author: Teammell :

text:
    Canal Bank and Trust Company, Richardson Leverich and Mrs. J. C. Rathborne, Joint Testamentary Executors of the Last Will and Testament of Joseph Rathborne, and Canal Bank & Trust Company, Trustee of the Last Will and Testament of the Late Joseph Rathborne, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 71736.
    Promulgated April 17, 1934.

      Benjamin W. Dart, Esq., for the petitioners.

      Elden McFarland, Esq., and John W. Smith, Esq., for the respondent.
   OPINION.

Teammell :

The petitioners contend that the respondent’s determination is erroneous and in support thereof urge that the decedent by his will created three trusts as follows:

(a) One for the corpus of the residue of his estate, out of which is to be paid from income the special annual legacies to William W. Rathborne of $5,000 and to Mrs. G. W. Rathborne of $30,000 and the general expense of the estate;
(b) A trust for one-half of the remainder of the income to be held, disbursed and invested for the account of J. Cornelius Rathborne, this trust to come into operation on the 21st birthday of J. Cornelius Rathborne, which was June 11,1930;
(c) A like trust for one-half of the remainder of the income to he held, disbursed and invested for the account of Kathlyn George Rathborne, this trust to come into operation on the 21st birthday of J. Cornelius Rathborne, which was June 11, 1930.

The fifth paragraph of the will provided that all revenues in excess of those required to make the payments provided for the several beneficiaries, as thereinafter set out, and in excess of the carrying charges and expenses should be invested and reinvested and form part of the capital of the trust estate. It also provided that from time to time the trustee might pay out of the capital of the estate any money needed for any of the purposes contemplated by the will, and in case the revenues were insufficient to make the payments provided for the beneficiaries the trustees could make up the deficiency out of capital. Paragraph seven of the will also provided for the trustee making payments out of capital under certain circumstances when the revenues or the accumulation thereof was insufficient to make the payments provided for the beneficiaries. Considering the foregoing in connection with all the other provisions of the will, we are unable to find that more than one trust was created or that it was the intention of the decedent to create more than one trust. See Margaret B. Sparrow et al., Trustees, 18 B.T.A. 1; State Savings Loan & Trust Co., 25 B.T.A. 228; aff'd., 63 Fed. (2d) 482; Johnson v. United States, 65 Ct. Cls. 285; John J. Rauers et al., Trustees, 28 B.T.A. 516. Only one trust having been created by the will, no segregation of the assets or of the income of the trust that the trustee might make for its own convenience for accounting purposes could in any wise serve to increase the number of trusts created by the will. The contention of the petitioners on this point is denied.

The petitioners urge that the income credited after June 11, 1930, to the respective accounts of J. Cornelius Rathborne and Kathlyn George Rathborne was not income falling within, the provisions of section 161 (a) (1) of the Revenue Act of 1928 but constituted distributions of income within the meaning and intent of sections 161 (a) (2) and 162 (b) and (c).

The Revenue Act of 1928 provides in part as follows:

SEC. 161. IMPOSITION OP TAX.
(a) Application of taw. — The taxes imposed by this title upon individuals shall apply to the income of estates or of any kind of property held in trust, including—
(1) Income * * * accumulated or held for future distribution under the terms of the will or trust;
(2) Income which is to be distributed currently by the fiduciary to the beneficiaries * * *
SEC. 162. NET INCOME.
The net income of the estate or trust shall be computed in the same manner and on the same basis as in the ease of an individual, except that—
* * * # * * *
(b) There shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is to be distributed currently by the fiduciary to the beneficiaries, * * * but the amount so allowed as a deduction shall be included in computing the net income of the beneficiaries whether distributed to them or not. Any amount allowed as a deduction under this paragraph shall not be allowed as a deduction under subsection (c) of this section in the same or any succeeding taxable year;
(c) In the case of income received by estates of deceased persons during the period of administration or settlement of the estate, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary or accumulated, there shall be allowed as an additional deduction in computing the net income of the estate or trust the amount of the income of the estate or trust for its taxable year which is properly paid or credited during such year to any legatee, heir, or beneficiary, but the amount so allowed as a deduction shall be included in computing the net income of the legatee, heir, or beneficiary.

Section 3 of the seventh paragraph of the decedent’s will provided that the trustee should pay out of the income of the trust estate and out of the principal if necessary, to J. Cornelius Rathborne and Kathlyn George Rathborne, through their mother or tutor, a sum sufficient to educate, maintain, and support them in accordance with their position in life and their prospects as his heirs. Section 4 of the same paragraph provided that during the 10-year period following J. Cornelius Rathborne’s having reached his majority the trustee should pay to him the income of his share of the estate (which was one half) in the following proportions: One third during the first three years, one half during the next three years, and the whole thereof during the remaining four years of the trust. Provision was also made for the payment to him of certain specified amounts and an increase in the allowance to him in event of his marriage. Similar provisions were made in section 5 of the same paragraph of the will with respect to the payments that were to be made by the trustee to Kathlyn George Rathborne. From a consideration of the foregoing provisions in connection with the provision in the fifth paragraph that all income in excess of that required to make the payments provided for the several beneficiaries and in excess of the carrying charges and expenses should be invested and reinvested and form a part of the capital of the trust estate, we think it is clear that the income of the trust estate falls within two classes, namely, income accumulated or held for future distribution under the terms of the will, and income which was to be distributed currently by the trustee to the beneficiaries. So far as the record discloses, the respondent, in determining the deficiency here involved, has not included in the taxable income of the estate any of the latter class, but has included only such income as was accumulated under the terms of the will. In thus including such income the respondent has followed the plain provision of section 161 (a) (1).

With respect to the income which was accumulated the petitioners take the position that such income was income “ which is to be distributed currently by the fiduciary to the beneficiaries ” within the meaning of section 161 (a) (2) and that, the trustee having credited the proportional parts of such income to the respective accounts of the two grandchildren, the amounts thus credited are allowable deductions in computing the taxable income of the trust estate for the year in question. This view ignores the fact that the income of the trust falls into two classes, both of which are recognized by the act and both of which are to be given different treatment under the act. Nothing that the trustee did or could have done with respect to crediting income to the accounts of the grandchildren on its books could alter the fact that under the terms of the will a portion of the income of the estate for the taxable year was to be and was accumulated by the trustee. During the taxable year J. Cornelius Rathborne reached his majority. The only portion of the income of the trust that the trustee was authorized to pay him during that year was one third of a one half thereof, or one sixth, the amount which the respondent eliminated from the income of the trust and taxed to him. No greater amount was payable to or distributable to him during the year. All of the income of the trust remaining, after the payments provided by the will to be made to the other beneficiaries and carrying charges and expenses, was to be accumulated and added to the corpus of the trust. Income thus accumulated could not be said to be income which was to be distributed currently.

