author: Green:

text:
    Fort Pitt Spring & Manufacturing Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 10906.
    Promulgated January 19, 1927.
    On May 15, 1921, an extension of time Raving been theretofore obtained, the petitioner filed its return for the year 1920, showing a net income of $165,508.12 and the tax due thereon to be $64,114.37. To the return was attached an application for special assessment. On December 15, 1921, it filed a claim in abatement pending the decision on its claim for special assessment. The Commissioner allowed the claim for special assessment and as a consequence, after the recomputation of the tax, allowed the claim in abatement in part. The petitioner appealed as to the part disallowed. The Commissioner moved to dismiss the proceeding on the ground that he had not determined a deficiency inasmuch as the total tax which he found to be due was less than the amount shown on the return to be due. Motion granted.

      George Maurice Morris, Esq., for the petitioner.

      Henry Bavenel, Esq., for the respondent.
    This petition was heard on the Commissioner’s motion to dismiss on the ground that no deficiency has been determined for 1920, the year here involved.
    FINDINGS OP PACT.
    On March 15, 1921, the petitioner filed a tentative return for 1920 showing an estimated tax of $65,000, and paid $17,000 as the first installment. On the same date an extension was granted to May 15, 1921, for filing the return. Later a further extension was granted to June 15. The return was filed June 14, 1921, showing a tax of $64,114.37 on a net income of $165,508.12. Accompanying the return was an application for assessment of profits taxes under section 328 of the Revenue Act of 1918.
    On December 15, 1921, a claim was filed by the petitioner for the abatement of $13,267.65 of the amount of tax shown on its return for 1920 “ until such time as the decision of the Commissioner of Internal Revenue upon its application aforementioned, shall enable the amount of said tax to be accurately determined.” Assessment of the tax under section 328 was allowed by the Commissioner, and under date of November 21, 1925, a letter was directed by the Commissioner to the petitioner reading in part as follows:
    IT: E: SM
    COB-C0311 Nov. 21, 1926.
    Fort Pitt Spring & Manufacturing Company,
    P. O. Box 917,
    Pittsburgh, Pennsylvania.
    Sirs:
    Reference is made to your corporation incom'e and profits tax return for the calendar year 1920,

      you are advised that after careful consideration and review, your application under the provisions of Section 327 for the assessment of your profits tax as prescribed by Section 328 of the Revenue Act of 1018 has been allowed, your profits tax is based upon a comparison with a group of representative concerns which in the aggregate may be said to be engaged in a like or similar trada or business to that of your company.
    The result of the audit under the above-mentioned provisions is as follows:

      Net meóme

    Net Income, Bureau letter April 24, 1025___$161, 590.50

      Deductions: ■

    (a) “Capital expenditures” adjustment reversed_$466.62
    (b) “ Replacements ” allowed as expense_ 646.29
    (c) Depreciation on restored items_ 141.07
    (d) Interest- 18. 64
    -:— 1,272. 62
    Corrected Net Income_$160,317.88
    * * * * * * *

      Computation of Tarn.

    Profits Tax Section 328_ $40, 619.48
    Net Income-$160,317.88
    Less:
    Profits Tax_$40, 619.48
    Exemption- 2, 000. 00 42, 619.48
    Taxable at 10%_$117, 698.40 11,769. 84
    Total tax liability_ 52,389.32
    Tax assessed:
    Original Account No. 404409_$64,114. 37
    Tax liability_ 52, 389.32
    Overassessment indicated_$11,725.05
    In accordance with the above conclusions, your claim for the abatement of $13,267.65 will be rejected for $1,542.60.
    This petition alleging .the determination of a deficiency in the amount of $1,542.60 based on the Commissioner’s letter of November 21, 1925, was filed on January 13, 1926. .The only allegation of error set forth in the petition is the failure of the Commissioner further to reduce net income by allowing a further deduction, under ordinary and necessary expenses, in the amount of $17,824.89, alleged to have been paid to employees as compensation for services rendered.
   OPINION.

Green:

The Commissioner has moved to dismiss this appeal on the ground that no deficiency has been determined against the petitioner for the year 1920 within the meaning of section 278 of the Revenue Act of 1924, which defines a deficiency as follows:

Sec. 273. As used in this title the term “ deficiency ” means—
(1) The amount by which the tax imposed by this title exceeds the amount shown as the tax by the taxjjayer upon his return; but the amount so shown on the return shall first be increased by the amounts previously assessed (or collected without assessment) as a deficiency, and decreased by the amounts previously abated, credited, refunded, or otherwise repaid in respect of such tax; or
(2) If no amount is shown as the tax by the taxpayer upon his return, or if no return is made by the taxpayer, then the amount by which the tax exceeds the amounts previously assessed (or collected without assessment) as a deficiency; but such amounts previously assessed, or collected without assessment, shall first be decreased by the amounts previously abated, credited, refunded, or otherwise repaid in respect of such tax.

The Commissioner has taken the position that the tax shown by the petitioner on its return is $64,114.37, and that a denial in part of a claim for the abatement of $13,267.65 of that amount, no amounts having been “previously assessed (or collected without assessment) as a deficiency ” nor “ abated, credited, refunded, or otherwise repaid in respect of such tax,” is not the determination of a deficiency within the meaning of section 273 quoted above. It is the contention of the petitioner, however, that since the return was accompanied by a request for relief under section 328, $64,114.37 was not the amount shown on its return as the tax, within the meaning of our decision in the Appeal of John Moir, 3 B. T. A. 21, wherein we held the starting point in the computation of a deficiency to be the amount admitted on the return as the tax, and that denial in part of the claim in abatement is the determination of a deficiency within the meaning of section 273. The petitioner also relies upon our decision in the Appeal of Continental Accounting & Audit Co., 2 B. T. A. 761.

Without passing on the question as to whether or not an application for special assessment filed with a return is such a protest as denies the petitioner’s liability for the tax or a part of the tax shown on the return, in effect like the protest in Appeal of Continental Accounting & Audit Co., supra, we are of the opinion that, even though we assume in this case that the application for special assessment was such protest, the Commissioner has not determined a deficiency. At the most, the petitioner’s application for special assessment was a denial only of that part of the tax shown in the computation on its return as would be eliminated by computation of the tax under the provision of section 328. The conclusion that such was the petitioner’s position at the time of filing the return is supported by statements appearing in the claim for abatement subsequently filed, wherein the abatement of $13,267.65 was claimed until the decision of the Commissioner on the application for special assessment should “enable the amount of said tax to be accurately determined.”

The petitioner does not now claim that the Commissioner erred in applying the provisions of section 328, and unless the tax has otherwise been increased by the determination of the Commissioner, there is no ground for claiming that a deficiency has been determined. In this respect, the facts show that the tax has been decreased. In its return the petitioner admitted its tax to be the tax properly computed on a net income of $165,508.12, whereas the Commissioner has determined the correct tax to be an amount resulting from a computation, using the same rates, on a net income of $160,317.88. In other words, the Commissioner has determined the correct amount of the tax to be less than the tax admitted to be due by the petitioner on its return, which clearly distinguishes this case from the Appeal of Continental Accounting & Audit Co., supra, and Appeal of John, Moir, supra.

