author: Marquette:

text:
    Appeals of ANTHONY SCHNEIDER and RICHARD M. C. GLENN.
    Docket Nos. 4519, 4520.
    Submitted October 24, 1925.
    Decided February 19, 1926.
    1. Under the terms of the contracts herein, the stock of the American Cigar Oo. was income to the taxpayers in the respective years in which the certificates therefor were delivered to the extent of its fair market value at the times of such deliveries.
    2. Dividends which, by contract, are payable to persons not stockholders with respect to the stock upon which such dividends are declared do not constitute dividends as to them, within the meaning of section 201 (a) of the Revenue Acts of 1918 and 1921, and are subject to taxation at both the normal and surtax rates.

      E. H. Batson, Esq., for the taxpayers.

      John D. Foley, Esq., for the Commissioner.

      Before Marquette and Love.
    These appeals are from the determination of deficiencies in income taxes, for the years 1916, 1919, and 1920, in the amount of $7,551.53, and an overassessment for 1921, in the amount of $418.13, as to Schneider; and for the years 1916, 1919, and 1920, in the amount of $8,300.88, and an overassessment for 1921 in the amount of $288, as to Glenn.
    The two appeals involve substantially identical facts, and, by agreement of the parties, both appeals were consolidated for hearing and disposition.
    The questions presented are (1) whether certain stock, received by the ■ taxpayers under a contract, was income for 1916, or for other years, and (2) whether amounts received as dividends on the undelivered stock during the years 1916 to 1921, inclusive, constituted salary or dividends in the respective years of receipt.
    FINDINGS OF FACT.
    For many years prior to March 1, 1916, both taxpayers were vice presidents of Seidenberg & Co., Inc., and of the American Cigar Co., and had been instrumental in developing the business of manufacturing and selling the Roi-Tan cigar. Seidenberg & Co., Inc., was a subsidiary of the American Cigar Co. The taxpayers planned to sever their connection with the two named companies and to engage in an independent and competing business. Sylvester, the president of the two companies, entered into negotiations with the taxpayers to induce them to remain as vice presidents of the companies in which he was interested. The negotiations resulted in contracts being executed by each of the taxpayers with Seiden-berg & Co., Inc., under date of March 1, 1916, each contract being identical in terms and reading as follows:
    This contract, made and entered into this first day of March, 1916, by and between Seidenberg & Company, Incorporated, a corporation organized and existing under and by virtue of the laws of the State of New Jersey, party of the first part, and Richard M. C. Glenn of New York, N. Y., party of the second part:
    Witnesseth:
    Whereas party of the first part is engaged in the manufacture and sale of cigars, and is a subsidiary of American Cigar Company, and party of the second part is and has been since the organization of party of the first part, actively engaged in the promotion of the business of party of the first part as an officer of said party of the first part:
    And whereas said party of the second part has shown very great ability in his conduct and direction of the business of party of the first part, and party of the first part and its officers and directors, as well as officers and directors of said American Cigar Company, feel that the success and considerable achievements of party of the first part in building up a business now of large volume and large profits, are to a great extent due to the energy, skill and ability of party of the second part, and on that account is anxious to retain unimpaired and improved the service, energy and activities of party of the second part.
    And whereas party of the second part is anxious to continue to engage his efforts and services to party of the first part, but is anxious also to have a direct and continuing interest not only by way of monetary salary in the business he is helping to build, but also in the stock, and thereby the future of American Oigar Company which is the owner of all the stock of said party of the first part, and whose net profits are substantially and constantly enhanced by the profits arising from the operation of said party of the first part:
    Now, therefore, in consideration of the premises and, of other good and sufficient consideration moving to each of the parties hereto from the other, the receipt whereof is fully acknowledged, the parties hereto have covenanted and agreed, and do hereby covenant and agree to and with each other as follows:
    First: party of the second part covenants and agrees to and with party of the first part that he will continue in its service, giving to it, as heretofore, his whole time and very best efforts in the promotion of its business at least until March 1, 1921, upon the condition, and only upon the condition that he is continued in no lower official position with party of the first part than he now enjoys, and without reduction of regular salary, and that he is continued Vice President of the American Cigar Company, with like bonus from year to year as other Vice-Presidents have; party of the second part contemplates continuing thereafter in the service of said party of the first part, but limits his absolute obligation as aforesaid, and during all the said service whether as herein contemplated or as herein expressly' contracted for, party of the second part will in all ways co-operate with the other officers and directors of said party of the first part and American Cigar Company, its stockholder, to the best interest of the business, as in good conscience he is required to do, on account of the covenants and promises made by party of the first part hereinafter set out.
    Second: As an inducement to the foregoing covenant by party of the second part, and in lieu of additional salary to him for said five years’ service, and the service hoped for and expected by party of the first part after the termination of said five years, party of the first part hereby conditionally assigns to party of the second part an equitable ownership in fifteen hundred (1500) shares of the common stock of American Cigar Company out of three thousand (3000) shares of said stock this day equitably acquired by party of the first part. The conditions affecting this equitable assignment are as follows: Party of the second part shall be entitled to receive and enjoy all of said fifteen hundred (1500) shares, and immediately upon the receipt of dividends by the record holder of the said stock party of the first part will cause the same to be transmitted to party of the second part; On March 1, 1917, party of the first part will transfer or cause to be transferred to party of the second part one-fifth of said fifteen hundred (1500) shares, or three hundred (300) shares, and deliver the certificate therefor to party of the second part; on March 1, 1918, in like way a certificate for three hundred (300) shares additional, and so on, on the first of March of each year until certificfates for the whole fifteen hundred (1500) shares are delivered, the last certificate for three hundred (300) shares being in this way deliverable on March 1, 1921. If, in the meantime, party of the second part dies or voluntarily and definitely breaches the obligation entered into by him and set out in the next preceding paragraph hereof, then the obligation to make further deliveries shall cease, except that if such death or voluntary and definite refusal to carry out such obligation ceases at some time other than on March 1st, stock shall he delivered pro rata upon the happening of such death or breach of obligation, counting the period by months, and accounting each day between the 1st and 15th as if it had been the 1st of that month, and each day between the 15th and last of the month as if it had been the first day of the following month, e. g. if • such death or breach occurs on the 10th of August of any year before the full delivery of stock herein contemplated, then five-twelfths of the three hundred (300) shares deliverable the following March shall become deliverable ; and if on the 20th of September, then seven-twelfths of such stock shall become and be deliverable. Deliveries of stock shall be absolute, but if, pending the full deliveries during the full five year period, by death or breach of obligation as aforesaid further deliveries are excused, there shall likewise terminate all obligation on party of the first part to make or direct further payments of dividends, and as to the stock undelivered, this equitable assignment shall be and remain, as to the undelivered stock, null and void. The obligation on party of the first part to pay or cause to be paid to party of the second part all dividends paid on the undelivered portion of the One Hundred Fifty Thousand dollars ($150,000) of stock hereby conditionally assigned, shall extend not only to ordinary dividends, but to any distribution, whether of money, property, stocks or rights that the common stockholders of American Cigar Company became entitled to, and shall apply to all stock undelivered at the time such right accrues. The right preserved to party of the first part to decline to make further deliveries upon the voluntary and definite refusal of party of the second part to carry out his obligation set forth in the next preceding paragraph hereof, is intended only as collateral security to party of the first part, and is by no means intended to permit or authorize party of the) second part to disregard the obligation set out in the next preceding paragraph hereof, with only the penalty of thereby forfeiting his right to the then undelivered stock.
    The taxpayers each received dividend checks regularly on the basis of ownership of 1,500 shares of stock. They signed proxies for all meetings of stockholders and their proxies were recognized at all stockholders’ meetings.
    The taxpayers each received certificates for 300 shares of stock on March 1, 1917, and on March 1 of each year thereafter they each received certificates for 300 shares until certificates for the full 1,500 shares were respectively received.
    The taxpayers continued to serve as vice presidents of both companies during the years 1916 to 1921, inclusive, and received salaries during that period equal to the salaries paid to other vice presidents of the companies. On at least two occasions during the period the taxpayers received increases in salary.
    The Commissioner treated the receipt of certificates for 300 shares of stock in each respective year as equivalent to the receipt of income for that year to the extent of the value of the stock at the time of the receipt of the certificates. He also treated the dividends received upon the undelivered stock in each year as additional salary for that year, and subjected it to both-the normal and surtax rates for each year of receipt.

      DECISION.
    The determinations of the Commissioner are approved.
   OPINION.

Marquette:

The decision in these appeals rests upon the construction which must be given to the contracts, which are identical in terms, entered into between the respective taxpayers on the one part and Seidenberg & Co. on the other part. The taxpayers insist that, under the terms and intent thereof, they each became the owner of 1,500 shares of the capital stock of the American Cigar Co. in 1916, when the said contracts were executed, and that the value of said shares was income to them at that time. They further contend that the dividends payable and paid to them under the terms of the contracts constituted dividends as to them, as distinguished from compensation for their services. The Commissioner held that under the contracts the respective taxpayers each became the owner of 300 shares of said stock in each of the years in question which was income to them in the years of its receipt to the extent of its fair market value, and that dividends received by them on undelivered stock constituted compensation and were not dividends within the meaning of the statute.