The fact that the trustee credited to the respective accounts of the grandchildren on its books certain amounts, which under the terms of the will were to be accumulated and added to the corpus of the trust, does not serve to make such amounts deductible from the income of the estate and taxable to the grandchildren. Such amounts can not be said to have been credited to the grandchildren within the meaning of that term as used in the act. As was pointed out in Lynchburg Trust & Savings Bank v. Commissioner, 68 Fed. (2d) 856, taxpayers generally are charged with income not reduced to possession only if it can be said that the income is received constructively and has become so far subject to the taxpayer’s demand that its nonreceipt is a matter of his own choice. See also Commissioner v. Stearns, 65 Fed. (2d) 371. Under the circumstances presented here the grandchildren had no present choice respecting the receipt or nonreceipt of income accumulated and held by the trustee as a part of the corpus pursuant to the terms of the will.

In view of the foregoing we perceive no error in the action of the respondent in including in the taxable income of the trust estate the income which was accumulated by the trustee pursuant to the terms of the decedent’s will. His action therefore is sustained.

By way of argument the petitioners contend that the grandchildren are what is known as forced heirs under the law of Louisiana and that decedent could not dispose of his estate without leaving them the share of his estate (one third betwéen them) which was reserved to them by law and that the income of thei trust became theirs when received by the trustee. The petitioners admit, however, that the residuary portion of the estate which was left in trust to the grandchildren was in excess of the share reserved to them by law.

Pertinent portions of the Louisiana statutes (Dart’s 1932 Statutes) are as follows:

9815. Donations mortis causa or inter vivos permitted in certain cases.— It shall be lawful for anyone to- make a donation inter vivos or mortis causa of any kind of property, and of any amount, whereby an individual or individuals or, a bank or banks now or hereafter organized under the laws of this state for the purpose of conducting savings, safe deposit and trust banking business, or which have accepted the provisions of law relative thereto, and banks organized under the acts of the congress of the United States, are designated as trustee or trustees; provided, however, that nothing in this act shall be construed to affect the law in regard to the disposable portion, save that it shall be permissable to provide that the legitime or any portion thereof of any forced heir or heirs shall be administered in trust for his or their benefit by said trustee or trustees, the income to be paid annually or oftener to said forced heir or heirs, or his or their legal representatives. (Acts 1920, No. 107, s 1).
9816. Regulations of trusteeship Op donor — Bond of Trustee. — The donor of such property shall have the right to prescribe the number of trustees, the causes for which any trustee or trustees shall cease to be such; the manner in which vacancies, however occurring, shall -be -filled; the manner in which the property donated shall be administered, and the objects to which it, or part thereof, shall be applied; the period of duration of said trust, which shall not emceed ten years after the death of the donor, except when the beneficiary is a minor at the time of the death of the donor, in which case it shall not exceed ten years after the minor has attained majority; in what manner and under what circumstances the trustee or trustees shall be empowered to sell the property donated, or any portion thereof, or to change any investment once made. Provided that the designation in any act of donation inter vivos or mortis causa of an attorney for the trustee or trustees shall be binding upon such bank or banks. Individual trustees shall furnish bond for an amount to be fixed by the court which would have jurisdiction over the succession of the donor and with surety approved by said court, conditioned on the faithful performance of his or their duties unless the giving of the bond by such persons shall have been expressly dispensed with by the donor in the act of donation. (Acts 1920, No. 107, s 2).
*******
9818. Trustees — Poioers and duties — Compensation and expenses — Liability.— Said trustee or trustees shall administer the property entrusted to them in conformity with the directions contained in the act of donation, and shall have all the powers needed for such administration; and can mortgage, pledge, alienate or encumber the designated property whenever necessary in the opinion of the trustee, unless prohibited by the donor. Said trustee or trustees shall be entitled to reasonable compensation for its or their service payable annually which shall not exceed 10% of the annual income from the said property and to the reimbursement of all necessary and reasonable expenses paid or incurred in the performance of its or their duties or in the protection and preservation of the property so conveyed in trust. The trustee or trustees shall not be responsible for anything done, or any action taken by it or them except in the cases of its or their negligence or wilful misconduct. (Acts 1920, No. 107, s 4). [Italics supplied.]

From the foregoing we think it is clear that the interests of minor heirs may be vested in a. trustee for them until they reach their mar jority and for a period of 10 years thereafter, as was provided for in the decedent’s will with respect to the grandchildren. In our opinion this rule of law tends to support the action of the respondent rather than sustain the contention of the petitioners. We see nothing therein to indicate that more than one trust was created by the decedent’s will or that the income in controversy was not taxable as determined by the respondent.

Reviewed by the Board.

Judgment will be entered under Bule 50.


source: Caselaw Access Project

author: McMahon :

license: Public Domain

text:
    Joseph E. Uihlein, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 51234.
    Promulgated April 17, 1934.

      Ward Loveless, Esq., for the petitioner.

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

McMahon :

The first contention of the respondent, that, where a husband and wife living together file a single joint return of income, such husband and wife become a single taxing unit and, consequently, a loss sustained by the husband from the sale of stock to his wife, or vice versa, may not be taken as a deduction in the joint income tax return, as an individual can not sell property to himself, was considered in Frank B. Gummey, 26 B.T.A. 894, wherein the Board, resolving such contention adversely to the respondent, stated as follows:

* * * Where a husband and wife exercise the statutory right to file a single joint return gross income and deductions are listed as though they belonged to the one making the return, hut in reality they represent the combined receipts and deductions of each. To reach the aggregate net income, on which the tax is computed, consideration must be given to the transactions of each. In no other way can the combined taxable income be determined. The respondent has recognized this condition by the promulgation of regulations under section 51 of the 1928 Act providing that where husband and wife file a single joint return “ all deductions to which either is entitled shall be taken from such aggregate income.” A like regulation was in force under prior acts containing provisions similar to section 118 of the 1928 Act. Art. 401, Regulations 62, 65 and 69.
If the theory being advanced by the respondent here were carried out to its logical conclusion, a loss sustained by a husband or wife in a transaction between them would not be deductible under the statute on the ground that a person can not enter into a transaction with himself. A loss sustained by the husband in a transaction with his wife has been allowed as a deduction from gross income reported in their single joint return. Fleitmann et al., 22 B.T.A. 1291. The acquiescence of the respondent in the decision is shown in C.B. X-2, 214.
Had the petitioner and his wife filed separate returns, there would be no question about the deductibility of the losses sustained by each. In filing a single joint return they lost none of such rights; each remained an individual, and as such, a taxpayer, within the meaning of section 118 of the statute.

