor is there any basis for a charge that the suit was collusive and the decree inoperative. Freuler v. Helvering, supra. The trustees were entitled to seek the instructions of the court having supervision of the trust.

Hubbell v. Helvering, 70 Fed. (2d) 668 (C. C. A., 8th Cir.), following the Freuler case, held that where the local state court decided that beneficiaries could not recover amounts retained by trustees from income of a trust for depreciation on trust property and for unde-preciated cost of obsolete buildings, the amounts are not distributable to the beneficiaries nor taxable to them.

Respondent's attempt to distinguish the present case from the above cited controlling cases is not convincing.

We conclude and hold, therefore, that the payment to the trustees by the Fajardo Co. in 1932 of interest on its notes was not, to the extent of $25,000, income distributable to petitioner.

Reviewed by the Board.

Decision will be entered for the petitioner.


text:
    Carding Gill Limited, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 90406.
    Promulgated September 29, 1938.

      Dmid. A. BucMey, Jr., Esq., and Harvey L. Babbitt, Esq., for the petitioner.

      F. S. Gettle, Esq., for the respondent.
   OPINION.

Opper :

The three issues in this proceeding, while interrelated, may be stated separately: First, whether petitioner, being a foreign corporation, is subject to tax upon its income from the sale of securities in the United States; second, whether it is entitled to deductions for amortization of bond discount more than equal to any income from sources within the United States; and, third, whether it is subject to the 25 percent additional tax for delinquency in the filing of its return.

On the first question, petitioner urges that section 119 (a) of the Revenue Act of 1928 does not have the effect of including within petitioner’s taxable income profits from securities admittedly sold by it in the United States during the taxable years. In this contention it seems to us petitioner overlooks the provisions of section 119 (e), which reads in part as follows:

(e) Income from sources partly uAthin and, partly without United States.— Items of gross income, expenses, losses and deductions, other than those specified in subsections (a) and (e) of this section, shall be allocated or apportioned to sources within or without the United States, under rules and regulations prescribed by the Commissioner with the approval of the Secretary. * * * Cains, profits and income derived from the purchase of personal property within and its sale without the United States or from the purchase of personal property without and its sale within the United States, shall be treated as derived entirely from sources within the country in which sold * * *.

It is true the statute contains no express reference to personal property both purchased and sold within the United States. Gains therefrom, however, are obviously items of gross income, and are consequently to be treated, under specific legislative direction, by regulation. Hubert de Stuers, 26 B. T. A. 201, 205. Cf. Suffolk Co., Ltd., 37 B. T. A. 1156. The applicable provision of Regulations 74 makes the place of sale the test; and it is conceded on petitioner’s brief that the securities involved were sold in the United States. In any event, the place of purchase is not specified and the stipulation includes the profit from security sales among the items of petitioner’s “income from sources within the United States”, a phrasing which we must regard as including such evidentiary facts as may be requisite to bring it within that description. It may be that this question is not properly before us on the pleadings, since petitioner returned the profit from sales as gross income for each year and neither in the petition nor at the hearing was the point specifically raised; but for the reasons stated we conclude that petitioner can not in any event be sustained on this branch of its claim.

The deduction for amortization of bond discount is sought on the ground that petitioner issued its bonds for a consideration worth less than their face value. Unless this be the fact, petitioner can not succeed, and of it there is no proof. Nothing appears in the stipulation except petitioner’s arbitrary valuation of the property received, and no evidence was introduced apart from the stipulation. Petitioner contends that we may presume an obligation to be worth par in the absence of contrary evidence, citing Fruen Investment Co., 2 B. T. A. 542; Claude H. Birdsall, 2 B. T. A. 1169; and Southern Railway Co., 27 B. T. A 673. Even if we do so, and without attempting to decide the point, the case is not improved. In only one instance is the par value given, and then it is in terms of pounds sterling. The “principal amount” of debentures received in that instance is stated to be £720,000. If we convert this at the rate of $4.86 (the transaction took place in 1927) the result is $3,499,200, a figure greatly in excess of the $2,025,000 claimed by petitioner. But that is not all. Petitioner received in addition 1,400 “ordinary shares” of a par value of £1 each. And certainly there is no presumption that shares of stock are worth only par. Lincoln Cotton Mills, 15 B. T. A 680, 695; Premier Packing Co., 12 B. T. A. 637, 645. The case thus rests exclusively on petitioner’s claim unsupported by any evidence 'whatsoever, and this will not suffice. Kansas City Southern Railway Co., 22 B. T. A. 949, 964. Petitioner has not sustained a burden of proof of which its counsel was well aware, and the result of which was specifically indicated at the hearing.