Since no deficiency has been determined, the Board is without jurisdiction, and the appeal is

Dismissed.


source: Caselaw Access Project

author: Van Fossan:

license: Public Domain

text:
    Appeal of Siems, Carey-H. S. Kerbaugh Corporation.
    Docket No. 2777.
    Promulgated January 20, 1927.
    A promissory note payable to the Secretary of War, executed by tbe three owners of a corporation in their individual capacity, and securities individually owned or borrowed by such owners, which note and securities were turned over to the corporation and by it put up as security for the repayment of an advance made to it by the United States in aid of the performance of a supply contract between the corporation and the United States, and returned to said owners upon the termination of said supply contract, held, not to be part of the invested capital of the corporation.

      George A. O'Donohue, Esq., for the petitioner.

      M. N. Fisher, Esq., for the Commissioner.
    This appeal involves the correctness of a deficiency in income and profits tax of $102,884.13 for the calendar year 1919. Petitioner claims that a certain promissory note for $1,000,000, executed by three individuals and made payable to the Secretary of War, together with certain securities of the value of $750,000, put up with the War Credits Board as security for the performance of a contract, should be included in computing its invested capital.
    FINDINGS OF FACT.
    In May, 1918, a partnership composed of C. P. Siems, W. F. Carey and H. S. Kerbaugh, experienced railroad contractors, was negotiating with the War Department for a contract covering the construetion of a railroad into the spruce belt in the State of Washington and a second contract for the production and delivery of spruce flitches. After several days of conferences the partnership requested its counsel to come to Washington to advise them during the negotiations. Before leaving New York counsel for the partnership took steps to "organize the petitioner corporation under the laws of the State of Maine. He dictated the charter over the telephone to Portland, Me., and three persons’ as “ dummies,” signed it and filed it at the State Capitol. The charter was later sent by mail to the parties in Washington. The minimum amount of $1,000 required by the Maine law to be paid in was so paid in and went for organization expenses. • No stock was ever issued to cover this amount or for any other purpose. No stock certificates or stock books were ever printed, and the only arrangement as to the stock was an oral agreement by Siems, Carey, and Kerbaugh that they would take the stock up to $1,500,000 and pay for it as it might be needed. This was never done. Siems, Carey, Kerbaugh, and their counsel, Clarke, were made directors of the corporation.
    The War Department was under great pressure to get these contracts placed and the railroad constructed so that the spruce timber essential for airplane production could be delivered as early as possible. The first contract executed was for the construction of the railroad, the work on which was actually commenced by the corporation before the contract was signed on May 18, 1918. The corporation did not have sufficient funds to finance the contract and applied to the War Department for advance payments. An advance payment of $500,000 was authorized by the War Credits Board under a supplemental contract. To secure this advance the corporation gave its note, endorsed by Pliney Fiske, of Harvey Fiske & Son, and a surety company bond for $500,000 furnished by the Fidelity & Deposit Company 'of Maryland. This contract is not directly involved in the present case, but is referred to as one of the steps in the proceedings leading up to the production contract.
    In the second contract with the Government the petitioner agreed to deliver a minimum of 250,000,000 feet, board measure, of spruce timber flitches between December, 1918, and November, 1919, at a price ranging from $60 to $100 per thousand feet. It was stipulated in the contract that in the event of cancellation settlement should be made on the basis of cost plus 7 per cent. This contract was dated May 12, 1918, and immediately thereafter contractors applied to the War Credits Board to authorize advance payments on said contract. The Board offered to authorize a total advance of $6,000,000, in installments of $1,000,000 each, upon the execution by the corporation of its note for $6,000,000, secured by $2,000,000 of collateral. Petitioner corporation was unable to furnish the security nor was its banker, Harvey Fiske & Son, willing to undertake the transaction. The individuals composing the corporation made every effort to secure another institution to finance or underwrite the corporation, but without success. After considerable negotiation the War Credits Board asked counsel for the corporation what collateral Siems, Carey and Kerbaugh could provide. Their reply was that they could produce $750,000 in collateral and no more for this purpose. After further conferences the War Credits Board agreed to approve an advance of $750,000 upon the signing by the individuals of a joint and several promissory note for $1,000,000 and the deposit of $750,000 of bonds as collateral. The supplemental agreement incorporating the above understanding was drawn and signed by the parties and a joint and several note for $1,000,000, payable to the Secretary of War and signed by Chester P. Siems, William F. Carey and H. S. Ker-baugh as individuals, together with an aggregate of $750,000 of stocks and bonds, was turned over to the War Credits Board.
    The securities aggregating approximately $750,000 which were put up as collateral for the $1,000,000 note came from the following sources: $370,000 in miscellaneous stocks personally owned by Siems; $130,000 in miscellaneous stocks personally owned by Carey; and $250,000 of Liberty bonds borrowed from Mrs. Stone, wife of Stone, of Hayden, Stone & Co. The partnership of Siems and Carey also contributed its check for $35,000. At the time these securities were turned over by Siems to Clarke as counsel for the petitioner corporation, the following statements were made by Siems:
    Q. In delivering the securities to you, what statement, if any, did Mr. Siems make as to the status which the bonds were to have after their delivery to you, or as to the purpose for which you were to use them?
    A. Mr. Siems and I had been trying to raise the required collateral for the corporation, and we could not make it. He handed me these securities and said, “ I will fix it. I will turn these into the corporation.” That was all he said.
    Q. Did he use those identical words?
    A. Those were his identical words, to the best of my recollection, “ I am turning these over to the corporation.” He said no more than that.
    The above securities were never assigned to the corporation and were never taken up on any of its books.
    On June 20, 1918, the Bankers Trust Co. of New York, agent for the War Credits Board, receipted for the securities deposited with it in the following language: “ To be held for account and subject to the order of War Credits Board as per letter of Siems, Carey-Ker-baugh Corporation, June 20, 1918.” All interest collected by the Bankers Trust Co. on the securities during the time they were held was remitted to the corporation at its office in Seattle, Wash,

      Shortly after November 11, 1918, the United States canceled its prodnction contract with the petitioner and proceeded to make settlement under the terms thereof. On August 14, 1919, the War Credits Board returned to the petitioner corporation the note and securities that had been placed with it, and they were immediately returned to the original owners from whom they were obtained— $370,000 of personally owned securities to the estate of Siems, $130,-000 to Carey, and $250,000 of Liberty bonds to Hayden, Stone & Co. There was no formal corporate action of any kind indicating a distribution of capital assets nor any other corporate action with reference to the return of the securities.
   OPINION.

Van Fossan:

The question to be determined in this case is whether or not a note for $1,000,000 and securities aggregating $750,000 in value should properly have been included in the invested capital of the petitioner. The evidence is that the corporation was a mere shell. It never issued any stock, even for the $1,000 paid in for organization expenses. It printed no stock certificates. So far as the record shows it had none of the usual corporate books. In the financial extremity in which they found themselves the three owners of the corporation signed personally and individually a promissory note for $1,000,000, while two of the three owners contributed or loaned to the fund of $750,000 to be put up as security such personally owned securities as they had available. The Siems-Carey partnership contributed its check for $35,000 and there was also contributed $250,000 in Liberty bonds “borrowed under (Clarke’s) guidance from Mrs. Stone, wife of Stone, of Hayden, Stone & Company.” Practically the sole evidence that these securities were “ paid in ” to the corporation is to be found in the statement attributed to Siems (deceased before the hearing) contained in the testimony of Clarke set out in the findings of fact, in which he states, I will turn these into the corporation,” and, later, “ I am turning these over to the corporation.” The intention to pay in capital or a mere statement of such an intention standing alone is not enough. The actions of the parties and the corporation must evince the intention and effect the actual paying in. No single step was ever taken either by the stockholders or the corporation other than as outlined to effectuate the transfer to the corporation. The securities were never assigned to the corporation by their owners nor were they taken up on the books of the corporation. Every circumstance surrounding the transaction goes to show that the securities never belonged to the corporation. The corporation paid nothing for them and gave nothing in return. Title never passed to the corporation. It merely borrowed them from the individuals who owned them and upon the conclusion of their use returned the same securities to the sources from which they came.