See also Robert E. Binger, 22 B.T.A. 111; Carl P. Dennett, 30 B.T.A. 49; W. E. Brochon, 30 B.T.A. 404, also decided this date; and Frida Hellman Cole, 29 B.T.A. 602.

The remaining question to be considered is whether the transfer of 750 shares of the stock of Eline’s by the petitioner to his wife constituted a sale made in good faith.

The petitioner testified that the reduction of taxes was also considered, although his purpose was to dispose of the stock. Even though the sale involved herein was carried out with the express purpose of avoiding tax liability, such motive is not ground by itself for the denial of the allowance of the claimed loss. The courts and the Board have held that a loss sustained from a sale made in good faith with the sole purpose of decreasing tax liability is deductible if effected by legal means. United States v. Isham, 17 Wall. 496; Nace Realty Co., 28 B.T.A. 467; Theron E. Catlin, 25 B.T.A. 834; and cases cited.

In Wiggin v. Commissioner, 46 Fed. (2d) 743, the court stated:

The test of the validity of these contracts is not whether the motive therefor, perhaps even the dominant motive, may not have been to reduce Wiggin’s income taxes; the test is whether the transaction was real, the contract valid, as between him and the corporation.

While transactions involving members of the same family or those bearing a confidential relation to each other should be carefully scrutinized, Benjamin T. Burton, 28 B.T.A. 1242; James L. Robertson, 20 B.T.A. 112; Charles S. Hempstead, 18 B.T.A. 204; Albert W. Finlay, 17 B.T.A. 828; Royal Wet Wash Laundry, Inc., 14 B.T.A. 470; and P. B. Fouke, 2 B.T.A. 219, “ their recognition may not be denied when by proper evidence they are shown to be actual.” Benjamin T. Burton, supra.

Section 246.03 of the Wisconsin Statutes of 1925 provides as follows:

Any married female may receive by inheritance or by gift, grant, devise, or bequest from any person, bold to her sole- and separate use, convey and devise real and personal property and any interest or estate therein of any description, including all held in joint tenancy with her husband, and the rents, issues and profits thereof in the same manner and with like effect as if she were unmarried, and the same shall not be subject to the disposal of her husband nor be liable for his debts. Any conveyance, transfer, or lien executed by either husband or wife to or in favor of the other shall be valid to the same extent as between other persons.

As to the effect of this statute, the Wisconsin Supreme Court in Bradley v. Selden, 228 17. W. 494, stated: “ The statute now places the wife on the same legal basis as any other person, changing the rule which prevailed under the earlier decisions.”

The testimony of the petitioner and his wife is uneqhivdcable and uncontradicted. They testified that an actual bona fide sale, and not a gift, was intended; that no agreement or understanding existed between them that the stock was to be held by the wife as the property of the petitioner or the purchase price was to be returned by the petitioner to the wife; that the purchase price was paid by the'wife to the petitioner out of her own separate estate, which was substantial; that the transaction was treated as a sale upon the individual books of account of both the petitioner and his wife; that the stock transferred to the wife has been, ever since its transfer to her, a part of her separate estate; and that the petitioner never reacquired the stock from his wife.

The stock was transferred on the books of the corporation and a new certificate therefor issued to the wife. The bookkeeper of the petitioner and the bookkeeper of the petitioner’s wife testified that the transaction was treated as a sale by the petitioner and a purchase by his wife and so recorded in their respective books of account.

We have found that the fair market value of Eline’s preferred stock, at the time of the sale in question here, did not exceed $1 per share.

Upon the whole record in this proceeding it is our opinion that the sale in question was made in good faith, and we cannot agree with respondent’s contention, on brief, that it was an accommodation sale and not a bona fide sale. See Commissioner v. Hale, 67 Fed. (2d) 561, and Carl P. Dermett, supra, Cf. W. E. Brochon, supra.

The loss in question here is deductible.

Reviewed by the Board.

Decision will he entered under Buie 50,


author: McMahon ;

text:
    W. E. Brochon, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 61455.
    Promulgated April 17, 1934.

      L. A. Luoe, Esq., for the petitioner.

      Isadore Graf, Esq., for the respondent.
   OPINION.

McMahon ;

The respondent contends that where husband and wife file a joint income tax return they thereby constitute a single taxpayer; that purchases and sales of securities by husband and wife are to be treated as though made by one individual; and that therefore under the provisions of section 118 of the Revenue Act of 1928 a loss from the sale of securities by the husband may not be deducted if within BO days after such sale the wife acquired substantially identical property, citing I.T. 1997, C.B. III-1, p. 149. As conceded on brief by the respondent, the Board has held t'o the contrary in Frank B. Gummey, 26 B.T.A. 894. To the same effect is Joseph E. Uihlein, 80 B.T.A. 399. Upon authority of these cases we are unable to agree with the above contention of the respondent.

The respondent further contends that the alleged purchase of the 300 shares of Chicago Corporation stock at the end of December 1929 was actually made by the petitioner and that, therefore, the sale of the same number of shares of the same stock by the petitioner was not a bona fide sale.

The petitioner contends that he actually sold the stock as disclosed by the statements of the brokerage firm and the confirmation of sale; that the sale by the broker was an arm’s length transaction upon which he paid both commission and taxes, his account being credited with the amount of $3,894, the net proceeds of such sale; that the statement of the account of Pearl Brochon, his wife, shows that she purchased the stock for $3,975.77, and thus paid on the open market $38.27 more than the petitioner received “ gross ” in parting with his stock; that she paid considerably more than he received net, after the broker had deducted commission and taxes; that petitioner’s wife held the stock for almost a year, until November 1930, before she parted with the same at a loss; and that the respondent offered no testimony whatever to contradict either the clear evidence of the statements of the brokerage firm or the testimony of the petitioner.

The petitioner testified that he was prompted in making this transaction in part by a desire to establish a tax loss and in part by the fact that there was a substantial drop in the market and that he did not like the way the stock was acting; that when he decided to dispose of the 300 shares cif Chicago Corporation stock he discussed the matter with his wife; that his wife questioned his judgment in selling the stock, as she thought the stock would go up; that she wanted to buy the stock; that he placed the order to buy the stock for his wife with Morrison & Townsend by telephone; that his wife hád no funds of her own; that for that reason some one had to guarantee her account with the broker and he decided that he would rather guarantee it than ask her father or her aunt to do it; that the stock was sold in November 1930 at a loss and such loss was charged to his account because he had guaranteed the account of his wife; and that this was the only stock transaction in which his wife was ever involved as far as he knew.