A similar disposition is required with respect to the third question. Imposition of the delinquency tax for failure to file a return within the time prescribed by law is mandatory unless “it is shown that the failure to file it was due to reasonable cause and not due to willful neglect.” No cause whatsoever nor any attendant circumstances are in evidence. The sole reference in the stipulation to the delinquent filing is a statement that the returns were filed “upon notice from the Treasury Department.” It is suggested that petitioner, being a foreign corporation without officers or place of business in the United States, may be considered thereby to have sufficient “reasonable cause” for failure to file. Whether these facts alone, unaccompanied by some supporting statement or evidence relating them to the failure to file, would ever be sufficient we need not now determine. Certainly none of the cases cited by petitioner go so far. Fajardo Sugar Co. of Porto Rico, 20 B. T. A. 980; Hans Pederson, 14 B. T. A. 1089;Adelaide Park Land, 25 B. T. A. 211; Jockey Club, 30 B. T. A. 670. But here all that is shown is that petitioner is a foi’eign corporation, and whether it has officers or a place of business within the United States is a matter outside of the record. We are unable to conclude that petitioner has even attempted to make any such showing of reasonable cause as is required to avoid imposition upon it of the 25 percent delinquency tax.

Eeviewed by the Board.

Decision will be entered for the respondent.

       SEC. 119. INCOME PROM SOURCES WITHIN UNITED STATES.
      (a) Gross income from sources in United States. — The following items of gross income shall be treated as income from sources within the United States:
      (1) Interest. — Interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise, not including—
      (A) interest on deposits with persons carrying on the banking business paid to persons not engaged in business within the United States and not having an office or place of business therein, or
      (B) interest received from a resident alien individual, a resident foreign corporation, or a domestic corporation, when it is shown to the satisfaction of the Commissioner that less than 20 per centum of the gross income of such resident payor or domestic corporation has been derived from sources within the United States, as determined under the provisions of this section, for the three-year period ending with the close of the taxable year of such payor preceding the payment of such interest, or for such part of such period as may be applicable, or
      (C) income derived by a foreign central bank of issue from bankers’ acceptances;
      (2) Dividends. — The amount received as dividends—
      (A) from a domestic corporation other than a corporation entitled to the benefits of section 253, and other than a corporation less than 20 per centum of whose gross income is shown to the satisfaction of the Commissioner to have been derived from sources within the United States, as determined under the provisions of this section, for the three-year period ending with the close of the taxable year of such corporation preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence), or
      (B) from a foreign corporation unless less than 50 centum of the gross income of such foreign corporation for the three-year period ending with the close of its taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) was derived from sources within the United States as determined under the provisions of this section;
      (3) Personal Services. — Compensation for labor or personal services performed in the United States;
      (4) Rentals and Royalties. — Rentals or royalties from property located in the United States or from any interest in such property, including rentals or royalties for the use of or for the privilege of using in the United States, patents, copyrights, secret processes and formulas, good will, trade-marks, trade brands, franchises, and other like property; and
      (5) Sale of Real Property. — Gains, profits, and income from the sale of real property located in the United States.

      Akt. 678. Sale of personal property. — Income derived from the purchase and sale of personal property shall be treated as derived entirely from the country in which sold * * *.

       SEC. 291. FAILURE TO FILE RETURN. [Revenue Aet of 1928.]
      In case of any failure to make and file a return required by this title, within the time prescribed by law or prescribed by the Commissioner in pursuance of law, 25 per centum of the tax shall be added to the tax, except that when a return is filed after such time and it is shown that the failure to file it was due to reasonable cause and not due to willful neglect no such addition shall be made to the tax. * * *


author: Disney:

text:
    F. A. Gillespie, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 89442.
    Promulgated September 30, 1938.