When the securities were released by the War Credits Board and returned to their individual owners there was no corporate action of any kind taken in connection with such return. No liquidating dividend or other distribution of assets was made and there is no evidence of the securities ever officially passing through the hands of the corporation.

Whether or not property is paid in to a corporation depends upon the facts surrounding the transaction and not upon any single statement to the effect that they were paid in. This is a conclusion that may or may not be justified by the facts of the case. In this case it clearly was not justified. From the record we are convinced that neither the note nor the securities were ever “ paid in ” to the corporation within the proper legal meaning of that term.

There is another ground upon which it would appear to be necessary to find against the contention of petitioner. Upon the evidence it is clear to us that the securities were borrowed for a specific and temporary use and were later returned to their individual owners. They were never assigned to the corporation and title never passed. It follows, therefore, that if they were capital at all they were borrowed capital, which is expressly excluded from invested capital by section 326 (b), which reads:

As used in this title the term “ invested capital ” does not include borrowed capital.

The provisions of the above section of the law were applied adversely to the taxpayer in the Appeal of Warren-Lamb Lumber Co., 1 B. T. A. 786, 788, where the Board says:

It thus appears that even though we should accept the allegations of the taxpayer as evidence that Lamb, at the time when he made these advances, intended that the sum should become part of the invested capital of the business of the taxpayer, such intention was not actually carried out and made effective until the time when the notes, given by the taxpayer as evidence of the advances, were actually exchanged for the preferred stock shares of the taxpayer company, and this exchange not having taken place until after the close of the year 1917 we must necessarily hold that during the year 1917 these advances represented borrowed capital and not invested capital.

The evidence in support of the taxpayer was much stronger in the above-cited case than in the instant case. See also Appeals of Kelly-Buckley Co., 1 B. T. A. 1154, and Harrolds Motor Car Co., 5 B. T. A. 429.

Judgment will be entered for the Commissioner.

Littleton, Smith and Teussell dissent.

Milliken did not participate.


author: Trammell: Phillips,

text:
    Appeal of Lincoln L. McCandless.
    Docket No. 2783.
    Promulgated January 20, 1927.
    1. Amounts paid for surveys of land involved in litigation held to be capital expenditures.
    2. Upon tbe evidence, held, that tbe transaction upon wbicb tbe taxpayer sought to deduct a loss did not constitute a sale, and tbat tbe Commissioner properly added a penalty of 50 per centum of tbe total amount of tbe deficiency resulting from tbe disallowance of tbe deduction sought by tbe taxpayer.

      Urban E. Wild, Esq., Arthur S. Hoppe, Esq., and E. B. Oameron, O. P. A., for the petitioner.