In the construction of a contract, the primary object is to ascertain the intention of the parties as expressed therein, and the problem is not what separate parts or clauses mean but what the parties intended by the contract when considered as an entirety, for the separate parts of a contract have but little weight when compared with the contract taken as a whole. O’Brien v. Miller, 168 U. S. 281; United States v. Utah, Nevada & California Stage Co., 199 U. S. 414. And it follows that one part of a contract may affect the construction of a different part; in other words, the general intent controls special intent. A. Leschen & Sons Rope Co. v. Mayflower G. M. & R. Co., 173 Fed. 855; 35 L. R. A. (N. S.) 1. In the light of these rules of construction, we must ascertain what the parties intended by their agreement.

The evidence discloses that for some years prior to 1916 the taxpayers had been employed by Seidenberg & Co., a subsidiary of the American Cigar Co., and that at that time they were each vice presidents in both corporations. They determined to sever their connection with these corporations and to engage in competitive business on their own account. This intention was communicated to the president of the corporation, who was told by them that their determination would be carried out unless the corporation saw fit to give them $150,000 each. Negotiations were carried on between the parties which culminated in the contract of March 1, 1916.

The contract provided for the services of the taxpayers for a period of five years, they to be continued in no lesser official positions, without reduction of regular salary, and with like bonuses as other vice presidents, for which they agreed to give their services and to cooperate with the officers of the corporations to the best interests of the business. The second clause of the contract gives rise to the contentions hereinabove set forth. The opening sentence thereof is as follows:

As an inducement to the foregoing covenant by party of the second part, and in lieu of additional salary to him for said five years’ service * * * party of the first part hereby conditionally assigns to party of the second part an equitable ownership in fifteen hundred (1,500) shares of the common stock of American Cigar Co. * * * this to be equitably acquired by party of the first part.

The conditions of these equitable assignments were that the taxpayers were entitled to receive and enjoy all thereof and to have the dividends declared thereon. On March 1 of each year, commencing with the year 1917, there was to be transferred and delivered to each of them one-fifth of the 1,500 shares until certificates for the whole 1,500 shares were delivered, and death or a breach of the obligation entered into excused further deliveries. Deliveries of stock were to be absolute but, in case of death or breach of obligation, the right of the taxpayers to further dividends on the undelivered stock was to cease and the equitable assignment as to the undelivered stock would become null and void. The obligation of the corporation to pay dividends to the taxpayers on the undelivered stock extended to any distributions of money, property, stock, or rights pertaining to the common stock, and applied to all stock undelivered at the time the rights accrued. The clause concludes as follows:

The right preserved to party of the first part to decline to make further deliveries upon the voluntary and definite refusal of party of the second part to carry out his obligation set forth in the next preceding paragraph hereof, is intended only as collateral security to party of the first part, and is by no means intended to permit or authorize party of the second part to disregard the obligation set out in the next preceding paragraph hereof, with only the penalty of thereby forfeiting his right to the then undelivered stock.

What did the parties intend by these provisions of the contract? To us it seems clear that, in exchange for their services and their agreement to remain with the cprporation for five years, they were each to receive 1,500 shares of stock of the American Cigar Co., payable one-fifth each year, and that in the meantime they were to have the beneficial ownership during that period of the undelivered stock; that is, they had the right to all dividends and other increment of the undelivered stock, provided they did not die or breach the agreement, and, as to these rights, the conditions of the contract constituted conditions subsequent, while, with relation to the delivery of the stock, they constituted conditions precedent. Performance of the agreements was the quid, pro quo to the delivery of the absolute title to the stock, for the contract provides by its own terms that death or a breach should excuse further deliveries. The right to receive dividends or other increment of the stock is an incident of stock ownership — but is there any doubt that an owner of stock may, by agreement, separate this incident from his ownership and vest it in another without thereby making that other a stockholder ? We think not; and as we view this contract that is exactly what was intended. Seidenberg & Co. had acquired an . equitable interest in the stock and this equitable interest was transferred to the taxpayers with the further agreement on the part of the company to transfer to each of them the title to 300 shares each year as the agreement was performed. Until the stock was delivered to them, they had no title thereto and there was a possibility that through death or breach of agreement they would never acquire title. Nor do we think the fact that the right reserved to the company to decline to make further deliveries in case of breach was intended as collateral security changes the intent of the agreement. This clause was undoubtedly inserted for the benefit of Seidenberg & Co. and was intended to prevent the taxpayers from breaching the agreement with no penalty other than to excuse further deliveries of stock.

Upon consideration of the entire agreement, we are of opinion that the taxpayers became owners of the stock of the American Cigar Co. only as the stock was delivered to them each year, and that, as to the undelivered stock, they were not stockholders of the American Cigar Co. in respect thereof. Appeal of Roscoe H. Aldrich, 3 B. T. A. 911. This construction of the agreement conforms with the practical construction placed thereon by the parties themselves, for in making their returns the taxpayers returned as income in each year the shares received by them, and we think this fact is entitled to considerable weight.

Were the dividends declared on the undelivered stock dividends to the taxpayers, or did they constitute income in the nature of compensation? We have held that as to the undelivered stock the taxpayers were not stockholders of the American Cigar Co. Section 201 (a) of the Revenue Acts of 1918 and 1921 defines a dividend as “ any distribution made by a corporation * * * to its shareholders or members * * * out of its earnings or profits * * We held in Appeal of Roscoe H. Aldrich, supra, that a distribution to one other than a stockholder did not constitute the distribution a dividend as to him, and that in such circumstance it was subject to both the normal and surtax rates. That ruling is controlling here and has the further support of the agreement itself, wherein it is provided that the payments are to be “ in lieu of ” additional compensation. The amounts received by the taxpayers from dividends declared on undelivered stock constituted income to them subject to the normal tax and were not taxable as dividends.

The taxpayers have alleged error on the part of the Commissioner in his determination of the market value of the stock received under the contracts. No evidence was offered at the hearing bearing on the question of the fair market value of the stock in the respective years under consideration. The values thereof, as determined by the Commissioner, must stand.


source: Caselaw Access Project

author: Maequette:

license: Public Domain

text:
    Appeal of SANER-RAGLEY LUMBER CO.
    Docket No. 431.
    Submitted June 1, 1925.
    Decided February 19, 1926.
    1. Where a taxpayer keeps its books of account on tbe accrual basis and elects to make its returns for tbe year 1917 on that basis, tbe interest deduction is tbe amount of interest accrued within tbe year, and not tbe amount paid.
    2. Interest is an expense which accrues ratably over an elapsed period of time.
    3. Tbe evidence fails to establish that tbe taxpayer is entitled to special relief under tbe provisions of section 210 of tbe Beve-nue Act of 1917. Belief granted under section 328 of the Bevenue Act of 1918.

      George M. Morris, Esq., for the taxpayer.

      Lee I. Parle, Esq., for the Commissioner.
    Before Ivins, Marquette and Morris.
    This appeal is from the determination of a deficiency in income and profits taxes for the years 1917 and 1918 in the aggregate amount of $85,568.88, and the determination of an overassessment for the year 1919 of $24,644.01.
    FINDINGS OF FACT.
    The taxpayer is a corporation, organized under the laws of Texas on October 13, 1913, with a paid-in capital of $200,000. On October 22, 1913, the taxpayer purchased a tract of 10,146 acres of timber land for a consideration of $800,000, of which $150,000 was paid in cash and the balance was payable according to the terms of 13 promissory notes in the sum of $50,000 each.

      The original notes were canceled and new notes bearing date of January 22,1914, were substituted therefor. The notes were similar in form and the material parts thereof were as follows:
    $50,000.00 No. Thirteen Dallas, Texas, January 22, A. D. 1914.
    In installments, at the rate of $7.00 per thousand feet, log measure, Scribner’s rule, for each thousand feet of timber sawed off the lands purchased from J. M. Bemis, between the first and last day of each month, each installment payable on the 15th day of each month, next following, the undersigned promises to pay J. M. Bemis, or order, the sum of Fifty Thousand ($50,000.00) and no/100 Dollars with interest thereon from date until paid, at the rate of 6% per annum, the interest payable annually as it accrues, both principal and interest payable at Dallas, Texas, for value received, interest to cease on installments after payment.
    This note is one of a series of thirteen notes and each to be paid in the order of their number so that the next succeeding higher number comes due only on exhaustion of the preceding number.
    By reason of the fact that the payment of each installment of the principal due upon each of said notes stopped the running of interest upon that installment, and by reason of the fact that such installment due on the 15th day of each month was a variable, depending upon the amount of timber cut in the preceding month, it was impossible for the taxpayer to determine at the beginning of each year the amount of interest due on January 22 of the succeeding year. The president of the taxpayer directed that there be set aside on the taxpayer’s books from its sales a sufficient amount each month as a reserve to pay interest as it became payable. He directed that the monthly credit entries under the caption “ Reserve for other interest ” should be determined as a fair monthly proportion of the total interest expected to become payable during the current calendar year upon obligations incurred other than the obligation for the purchase of the original timber; and further directed that the monthly credit entries under the caption “ Reserve for timber interest ” should be determined as a fair monthly proportion of the total interest expected to become payable on January 22, of the succeeding taxable year. During the years 1916, 1917, and 1918 the taxpayer credited each month to these accounts a round sum to meet the interest expected to become due under the respective accounts, and the balance on each of these accounts at the end of each year was carried over into the reserve for the succeeding year. In its income-tax returns for the years 1917 and 1918, the taxpayer deducted the amount of its reserve for timber interest and the reserve for other interest, and the Commissioner in calculating the deduction for interest for both 1917 and 1918 accrued as of the end of the taxable year the amount of interest for which the taxpayer became liable within that year.