In substance, so far as the purported purchase of stock on margin by the wife is concerned, it was no more than a paper transaction appearing only on the records of the broker. She had no funds and no credit to pledge. She assumed no financial responsibility. Cf. Benjamin T. Burton, 28 B.T.A. 1242. While the stock was charged to her account, when the stock was sold in 1980 the loss reflected in her account was closed into petitioner’s account. Apparently the petitioner was deemed primarily liable to the broker.

The statement of Morrison & Townsend of the account of the petitioner discloses that the 300 shares were sold at 13%, or a total of $3,937.50. From this item the amount of $37.50 representing commission and the amount of $6 representing Federal and state tax were deducted, leaving a net credit to petitioner’s account of $3,894. The statement of Morrison & Townsend of the account of petitioner’s wife discloses that the 300 shares were purchased at the same price of 13%. However, there is an apparent error in the extension of the total, which is $3,975, or $37.50 more than $3,937.50, which is the correct amount.- Since the statement of the petitioner shows that he was charged a commission of $37.50 on the sale of 300 shares of stock at 13%, it may reasonably be assumed that this item of $37.50 included in the extension on his wife’s statement also represents broker’s commission. Assuming this to be true, the only difference in the two transactions as shown by such statements is that the petitioner was charged with a tax of $6, whereas the account of petitioner’s wife was charged with an item of 77 cents designated on her statement as the “ Int & Com ”. The purported sale price and purchase price were the same, i.e., 13%.

The case of Cole v. Helburn, 4 Fed. Supp. 230, cited by the petitioner, is distinguishable from the instant proceeding. In that case the defendant, a collector of internal revenue, made no contention that the sale of stock by the taxpayer was not a bona fide sale, and conceded that the stock was actually sold by the plaintiff and that the same stock was actually bought by plaintiff’s son. However, the collector contended that the transaction was within section 118 of the Revenue Act of 1928. The court held that, since the defendant had conceded that the father had actually sold the stock and that the son had actually bought the same, and since the father did not acquire title to his son’s stock until long after the expiration of 30 days following the sale of his own stock, section 118 had no application and plaintiff was entitled in his 1929 income tax return to deduct the loss sustained by him in the sale of his radio stock.

Under all the circumstances we are of the opinion that the transactions herein did not constitute an actual sale of the stock by the petitioner, but one in form merely, and that therefore the claimed loss is not deductible. Mrs. Niels (Mellie) Esperson, Executrix, 13 B.T.A. 596; aff'd., Esperson v. Commissioner, 49 Fed. (2d) 259; certiorari denied, 284 U.S. 658. See Lulu Tirrill Coombs, 80 B.T.A. 35; and Joseph Blumenthal, 30 B.T.A. 125. Cf. Joseph E. Uihlein, supra.

However, even if the sale by the petitioner were assumed to be an actual sale, we could not regard the purported purchase by the wife as other than a purchase by the petitioner, since she had no funds or credit of her own and) he at the outset ordered the same number of shares bought in her name and assumed financial liability therefor and later, in 1930, the loss reflected in the account of his wife was charged to his account. Consequently, under such an assumption and all the other facts and circumstances, the petitioner having purchased within 30 days after the sale by himself the same number of shares of the same stock sold by him, no deduction on such sale by him could be allowed under section 118, Revenue Act of 1928.

Reviewed by the Board.

Decision will be entered for the respondent.


author: Smith :

text:
    New York, Ontario and Western Railway Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 52693.
    Promulgated April 17, 1934.

      G. L. Andrus, Esq., and Hermon J. Wells, Esq., for the petitioner.

      James T. Haslam, Esq., for the respondent.
   OPINION.

Smith :

This proceeding is for the redetermination of a deficiency in income tax for 1926 of $57,885.15. The proceeding raises the question as to whether intercompany transactions should be excluded from income accounts of members of an affiliated group prior to computing the statutory net losses of the individual members and also excluded in computing the net income of the subsequent year prior to deducting the statutory net loss of the preceding year.

During the calendar years 1925 and 1926 the petitioner was the principal or parent corporation of a group of affiliated corporations which filed consolidated Federal income tax returns for those calendar years. The subsidiary companies filed for those years information returns on Form 1122, containing a stipulation that the tax should be assessed against the petitioner.

The corporations that were included in the consolidated returns for the above years are as follows:

New York, Ontario & Western Railway Oo.
Port Jervis, Monticello & Summitville Railroad Co.
Pecksport Connecting Railway Co.
Wharton Valley Railway Co.
Ontario, Carbondale & Scranton Railway Co.
Ellenville & Kingston Railroad Co.
Elk Hill Coal & Iron Co.
Anthracite Valley Water Co.
Scranton Coal Co.
Scranton Coal Co. is the owner of 100 percent of the Priceburg Water Co., a Pennsylvania corporation.

All of the aforesaid corporations were held by the respondent to be affiliated for the entire calendar years 1925 and 1926 and satisfied all the requirements of affiliation under the law.

In the consolidated return for 1925 no tax liability was reported and the respondent has found none.

The following intercompany transactions occurred between the various affiliated companies during the years 1925 and 1926.

(a) Property of the Ontario, Carbondale & Scranton Railway Co. was operated by the petitioner under lease for an agreed rental of $75,000 for each year, an amount equal to the interest on all of its outstanding bonds which were held by the petitioner. The payment of the rental and the receipt of the interest are recorded in the accounts of the petitioner and of the Ontario, Carbondale & Scranton Railway Co.

(b) The property of the Ellenville & Kingston Railroad Co. was operated by the petitioner under lease for an agreed rental of $26,000 for each year, an amount equal to the interest on all of its outstanding bonds which were held by the petitioner. The payment of the rental and the receipt of the interest was recorded in the accounts of the petitioner and of the Ellenville & Kingston Railroad Co.

(c) The property of the Port Jervis, Monticello & Summitville Railroad Co. was operated by the petitioner under lease for an agreed rental of $18,000 for each year, an amount equal to the interest on all of its outstanding bonds which were held by the petitioner. Payment of the rental and the receipt of the interest was recorded in the accounts of the petitioner and of the Port Jervis, Monticello & Summitville Railroad Co.