      A. 0alder Machay, Esq., Ward Loveless, Esq., John D. Foley, Esq., and W. Frank Gibbs, Esq., for the Commissioner.
    This appeal is from the determination of a deficiency in income tax for the year 1921 in the amount of $6,010.96 and a fraud penalty in the additional amount of $3,005.48. The taxpayer asserts that the Commissioner erred in the following particulars: (1) In disallowing a deduction of $524.75 paid in 1921 for surveys of land upon which suit in partition was pending; (2) in disallowing a deduction of $133.25 paid in 1921 for surveys of land in an endeavor to quiet title; (3) in disallowing a deduction of $42,500 which the taxpayer claimed as a loss suffered on the sale of shares of stock sold during the year 1921; and (4) in determining a fraud penalty against the taxpayer.
    FINDINGS OF FACT.
    1. The taxpayer is a citizen of the United States and a resident of Honolulu, T. H.
    2. In 1921 and for several years prior thereto the taxpayer and one James Armstrong owned certain lands at Pearl City, Oahu, T. H., as tenants in common. Armstrong brought an action against the taxpayer in 1921 for the partition of these lands. After this action was brought, the taxpayer employed a surveyor to make a survey of the lands in an effort to determine whether the lands could be divided in kind between the parties. The taxpayer paid the surveyor $524.75 in 1921 and sought to deduct the same in his income-tax return for that year as an ordinary and necessary business expense. This deduction was disallowed by the Commissioner. The suit in partition was terminated by Armstrong purchasing the taxpayer’s interest in the lands. A part of the taxpayer’s business enterprises in 1921 was the purchase, sale, and renting of real estate.
    3. For a number of years prior to 1921, the taxpayer claimed title to certain lands at Waiele, T. II., known as “ Waimalu Lands.” The Territory also claimed title to the lands and brought suit in the Territorial Land Court for registration of its claimed title. As the issues involved boundary lines, the taxpayer caused a survey of the lands to be made and brought suit to register his title, in order to protect his own interests. The taxpayer paid $133.25 for these surveys in 1921 and claimed that amount as a deduction in his income-tax return for that year as an ordinary and necessary business expense. This deduction was disallowed by the Commissioner. The two suits for registration of title are still undetermined.
    4. The California-Hawaiian Development Co. is a corporation which was organized under the laws of the State of California on or about September 27,1911. This company, hereinafter called the corporation, was organized by the taxpayer and several associates, among whom was C. G. Bockus, for the purpose of acquiring from the Sierra Nevada Development Co., an Arizona corporation, certain mining properties in Placer County, California. The corporation was incorporated with a capital stock of 3,000,000 shares having a par value of one dollar each. Sometime in 1909 the taxpayer had purchased shares of stock in the Sierra Nevada Development Co. at the price of $7.50 for shares having a par value of $10 each. These shares were exchanged in 1911 for shares of stock in the corporation at the ratio of one for twenty.
    5. C. G. Bockus was a resident of Honolulu for many years prior to March, 1922, when he left Honolulu for San Francisco, Calif., where he has since continued to reside. He had been one of the organizers and for some time secretary of the corporation, and was a licensed dealer in stocks, bonds, and general securities in the Territory of Hawaii during the year in question. He was on terms of intimate friendship and association with the taxpayer and had many business dealings in the sale and purchase of stocks and bonds for him.
    6. On or about December 10, 1921, Bockus called at the office of the taxpayer in Honolulu and offered to purchase some of his stock in the corporation at 5 cents per share. At that time the taxpayer told Bockus that he would consider the matter. Subsequently, and on December 15, 1921, Bockus again called on the taxpayer and renewed his offer. On that date the taxpayer informed Bockus that he would sell him 100,000 shares of the stock of the corporation. The taxpayer then produced certificate 184 for 280,800 shares of the stock of the corporation and endorsed and delivered it to Bockus. This was done with the understanding that Bockus was to surrender the certificate for cancellation and have two certificates issued in lieu thereof; one to himself for 100,000 shares and the other to the taxpayer for 180,800 shares. At that time Bockus gave the taxpayer a receipt for the certificate for 280,800 shares, on which he wrote “ of which 100,000 shares is sold to me at five cents per share, balance to be returned.” At the same time the taxpayer made a memorandum as follows:
    Dec. 15/21
    Sold to O. G. Bockus 100,000 shares at 50 of O. H. D. Co. Stock out of Certificate #184 of_ 280, 800
    Sold_ 100, 000
    Due L. Li. McC_ 180, 800
    This stock cost $37.50 Per Share. Paid 8 assessments 2 at 20
    6 at 1‡ total 10 cts. Per share or_3, 750
    1,000
    Total cost per share-4, 750
    Bockus mailed certificate 184 to the office of the corporation in San Francisco for surrender and transfer on or about December 22, 1921. The certificate was canceled by the secretary of the corporation on December 30, 1921. In lieu thereof, certificate 691 for 100,000 shares was issued to Bockus, and certificate 698 for 180,800 shares was issued to the taxpayer. Both certificates were mailed to Bockus. He retained certificate 697 and delivered certificate 698 to the taxpayer. On December 15, at the time of the purported sale, Bockus told the taxpayer that he would give his note in payment for the stock. The taxpayer assented to this and Bockus then made out and delivered to him a promissory note or I O U in the amount of $5,000. This transaction, which the taxpayer claims was a sale, was made because he desired to sustain a loss for the purpose of deducting the amount thereof from his income in his tax return for the year 1921.
    7. The shares of stock transferred by the taxpayer to Bockus were acquired by him December 80, 1911, in exchange for the shares of stock of the Sierra Nevada Development Co. which he owned. At the ratio of exchange, the cost to the taxpayer of the shares in the corporation was 37½ cents per share. During the period from December 26, 1914, to June 28, 1921, the taxpayer paid assessments amounting to 11 cents per share, thus making the total cost of each share 48⅝ cents, or $47,500 for the 100,000 shares. The fair market value of the stock on March 1,1913, was 50 cents per share.
    8. A day or two after the delivery of certificate 184 to Bockus, the .taxpayer gave the receipt for the certificate which Bockus had signed at the time of the delivery and his own memorandum of the transaction to one J. S. Martin, who was his bookkeeper, for filing. At that time the taxpayer told Martin the details of the transfer of the 100,000 shares to Bockus. Martin then asked the taxpayer why he had not been given a chance to buy that stock and stated that he would like to buy 100,000 shares at 5 cents per share and give his note in payment therefor. The taxpayer then told Martin that he would see Bockus about it. Accordingly, the taxpayer called on Bockus and told him that Martin desired to buy the 100,000 shares at 5 cents per share and give his note in payment therefor. After that conversation, Bockus called on the taxpayer and stated that he would be willing to transfer the 100,000 shares to Martin, if the taxpayer would accept Martin’s note for $5,000, return to Bockus his note or I O U and also pay Bockus a broker’s commission on the deal. The taxpayer assented to this offer and informed Martin on or about December 21, 1921, of Bockus’ condition and stated that he would accept Martin’s note. Martin immediately made out his promissory note for $5,000 payable to the taxpayer and delivered it to him. The taxpayer returned to Bockus his note or I O U for $5,000, which Bockus destroyed. Subsequently, in April, 1922, the taxpayer paid Bockus $200 on account of the brokerage agreed upon for the transfer of the shares to Martin and, in August, 1922, paid the balance of $50, taking a receipt for each payment. When certificate 697 for the 100,000 shares was received by Bockus, he endorsed it and gave it to the taxpayer for delivery to Martin. The certificate was delivered to Martin and he placed it in the safe of the office in which he was employed by the taxpayer and held it there until about the first of June, 1922, when he sent it to San Francisco for transfer to his own name. It was canceled on June 8,1922, and certificate 702 was issued to Martin in lieu thereof. Martin paid $20 for transfer stamps on this certificate. The promissory note which Martin had given the taxpayer was kept in the safe in the office in which he was employed by the taxpayer. Martin made no entries on the taxpayer’s books, either of the purported sale of the 100,000 shares of stock to Bockus or the reciept of his note or I O U for $5,000, nor did he make any entries of the promissory note given by him to the taxpayer. Neither did Martin pay any interest to the taxpayer on the promissory note which he gave.
    9. Sometime in August, 1922, Martin received a notice of an assessment levied on the 100,000 shares of stock represented by certificate 702. He did not want to pay the assessment and so informed the taxpayer, who stated that, if Martin could not pay the assessment, he would take the stock back. Martin had access to the taxpayer’s office safe. Fie took therefrom the promissory note for $5,000, which he had given the taxpayer, and destroyed it. He then endorsed and delivered certificate 702 to the taxpayer, who paid the assessment thereon. This certificate was canceled on September 21, 1922, and certificate 706 was issued to the taxpayer in lieu thereof. The taxpayer paid for the tax stamps on this last transfer.

      10. The taxpayer purchased no shares of the stock of the corporation within sixty days prior or subsequent to the transfer of the 100,000 shares to Bockus or to Martin.
    11. In his income-tax return for the year 1921, the taxpayer claimed a loss of $42,500 on the transfer to Bockus of the 100,000 shares of stock of the corporation and sought to take a deduction of that amount as a loss on such transfer on the ground that it was a sale. The Commissioner disallowed such deduction, asserted that the alleged sale was false and fictitious, determined a deficiency of $6,010.96, and added a fraud penalty of 50 per cent in the amount of $3,005.48.
    12. The transfer to Bockus of the 100,000 shares of stock of the corporation and their subsequent transfer to Martin were made with intent to evade tax, and the return of the amount of $42,500 by the taxpayer as a loss resulting from a sale was false and fraudulent.
   OPINION.

Trammell:

The amounts paid for surveys of the Pearl City tract and the Waimalu Lands, as described in findings 1 and 2, are clearly capital expenditures and can not be deducted as ordinary and necessary business expenses. Appeal of Consolidated Mutual Oil Co., 2 B. T. A. 1067.

The important question involved in this appeal is whether the taxpayer was guilty of fraud with intent to evade tax when he sought to deduct a loss of $42,500 on the purported sale of 100,000 shares of stock of the corporation. The taxpayer admitted that his sole purpose in transferring this stock was to write off a loss from his income for 1921. Whether he is entitled to deduct the loss depends on whether the transaction between him and Bockus on December 15, 1921, was a sale. If it was, the deduction was proper; if it was not, the deduction can not be allowed.

The Commissioner denies that the transaction between the taxpayer and Bockus was a sale and asserts that it was a mere pretense. The taxpayer declared that he sold the stock to Bockus, and that subsequently, at his request, Bockus sold the stock to Martin. Bockus in his testimony corroborates the taxpayer. However, the accompanying details and circumstances must be considered in interpreting the purpose and intent of the transaction with respect to the taxing law.

Stripped to bare essentials, the history of the taxpayer’s deals with Bockus and Martin is as follows: The taxpayer, who was the owner of a large number of shares of stock of the corporation, agreed to “ sell ” 100,000 shares thereof to Bockus in return for a note or an I O U. When he discovered that Martin wanted the stock, the tax-. payer was so anxious that his bookkeeper should have it that he agreed to pay Bockus a broker’s commission for destroying his note or I O TJ and accepted Martin’s note in its place. This second note was allowed to repose in the office safe where Martin had ready access to it. Later on, and after the taxpayer had filed his income-tax return with the $42,500 deducted as a loss therein, Martin decided that he did not want to pay an assessment on the stock. The taxpayer with apparent willingness, and without any apparent consideration of the fact that the sale of the stock by the corporation to satisfy the assessment would be Martin’s loss and not his, permitted Martin to take the note from the safe and destroy it, accepted return of the stock certificate, and paid the assessment to the company. The results of these transactions were that Bockus received a commission and was relieved of his obligation on the note, Martin was permitted to escape all liability on his note, and the taxpayer had his stock returned to him, paid an assessment thereon, and deducted a loss which, had it not been challenged by the Commissioner, would have enabled him to escape taxation for the year 1921.