      The taxpayer kept its books and made its income-tax returns . upon the accrual basis, with the exception of the reserve for tim-. ber interest, and the reserve for other interest accounts and the reserve for taxes.
    On February 20, 1917, the taxpayer sold the turpentine to be extracted from 5,000 acres of its timber land for the sum of $66,625. Of this amount the sum of $22,208.23 was paid in cash and the balance in two interest-bearing promissory notes for $22,208.23 each, ■due, respectively, one and two years from February 20, 1917. In making its income-tax returns for the year 1917, the taxpayer showed as income from the sale of said turpentine rights the sum ■of $22,208.23. To this amount the Commissioner added $44,416.67, making a total of $66,625 as the amount for which the turpentine rights were sold. The taxpayer and the Commissioner have stipulated that the issue relative to the sale of the turpentine rights shall be determined in accordance with the basis set forth in the report of the Engineering Division of the Income Tax Unit, dated April 28, 1925.
    Taxpayer was engaged, during the years under review, in the business of cutting and manufacturing into lumber, etc., a tract of long leaf yellow pine timber. The gross sales, the net income, the invested capital, the excess profits and normal profits taxes proposed to be assessed by the Commissioner in the deficiency letter dated August 22, 1924, together with the percentage borne by these items to one another for the years 1917, 1918, and 1919, are as follows :
    1917.
    • Sales (timber, store, turpentine)-$498,922.57
    Total invested, capital at beginning of year- 234,124.77
    Invested capital (including allowance for interest)- 470,626.25
    Net income_ 180, 374. 67
    Tax (excess profits, $52,090.92; normal, $7,697.03)- 59,787.95
    Percentage of income to invested capital-38.326
    Percentage of total tax to net income- 33.15
    Percentage of excess profits tax to net income- 28. 88
    Percentage of income to invested capital at beginning of year- 77.04
    1918.
    Sales (timber and store)_$364,017.40
    Invested capital- 365, 081.19
    Net income_ 90,497.83
    Tax (excess profits, $40,791.77; normal, $5,724.72)- 40,516.49
    Percentage of income to invested capital- 24. 79
    Percentage of total tax to net income- 51.40
    Percentage of excess profits tax to net income- 45. 07

      1919.
    Sales (timber and store)_$505,939.69
    Invested capital_ 408, 893.63
    Net income- 162,107.40-
    Tax (excess profits, $41,344.92; normal, $11,876.25)_ 53,221.17
    Percentage of income -to invested capital_ 39. 64
    Percentage of total tax to net income_ 32. 83
    Percentage of excess profits tax to net income_ 25. 50-
    The taxpayer, throughout the period under consideration on the dates stated below, had the following amounts of borrowed money in its business:
    Jan. 1, 1917-$773, 704.90
    Jan. 1, 1918-506, 653.74
    Jan. 1, 1919-373, 384. 76
    Dec. 31,1919. 272, 609. 00
    The only officers who received a salary from the taxpayer during-the period 1917 to 1919, inclusive, received the following amounts:

    All the officers were experienced lumbermen. They were actively engaged in this business. They handled the finances of the taxpayer, directed and superintended the cutting of the timber and the manu-. facturing of lumber, and conducted the sales of the products.
    The capital stock of the taxpayer was never increased beyond the $200,000 paid-in capital at the time of its incorporation.
    The plant account of the taxpayer on December 31, 1916, totaled $194,979.73.
    In addition to its income from the proceeds of its business of manufacturing and selling lumber, the taxpayer’s books show net income, during the years under consideration, from other sources as follows:

    The taxpayer did not receive 50 per cent or more of its gross income for any of the taxable years under consideration on a cost-plus basis from Government contracts.

      DECISION.
    The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 10 days’ notice, under Rule SO.

   OPINION.

Maequette:

The first question presented, by the taxpayer is whether, under the Revenue Act of 1916, it is entitled to deduct interest paid during the taxable year 1917. It bases its contention upon the provisions of section 12 (a) of the Revenue Act of 1916, allowing as a deduction the amount of interest paid within the year. The facts show that its books were kept and its tax returns were made on the accrual basis.

The Board has had occasion to pass directly upon the principle here involved in Appeal of Tel-Electric Co., 1 B. T. A. 434, and Appeal of North Wayne Tool Co., 2 B. T. A. 366, wherein it has been held that a taxpayer keeping its books of account upon an accrual basis and, under the provisions of section 13 (d) of the Revende Act of 1916, electing to make its returns on that basis, can not deduct from the gross income of 1917, although paid in that year, interest which accrued and became a liability in years prior thereto. The reason for this is that the provisions of section 13 (d) give the taxpayer an option, where its books are kept on a basis other than that of cash receipts and disbursements, to make its returns on the basis upon which its books are kept, provided such basis clearly reflects the income. The taxpayer herein, having kept its books on the accrual basis and having elected to make its returns on that basis, can not now be heard to say that it should be permitted to deduct interest paid within that year. The provisions of sections 12 (a) and 13 (d) must be read together. In the recent decision of the Supreme Court in United States v. Anderson, 269 U. S. 422, decided January 4, 1926, the following was said in respect of those sections:

While § 12(a) taken by itself would appear to require the income tax return to be made on the basis of actual receipts and disbursements, it is to be read with § 13(d) which we have quoted and which obviously limits in some respects the operation of § 12(a) by providing in substance that a corporation keeping its books on a basis other than receipts and disbursements, may make its return on that basis provided it is one which reflects income.
Standing by themselves and taken at their face value, these sections would seem to require the taxpayer to make his return on the basis of receipts and disbursements or, in the alternative, on the basis of its own books of account if they reflect true income, under such regulations as the Commissioner may make, and indeed to require the latter alternative if the taxpayer is unable io make his return on that basis.

In respect of the year 1917, we are of opinion that the Commissioner properly required the taxpayer to deduct interest on its-indebtedness which accrued during that year, and that, with respect to the year 1918, the proper deduction is the amount of interest accrued within the year.

The taxpayer contends, however, that as the interest became due- and payable by the terms of the notes on January 22 in each year, it was not accrued until that date. The Board has had occasion to consider the question of when interest accrues and has held that interest is an expense which accrues ratably over an elapsed period of time. Appeal of Chatham & Phenix National Bank, 1 B. T. A. 460; Appeal of Cumberland Glass Manufacturing Co., 2 B. T. A. 1122. The Commissioner, therefore, correctly accrued the interest to December 31 of each year.

The taxpayer and the Commissioner have stipulated that the issue with respect to the sale of turpentine rights shall be determined in accordance with a memorandum of the Engineer Division of the Income Tax Unit, annexed to the stipulation. In the computation of the tax, the income, if any, for the years in question, with respect to the sale of such rights, will be computed in accordance with such memorandum.

The taxpayer claims the right to special relief under the provisions of section 210 of the Revenue Act of 1917 and section 327 of the Revenue Act of 1918. The evidence presents no ground for relief under section 210, supra. In our opinion, however, the evidence shows such abnormality as to entitle the taxpayer to computation of its taxes for the year 1918 under the provisions of section 328 of the Act of 1918, and the Commissioner’s computation thereunder will be considered final.


author: Arundell

text:
    Appeal of EMERSON ELECTRIC MANUFACTURING CO.
    Docket No. 1010.
    Submitted November 17, 1925.
    Decided February 19, 1926.
    1. Commissions paid to brokers for the sale of the capital stock of a corporation are not deductible as ordinary and necessary expenses of carrying on a trade or business.
    2. Fees paid to lawyers for negotiating the sale of the capital stock of a corporation and for securing an amendment to its charter to authorize an increase in its capitalization are not deductible as ordinary and necessary expenses of carrying on a trade or business.
    3. Fees paid to the State of Missouri for amending taxpayer’s charter to increase its capitalization are not taxes deductible under section 234(a) (3), but are capital expenditures.

      William F. Fahey, Esq., for the taxpayer.

      Robert A. Littleton, Esq., for the Commissioner.

      Before SteRnhagen, Lansdon, and Arundell.
    This is an appeal from the determination of a deficiency in income and profits taxes for the fiscal year ended September 30, 1920, in the amount of $44,394.46. The deficiency arises from the refusal of the Commissioner to allow as deductions the amount of $104,501.25 paid as brokers’ commissions, attorneys’ fees, and fees to the State of Missouri incident to the increase in the capital stock of the taxpayer and the issue and sale of certain of its preferred stock.
    FINDINGS OF FACT.
    The taxpayer was incorporated under the laws of the State of Missouri in September, 1890. Its original capital was $50,000, which was increased to $15,000 in 1892, to $300,000 in 1901, to $600,000, in 1907, to $800,000 in 1917, and to $2,800,000 in November, 1919. Some of the increases in capitalization prior to November,. 1919, were due to the issuance of stock dividends. It was the practice of the corporation to charge to expense all expenditures incurred incident to the increase of its capital stock. The greatest expense incident to an increase of its capital stock prior to the increase of November, 1919, did not exceed the sum of $360.
    The increase authorized in November, 1919, took the form of 20,000 shares of preferred stock of the par value of $100 each, carrying 7 per cent cumulative dividends. The stock was callable at the option of the taxpayer at the price of $115 per share and accrued dividends to the date of redemption. The firm of Spencer Trask & Co., a copartnership, subscribed for 10,000 shares of the authorized increase in the capital stock of the corporation of the par value of $1,000,000. An agreement existed between the taxpayer and the firm of Spencer Trask & Co. whereby the latter agreed to sell and distribute the $1,000,000 of preferred stock. This agreement was fully complied with, and thereafter, during the taxable year, Spencer Trask & Co. paid to the taxpayer $1,000,000 in cash and received from it $100,000 as a commission for selling and disposing of this stock as agreed.
    The taxpayer, during the same year, paid to the law firm of Koerner, Fahey & Young the sum of $3,500, for legal services rendered in connection with its negotiations with Spencer Trask & Co. and the amendment of its charter authorizing an increase of its capital stock.
    During the taxable year in question, the taxpayer paid to the State of Missouri, as fees in connection with the amendment of its charter, the sum of $1,001.25, without which payment it .would not have been authorized to sell its stock.