(d) The Scranton Coal Co. paid to the petitioner $198,500 in 1925, and $161,493.05 in 1926, as interest on its bonds held by the petitioner.

(e) The Scranton Coal Co. paid to the Elk Hill Coal & Iron Co. $70,788.83 in 1925, and $128,128.91 in 1926, as rent for the use of its properties.

(f) The Scranton Coal Co. paid to the Priceburg Water Co. $50 in each year for water. This amount represented profit to the Price-burg Water Co. in each year.

(g) The Scranton Coal Co. sold fuel to the petitioner for $60,-861.96 in 1925, and for $138,167.03 in 1926, which amounts included no profit to the Scranton Coal Co.

(h) The Elk Hill Coal & Iron Co. paid to the petitioner $55,625 in 1926 as interest on its bonds held by the petitioner.

(i) The Elk Hill Coal & Iron Co. paid to the Scranton Coal Co. $56,000 as interest on its bonds held by the Scranton Coal Co.

In computing the deficiency of $57,885.15 for the year 1926, the respondent included as income to the recipient members of the affiliated group and as deductions to the payor members all items representing transactions between the various members of the group. Based upon such a computation the respondent computed statutory net losses for certain members of the- affiliated group for 1925, which he deducted from the income of the respective members for the year 1926 in the determination of the above named deficiency. The respondent states that in computing the consolidated net income for the year 1926 he erroneously disallowed a deduction of $600.

The parties have stipulated as follows:

(a) If all intercompany transactions whether or not resulting- in any profit or loss to the separate corporation should be eliminated in computing' the statutory net loss of each company for 1925, and all intercompany transactions should be eliminated in computing the separate income of each company for 1926 for the purpose of applying its 1925 loss against its 1926 income, the deficiency for the year 1926 is $30,068.38.
(b) If only intercompany profits and losses should be eliminated in computing the statutory net loss of each company for 1925, and only inter-company profits and losses should be eliminated in computing the separate income of each company for 1926 for the purpose of applying its 1925 loss against its 1926 income, the deficiency for the year 1926 is $8,531.75.
(c) If intercompany transactions should not be eliminated in computing the statutory net loss of each company for 1925 and intercompany transactions should not be eliminated in computing the separate income of each company for 1926 for the purpose of applying its 1925 loss against its 1926 income the deficiency for the year 1926 is $56,234.96.
(d) If intercompany transactions should not be eliminated in computing the statutory net loss of each company for 1925, but all intercompany transactions should be eliminated in computing the separate income of each company for 1926 for the purpose of applying its 1925 loss against its 1926 income, the deficiency for the year 1926 is $43,341.79.'
(e) If intercompany transactions should not be' eliminated in computing the statutory net loss of each company for 1925 and only intercompany profits and losses should be eliminated in computing the separate income of each company for 1926 for the purpose of applying its 1925 loss against its 1926 income, the deficiency for the year 1926 is $24,689.24.

The portions of the Revenue Act of 1926 material to the determination of the issue presented are as follows:

Sec. 23S. (a) In the ease of a corporation subject to the tax imposed by section 230 the term “gross income” means the gross income as defined in sections 213 and 217 * * *.
Seo. 213. (a) The term “gross income” includes gains, profits, and income derived from salaries, wages, or compensation for personal service * * * of whatever kind and in whatever form paid * * *; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. The amount of all such items shall be included in the gross income , * * . *.
Seo. 206. (a) As used in this section the term “net loss” means the excess of the deductions allowed by section 214 or 234 over the gross income, with the following exceptions and limitations:
* * * * # * *
(4) The deduction provided for in paragraph (6) of subdivision (a) of section 234 of amounts received as dividends shall not be allowed;
(5) There shall be included in computing gross income the amount of interest received free from tax under this title, decreased by the amount of interest paid or accrued which is not allowed as a deduction * * *.
(b) If, for any taxable year, it appears upon the production of evidence satisfactory to the Commissioner that any taxpayer has sustained a net loss, the amount thereof shall be allowed as a deduction in computing the net income of the taxpayer for the succeeding taxable year * * *.
Seo. 240. (a) Corporations which are affiliated * * * may, * * * under regulations prescribed by the Commissioner with the approval of the Secretary, make a consolidated return of net income for the purpose of this title, in which case the taxes thereunder shall be computed and determined upon the basis of such return. * * *

Regulations 69, prescribed by tbe respondent under tbis statutory authority, contain the following provisions:

Abt. 631. Affiliated, corporations. — Consolidated returns are based upon the principle of levying the tax according to the true net income of a single enterprise, even though the business is operated through more than one corporation. Where one corporation owns the capital stock of another corporation or other corporations, or where the stock of two or more corporations is owned by the same interests, a situation results which is closely analogous to that of a business maintaining one or more branch establishments. In the latter case, because of the direct ownership of the property, the net income of the branch forms a part of the net income of the entire organization.
Akt. 635, Consolidated net income of affiliated corporations. — Subject to the provisions covering the determination of taxable net income of separate corporations, and subject further to the elimination of intercompany transactions (whether or not resulting in any profit or loss to the separate corporations), the consolidated taxable net income shall be the combined net income of the several corporations consolidated. * * *

This provision concerning intercompany transactions has been carried through the respondent’s regulations without change since 1921 (Regulations 65, art. 636; Regulations 62, art. 636) and, except for the matter in parentheses, was included in regulations promulgated under the Revenue Act of 1918 (Regulations 45, art. 637).

It has been judicially determined that an affiliated corporation remains a taxpayer, the affiliated group being really a tax-computing unit. Woolford Realty Co. v. Rose, 286 U.S. 319; Swift & Co. v. United States (Ct. Cls.), 38 Fed. (2d) 365; Sweets Co. of America v. Commissioner, 40 Fed. (2d) 436; Commissioner v. Ben Ginsburg Co., 54 Fed. (2d) 238; Delaware & Hudson Co. v. Commissioner, 65 Fed. (2d) 292.

A question closely analogous to the one here presented was decided by the Court of Claims in Swift & Co. v. United States, supra. That case arose under the net loss provisions of the Revenue Act of 1921, section 204 (b). The plaintiff was the parent company in a group of some 60 affiliated corporations. There had been certain changes in the membership of the group during the years involved and the major questions presented were whether the affiliated corporations were entitled to the benefit of the net loss carry-over provisions regardless of such changes and, if so, to what extent. In the course of its opinion the court said:

* * * It is contended, on behalf of the defendant, that the general use of the rule laid down in the regulation referred to would give large opportunity for evasion of taxes, but if the rule be applied in the manner that we have hereinafter set forth, it will he observed that all intercompany transactions are eliminated * * * and that consequently no opportunity for evasion is afforded. [Emphasis supplied.]