The salient features of the transaction are not indicative of good faith therein. They do not indicate a sale which can be recognized under the revenue acts. The admitted intent to deduct a loss appears to be supported by a motive to take the loss without regard to the method employed. By a circuitous process the taxpayer sold the stock to himself for $250. This is a condition not dissimilar from, hut more flagrant than, the condition developed in Appeal of James Dobson, 1 B. T. A. 1082.

On the evidence submitted in this appeal, we are not warranted in overturning the action of the Commissioner in denying the deduction. Nor can we, when confronted with such a peculiar situation, disturb the Commissioner’s finding of fraud.

Judgment will be entered on SO days' notice, winder Rule 50.

Milliken did not participate.

Murdock dissents.

Phillips,

dissenting: While the transactions recited above are not free of suspicion, I have reached the conclusion, after hearing and weighing the testimony of the witnesses and considering the circumstantial evidence, that the record in this appeal, which is one step in the proceedings to impose a penalty for a criminal act, is insufficient to meet the requirement of the common law that commission of the crime must be established beyond a reasonable doubt.

The transactions, on their face, were regular. The testimony of the parties is that a sale was made and that there was no collateral agreement or secret understanding with respect to the stock. The sales price represented the fair market value of the stock and there is nothing to indicate that Bockus and Martin were unable to meet their notes. In fact, the testimony indicates the contrary. The exaction by Bockus of a commission as a condition of the sale to Martin would not seem unusual if, as taxpayer contends, Bockus was then the owner of the stock, nor are the facts with reference to the subsequent re-acquisition of this stock unusual.

I am unwilling to adjudge this taxpayer guilty of the crime charged on suspicion alone, when the suspicious circumstances in the record are susceptible of an innocent interpretation, and for that reason I must dissent from the conclusion reached.

Trussell concurs in this dissent.


text:
    Appeal of John A. McCandless.
    Docket No. 2784.
    Promulgated January 20, 1927.
    Upon the evidence, held, that a transfer of shares of stock by the taxpayer did not constitute a sale and that no deductible loss resulted therefrom; also, that the fixing of a fraud penalty of 50 per centum of the total amount of the deficiency, resulting from the disallowance of the deduction sought, was proper.

      Urban E. Wild, Esq., Arthur S. Hoppe, Esq., E. R. Gamer on, O. P. A., and A. R. Bechtold, G. P. A., for the petitioner.

      A. 0adder Machey, Esq., Ward Loveless, Esq., John D. Foley, Esq., and W. Frank Gibbs, Esq., for the Commissioner.
    This appeal is from the determination of a deficiency in income tax in the amount of $9,216.84 for the year 1921, and an added fraud penalty of $4,608.42, or a total deficiency of $18,825.26.
    FINDINGS OF FACT.
    1. The taxpayer is a citizen of the United States and a resident of Honolulu, T. H.
    2. The California-Hawaiian Development Co. is a corporation which was organized under the laws of the State of California on or about September 27, 1911. This company, hereinafter called the corporation, was organized by the taxpayer and several associates, among whom was C. G. Bockus, for the purpose of acquiring from the Sierra Nevada Development Co., an Arizona corporation, certain mining properties located in Placer County, California. The corporation was incorporated with a capital stock of 3,000,000 shares having a par value of one dollar each. Sometime in 1909 the taxpayer had purchased shares of stock in the Sierra Nevada Development Co. at the price of $7,50 for shares having a par value of $10 each. These shares were exchanged in 1911 for shares of stock in the corporation at the ratio of one for twenty, thus making the cost to the taxpayer of such shares in the corporation 37½ cents each.
    3. C. G. Bockus was a resident of Honolulu for many years prior to March, 1922, when he left Honolulu for San Francisco, Calif., where he has since continued to reside. He had been one of the organizers and for some time the secretary of the corporation, and was a licensed dealer in stocks, bonds and general securities in the Territory of Hawaii during the year in question. He was on terms of intimate friendship and association with the taxpayer and had many business dealings in the sale and purchase of stocks and bonds for him.
    4. On or about December 10, 1921, Bockus called at the office of the taxpayer in Honolulu and stated that he desired to purchase some of the taxpayer’s shares in the corporation. At that time the taxpayer told Bockus he would consider the offer. A few days later Bockus again called on the taxpayer without any resulting arrangement. On or about December 21, Bockus made another visit to the taxpayer’s office. At that time the taxpayer produced certificate 95 for 267,780 shares of the stock of the corporation. The certificate was then endorsed by the taxpayer and delivered to Bockus, who, at the same time, gave to the taxpayer his demand promissory note for the sum of $13,389. Bockus took the stock away with him and within the next few days mailed it to the office of the corporation in San Francisco, where, on December 30, 1921, it was canceled and certificate 696, for the same number of shares, was issued in lieu thereof in the name of O. G. Bockus. This certificate was mailed to Bockus and received by him at Honolulu. Bockus held certificate 696 in his possession until May, 1922. The taxpayer paid for the documentary stamps on the promissory note given to him by Bockus and also on the stock certificate delivered by him to Bockus. Previous to December 10, 1921, the taxpayer had endeavored to sell some of his shares of stock in the corporation to other brokers, but did not so dispose of any of his stock. At the time of the transfer of certificate 95 on December 21, 1921, the taxpayer paid $267 to Bockus as a part of a brokerage commission on the transfer and, in February, 1922, paid him an additional amount of $1,000 as the balance due on such commission. This transfer of stock to Bockus for. a promissory note, which the taxpayer claims was a sale, was made because he desired to sustain a loss for the purpose of deducting the amount thereof from his income in his tax return for 1921.
    5. The shares of stock transferred by the taxpayer to Bockus were acquired by him November 14, 1911, in exchange for the shares of stock of the Sierra Nevada Development Co. which he then owned. At the ratio of exchange, the cost to the taxpayer of the shares represented by certificate 95 was 37½ cents per share. During the period from December 26, 1914, to June 28, 1921, the taxpayer paid assessments amounting to 11 cents per share, thus making the total cost of each share 48½ cents, or $129,873.30 for the 267,780 shares. The fair market value of the stock on March 1, 1913, was 50 cents per share.
    6. In his income-tax return for the year 1921, the taxpayer claimed a loss of $116,484.30 on the transfer to Bockus of the 267,780 shares of stock of the corporation and sought therein to take a deduction of that amount as a loss on such transfer on the assertion that it was a sale. The Commissioner disallowed the deduction sought, asserted that the alleged sale was false and fictitious, determined a deficiency in the amount of $9,216.84, and added a fraud penalty of $4,608.42.
    7. In the latter part of May, 1922, the taxpayer called on Bockus at his office in San Francisco and inquired of him as to whether he could pay the promissory note for $13,389. Bockus replied that he could not and requested the taxpayer to take back the stock in exchange for the note. In response to this request the taxpayer delivered the note to Bockus, who tore it up. Bockus then endorsed certificate 696 and immediately delivered it to the taxpayer. This certificate was canceled June 9, 1922, and certificates 703 and 704 were issued to the taxpayer in lieu thereof. On this return transfer the taxpayer paid Bockus another brokerage commission amounting to $1,267.
    8. Sometime in November, 1922, Bockus and the taxpayer had a conversation in San Francisco in which Bockus informed the taxpayer that he was heavily involved financially and that there was likelihood of bankruptcy proceedings being instituted against him by his creditors. . The taxpayer expressed his willingness to assist Bockus and offered to sell him some stock in the corporation after the bankruptcy petition had been filed, in order to give Bockus an opportunity to make some money by reselling the stock. The taxpayer was to make no final decision until he returned to Honolulu. His return to that city followed within the next week or two. The creditors of Bockus filed a petition in involuntary bankruptcy against him on December 7, 1922, and, on December 28 he was adjudged a bankrupt. Prior to the latter date and after December 7, the taxpayer mailed certificates 126, 197, 324, 350 and 409 for a total of 152,736 shares of stock in the corporation, which stood in his name on the books of the corporation, to H. A. Kunz, secretary, at San Francisco. These certificates were accompanied by written instructions-from the taxpayer for Kunz to'issue a certificate for the 152,736 shares to Bockus and take in return therefor Bockus’ promissory note for the amount of $3,054.72. At the same time the taxpayer wrote to Bockus informing him of the instructions to Kunz. Bockus executed his demand promissory note for $3,054.72, delivered it to Kunz and, oh December 27, 1922, Kunz issued certificate 713 in Bockus’ name for the 152,736 shares and delivered it to him, In November, 1923, Bockus told the taxpayer that he had not sold the stock and was unable to pay the promissory note. The taxpayer then informed Bockus that sufficient opportunity to sell the stock had been given him and stated that he, the taxpayer, desired to repurchase the stock by cancellation of the note. Certificate 713 was endorsed by Bockus and returned to the taxpayer. A brokerage commission of $230 was paid to Bockus by the taxpayer on each of these stock transfers. In his income-tax return for the year 1922, the taxpayer claimed a loss of $54,984.96 on the transfer of the 152,736 shares of stock to Bockus in December, 1922, and deducted that amount as a loss.
    9. The taxpayer purchased no shares of the stock of the corporation within sixty days prior or subsequent to the transfer of the 267,780 shares of stock of the corporation described in paragraph 5.
    10. The transfer to Bockus of the 267,780 shares of stock of the corporation was made with intent to evade tax, and the return of the amount of $116,484.30 by the taxpayer as a loss resulting from a sale was false and fraudulent.
   OPINION.