      The business of the taxpayer had increased to such volume that it was necessary and expedient for it to acquire additional capital, and it procured such capital by the sale of its preferred stock on the advice of its bankers, lawyers, and stockholders. In order to sell such stock, it was necessary for the taxpayer to employ persons engaged in the business of stock selling, as the taxpayer was not familiar with this line of work. Under the laws of Missouri, if the consideration received for stock is cash, cash must be received by the corporation in the full amount of the par value of the stock issued.
    DECISION.
    The determination of the Commissioner is approved.
   OPINION.

Arundell

: The taxpayer claims as a deduction from its gross income for the fiscal year ended September 80, 1920, the amount of $104,501.25 paid for the purposes set forth in the findings of fact. The major item is the sum of $100,000 paid to Spencer Trask & Co. incident to the marketing of the taxpayer’s preferred stock of the par value of $1,000,000. The entire issue of 10,000 shares was subscribed for by Spencer Trask & Co., which paid the taxpayer in payment therefor $1,000,000. Under the laws of Missouri, if stock is issued for cash, it is necessary that the corporation receive cash in an amount not less than the par value of the stock issued therefor. It was by reason of this provision of the statute that the transaction took the form of the payment to the taxpayer by Spencer Trask <⅞ Co. of the full sum of $1,000,000 and a check by the taxpayer to the brokers in the sum of $100,000.

If the amount so paid to the brokers is deductible, it is by reason of section 234 (a) (1) of the Eevenue Act of 1918, which provides that there shall be allowed as deductions, “ all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered.” The taxpayer contends that, the securing of additional capital in order to efficiently operate its business being absolutely necessary, the expenses incident thereto were not only necessary, but, in the cirmcumstances, ordinary expenses; and, further, that the amount paid to the brokers represented “ other compensation for personal services actually rendered ” and, therefore, constituted a proper deduction from income.

That the amount paid to Spencer Trask & Co. for services rendered in connection with the flotation of the taxpayer’s capital stock represented compensation for personal services actually rendered is true, but that does not of itself bring the expenditure within the category of deductible expenses contemplated by the statute. The word “ including,” as used in the clause “ including a reasonable allowance for salaries or other compensation,” signifies the intent to include as deductible expenses only such salaries or other compensation as are ordinary and necessary expenses in carrying on a trade or business.

The use of capital is ordinarily and generally necessary in the conduct of a business enterprise, but it does not follow that the expense incident to its procurement is an ordinary and necessary business expense within the purview of the statute.

Expenses incurred by a corporation in selling its capital stock, the proceeds from which are to be permanently invested in property or otherwise used in the operation of the business, subject to all its risks and hazards, are not deductible expenses, for the reason that such expenses are incurred in connection with a capital transaction. The only effect of expenses of this character, as in the case of discount at which the shares of stock may be sold, is to reduce the capital available to the corporation, and they can not be used to reduce the income from operations. They represent a capital expenditure which should be charged against the pro-céeds of the stock and not recouped out of operating earnings. Further, it is clear to us that the revenue of a day or a year should not be burdened with the cost of acquiring additional capital, the benefits from which will inure the corporation over a long period of years. This is the doctrine generally recognized and adopted in the treatment of expenses incident to the procuring of temporary capital through the flotation of bonds and other term securities, and in such cases the expenses are written off over the life of the indebtedness.

We think it is perfectly clear that the amount received by a corporation in excess of the par value of its stock is not income to the corporation, but is in fact a paid-in surplus, and that the converse is equally true, that when stock is sold for less than its par value the corporation has not suffered a loss. Appeal of Simmons & Hammond Manufacturing Co., 1 B. T. A. 803. It is contended, however, that this is not a case where stock is sold for less than par, but that the taxpayer in fact received $1,000,000 and thereafter paid out $100,000 as expense incurred in its sale and distribution. Obviously the net result to the corporation is the same whether it sells its stock to a broker at a discount or whether it sells the stock through salesmen employed for the purpose and pays a salary or other compensation for their services.

What has been said with reference to the payment of $100,000 incident to the sale of the taxpayer’s preferred stock is equally true of the item of $3,500 paid for legal services in connection with the taxpayer’s negotiations with the brokers and in the amendment of its charter authorizing the sale of its stock. Such an item is, in our opinion, a capital expenditure and not an ordinary and necessary expense of carrying on a business, and is, therefore, not deductible.

The fees paid to the State of Missouri, in the amotint of $1,001.25, in connection with the amendment of the taxpayer’s charter in order that it might increase its capitalization, is not a tax, but is a fee, and as such is deductible only if it falls within the provisions of section 234 (a)(1). For the reasons heretofore advanced, we are of the opinion that this item is a capital expenditure and not an ordinary and necessary expense. Appeal of Logan-Gregg Hardware Co., 2 B. T. A. 647.


author: ARUndell StekNhageN,

text:
    Appeal of THEODORE SCHILLING.
    Docket No. 4323.
    Submitted September 25, 1925.
    Decided February 19, 1926.
    Section 205(e) of the Revenue Act of 1921 construed.

      Gerard B. Townsend, Esq., for the taxpayer.

      W. F. Gibbs, Esq., for the Commissioner.
    Before Sternhagen and Arundell.
    This is an appeal from the determination’ of a deficiency of $114.20 in income taxes for 1921. The taxpayer alleges the Commissioner erred in computing the tax on the taxpayer’s share of profits of a partnership whose return was made on the basis, of a fiscal year ended June 30, 1921. The facts are not disputed. There was no appearance on behalf of the taxpayer at the hearing, and the case was submitted on the pleadings and briefs.
    FINDINGS OF FACT.
    The taxpayer is a nonresident alien individual. He is a member of the firm of Frederick Ludevig & Co., a partnership doing business in the United States at 110 Fifth Avenue, New York City.
    The taxpayer’s return was for the calendar year. The partnership return was on the basis of a fiscal year ended June 30, 1921. His share of the partnership profits was $9,720.66. His only other income in 1921, was $892.91, interest. In computing the tax, he applied the normal rate for 1920 to one-half of his income from the partnership, and he applied the normal and surtax rates for 1921 to the sum of one-half of the income from the partnership and his other income in 1921, as illustrated by the following table:

    DECISION.
    The determination of the Commissioner is approved.
   OPINION.

ARUndell

: The taxpayer made his 1921 income-tax return for the calendar year. The principal part of his income was his distributive share, as a partner, of the net income of Frederick Ludevig & Co. The latter made a return on the basis of a fiscal year ended June 30, 1921. The taxpayer reported the entire amount of his distributive share of the income of the partnership for the fiscal year mentioned, which is in conformity with section 210 (a) of the Eevenue Act of 1921. This statute also provides (section 205 (c)) for subjecting such income to tax at the rates in effect in the different calendar years into which the fiscal year extends. The section reads as follows:

If a fiscal year of a partnership begins in 1920 and ends in 1921, or begins in 1921 and ends in 1922, then (1) the' rates for the calendar year during which such fiscal year begins shall apply to an amount of each partner’s share of such partnership net income (determined under the law applicable" to such year) equal to the proportion which the part of such fiscal year falling within such calendar year bears to the full fiscal year, and (2) the rates for the calendar year during which such fiscal year ends shall apply to an amount of each partner’s share of such partnership net income (determined under the law applicable to such calendar year) equal to the proportion which the part of such fiscal year falling within such calendar year bears to the full fiscal year.

In the 1918 Act, and also in the 1924 Act, a method of computing the tax in such cases was prescribed. The 1918 provision is set out below; the 1924 provision is substantially the same.

Sec. 206. That whenever parts of a taxpayer’s income are subject to rates for different calendar years, the part subject to the rates for the most recent calendar year shall be placed in the lower brackets of the rate schedule provided in this title, the part subject to the rates for the next preceding calendar year shall be placed in the next higher brackets of the rate schedule applicable to that year, and so on until the entire net income has 'been accounted for. * * *

There is no similar provision in the 1921 Act.

In computing the tax the Commissioner allocated the entire net income to the so-called brackets provided for by section 211 of the 1921 Act — apparently first disposing of the proportion of net income subject to 1921 rates, and then allocating the proportion subject to 1920 rates without leaving any gaps in the brackets not entirely filled by the 1921 proportion. He then computed the tax on the entire amount at one operation, assuming that, since the 1920 rates and 1921 rates are the same in so far as they affect this taxpayer, there would by his method of allocation be no difference in the result, which is true. The taxpayer in making his computation placed each proportion of his income in the lower brackets of the respective years.