      Harold E. Rorschach, Esq., and Jach L. Rorschach, Esq., for the petitioner.

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

Disney:

Two questions are here presented: (1) Was $15,000 received by petitioner in 1934 taxable to him under section 22 (b) (2) of the Revenue Act of 1934 as received under an annuity, or exempt from taxation because constituting only a return of corpus, petitioner contending that the statute is unconstitutional? (2) Was $20,000 received by petitioner’s former wife during 1934 taxable to him as paid her in discharge of petitioner’s marital obligations?

As to the first proposition: Section 22 (b) (2) of the Revenue Act of 1934 specifically provides that amounts received as an annuity under any annuity or endowment shall be included in gross income, except the excess of amount received' in the taxable year over an amount equal to 3 percent of the aggregate premiums or consideration paid for such annuity. Unconstitutionality of the act must clearly appear before we are justified in holding that it should not be enforced. Rita O’Shaughnessy, Executrix, 21 B. T. A. 1046. Petitioner contends that, since at time of purchase of the annuity petitioner was of the age of 60 years, and his wife, for whom an annuity was purchased at the same time out of the same lump consideration, was of the age of 56 years, and the consideration paid was of an agreed value of at least $1,417,757.50, therefore neither petitioner nor the wife could, during their lifetime, receive back the corpus of the investment, with resultant unconstitutionality of the statute; and further that in any event there should be excluded from gross income under the statute the excess of the amount received on annuity over 3 percent of the amount necessary to purchase the annuities. As to this suggestion, it seems sufficient to state that the statute does not provide for computation of the 3 percent on some amount reasonably necessary to purchase the annuity in question, but designates 3 percent of the “consideration paid for such annuity.” Plere the annuities were, received pursuant’ to a contract transferring property of much greater value than the amount which would have been necessary to purchase the annuities from a life insurance company. If the amount of tlie value of such property is the amount of “consideration paid for such annuity”, then we can not, under the statute, find any other amount as the basis for computing the 3 percent. Property agreed to have a value of at least $1,417,757.50 was conveyed. The contract between petitioner, his then wife, and the company thereafter paying the annuity, conveying the property to the company recites that the annuities were to be paid “as part consideration” for the transfer of the property; whereas a companion agreement between petitioner and his then wife, executed the same day and upon the same subject, recites that “in consideration of the conveyance of said property to such corporation” they will cause the corporation to pay the two annuities. ISTo other consideration for the property conveyance to the corporation, other than the payment of the annuities, appears in the contracts. We conclude, therefore, that the property of the value above stated was the consideration for the two annuities. The wife was to receive $25,000 per year. It is obvious that, based upon a consideration of $1,417,757.50, the 3 percent would exceed the entire amount of both annuities provided for, and exceed by a greater amount the $35,000 of actual receipts within the taxable year under the two annuities by both petitioner and his former wife, and therefore no amount remains for exclusion from gross income under the provisions of the statute — with the result that the entire amount of the annuities is taxable — provided the statute is constitutional. Obviously, it is not unconstitutional by reason of the fact that such a large amount was paid as consideration for the annuities as to leave, as above seen, no deduction or exclusion from gross income; for such situation arose because of payment for the annuities of an amount greater than they could have been purchased for, from insurance companies, and not because of the statute itself, which, by its terms, had the annuities been purchased at the prices at which they could have been obtained, would, though taxing the amount received as annuity, have ajlowed an exclusion of a considerable amount thereof from gross income. The result of the statute, so applied, is to permit re-coupment of original cost of annuity (calculated according to life expectancies) , but to require payment of tax upon what the legislative body believed to be the income ordinarily realized by the annuitant. That in this particular case the result is different is plainly not due to the statute, but to payment of an excessive price for the annuity, which demonstrates that unconstitutionality of the statute has not been shown, the corpus of the investment not appearing to have been invaded for taxing purposes. We therefore conclude that the statute is not unconstitutional, and that respondent did not err in his determination of deficiency so far as same is based upon the $15,000 annuity received by petitioner.