The court then set forth its method of applying the provisions of the statute and regulations and added :

The results, as shown above, are of course determined on a consolidated basis; that is, after the elimination of intercompany- transactions pertaining to the various members of the groups. [Emphasis supplied.]

In Post & Sheldon Corp., 28 B.T.A. 26, we held that in computing consolidated net income for 1928 of affiliated corporations having prior net losses, intercompany transactions which in any way affect the total net income or the separate net income or apportioned tax of any member must be eliminated. In that case we were concerned only with the elimination of intercompany transactions for the year 1928. The two affiliated corporations had sustained net losses for the year 1926, which they desired to carry forward into the year 1928. The respondent had refused to eliminate the intercompany transactions and upon the basis of such refusal had determined a deficiency.

We are of the opinion that the logical application of the i*espond-ent’s regulations to the facts involved in this proceeding requires the elimination of all intercompany transactions for both of the years 1925 and 1926. The theory of a consolidated return is the taxation of a group of corporations as a single enterprise. Ordinarily inter-company transactions must be eliminated in the determination of the consolidated net income. Such elimination does not affect the taxable net income for a single year. It is only when net losses are to be brought forward that the failure to eliminate intercompany transactions may affect the tax. That is the situation here. The fact that the tax liability of the petitioner for the year 1926 is lessened by the elimination of intercompany transactions is no reason for not applying the rule laid down by the Commissioner’s regulations.

Judgment will be entered for the respondent of a deficiency for 1926 of $30,068.38.


author: Smith: McMahon, Steenhagen,

text:
    Pennsylvania Indemnity Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 71992.
    Promulgated April 17, 1934.

      Galvin H. Rankin, Esq., and Frederick E. S. Morrison, Esq., for the petitioner.

      Percy S. Grewe, Esq., for the respondent'.
   OPINION.

Smith:

This is a proceeding for the redetermination of a deficiency in income tax for 1930 of $8,636.36. The petition alleges that the respondent erred in the determination of the deficiency (1) in the denial of the petitioner’s right to file a consolidated return with its wholly owned subsidiary, the Pennsylvania Indemnity Corporation, and the latter’s wholly owned subsidiary, the Pennslyvania Indemnity Fire Corporation, and (2) in disallowing the deduction of an alleged loss of $247,631.29 upon the sale of securities in the year 1930 upon the ground that the loss was incurred in a transaction not entered into for profit.

The facts with respect to the first issue are that the petitioner is a Pennsylvania corporation organized “ for the purpose of transacting a general insurance agency and brokerage business and for the transaction of such other business as may be incidental thereto.” During the year 1930 it owned all of the capital stock of the Pennsylvania Indemnity Corporation, a Pennsylvania corporation organized for the purpose of insuring against losses resulting from casualties, which in turn owned all of the capital stock of the Pennsylvania Indemnity Fire Corporation, a Pennsylvania corporation organized for the purpose of insuring against losses or damage of property by fire, explosion, transportation, collision, larceny, theft, etc. The petitioner filed a consolidated return with the two above named insurance companies for the calendar year 1930. The respondent has held that the petitioner may not file a consolidated return with the two insurance companies for 1930 by reason of section 141 (e) of the Revenue Act of • 1928, which specifically provides: “An insurance company subject to the tax imposed by section 2Ó1 or 204 shall not be included in the same consolidated return with a corporation subject to the tax imposed by section 13.”

It is agreed that the two insurance companies above referred to are subject to the tax imposed by section 204 and that the petitioner is subject to the tax imposed by section 13. In its petition the petitioner alleges .that section 141 (e) of the Revenue Act of 1928 is unconstitutional. It has, however, made no argument in support of this contention and we find no support therefor. The petitioner’s contention upon this point is not sustained.

The facts relating to the second contention are that the petitioner’s subsidiaries had investments in stocks and bonds which had greatly depreciated in value. On November 20, 1930, the petitioner’s board of directors adopted a resolution which reads as follows:

Besolved, That the Officers are hereby authorized to purchase from the Pennsylvania Indemnity Corporation and/or Pennsylvania Indemnity Fire Corporation such, securities as they deem advisable, at a figure up to the book value of said securities as shown on the hooks of the Pennsylvania Indemnity Corporation and/or Pennsylvania Indemnity Fire Corporation.

Pursuant to such resolution the petitioner acquired securities from its subsidiaries at a cost of $666,967.37, which amount represented the cost of the securities to the subsidiaries but which securities at the time of purchase by petitioner had a fair market value of $420,051. These securities were sold by the petitioner through brokers at an amount to net it $419,330.08. Some of the securities were sold on the same day acquired from its subsidiaries and some a few days later. In its income tax return for 1930 petitioner deducted as a loss upon the sale of these securities the amount of $247,637.29, which deduction was disallowed by the respondent in the determination of the deficiency for the reason that “ the Bureau holds that the loss on the sale of securities in the amount of $247,637.29 was not a transaction entered into for profit and therefore has disallowed a loss of $247,-637.29 claimed on the return.”

Section 23 (f) of the Revenue Act of 1928 provides that a corporate taxpayer may deduct from gross income “ losses sustained during the taxable year and not compensated for by insurance or otherwise.” Section 113 of the same act provides that the basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property.

We are of the opinion that the reason given by the respondent for disallowing the deduction of the loss, namely, that it was not incurred in a “transaction entered into for profit,” is not in itself a sufficient ground for disallowing the deduction of the loss. The statute permits the deduction of losses from sales of property by a corporation even though the property was not acquired in a transaction entered into for profit. We are of the opinion, however, that the statute which permits a corporation to deduct from its gross income losses sustained upon the sales of property contemplates normal business transactions. Where a corporation for one reason or another purchases property at an amount in excess of the fair market value or in excess of the market price the transaction is not a normal business transaction.

In Donald McDonald, Jr., Administrator, 28 B.T.A. 64, we had before us the case of a taxpayer who acquired stock from his daughter-in-law at a price in excess of the fair market value thereof. The taxpayer paid a high price for the stock in order to help his daughter-in-law out of financial difficulties. In his income tax return the taxpayer claimed the right to deduct from gross income the difference between the price which he had paid the daughter-in-law for the stock and the price at which he sold it. We sustained the Commissioner in disallowing so much of the claimed loss as represented the difference between the selling price and the fair market value of the stock at the time it was acquired. In the course of our opinion we stated:

* * * we think that they [the legislators] did not intend to allow a deduction for that part of the loss which resulted in this case from paying more than a fair price for the stock. The excess cost was paid for personal reasons, would not have been paid otherwise, and can not be the basis of a loss.