Section 205 (c) of the 1921 Act provides that the rates for the calendar year during which such fiscal year begins shall apply * * The question is, to what rates does this language refer? Hoes it mean the minimum rates, as contended by the taxpayer, or does it mean those rates of the 1920 rate schedule corresponding to the 1921 rates which would apply without question if section 205 (c) did not exist. In support of his position, the taxpayer invokes the rule of strict construction; that taxing statutes must not be extended by implication beyond their clear import, Gould v. Gould, 245 U. S. 151; United States v. Field, 255 U. S. 257; and the corollary, that if words are doubtful, the doubt must be resolved against the Government and in favor of the taxpayer. United States v. Merriam, 263 U. S. 179.

Section 205 (c) must be construed with reference to the other sections of the Act and its meaning found from the Act as a whole. Kohlsaat v. Murphy, 96 U. S. 153; Mansfield v. Excelsior Refining Co., 135 U. S. 326, 336; United States v. Burr, 159 U. S. 78, 84. Consideration of the other sections of Title II (relating to “ income tax ”), impels us to the conclusion that the meaning and intent of this section are clear, and therefore there is no room for the appli-nation of the principles relied on by the taxpayer. The vital sections in this title are 210 and 211. These are the sections that impose the tax. The other sections of the" title contain definitions, bases for arriving at net income, methods of computing the tax in special cases, administrative provisions, etc. Section 210 imposes for each taxable year a normal tax of 8 per centum. Section 211 provides that, in addition to the normal tax, “ there shall be levied, collected, and paid for each taxable year ” a surtax upon net income from $5,000 (in the case of the year 1921) on up, by gradations, at progressively increasing rates. The net income reported by this taxpayer is all income for the taxable year 1921. For arriving at the amount of the surtax upon the net income for the taxable year, section 211 does two things; it specifies the graduated amounts of net income, (commonly referred to as brackets), which shall be subject to surtax; and it prescribes a graduated schedule of rates to be applied in these several brackets. It expresses clearly the intention of Congress to adopt a plan under which income should be subjected to progressively greater tax as it increased in amount. The section is modified by section 205 (c) only in the respect that, in the class of cases therein mentioned, a different schedule of rates is to be applied to a part of this income. We can find nothing in section 205 (c) which would authorize such part of the income to be taken out of the brackets where it is put by section 211 and to be placed in the lower brackets. Cf. Appeal of M. Fowler, 1 B. T. A. 1212. Section 205 (c) is subordinate to section 211, and the expressed intent of the latter is controlling in the construction of section 205 (c). Caha v. United States, 152 U. S. 211, 214; United States v. Burr, 159 U. S. 78, 84.

The taxpayer also argues that his method must be adopted in order that effect may be given to the action of Congress in repealing section 206 of the Bevenue Act of 1918. It is our view that section ■206 merely prescribes the maimer in which the tax shall be computed in cases coming within section 205 (c). Its omission left the way-open to the Commissioner to adopt a method of applying section 205 (c) consistent with the provisions of the Act. We think the Commissioner’s method is proper.

StekNhageN,

dissenting: During the calendar year 1921, which tvas the taxpayer’s accounting period, he received income through the partnership amounting to $9,720.66. This amount was his distributive share of the partnership income for its fiscal year ending June 30, 1921, and was taxable to him under the following provision of the Revenue Act of 1921:

Sec. 218. (a) That individuals carrying on business in partnership shall be liable for income tax only in their individual capacity. There shall be included in computing the net income of each partner his distributive share, whether distributed or not, of the net income of the partnership for the taxable year, or, if his net income for sucji taxable year is computed upon the basis of a period different from that upon the basis of which the net income of the partnership is computed, then his distributive share of the net income of the partnership for any accounting period of the partnership ending within the fiscal or calendar year upon the basis of which the partner’s net income is computed.

The method of computing the tax of the individual partner upon income which included his share of the partnership income covering a period which extended back into 1920 was expressly provided in section 205 (c) :

If a fiscal year of a partnership begins in 1920 and ends in 1921, . . . then (1) the rates for the calendar year during which such fiscal year begins shall apply to an amount of each partner’s share of such partnership net income (determined under the law applicable to such year) equal to the proportion which the part of such fiscal year falling within such calendar year bears to the full fiscal year, and (2) the rates for the calendar year during which such fiscal year ends shall apply to an amount of each partner’s share of such partnership net income (determined under the law applicable to such calendar year) equal to the proportion which the part of such fiscal year falling within such calendar year bears to the* full fiscal year.

The partnership’s fiscal year began in the middle of 1920 and ended in the middle of 1921, so the proportion thereof which fell within the calendar year 1920 is one-half. One-half of this partner’s share ($9,720.66) of the partnership income is $4,860.33, and section 205(c) provides that th.e rates for 1920 shall apply to this amount and that the rates for 1921 shall apply to the remaining half.

The taxpayer has computed his tax by taking each half separately and applying to each such amount the rates prescribed in the schedule of that year, as if such amount were a separate and independent subject of tax for that year, and then adding the taxes of the two years together and arriving at his total tax for 1921. Thus he applies to the 1921 proportion the normal tax and the lowest surtax, and to the 1920 proportion the normal tax, and escapes the higher surtax which would result if the 1921 schedule of rates were applied to the income as a whole. This he contends is a literal application of the statute to which he is expressly entitled.

The Commissioner has in effect (the schedules for 1920 and 1921 in this instance carrying the same rates) applied the 1921 rates up to $5,326.06, and then the next higher rates of the 1920 schedule to the remaining $4,860.33. The rates for 1920 and 1921 being the’ same, this computation has the same result as the application of the 1921 rates directly to the entire income of the partner without apportionment.

I am of opinion that the Commissioner’s method is not in accordance with the statute. If Congress had chosen to provide this formula, there could have been no room to question its fairness j but, when Congress chooses to prescribe a method as definitely as it did in section 205(c), it must be applied in accordance with its terms, and there is no room for any other method, however more reasonable the Commissioner may believe it to be. The Commissioner’s method presupposes that after apportioning the income the lower rates are first applied to the 1921 income and the higher rates then applied to the 1920 income. I see no basis in the statute for this assumption or its converse. When the statute says that the rates of 1920 shall be applied to the 1920 proportion of income, I see no reason to incorporate the qualification that it means the higher rates applicable to an amount in excess of the 1921 income.

Were this construction otherwise doubtful, it would become unquestionably clear in the light of the further fact that the very method used by the Commissioner is one formerly expressly prescribed by statute and by the 1921 Act repealed. Section 206 of the Eevenue Act of 1918 provided:

That whenever parts of a taxpayer’s income are subject to rates for different calendar years, the part subject to the rates for the most recent calendar year shall be placed in the lower brackets of the rate schedule provided in this title, the part subject to the rates for the next preceding calendar year shall be placed in the next higher brackets of the rate schedule applicable to that year, and so on until the entire net income has been accounted for.

If Congress had intended that this method was to be continued, why did it repeal the provision? We must assume the repeal was deliberate and indicates an intention to discontinue the method then in force. The enactment of a similar provision again in the Eeve-nue Act of 1924 can not be construed as retroactive in the absence of clear language to that effect. This is a situation of a very special nature, which Congress recognized by providing in a special section of the statute for its treatment. In such a situation, the statute must be applied precisely in accordance with its carefully drawn terms. It is the same sort of situation as we had before us in the Appeal of F. J. Thompson, Inc., 1 B. T. A. 535, where a strict application of the statute worked favorably to the Commissioner. Here the reverse happens to be true.

On reference to the Board, Littleton and Tetjssell concur in the dissent.


author: MoRRis:

text:
    Appeal of JULIUS G. DAY, Executor, Estate of HARRY GOODYEAR DAY. Appeal of LOUIS E. STODDARD, Executor, Estate of EZEKIEL G. STODDARD.
    Docket Nos. 2048, 2725.
    Submitted November 1, 1925.
    Decided February 19, 1926.
    The value of certain shares of stock as of the date of the decedents’ deaths determined.

      Edward B. Burling, H. O. Kilpatrick, Hampson Q-a/ry, and E. L. Bono, Esqs., for the taxpayers.