Was the $20,000 received by petitioner’s former wife properly included in his income? The answer depends, in the first instance, upon whether his property was paid for the annuity, the income of which was received in 1934 by his former wife. It was paid for during the coverture, at a time when marital difficulties were being experienced between petitioner and his then wife, and the agreement recites that the wife gives up any claim of alimony, support, or maintenance, but this does not determine that the payment was made by him.' Respondent has apparently assumed that the property transferred in payment stood in the name of and belonged to petitioner, and of course petitioner has the burden of showing otherwise. But we think he has so shown, by the only evidence before us. The record is devoid of any evidence as to who was record owner of the property conveyed, and petitioner furnished the only direct light upon the subject when he testified “It was both of our property.” It is true that he had just given his mere opinion that she owned half of the property, but, without giving such expression of opinion weight, we have in the above quoted language a positive statement that the property belonged to both husband and wife. The record shows that the wife did own separate property, for on February 9, 1921, F. A. Gillespie executed a declaration of trust reciting that several years earlier he had conveyed and transferred to her the equitable title to certain interests in properties, and by the declaration of trust he recognizes his trusteeship for her for 1,995 shares of stock of F. A. Gillespie & Sons Co. out of 9,995 shares held by him for himself, wife, and sons. It is recited that the property, being acquired since marriage, is community property and is “hereby transferred each to the other as follows”, pursuant to which each agrees to convey to F. A. Gillespie & Sons Co. (with certain exceptions) all property held jointly, separately standing in their names, or the names of others, in consideration of payment of annuities to each. It is plain, therefore, that the wife did contribute property in payment of the annuity received by her in consideration for the transfer, from which in 1934 she received income, and respondent’s determination to the contrary is clearly error, in part at least. They both conveyed property. She signed conveyances. Though this was not community property, the owners not being domiciled in a community property state, their common ownership, shown by the husband’s statement above set forth, is presumably upon an equal basis. The agreement and conveyance constituted in effect a division of property and the application by each of his or her share to the acquisition of an annuity. Certainly nothing prevented division of the property which they regarded as commonly owned, and the use thereof when divided does not constitute purchase of the annuity by the husband pursuant to marital duty. 'We therefore conclude that the wife contributed the property which provided the annuity paid to her in 1934, and that therefore it is not to be included in petitioner’s income.

We therefore hold that the respondent was in error in including the $20,000 received by Maud G-illespie in 1934 in petitioner’s income.

Eeviewed by the Board.

Decision will he entered vmder Rule 50.

Leech and Mellott dissent.

       SEC. 22. GROSS INCOME.

        * # * * * * *
      (b) Exclusions from Gross Income. — The following items shall not be included in gross income and shall be exempt from taxation under this title :
      * * * ⅜ # * *
      (2) Annuities, Etc. — Amounts received (other than amounts paid by reason of the death of the insured and interest payments on such amounts and other than amounts received as annuities) under a life insurance or endowment contract, but if such amounts (when added to amounts received before the taxable year under such contract) exceed the aggregate premiums or consideration paid (whether or not paid during the taxable year) then the excess shall bo included in gross income. Amounts received as an annuity under an annuity or endowment contract shall be included in gross income; except that there shall be excluded from gross income the excess of the amount received in the taxable year over an amount equal to 3 per centum of the aggregate premiums or consideration paid for such annuity (whether or not paid during such year), until the aggregate amount excluded from gross income under this title or prior income tax laws in respect of such annuity equals the aggregate premiums or consideration paid for such annuity. In the case oí a transfer for a valuable consideration, by assignment or otherwise, of a life insurance, endowment, or annuity contract, or any interest therein, only the actual value of such consideration and the amount of the premiums and other sums subsequently paid by the transferee shall be exempt from taxation under paragraph (1) or this paragraph


author: Keen:

text:
    Daniel N. Gutmann, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 85242.
    Promulgated September 30, 1938,

      H. N. Wyatt, Esq., and W. R. Arrington, Esq., for the petitioner.

      Garroll Walker, Esq., for the respondent.
   OPINION.