Trammell:

The sole- question for consideration is whether the attempt by the taxpayer to deduct a loss of $116,484.30 in his income-tax return for 1921 was a fraud with intent to evade tax. The Commissioner asserts that the transaction upon which the deduction was predicated was a pretended sale, designed to effect an evasion of taxation. The taxpayer admits that the transfer described in paragraph 4 of the findings was made in order that he might deduct a loss for the taxable year. If the transaction was a sale, the taxpayer’s admission expresses a perfectly legal intent, United States v. Isham, 17 Wall. 496; Appeal of Pennsylvania Co. for Insurance, etc., 2 B. T. A. 48; Appeal of Benjamin T. Britt, 2 B. T. A. 53; Appeal of Harold B. Clark, 2 B. T. A. 555. Whether the proper intent existed in the present case remains to be determined from the circumstances surrounding the transaction.

The evidence discloses a tangled web of circumstances from which it is difficult to unravel the threads of truth. From a brief narrative of what at first appears to be an actual sale of shares of stock, the testimony, in its extended detail, presents confusion and suspicion.

Bockus and the taxpayer testify with positiveness that, on or about December 10, 1921, Bockus called on the taxpayer and told him that he wanted to buy some of the corporation stock; that a few days subsequently there was another conversation about the matter, and that on December 21, 1921, the negotiations were closed by the taxpayer selling to Bockus certificate 95 for 267,780 shares of the stock and taking in payment therefor Bockus’ demand promissory note for $13,389. Both witnesses testified that this transaction was a sale and was intended by both to be a sale. In corroboration it was shown that certificate 95 was surrendered by Bockus and canceled on the books of the corporation; that certificate 696 was issued to Bockus in lieu thereof and retained by him for some four or five months. These, in brief, are the facts upon which the taxpayer relies to support his right to a deduction of a loss and to defeat the deficiency and added penalty.

According to Bockus, his offer to purchase was made on his own behalf and he was not acting as a broker, but as a principal, in making the purchase. Yet we find him charging, and the taxpayer paying in cash, a brokerage commission of $1,267 on a sale which involved Bockus giving a note of somewhat doubtful value in payment for the shares of stock. Bockus testified that this commission was justified by custom, yet, when pressed on cross examination, he admitted that in all his dealings he had never before received a commission for giving a note for stock which he purchased for his own use and benefit. To further aid in making the sale, the taxpayer, in addition to paying for the revenue stamps on the transfer of the shares to Bockus, paid for the stamps on the note given him by Bockus, despite the fact that Bockus was to receive a rather liberal commission on the deal. Apparently the taxpayer was not only desirous of making a sale, but was extremely anxious to facilitate it for the purpose of taking a loss within the year in issue.

Bockus held certificate 696 until the latter part of May, 1922, or approximately two and a half months after the taxpayer was required to file the income-tax return for 1921 in which he had deducted a loss of $116,484.30 on the purported sale. There is no testimony to show that Bockus made any attempt to dispose of it by sale during the period of his possession and thus realize a profit, though he testified that his reason for purchasing the stock was to make a profit on resale. When the taxpayer called on Bockus in the latter part of May, 1922, and inquired as to whether he could pay the note and Bockus requested the taxpayer to repurchase the stock by giving him back bis note, the taxpayer was peculiarly prompt in acquiescing and obviously generous in paying Bockus a commission to sell back the stock to him in consideration for a note which was apparently worthless. In the sale and repurchase of the stock, the taxpayer paid commissions amounting to $2,534. For these payments he had the stock restored to his possession, but had claimed a deduction in his income-tax return which had saved him from the payment of a tax of $9,216.84. These circumstances are such as to throw strong suspicion upon the bona ftdes of the transaction of December 21,1921.

This suspicion is augmented when we consider the further transactions between the taxpayer and Bockus. In November of 1922, about six months after Bockus had declared himself unable to pay his note of December 21, 1921, and in the face of confession by him of impending bankruptcy proceedings, the taxpayer again discussed another sale of corporation stock to Bockus. Immediately following the filing of the creditors’ petition in involuntary bankruptcy against Bockus, the taxpayer in Honolulu mailed certificates representing 152,736 shares of the corporation stock to San Francisco to be delivered to Bockus upon his executing and delivering a promissory note in the amount of $3,054.72, at the rate of 2 cents per share, in favor of the taxpayer. This note was delivered to the taxpayer’s agent on December 27, 1922, just before the close of the taxable year, and the taxpayer in his income-tax return deducted a loss of $54,984.96 on the purported sale. Again we find Bockus retaining the stock, again we find him unable to pay his note, once more we find the taxpayer willing to repurchase the stock, after the filing of his return by returning Bockus’ promissory note, and again we find that the taxpayer has paid Bockus a commission on each of the so-called sales.

From the testimony of the taxpayer and Bockus we are of the opinion that the transfer of stock to Bockus in December 21, 1921, was not a sale, that it was a mere pretense to permit the taxpayer to claim a loss, and that the return was false and wilfully so made.

Judgment will be entered on 30 days' notice, umder Rule 50.

Miluken did not participate.

Muedock dissents.