      L. 0. Mitchell, Esq., for the Commissioner.
    Before Marquette, MoRRis, Greek and Love.
    These are appeals from determinations of deficiencies in estate taxes against the estate of Harry Goodyear Day, of $4,675.53, and against the estate of Ezekiel G. Stoddard, of $10,680.84. The qnestion involved is the value of certain shares of stock in the Red River Valley Co., owned by each of the decedents at the time of his death.
    FINDINGS OF FACT.
    1. Harry Goodyear Day died testate October 16, 1922, and, at the time of his death, was a resident of New Haven, Conn. Julius G. Day was the duly appointed, qualified, and acting executor of the said estate.
    Ezekiel G. Stoddard died testate September 18, 1923, and, at the time of his death, was a resident of New Haven, Conn. Louis E. Stoddard was the duly appointed, qualified, and acting executor of his estate.
    2. Each of the above decedents, at the time of his death, owned stock in the Red River Valley Co. as follows:
    Shares.
    Harry Goodyear Day- 800
    Ezekiel G. Stoddard_2,035
    The executor of each estate filed an estate-tax return wherein the stock of the Red River Valley Co. was valued at $125 per share. The Commissioner valued the said stock at $175 per share. There was no change in the affairs of the said company, or in the general market conditions between the two dates of death, and the fair market value of the stock was substantially the same on both dates.
    3.The said Red River Valley Co. was incorporated in 1898 and, at the dates involved in these appeals, had a capital stock of $1,000,-000, divided into 10,000 shares, of the par value of $100 each. It was engaged in the business of owning and operating a large cattle ranch in San Miguel County, N. Mes. Its ranch consisted of a large body of land, 474,419.6 acres in extent, upon which it maintained a range herd of between 18,000 and 20,000 cattle. In addition to the range herd, it owned approximately 900 registered thoroughbred cattle, kept for the purpose of improving the quality of the main herd. It also owned about 800 horses and mules. The entire property was well fenced and the cattle were ranged for the entire year. No appreciable portion of the land was cultivated. It was the practice of the company each year to sell the yearling steers and certain cows which could not survive the winter. The yield of calves in normal years would be about 7,000. In normal years the operating expenses were about $125,000.
    As a precaution against lean years or disasters, the company built up and maintained a reserve of approximately $650,000, consisting of marketable negotiable bonds and preferred stock. The years 1922 and 1923 were unusually disastrous for cattle ranches, as there was a marked depression in the cattle market during these years.
    4. There were very few transfers of stock of the said company, as the stock was mostly held by the original organizers or as a trust investment for their estates. The only sales of a substantial portion of the stock were in the year 1913, when one block of 625 shares was sold for $125 per share and another block of 1,000 shares was sold for the same price. These were purchased by the officers or stockholders of the corporation from other stockholders who desired to sell their interests. In the year 1921, 2 shares were sold for $100, and, in the year 1923, 26 shares were sold for $100. On August 4, 1924, a stockholder offered to sell 106 shares of stock, held as a trust, for $135 per share, the offer being good for two months. The offer was made to the president of the company, who did not accept it. In 1915, 250 shares of said stock were appraised by the probate court at $100 per share in the probating of the estate of the wife of Louis E. Stod-dard. The State courts, in the probating of the estates in this appeal, appraised the value of the stock at $125 per share. No stock at any time had been sold for more than $125 per share. No effort was made to buy or sell any substantial amount of said stock since 1913.
    5. The net earnings of the Bed Biver Valley Co. for the fiscal years ended March 31, 1914, to March 31, 1922, and the dividends paid for the fiscal years ended March 31, 1914, to March 31, 1925, inclusive, were as follows:

    6. The'balance sheets of the Eed Eiver Yalley Co. as they appear upon the books of the corporation as of March 31, 1922, 1923, and 1924, are as follows:

    1 As shown on capital stock tax return.
    7. The said investments mentioned in the balance sheets of said corporation had a fair market value on October 16, 1922, and on September 18, 1923, of approximately $650,530.92, computed in accordance with quotations as of that date in standard financial publications.
    The land consisted of 474,419.6 acres, valued on the books of the taxpayer at $3 per acre. This land was assessed for state taxation purposes during the years 1922 and 1923, at $1.75 per acre. In 1918, under favorable market conditions, 260,000 acres of the land were sold at $3 per acre.
    The Eed Eiver Valley Co., in its capital stock tax return, reported a fair value of its assets and liabilities as of March 31, 1922, and 1924, as follows:

    DECISION.
    The determination of the Commissioner is approved.
   OPINION.

MoRRis:

The determination of the value of the stock of the Eed Eiver Valley Co., as of the time of the death of the decedents, is determinative of the sole issue in this appeal. The taxpayers reported a value of $125 per share but at the hearing contended the proof evidenced a value of $100 per share. The Commissioner fixed a value of $175 per share. The taxpayers rely in part upon the fact that there were no actual sales of stock in excess of $125 per share. The evidence shows, however, that there were but few transfers and practically none about the time of the death of the decedents. The only appreciable sales were in the year 1913, during which blocks of 625 shares and 1,000 shares were purchased by one set of stockholders from another for $125 per share. Since that time the stock has been held by the original stockholders, their heirs, or estates, and no sales were reported, except two shares in 1921 and 26 shares in 1923, at $100. On June 4, 1924, a certain block of 106 shares, belonging to trusts, was offered for sale at $135, for a limited time, tó an officer of the company, but the offer was not accepted. Officers of the company and several stockbrokers and bankers testified that, in their opinion, it would have been difficult, under the circumstances, to sell the stock above par. The evidence, however, does not disclose that any serious effort was ever made to sell or buy any substantial amount of the stock, but, on the contrary, the stock was closely held and the stockholders evidently were satisfied with their investment.

Isolated transfers of stock are not conclusive of the fair market value of other stock of the same issue. We have held that jvhen there is no evidence of market and but a few isolated sales, we must fall back upon an examination of the value of the assets behind the stock and analyze the earnings, balance sheets, and general conditions of the corporation itself, Appeal of Estate of Jacob Fish, 1 B. T. A. 882; Appeal of Howard K. Walter, 2 B. T. A. 453; and this is the situation in this appeal.

Even a most casual examination of the balance sheets and schedule of dividends and net earnings discloses that the corporation was in a most excellent condition. It was capitalized at $1,000,000, but, in spite of annual dividends over a consecutive period of over 10 years, averaging nearly 14 per cent, it had a book surplus on March 31, 1923, of $1,860,404.90, and on March 31, 1924, of $1,702,058.60. There was practically no indebtedness and its assets consisted of tangibles of a most substantial character. It had in its reserve securities admittedly of a market value of $650,530.92. It owned 474,419.6 acres of land valued on its books at $1,423,258 (at $3 per acre), and.even the assessed valuation of the land, fixed by the State Tax Commission of New Mexico at $1.75 per acre, gave it a value of approximately $830,000. The cattle were worth well over $550,000. In addition to this, the company had substantial assets in the form of cash, notes and accounts receivable, and improvements. We are also impressed with the fact that the company was a successful going concern, conservatively and efficiently managed, with every prospect of continued success. A valuation of the assets under the evidence adduced would be well over $2,000,000, a large portion of which were liquid assets. We are not overlooking the fact of the depressed market conditions in the cattle industry during the years 1922 and 1923. We note, however, that the company weathered the storm without dipping appreciably into its surplus, due to its foresightedness and excellent management, which we belive is illustrative of the stability of the corporation.

Without going into a detailed analysis of the various factors entering into the valuation of the stock, a summary of the evidence of value is substantially as follows :

Sale price of 1,625 shares in 1913- $125
Sale price of 2 shares, 1921- 100
Sale price of 25 shares, 1923-1- 100
Book value Mar. 31, 1922- 305
Book value Mar. 31, 1923_ 300
Book value Mar. 31, 1924-,_ 280
Fair value reported in capital stock tax return for 1922- 233
..Fair value reported in capital stock tax return for 1924- 220
Appraised value Connecticut probate court, 1923- $128-
Offer of 106 shares but not accepted in 1924_ 135-
Valuation fixed by Commissioner_ 17⅛

The sale price of stock in 1913 should have no bearing on its value in 1922 and 1923, as, since that time, although the balance sheets of 1913 are not in evidence, it is admitted that a substantial portion of the surplus in the form of securities had been built up, and, also, the company has since that time a history of consecutive annual dividends and earnings averaging nearly 14 per cent. And neither are the isolated sales of the few shares in 1921 and 1923 indicative of the value, as we have pointed out.

We are convinced, from the evidence, irrespective of the method employed by the Commissioner in arriving at the value of the stock, that the value of $175 per share was very conservative and that the evidence is insufficient to disturb this -valuation.


author: Lansdon:

text:
    Appeal of BENJAMIN COLITZ.
    Docket No. 3004.
    Submitted June 9, 1925.
    Decided February 19, 1926.
    1. Bonus, agreed to as to terms but not as to amounts at beginning of year, paid to manager at close of tbe year, in excess of drawing account, allowed as a deduction from taxpayer’s gross income for tbe calendar year 1919.
    2. Amount taken as a deduction from taxpayer’s gross income for tbe year 1919 as a bad debt allowed.
    3. Books of account kept by taxpayer during tbe year 1919 failed to reflect true income. Computation of Commissioner by percentage method of one department of taxpayer’s business for sueb department approved.

      Jacob Auer, O. P. A., for the taxpayer.