We think that the same reasoning is applicable in the proceeding at bar. The petitioner paid for the securities acquired from its subsidiaries an amount in excess of their fair market value for the purpose of bettering the financial condition of its subsidiaries. The substance of the transaction was a transfer by the petitioner to the subsidiaries of the excess of the price paid over the market value. That amount did not represent a part of the cost of the securities. We are of opinion that the only amount of loss which the petitioner is entitled to deduct from gross income is the difference between the fair market value of the securities at the date acquired and the price realized for them on their sale. Cf. Rubay Co., 9 B.T.A. 133.

Reviewed by the Board.

Judgment will be entered under Rule 50.

McMahon,

concurring: While I concur in the result, I cannot agree with the grounds therefor stated in the majority opinion.

The petitioner was the selling agent of its two wholly owned subsidiaries and this constituted its sole business. It acquired from them certain securities, having a market value of $420,051, for the sum of $666,967.37, which amount represented the cost thereof to them.

Situations may arise which would induce a purchaser to pay more than the market price to acquire property. Such a purchase may be and often is, as a matter of common knowledge, a normal transaction. Where the statute provides that “ cost ” shall be the basis for the computation of loss or gain, it means cost, whether the cost happens to be above or below the market value, provided an actual purchase was intended.

While the respondent disallowed the claimed loss upon the ground that it was not incurred in a “ transaction entered into for profit ”, and while this is not a ground for disallowing the deduction of a loss by a corporate taxpayer, nevertheless the burden was upon the petitioner to show that it was entitled to the deduction. No explanation of the circumstances surrounding the alleged purchase of the securities from its subsidiaries was advanced by the petitioner and no reason was given for the payment of substantially more than the market; price, except that counsel for the petitioner upon oral argument stated as follows:

It is quite true that the petitioner did not need to do that. [Pay book value instead of market value.] It did not need to sustain that loss, hut it had to realize that it was in an insurance business as a whole, taking the three companies as one business entity, or one business group. It was in the insurance business and they had to protect policyholders.
Now, obviously the petitioner, by keeping these insurance companies in a healthy condition would obviously be able to sell more insurance. Or, rather, it would not sell less insurance because the insurance companies could show that they were sound.

As pointed out, not only were the subsidiaries wholly owned by the petitioner, but it was also their agent and this constituted its sole business. These facts, viewed in the light of the statement of counsel, support the inference that the petitioner not only intended to protect its investment in its subsidiaries, but also its own business. Obviously, unless its subsidiaries could show that “they were sound”, the petitioner would not be able to sell their policies of insurance, and by putting its subsidiaries in a sound financial position it enabled them to continue in business and also enabled itself to continue as agent and to sell at least as much insurance as it had theretofore sold. This was not a transaction comparable to a transaction between members of a family; it constituted a business transaction and must be viewed in that light. In reference to a somewhat analogous situation in B. Estes Vaughan, 17 B.T.A. 620, the Board stated as follows:

There appears to have been no legal obligation upon petitioner to make this payment, but the practical situation was compelling. Petitioner was president, director and a substantial stockholder in four banks. The defalcations had taken place while he was active manager of the bank. If the impaired capital had not been made whole on the date the defalcation was discovered, the bank would have been compelled to close its doors. The effect upon the reputation of the petitioner as a banker, upon the other banks of which he was president, and upon his investments in those banks, might have proven disastrous. It is urged that a payment under such circumstances is such a loss as is deductible. The Commissioner urges that it was made to protect the investment of petitioner ; that it must be treated as additional cost of that investment; and that until the stock is disposed of it can not be said that petitioner has sustained a loss. We believe this to be the better view. Petitioner might have taken his loss by permitting the bank to be liquidated. In that case he would have been permitted his deduction. He chose instead to put more funds into the venture, giving it new life. * * * While these funds left the hands of the petitioner, they went to enrich a corporation in which he was a substantial stockholder.

In other words, the amount paid in by that taxpayer was held to be a capital contribution and hence a part of the cost of his stock. The cause of the impairment of the capital is immaterial, whether through defalcations as in the above situation or through decrease in market value of assets as in the instant proceeding. In this view the difference between the cost of the securities to petitioner’s subsidiaries and the market value at the date of purchase of such securities, by the petitioner, constituted a capital contribution on the part of petitioner and therefore is not deductible as a loss. See Washington State Bank, 20 B.T.A. 33; and W. R. Ranney, 16 B.T.A. 1399; affirmed in First Nat. Bank in Wichita v. Commissioner, 46 Fed. (2d) 283.

Steenhagen,

dissenting: It seems to me that the Board has artificially construed the plain facts. The petitioner bought the securities from another corporation, which the statute treats as separate and unaffiliated, for a contract price of $666,967.37, the amount of which was paid. Nothing was said about a gift or a capital contribution. If the purchase price had been less, the selling corporation would have sustained a loss, deductible on its return. By the present decision, although the securities actually diminished in value and were disposed of at less than cost, neither corporation gets a deduction for the loss which was indubitably sustained. There is, in my opinion, nothing in the circumstances to compel such a result.

GoodRICH agrees with this dissent.


author: Arundell:

text:
    Burrows McNeir, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 68480.
    Promulgated April 17, 1934.

      Frank J. ATbus, Esq., for the petitioner.

      Richard W. Wilson, Esq., and Dale H. Flagg, Esq., for the respondent.
   OPINION.

Arundell:

This proceeding involves deficiencies in income tax determined by the respondent for the years 1929 and 1930 in the respective amounts of $2,736.10 and $186.27. Tax assessed for 1929 in the amount of $36.02 is also disputed, making a total of $2,772.12 in controversy for that year. The controversy for the year 1930 was settled at the hearing by the concession of counsel for respondent of a deductible loss sustained by petitioner in the operation of a farm and the petitioner’s abandonment of a claimed bad debt deduction. Decision of no deficiency will be entered for the year 1930.

The remaining question is whether a loss sustained in 1928 was a statutory net loss so that petitioner may carry it forward and reduce 1929 income. The 1928 loss was occasioned by the worthlessness of stock of the Alliance Realty Co. Respondent concedes worthlessness in 1928, resulting in a deductible loss of $60,000 and a consequent net loss for the year in the amount of $30,340.69.