Phillips,

concurring: The record before us in this proceeding, unlike the two appeals of taxpayer’s brothers, which were heard at the same time, is, in my opinion, sufficient to establish the crime charged beyond any reasonable doubt. I therefore concur in the result which has been reached.


text:
    Appeal of Royal Mineral Association.
    Docket No. 3146.
    Promulgated January 20, 1927.
    Depletion. — Commissioner’s determination of tlie March 1, 1913, value of the right to receive royalties from leases of iron ore approved.

      Paul E. Bhorb, Esq., and Frank W. Wilson, G. P. A., for the petitioner.

      Arthur J. Seaton, Esq., for the Commissioner.
    This is an appeal from a determination by the Commissioner of a deficiency in income and profits taxes for the years 1919 and 1920 in the respective amounts of $67.69 and $17,780.77, a total of $17,-848.46. The sole issue relates to a determination of the deduction to -which the petitioner is entitled for the years in question on account of depletion of the March 1, 1913, value of its iron ore properties.
    FINDINGS OF FACT.
    The petitioner, a Minnesota corporation with its principal office at Duluth, was, on March 1, 1913, and during the years in question, the owner of an undivided one-third interest in several iron-ore mines situated on the Mesaba range, which mines were leased, at the times stated, to operating lessees under eight separate lease agreements. Seven leases known as Nos. 1, 3, 4, 5, 6, 7, and 8, provided for payments by the lessees on a 25 cents per ton royalty basis, while in the case of lease No. 9 the royalty was $1.25 per ton.
    Under date of September 2, 1924, the petitioner transmitted to the Commissioner a schedule containing, among other things, the following information:
    (a) Estimated ore reserves in each mine at March 1, 1913, as follows:

    (b) Operating lessees’ program of ore production, after March 1, 1913, for each mine, as follows:

    (c) Estimated expenses based upon 3 per cent of gross royalties.
    Upon investigation the Commissioner ascertained that the operating lessees under leases designated Nos. 4, 7, and 8, had no definite programs of ore production at March 1, 1913. During the years in question no ores were extracted from the mines covered by leases Nos. 7 and 8, the operating lessees making the minimum royalty payments provided for in the lease agreements.
    With these data before him the Commissioner proceeded to determine the March 1, 1913, value of the petitioner’s interests in the several mines for the purpose of computing the deductions to which the petitioner was entitled for the years in question on account of depletion. He accepted the petitioner’s estimates of the ore reserves at March 1,1913, as well as the estimates of expected future royalties and expenses, and also the operating lessees’ programs of ore production, with some minor modifications to which no objection has been made by the petitioner. In the determination of the March 1, 1913, value, the Commissioner valued each mine separately in the following maimer: To the estimated future net royalties to be derived from each of the three classes of ore, discount factors taken from Hoskold’s tables were applied to reduce those royalties to their present worth at the date of beginning of extraction of each class of ore, and against the resulting sums further discount factors, representing the present worth of $1 at 6 per cent compound interest according to the number of years of deferment of operations after March 1, 1918, were applied to reduce such sums to their present worth at March 1, 1918. The sums thus obtained for all mines grouped under a single lease were added together and the total thereof was fixed by the Commissioner as the March 1, 1913, value of all the mines covered by a single lease.
    The discount factors used by the Commissioner, in reducing the estimated future royalties for each class of ore to their present worth at the date of beginning of extraction, are taken from Hoskold’s tables, computed on the basis of a risk rate of 6 per cent, according to the number of years of active operations necessary to exhaust each class of ore, except in the case of the estimated future royalties under leases filos. 4, t, and 8. In computing the March 1, 1913, value of petitioner’s interests in the mines covered by leases fiTos. 4, 7, and 8, the Commissioner used a risk rate of 6 per cent in reducing the annual minimum royalty payments provided for in the lease agreements to their present worth at March 1, 1913, and a risk rate of 8 per cent in computing the present worth of the estimated future royalties in excess of the minimum royalty payments.
    The depletion deductions allowed by the Commissioner for the years in question are computed on the basis of a single unit rate for each lease ascertained by dividing the total March 1, 1913, value of all mines covered by a single lease by a figure representing their total ore reserves at March 1,1913.
   OPINION.

Green:

The sole assignment of error set out in petitioner’s petition is that the deductions allowed by the Commissioner for the two years in question, on account of depletion of the petitioner’s interests in several ore properties, are not reasonable allowances as contemplated by section 234(a) (9) of the Revenue Act of 1918. The determination of the deductions to which the petitioner is entitled, as a matter of statutory right, on account of depletion of its interests in certain ore properties, must be made through the use of three factors: (1) Estimated ore reserves in place in the mines at March 1, 1913; (2) March 1,1913, value of those reserves; and (3) tonnage sold by the several lessees during the years in question. By dividing the second factor by the first, a unit rate of depletion is obtained which, when multiplied by the third factor, will produce a result representing the proper annual depletion allowance. The Commissioner and the petitioner are in agreement as to the figures repre-seating the first and third factors, but disagree as to the March 1, 1913, value of the ore reserves and of the petitioner’s interests therein at that date. Consequently, the issue presented by this appeal must be decided accordingly as we find that the March 1, 1913, value fixed by the Commissioner is correct or incorrect.

In the determination of the value, at any basic date, of ore. properties, in the case of a lessor, the most common and generally accepted method of making such a valuation is what is known as the present-value method. This method contemplates that the total expected income to be derived from the extraction and/or sale of ores by operating lessees will be received by the lessor in equal annual installments over the estimated life of the property. Where the programs of production of the operating lessees contemplate a material variation in the annual production and sale of ores from a uniform scale over the life of the property, then the method must be modified so as to give effect to actual conditions. The March 1, 1913, value of the petitioner’s interests in several ore properties fixed by the Commissioner was determined in principle in accordance with the present-value method, and gives effect to the variations in annual production which must result through the carrying out by the lessees of their programs of production. However, the petitioner contends that in the application of the present-value method the Commissioner has fallen into error in several respects and hence his valuation is erroneous.

We have set out in our findings of fact how the Commissioner reached his determination as to the March 1, 1913, values of the interests of this petitioner in certain ore properties. For the sake of clarity we illustrate below his determination as to the value of a single mine, described in the several exhibits as Tract No. 1, Lot No. 3, NE14 of NW% and Lot No. 4, NWy4 of NW%, Section 6, Township 57, Eange 20:

The classification of the estimated ore reserves at March 1, 1913, according to open pit, milling, and underground, was made in accordance with the method to be used in their extraction. Open pit ore, being the top layer, is removed by steam shovel; milling ore is mined and broken down by hand methods and then taken out by steam shovels; while underground ore is broken down into cone-shaped openings, drawn out at the bottom of the cone through chutes, loaded into cars underground, trammed to the shaft and hoisted to the surface. With respect to some of the mines, the operating lessees’ programs of ore production ostensibly provided for the deferment of operations in respect of milling and underground ores until the open pit ores had been entirely exhausted. With respect to certain other mines, milling and underground operations overlapped open pit operations, and in still further instances the three operations were to be carried on simultaneously. The active life in years is the operating lessee’s estimate of the time necessary to exhaust each class of ore, while the deferred life in years represents the operating lessee’s estimate of the number of years before extraction of each class of ore will commence. The discount factors computed on the basis of a risk rate of 6 per cent are those prescribed by Hoskold’s tables for ascertaining the present worth of $1 accumulated over a period of years, assuming that the income will be received in equal annual installments. The deferred factor computed on the basis of 6 per cent compound interest is used to reduce the present worth of royalties at the date the petitioner will begin to receive them to their present worth at March 1, 1913.