      Arthur J. Seaton, Esq., for the Commissioner.
    Before KoRNER, Steenhagen, Lansdon, Geeen, and Love.
    This appeal is from the determination of a deficiency in income tax for the calendar year 1919 in the amount of $1,977.69, all of which is in controversy. Three issues are involved: (1) Deduction of an alleged bonus in addition to salary paid an employee; (2) whether the amount of $1,200 was properly deducted as a bad debt; and (3) whether the Commissioner erred in computing the taxpayer’s income by the so-called percentage method.
    EINBINGS OP PACT.
    1. The taxpayer is an individual residing in Chicago. During the year involved in this appeal he operated two business concerns, known as the Paper Mills Supply Co. and the Colitz Metal & Refining Co., respectively, as the sole proprietor of each,
    2. The Colitz Metal & Refining Co. began business as a partnership some time in the year 1917. The partners were the taxpayer, who contributed most of the capital, his brother, Julius Colitz, and A. A. Rothstein. The operations of this concern were not successful. The losses sustained by the company soon eliminated the capital contributions of Julius Colitz and Rothstein, together with a proportional amount of the capital supplied by the taxpayer, whereupon Rothstein and Julius Colitz withdrew from the partnership before the end of the year 1918, and, from the date of the withdrawal of said Julius Colitz, the taxpayer became the sole proprietor of the business, which he then voluntarily proceeded to liquidate. During the liquidation period, the taxpayer employed Julius Colitz to look after the affairs of the business and for such services paid him a salary of $40 per week during a part of 1919.
    3. A. Grossman was manager of the Paper Mills Supply Co. during 1919. He was employed by the taxpayer under an agreement that he should have a drawing account of $40 per week and an additional bonus at the end of the year in whatever amount the taxpayer might then determine. During the year, in addition to the full amount of his weekly drawing account, Grossman was paid the amount of $3,600, which was charged to his personal account on the books of the company. At the end of the year, the taxpayer determined that the bonus which he had agreed to pay Grossman for that year should be the amount of $3,500, which was thereupon credited to the said Grossman’s personal account and charged against surplus.
    4. The Chicago Waste Paper Co., at that time a debtor of the taxpayer in connection with that department of his business conducted as Paper Mills Supply Co., in an amount not disclosed by the record but in excess of $1,400, became a bankrupt in 1919. After investigating and estimating the value of the assets of such bankrupt, the taxpayer decided that not more than $200 could be realized from the proceeds of the liquidation in bankruptcy in progress at the end of the year 1919, and, as of December 31, 1919, charged the amount of $1,200 off his books of account and deducted the same from his gross income in his income-tax return for the year in question as a debt ascertained to be worthless and charged off within the taxable year. He never realized anything from this debt, which was worthless at the close of the year 1919.
    5. The business records and accounts of the Colitz Metal & Refining Co. which were supplied to an agent of the Commissioner did not reflect true income for the year 1919, and the taxpayer’s tax liability, so far as it related to the operation of such company for the year in question, was computed on the percentage basis.

      DECISION.
    The deficiency should be computed in accordance with the foregoing findings of fact and the following opinion. Final determination will be settled on 10 days’ notice, under Rule 50.
   OPINION.

Lansdon:

Upon audit of the taxpayer’s income-tax return for the calendar year 1919, the Commissioner disallowed the deductions from gross income taken as a bonus to an employee and as a bad debt, both of which were in connection with the department of the taxpayer’s business conducted as Paper Mills Supply Co. The Commissioner approved the computation of the revenue agent, based on the percentage method, of the income and tax liability of the business conducted by the taxpayer under the name and style of Colitz Metal & Refining Co., a sole proprietorship. It is from such disallowances and computation that this appeal is taken.

In the light of all the evidence adduced, we are of the opinion that the bonus of $3,500 is an allowable deduction from the taxpayer’s gross income for the year in question in connection with his business operations carried on under the name and style of Paper Mills Supply Co., and that the amount of $1,200, representing a debt which was actually worthless and was so determined and charged off as such within the year 1919 is an allowable deduction from the taxpayer’s gross income for the calendar year 1919 in connection with that department of his business conducted under the name and style of Paper Mills Supply Co. Appeal of Mason Machine Works Co., 3 B. T. A. 745.

The taxpayer failed to produce all the books of account going to show income and tax liability for the year 1919 in connection with the department of his business conducted under the name and style of Colitz Metal & Refining Co., either for audit by the Commissioner or as evidence for the consideration of the Board, and, as the books produced, audited and in evidence in this appeal do not reflect the true income of that department of his business, the use of the so-called percentage method employed by the Commissioner in computing the income and tax liability of such department must be approved. We have found, however, that during the year 1919 the taxpayer was the sole proprietor of the Colitz Metal & Refining Co., and that Julius Colitz and Rothstein were not co-partners with the taxpayer in that year. It follows, therefore, that the amounts paid to Julius Colitz were compensation for services rendered and not distributions of partnership earnings.


author: Phillips

text:
    Appeal of BANK OF COMMERCE.
    Docket No. 4156.
    Submitted October 22, 1925.
    Decided February 19, 1926.
    1. Under section 277 (b), Revenue Act of 1924, the period within which an assessment of the deficiency determined by the Commissioner may be made is extended when an appeal is taken to the Board.
    2. Taxes imposed upon the shares of the stockholders of a Georgia banking corporation, where the statute required the bank to make the return and pay the tax, held to be a tax imposed upon the shareholders, and, under the Revenue Act of 1918, not to be a proper deduction in determining the net income of the bank.

      Bradley Hogg, Esq., for the taxpayer.

      J. W. Fisher, Esq., for the Commissioner.
    Before Phillips and Teammell.
    The taxpayer appeals from the determination of deficiencies in income and profits tax of $247.10 for 1919 and of $438.14 for 1920. It assigns as error the refusal of the Commissioner to permit taxpayer to deduct taxes levied upon its capital stock by the State of Georgia, and also alleges errors of computation. As a defense to the 1919 deficiency, it claims that the time within which the assessment could be made has expired.
    FINDINGS OP FACT.
    1. The taxpayer is a corporation, organized under the laws of the State of Georgia, with its principal office at Americus.
    2. Taxpayer’s income and profits-tax return for 1919 was filed May 8, 1920. The notice of the deficiency from which this appeal is taken was mailed to the taxpayer on March 14, 1925.
    3. In 1919 taxpayer paid to the State of Georgia a tax of $1,720.32 on its shares of stock, and in 1920 it paid a similar tax of $2,119.33. These taxes were claimed by the taxpayer as deductions in the respective years and were disallowed by the Commissioner in computing the deficiency.
    DECISION.
    The determination of the Commissioner is approved.
   OPINION.

Phillips

: Taxpayer complains that certain errors of computation have been made in the deficiency letter which are apparent upon their face. The report of an internal revenue agent who examined taxpayer’s books allowed depreciation for 1919 of $1,255.78 and for 1920 of $1,288.81, of which $300 in each year was allowed upon the appreciated March 1, 1913, value of a building in excess of its cost. The Commissioner subsequently notified the taxpayer that the depreciation had been increased for 1919 by $384.68 and for 1920 by $414. It does not appear whether any part of such additional depreciation was based upon the appreciated March 1, 1913, value of the building. The revenue agent’s report was used as a basis for the computations in the deficiency letter. The depreciation allowed by him was reduced by $300 in each year, the letter stating that depreciation would not be allowed upon the appreciated March 1,1913, value of the building without proof of such value. Such deficiency letter also increased the depreciation allowed in the agent’s report by $84.68 for 1919 and by $114 for 1920, each of these items being $300 less than the additional depreciation allowed by the Commissioner in a previous letter, referred to above. On this state of the record it is impossible to determine whether any error was committed by the Commissioner, for there is nothing upon which we can determine whether the taxpayer was entitled to the additional depreciation of $384.68 for 1919 and $414- for 1920, as allowed by the Commissioner at one time, or $84.68 for 1919 and $114 for 1920, as finally determined by the Commissioner.

The taxpayer’s income for 1920 was computed by the Commissioner upon the basis of the profits shown upon taxpayer’s books, certain adjustments being made in the book profits. To such book profits the Commissioner has added, among other things, the amount of $258.97, stated to be loss upon sale of bonds, apparently determining that no such loss had been incurred. If the profits shown upon taxpayer’s books reflected a loss of such amount and such a loss was not, in fact, sustained, the determination of the Commissioner is correct. No proof was introduced, the taxpayer relying upon what he claimed to be an error upon the face of the computation. The determination of the Commissioner upon this point must be approved.

Taxpayer further claims that there is no deficiency in tax for 1919, since the time within which an assessment could be made has expired. The return was filed on May 8, 1920. Notice of the deficiency from which this appeal is taken was mailed to the taxpayer on March 14, 1925. Taxpayer relies upon the five-year statute of limitations and disregards the provisions of section 277 (b) of the Eevenue Act of 1924, which extends the period of limitations when a deficiency letter is mailed to the taxpayer. The statute clearly extends the period of limitations in such a manner that appeals to this Board can not be used for the purpose of delaying assessment until after the period has expired within which an assessment may be made.

The principal contention of the taxpayer is that the Commissioner committed error in refusing to allow as a deduction taxes paid to the State of Georgia upon its shares of stock. The Georgia statute provides:

No tax shall be assessed upon the capital of banks, or banking associations, organized under the authority of this State, or of the United States, located within this State, but the shares of the stockholders of the banks or banking associations, whether resident or non-resident owners, shall be taxed in the county where the banks or banking associations are. located, and not elsewhere, at their full market value, including surplus and undivided profits, at the same rate provided in. this Article for the taxation of monied capital in the hands of private individuals; * * *.
The banks or banking associations themselves shall make the returns of the property and the shares herein mentioned, and pay the taxes herein provided. Provided, further, That all property used in conducting or operating a branch bank shall be returned for taxation in the county where such branch bank may be located. The true intent and meaning of this section is that the bank itself shall return for taxation and pay the taxes on the full market value of all shares of said bank stock. (Ga. Code, 1910, sec. 991.)

The taxpayer relies principally upon the decision of the District Court for the Southern District of Florida in United States v. Guaranty Trust & Savings Bank, 253 Fed. 291; 1 Am. Fed. Tax Rep. 1012. In that case the statute under construction provided:

The owner or holder of stock in any incorporated company doing business under the corporate name shall not be taxed for such stock: Provided, that such stock is returned for taxation by such incorporated company and taxes are paid thereon by such company, or the property of said company is assessed for taxes where located and taxes are then paid on such property.