Keen:

1. The first question is whether petitioner is barred from taking a deduction for the loss of $12,615.69 claimed by him on the surrender of his Gutmann & Co. stock on the ground that it is within the prohibition of the “wash sale” provision, section 118 of the Revenue Act of 1932, set out in the margin. The respondent contends in his deficiency notice that the option given to petitioner “was a part of a transaction whereby 519 shares of Gutmann & Co. stock were surrendered in consideration of the cancellation of notes given by you to the company in payment for certain stock.” The option appears as part of the minutes of the meeting of the board of directors on June 27, 1933. The uncontradicted testimony of the petitioner, however, shows that he was in complete ignorance of the option as an existing or potential right until late in September 1933, some three months after his surrender of the stock to the company on June 27 of that year; and the testimony of the company’s treasurer shows that it was the custom of the company to have its minutes drawn by its counsel; that the idea of an option to be given the surrendering stockholders, as he put it, “to sweeten the pill”, occurred to him the day after the meeting, and he suggested it to counsel, who did not draw the minutes in question until September; and the option was thereafter read and approved by the directors as part of the minutes.

The petitioner contends that no contract right between petitioner and the corporation could arise until the board of directors had acted in September; that petitioner had done nothing in the interim to become a party to such a contract; that, there being no written evidence of the option contract made within 30 days either before or after June 27, 1933, it was, even if existent within this period, invalid under the Illinois Statute of Frauds, Smith-Hurd’s Illinois Annotated Statutes, ch. 121 ½, sec. 4; and that the option was unenforceable for lack of consideration.

We are not concerned here with the question of varying a written instrument by parol evidence, since there is no attack on the ultimate validity of the option after it was ratified by the corporation’s board of directors and made known to petitioner. Its validity within 30 days after the surrender by petitioner of his stock in consideration of the cancellation of his indebtedness to the corporation is alone to be considered. An analogous question was recently decided by the Court of Appeals for the First Circuit in Carney v. Crocker, 94 Fed. (2d) 914, where the trustees and directors of a trust association who owned over 50 percent of its stock on March 24, 1933, adopted a resolution to distribute a dividend on June 29, 1933, to shareholders of record on June 22, 1933, subject to the approval of the president, treasurer, and assistant treasurers. The resolution was informally approved by such officers on or about April 25, 1933, but the approval was not recorded on the books or made public or in any manner communicated to any of the shareholders except the trustees. The dividend was distributed on the date specified. The court said:

* * * Here the resolution voted by the trustees, the directors, on March 24, 1933, by its very terms was not a fully declared dividend, for it was made conditional upon the approval of the president, treasurer and assistant treasurers. It is true that on April 25, 1933, and prior to June 16, of that year, the officers of the association described in the resolution met and informally approved the resolution, but their informal approval was not recorded on the books of the corporation (if that would have been helpful) or made public, or communicated to any of the shareholders except the trustees, who in this case stand as the directors of the association. In other words the shareholders other than the director-trustees, had no knowledge of an approval of the resolution. This being so the relation of debtor and creditor, between the association and the shareholders, did not arise before June 16, 1933, and it was within the power of the trustees, so far as this record discloses, to have rescinded the resolution of March 24, 1933, at any time before June 29, 1933, when the distribution was made. It necessarily follows that the dividend was not fully and unconditionally declared before June 16, 1933, and was subject to the tax imposed by section 213 (a) [of the National Industrial Recovery Act].

The same conclusion must be reached here, that no contract in respect of the option existed between petitioner and the corporation before the option was ratified by the corporation’s directors; or, if the option right be treated as a gift, and informal ratification could be assumed, that the gift was not completed until acceptance by the petitioner donee, a necessary requisite.

The statute provides that no deduction shall be allowed where “the taxpayer * * * has entered into a contract or option so to acquire, substantially identical stock or securities.” The testimony here is uncontroverted that petitioner had no knowledge of the proposed option until some time in September, more than two months after his surrender of his stock. There is a rational explanation of what was done, and the testimony, unlike that in Rand v. Helvering, 77 Fed. (2d) 450, is not colored by the circumstances. It would seem obvious therefore that he could not in any sense be said to have “entered into a contract or option” within the proscribed period.