The petitioner points out what it believes to be two fundamental errors in the Commissioner’s method of computing the March 1,1913, value of its ore properties, as follows:

(1) The valuation of each mine is based upon a classification of ores according to the process of extraction to be employed by the operating lessees; and

(2) Ores which will be extracted and sold simultaneously have been assigned different values though the lease agreements provide the same royalty payment in respect of every ton of ore extracted.

With respect to the first allegation of error, the petitioner contends that a valuation based upon a classification of ores according to the process of extraction must necessarily be erroneous, since the leases make no distinction in the value of the ore, but, on the other hand, irrespective of the process of extraction employed, it is entitled to receive the same royalty for every ton of ore extracted and sold. With respect to the second allegation of error, the illustration heretofore set out shows precisely the ground upon which it is predicated. It will be noted therefrom that, during the last eleven years of the life of the mine, open pit, milling, and underground operations will be carried on simultaneously. It would appear from this illustration, at first glance, that the Commissioner has assigned a March 1, 1913, value to each ton of open-pit ore mined during the last eleven years of 10.824 cents ($1,375,211-4-12,105,110) and a value, at the same date, to each ton of milling or underground ore mined during the same period, of 6.103 cents ($224,019.55-4-3,670,570). This is a circumstance which the petitioner can not understand, since under the terms of its lease it is entitled to the same royalty on every ton of ore mined whatever the process involved. It contends that each ton of ore had an equal value at March 1,1913.

It is apparent from its petition and all the arguments set out in its brief, that the petitioner is laboring under a misapprehension as to just what is the basis of the Commissioner’s valuation. The petitioner has assumed that the Commissioner has valued each class of ore separately according to the process of extraction employed. But this is not a correct assumption. The Commissioner has made reference in his valuation schedules to the three classes of ore simply as a matter of convenience and for the purpose of readily identifying certain items in those schedules relating to production with the same items as they appear in the operating lessee’s programs of production. For instance, reverting again to the illustration, the classification of the ore reserves into three classes is of no importance whatever and the Commissioner’s valuation is not in the least affected by it. The important thing in this respect is that, according to the operating lessee’s program of production, 12,705,110 tons of ore will be extracted during twenty-eight years by the open pit process, an annual production by this process during the life of the mine, of 453,753-26/28 tons, and that during the last eleven years 3,670,750 tons of ore will be extracted by the milling and underground processes, an annual production by the latter process during the last eleven years of 333,704-6/11 tons. But all of this simply indicates that, irrespective of the processes of extraction involved, during the first seventeen years of the life of this mine the annual production by the operating lessee will be 453,753-26/28 tons, while the production for the last eleven years of the life of the mine will be 787,458 tons.

The March 1,1913, value of the petitioner’s interests in certain ore properties may, in the absence of evidence of a more satisfactory basis, be computed upon the present worth at that date of the expected future royalties. To determine the present worth of those royalties at the basic date, March 1, 1913, necessitates a determination of the rate at which those royalties will be received by the petitioner, and this, in the last analysis, must depend upon the estimated rate of extraction according to the operating lessee’s program of production. Having determined the rate at which the ores will be extracted and the royalties received, appropriate discount factors must be applied to those expected royalties to reduce them to their present worth at the basic date. In the illustration the expected minimum annual production over the life of the mine will be 453,753-26/28 tons, hence, on a 25 cent royalty basis, the expected annual minimum royalties over the same period will be $113,438.25, or a total for the period of $3,176,271. To ascertain the present worth of these minimum royalties at March 1,1913, necessitates the application of a single discount factor, predicated upon a fair risk rate and the length of the period over which the income will accumulate. From the eighteenth to the twenty-eighth year there will be an additional annual production over the minimum of 333,704-6/11 tons, yielding additional royalties to the petitioner during this period of $83,426 per annum, a total for the period of $917,687.50; but the petitioner will not begin to receive these additional royalties until the beginning of the eighteenth year, hence, the application of the single discount factor referred to above, to these additional royalties, will only serve to reduce them to their present worth at the beginning of the eighteenth year, so that a further discount rate, representing the present worth of $1 at a fair rate of compound interest for seventeen years, must be applied to reduce the royalties to their present worth at March 1, 1913. The sum of the present worths at March 1, 1913, of the minimum and additional royalties is the March 1, 1913, value of the lessor’s equity in the ore in this mine. The following illustrates the working out of this method of valuation:

Estimated expense 3% of gross royalties:
Present worth at March 1, 1913, of net minimum royalties, 6% and 4%. ($3,176,271.00 — $96,288.13) X.446356_$1,375,215.19
Present worth at March 1, 1913, of additional royalties 3rd to 28th yr. 6% and 4%— ($6.50 — $0.20) X.465820X.88999644_ 2.61
Present worth at March 1, 1913, of additional royalties 18th to 28th yr. 6% and 4%= ($917,687.50 — $27,530.63) X.677672X .37136442_ 224, 019.75
Present worth at March 1, 1913, of lessor’s equity in the mine_ 1, 599,237. 55
Present worth at March 1,1913, of petitioner’s one-third interest- 533, 079.18

The method adopted by the Commissioner is but a short cut which arrives at the same result. Under the method outlined above, as well as the Commissioner’s method, each ton of ore in the mine, irrespective of the process of extraction to be employed, has the same valué at March 1, 1918, ascertained by dividing the value of the lessor’s equity by the total ore reserves.

All that has previously been said with respect to the one mine used in the illustration applies with equal force to all the ore properties we have under consideration.

The petitioner contends that the only proper method of valuing its interests in these ore properties at March 1, 1913, is to assume that the ores contained in each mine will be extracted by the operating-lessees in equal amounts over the maximum life of the mine, and that the royalties will be received in equal installments. The petitioner considers the maximum life of the mine as the number of years of active operations necessary to exhaust all the ores plus the number of years of deferment of operations. With this contention we are forced to disagree. With respect to all the mines, except those covered by leases Nos. 4, 7, and 8, the operating lessees had, at March 1, 1913, laid down programs of operation and production. With respect to several of the mines these programs called for a deferment of all operations for a period in some instances running as long as eight years. In the case of some mines the programs provided for a considerable production in the early years with a much lessened output in later years, while the converse was provided for in the case of still other mines. In the valuation of these ore properties as of March 1, 1913, we see no good, reason to disregard the operating lessees’ programs of production which later developments have shown to have been reasonably correct.

The petitioner contends that in computing the values of the ores in the mines covered by leases Nos. 4, 7, and 8, the Commissioner should have used a risk rate of 6 per cent in lieu of 8 per cent for the purpose of ascertaining the present worth at March 1, 1913, of expected future royalties in excess of the minimum royalty payments provided for in the lease agreements. As pointed out in our findings of fact, the operating lessees under these three lease agreements had at March 1, 1913, no definite programs of operation. During the taxable years in question no ore was produced from the mines covered by leases Nos. 7 and 8, the lessees under these leases making only the minimum royalty payments provided in the lease agreements; and this appears to be true with respect to the mines covered by lease No. 4, although the record is not entirely clear in that respect. At March 1,1913, it was highly speculative as to when the petitioner would begin to receive under these three leases royalties in excess of the minimum royalty payments provided in the lease agreements, and the same situation appears to have still existed eight years later. Under such circumstances, we approve the Commissioner’s action in adopting a risk rate of 8 per cent in valuing the mines covered by leases Nos. 4, 7, and 8.

Judgment will be entered for the Commissioner.