In that case the decision was reached that the tax was imposed upon the corporation and not upon the shareholders. The provisions of the Georgia statute are different. They provide that no tax shall be assessed upon the capital of the corporation but that the shares of the stockholders shall be taxed. The section further provides that the tax upon the shares shall be paid by the bank. It does not appear that there is any express provision in the statute by which the bank is to be reimbursed by its shareholders, and this is relied upon by taxpayer as establishing the fact that the payment is made by the bank for its own account without recourse for reimbursement against the stockholders.

There are a number of decisions of the courts construing such statutes as that here in question. These decisions include National Bank v. Commonwealth, 9 Wall. 353; Home Savings Bank v. Des Moines, 205 U. S. 503; First National Bank v. McNeel, 238 Fed. 559; 1 Am. Fed. Tax Rep. 723; National Bank of Commerce v. Allen, 223 Fed. 472; 1 Am. Fed. Tax Rep. 483; Eliot National Bank v. Gill, 218 Fed. 600; 1 Am. Fed. Tax Rep. 407.

In some of tbe statutes involved in these decisions express provision was made that the bank should have a lien upon the dividends and upon the stock for reimbursement for the tax paid. In others there was no such provision. In First National Bank v. McNeel, supra, section 4273 of the Code of Mississippi of 1906 was under construction by the Circuit Court of Appeals for the Fifth Circuit. The statute provided that the principal officer of each bank should deliver to the assessor of taxes of the county in which it was located a written statement, under oath, of the number and amount of all the shares of its capital stock paid in and of the amount of its undivided surplus or accumulations of any sort, that the value of such shares should be based upon the sum of such amounts and should be the basis of taxation of such shares to the holder or owner thereof. The bank was required to pay the tax. In that case the court, which included District Judge Call, who subsequently decided the case of United States v. Guaranty Trust & Savings Bank, supra, upon which the taxpayer relies, held, in a per curiam, decision, that the tax was upon the shareholder and not upon the bank.

In Home Savings Bank v. Des Moines, supra, the Supreme Court held unconstitutional a tax imposed upon the capital of banks where, by express provision of the law, the tax was imposed upon the banks and not upon the individual stockholders. The court distinguishes the case before it from the case where the tax is imposed upon the shareholders and is to be paid by the bank, upon the ground that, in the latter case, the corporation has a common-law right to recover from the shareholders the tax paid.

We do not conceive that the provision of the Georgia statute making the bank liable to make the return -and to pay the tax prevents a recovery from the shareholders. The law provides in express terms that the tax is not upon the capital of the bank but is upon the shares of the stockholders. The bank is the agency through which the tax upon the shares is to be collected. Having paid a tax imposed upon its shareholder, it has the right at common law to collect such tax, whether or not a lien is granted by express provision of the law. National Bank v. Commonwealth, supra. In that case the Supreme Court, construing such a provision of the laws of Kentucky, says:

If the State of Kentucky had a claim against a stockholder of the bank who was a non-resident of the State, it could undoubtedly collect the claim by legal proceeding, in which the bank could be attached or garnisheed, and made to pay the debt out of the means of its shareholder under its control. This is, in fact, what the law of Kentucky does in regard to the tax of the State on the bank shares.

We conclude that the tax under discussion is imposed upon the shareholders and not upon the bant, that the bank is merely a means used by the State to enforce collection, and that the tax is not a proper deduction, under the- Revenue Act of 1918, from the income of the taxpayer.


author: Teammell

text:
    Appeal of NATIONAL CASKET CO.
    Docket No. 1468.
    Submitted October 26, 1925.
    Decided February 19, 1926.

      Held, under tbe evidence, that invested capital can not be determined and that tbe tax should be computed under section 210 of tbe Revenue Act of 1917 and section 328 of tbe Revenue Act of 1918.

      Richard T. Greene and James L. Dohr, Esqs., for the taxpayer.

      Ward Loveless, Esq., for the Commissioner.
    Before Trammell and Love.
    This is an appeal from the determination of a deficiency in income and profits taxes for the fiscal year ended June 30,1918, in the sum of $85,861.72. The deficiency arose from the action of the Commissioner in eliminating from invested capital certain value attributed to intangibles.
    FINDINGS OF FACT.
    1. The taxpayer is a New York corporation, organized in the year 1890 with a capital stock of $3,000,000, divided into 30,000 shares of a par value of $100 each. The taxpayer was organized for the purpose of taking over the business of three corporations, to wit, the Stein Manufacturing Co., the Hamilton, Lemmon, Arnold Co., and the Chappel, Chase, Maxwell Co. Of the total capital stock, $1,500,000 was issued for tangible assets, consisting of the buildings, land, machinery and equipment and cash of the three corporations. Each of the said corporations transferred tangible assets of the value of $500,000, for which each received $500,000 in stock. The value of the tangible assets was ascertained by a joint committee, which carefully appraised the property. In case the tangible assets lacked the value of $500,000, cash was contributed to make up the difference. The Stein Manufacturing Co. contributed approximately $100,000 in cash to make up this difference in tangible assets. In addition to the $1,500,000 stock issued for tangible assets, $1,500,000 in stock was issued for the intangible assets, consisting of good will, patents, licenses, etc., $500,000 being issued to each company. The three corporations at the time of the consolidation were the three leading manufacturers and sellers of caskets in the United States and were competitors in the same territory. The organization of the taxpayer was the culmination of numerous negotiations and conferences at arm’s length.
    2. The Stein Manufacturing Co. was located at Kochester, N. Y. Its specialty was the manufacture and sale of cloth-covered caskets.
    It had valuable patents on casket lids and metal linings for caskets. Its market embraced all the territory east of the Mississippi River. It had been a profitable going concern for over 15 years. Its net earnings for the period immediately preceding 1890 were as follows:
    1886— $66,963.00
    1887— 78,187.91
    1888— 54,474.90
    1889— 46,539.03
    Total_ 246,164.84
    Average- 61,541.21
    The Hamilton, Lemmon, Arnold Co. was located at Pittsburgh and its market also embraced all the territory east of the Mississippi River. This concern had also operated successfully for over 15 years. Its product consisted principally of varnished caskets of the more expensive types. The earnings for the period immediately preceding 1890 were as follows:
    1886— $41,027.32
    1887_ 68,883.83
    1888— 61,952.88
    1889_|_. 76,521.37
    Total- 248,385.40
    Average- 62,096.35
    The Chappel, Chase, Maxwell Co. was located at Oneida, N. Y. It was larger and more aggressive than the other two. Its specialty was service to its customers. No books were available to show the earnings for the four years immediately preceding 1890, nor was there any other competent evidence thereof.
    All three of these concerns had an established line of customers, consisting of undertakers and jobbers in all parts of the United States east of the Mississippi River. They also had branch houses and maintained a force of salesmen to market their products. They were recognized throughout the trade as the three leading casket manufacturers.
    3. The taxpayer, after its organization, took over the factories, inventories, personnel, and all the business of the said corporations and continued successfully to operate the combined business. By means of the merger the taxpayer was able to effect many economies, such as the elimination of duplication of branch houses, sales force, and the manufacture of the same type of caskets in the various factories. Special lines were assigned to each factory. The taxpayer was financially successful from the start and has continued so to the present time. The organizers of the taxpayer, in fixing the capitalization at $3,000,000, anticipated and expected from the data at their disposal that substantial dividends could be paid on such capitalization. The taxpayer, ever since its organization, has always paid annual dividends. The net profits for the four years immediately following its organization in 1890 were as follows:
    Year ended June 30, 1891_ $191,034.05
    Year ended June 30, 1892_ 208, 678.97
    Year ended June 30, 1893_ 222,965. 47
    Year ended June 30, 1894_ 173, 688. 77
    Year ended June 30, 1895_ 204,495.33
    Total_ 1, 000,862. 59
    Average_ 200,172. 52
    4. The taxpayer claims that the good will acquired by the issuance of $1,500,000 of stock in 1890 had a value of $1,500,000. The Commissioner refused to allow any value for intangibles in computing invested capital.
    DECISION.
    The deficiency should be computed in accordance with the following opinion. Final determination will be made upon 15 days’ notice, in accordance with Rule 50.
   OPINION.

Teammell

: While the evidence convinces us that the taxpayer acquired valuable intangible assets for stock, it is wholly insufficient to enable us to make a finding as to what the value thereof was. Good will acquired for stock, subject to the statutory limitation, is properly a part of invested capital, but that part can not be determined, since we can not determine the value of the intangibles.

The taxpayer alleged in its petition that, if the Board did not allow it to include in its invested capital the value of intangibles, it would be entitled to have its taxes computed under section 210 of the Revenue Act of 1917 and section 328 of the Revenue Act of 1918, and that evidence as to the two corporations which it claimed should be used as comparatives.

From the evidence introduced as to comparative corporations, we are not convinced that the corporations offered as comparatives were similarly situated, within the meaning of the statute.

The case is therefore referred to the Commisisoner for a redeter-mination of the deficiency, if any, by computing the tax under the provisions of section 210 of the 1917 Act and section 328 of the 1918 Act by the use of proper comparatives, the determination of the tax liability by the use of such comparatives to be final.

On reference to the Board, James did not participate.