The loss on surrender by petitioner of his shares was obviously a capital loss and deductible as such.

2. We turn now to the second question, the March 1, 1913, value of the 189 shares sold by petitioner on June 27, 1933, which he had received as part of a gift of 200 shares from his father in 1925. In the case of gifts, the donee, of course, must take the donor’s basis, sec. 113 (a) (2); and, since the donor held these shares, or rather earlier shares of which these were the natural proliferation in the course of corporate growth, on March 1, 1913, the respondent must employ the fair market value on that date as his basis, sec. 113 (a) (13). In doing so he has used existing book values as of that date of $85.77 a share, which has resulted in his determination of a gain of $7,108 on their surrender in 1933. The petitioner in his return used the same 1913 book value, but in his petition contends that this was erroneous. He now denies that any gain was realized on the whole transaction of surrender, and contends that the evidence supports a March 1, 1933, value of $133 a share, upon which he founds his claim for a refund of taxes paid in the amount of $129.17. He also contends that the stipulation supports a finding that only 189 of the 200 shares received as a gift were surrendered, but it is impossible to tell from the record which shares were surrendered, since the certificates covering all 530 shares were turned over by petitioner to the corporation and one new certificate for 11 shares was received back by him. We must resort to the presumption raised by the Commissioner’s “first in, first out” rule, Art. 58, Regulations 77; and, since the gift shares were the last received by the petitioner, we may presume that those sold and surrendered included only 189 of these, and thus hold in his favor. The benefit of the rule, although commonly invoked by the Commissioner, need not on that account be denied to petitioner.

We think the 1913 basis used was too low, and have found that the shares sold were then worth not less than $133 each, or more than the sale price to Gutmann & Co., which was $121.31, and accordingly that no gain was realized on the sale.

We need not elaborate the facts set out in our findings which support this conclusion. Since Gutmann & Co. was a closely held corporation and no sales of its stock took place around March 1, 1913, its stock value must be determined by the then value of its assets, sec. 113 (a) (13). Its methods of accounting were very conservative, as two expert witnesses testified and as is shown by an auditor’s report drawn February 20, 1923, and put in evidence. Proper adjustments in capital account and depreciation showed that net earnings had been underestimated and the assets thereby undervalued, and, since no proper account had been taken of the value of intangibles, good will, and the trade secrets of tanning employed by the company, the value of these intangibles must be added to the total value of the assets.

Without approving in detail the methods employed by the expert witnesses in arriving at a valuation, we are of the opinion that in all the circumstances the determination of a fair market value on March 1,1913, of $133 a share for the 189 shares was reasonable and supported by the evidence. We hold, accordingly, that the deficiency be expunged and that the petitioner has made an overpayment.

Decision will be entered under Rule 50.

       SEC. 118. LOSS FROM WASH SALES OF STOCK OR SECURITIES.
      (a) In the case of any loss claimed to have been sustained from any sale or other disposition of shares of stock or securities where it appears that, within a period beginning 30 days before the date of such sale or disposition and ending 30 days after such date, the taxpayer has acquired (by purchase or by an exchange upon which the entire amount of gain or loss was recognized by law), or has entered into a contract or option so to acquire, substantially identical stock or securities, then no deduction for the loss shall be allowed under section 23 (e) (2) ; nor shall such deduction be allowed under section 23 (f) unless the claim is made by a corporation, a dealer in stocks or securities, and with respect to a transaction made in the ordinary course of its business.
      (b) If the amount of stock or securities acquired (or covered by the contract or option to acquire) is less than the amount of stock or securities sold or otherwise disposed of, then the particular shares of stock or securities the loss from the sale or other disposition of which is not deductible shall be determined under rules and regulations prescribed by the Commissioner with the approval of the Secretary.
      (c) If the amount of stock or securities acquired (or covered by the contract or option to acquire) is not less than the amount of stock or securities sold or otherwise disposed of, then the particular shares of stock or securities the acquisition of which (or the contract or option to acquire which) resulted in the nondeductibility of the loss shall be determined under rules and regulations prescribed by the Commissioner with the approval of the Secretary.