Petitioner’s first acquisition of Alliance Realty Co. stock was in 1925. He loaned money to an acquaintance to enable him “to complete a deal for a hotel ” in Florida. He shortly learned that negotiations had not progressed as far as he had been led to believe and endeavored to get his money back. He was unable to obtain repayment and was persuaded to advance additional funds. The advances so made amounted to about $40,000 and for them he received stock, $20,000 common and $20,000 preferred, some of which he sold. He later traded a boat which had cost him about $20,000 for $10,000 common and $10,000 preferred Alliance stock. Still later he exchanged real estate for additional stock in the amount of $40,000. The Alliance Realty Co. acquired and operated the Monterey Hotel. The operation was not successful and the property was taken over by the bondholders in 1928. From the time of construction in 1925 until its surrender to the bondholders in 1928 petitioner had an office in the hotel and supervised its operation.

For a number of years petitioner has traded various kinds of property. He has traded cattle, sheep, gasoline engines, automobiles, boats, typewriters, pumps, and electric motors; at one time he traded an airplane for stock of a laundry company; he did some trading in real estate. He made his trades at irregular intervals, at times several in one day and at others not more than one a week. He is a machinist by trade, and his garage in Florida was equipped with a lathe and drill press and other tools. He kept a supply of pumps in the garage. Petitioner received income from a trust fund and from securities other than the Alliance Realty stock.

Petitioner’s argument is that the Alliance Realty Co. stock was acquired in trades for other property; that his business was that of trading generally as distinguished from trading in securities; that his trades occurred with sufficient regularity and required sufficient time to constitute a business regularly carried on. He does not claim to have dealt in securities sufficiently to make that a trade or business regularly carried on within the meaning of section 117 of the Revenue Act of 1928. Neither does he claim that the loss was a net loss by reason of his being a heavy stockholder in the hotel company and his business was that of supervising the operation of the hotel property. Cf. Burnet v. Clark, 287 U.S. 410, where a net loss deduction was denied to an individual managing a corporation and owning a majority of the stock, the loss growing out of a sale of the stock and payment of notes of the corporation endorsed by the taxpayer.

Assuming for the moment that trading property for other property was petitioner’s regular trade or business, it does not appear that the stock which became worthless was all acquired in a trade. When he first became involved in the hotel deal he put in cash to the extent of $40,000, for which he received stock. He testified that he sold some of the first acquired stock, but does not say how much. Apparently the sales were not in any substantial amount, as he owned $75,000 or $80,000 worth in 1928. The acquisition of stock for cash obviously was not an acquisition in a trade or an exchange.

But passing this, we have the question of whether petitioner’s activities as a trader amounted to the conduct of a trade or business regularly carried on. That he had a penchant for swapping things is undeniable on the record, his testimony being that he started trading in early boyhood and has continued it ever since. It does not appear, however, that his trading was conducted with a view to making a livelihood or profit. The intent of reaping a profit — if not a livelihood — is an essential element in bringing a transaction within the accepted definitions of trade or business. See Elmore L. Potter, 18 B.T.A. 549, and cases cited. In Harriet P. Schermerhorn, 26 B.T.A. 1031, the taxpayer was not dependent on profit from trading for her livelihood, but, as said in the opinion, “ it is not denied that petitioner carried on these activities in the hope of profit.” Fondness for a particular kind of enterprise or pleasure derived from engaging in an activity does not prevent classification as a trade or business, see Wilson v. Eisner, 282 Fed. 38, where the business was that of breeding and raising horses, but in such cases “ intention is important,” Commissioner v. Marshall Field, 67 Fed. (2d) 876. In the latter case the court concluded from the evidence that the taxpayer “ embarked in these enterprises with the expectation of making profits; at least he did so with an earnest and honest intention.” In the present case we are unable to find from the evidence that petitioner engaged in the trading of property with any intention of making a profit, and so we are unable to conclude that his trading amounted to a trade or business within the meaning of the taxing statute.

Decision will be entered for the respondent for the year 1929, and decision of no deficiency will be entered for the year 1930.


author: Smith:

text:
    The Sugar Creek Coal and Mining Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 73758.
    Promulgated April 18, 1934.

      Evert L. Bono, Esq., for the petitioner.

      A. H. Fast, Esq., and H. D. Thomas, Esq., for the respondent.
   OPINION.

Smith:

This is a proceeding for the redetermination of a deficiency in income tax for the fiscal year ended May 31, 1931, of $67,535.47. The issue presented is whether advance mining royalties, not included in gross income for the years in which received by reason of the fact that they were credited to a reserve account upon the petitioner’s books of account, should be included in the gross income of the year in which they were credited to the petitioner’s profit and loss account where the statute of limitations has operated against the assessment and collection of deficiencies for the years in which the royalties were received.

The petitioner was the lessor of certain coal lands located in Ohio. These lands were leased to an operating company as lessee, the lessee being given the right to mine the coal. The lease passed through several lessees by assignment, the Ohio Collieries Co. being the lessee during the taxable year. The lease provided for a certain royalty payable to the petitioner per ton of coal mined, and a minimum number of tons per year was fixed by the lease as the amount of coal on which the lessee company was to pay royalty. In the event the lessee failed to mine the minimum amount it had the right to take out such coal in future years. For most of the years from 1904 to the taxable .year the lessee failed to mine the minimum tonnage although, in accordance with the terms of the lease, it paid to the petitioner each year up to 1927 the required royalty based on the minimum tonnage. The excess received by the petitioner each year over and above the royalty applicable to the tonnage actually mined was set up on the petitioner’s books as “ advanced royalty.” Such amounts were not reported as income on its returns. On July 14, 1930, an agreement was entered into amending the lease in certain respects. Under the terms of this agreement the advance royalties, which at that time amounted to $563,319.25, were “ mutually cancelled and released.” They were taken into the income account of the petitioner as of May 31,1931.

In the notice of deficiency upon which this proceeding is based the respondent has included the $563,319.25 as taxable income for the fiscal year ended May 31, 1931. This sum represents advance royalties from 1904 through 1927. At the hearing of this proceeding the respondent admitted that royalties paid to the petitioner previous to March 1, 1913, should not be included in the deficiency on the ground that they constituted capital. Since the taxpayer filed an amended return for 1927 which included royalties received in that year, the respondent admits that these sums should likewise be excluded from the total royalties to be included in the gross income of the taxable year. Thus, the ultimate position of the respondent is that only advance royalties received for the taxable periods from March 1, 1913, to December 81, 1926, should be included in gross income for the fiscal year ended May 31, 1931. This action on the part of the respondent reduces the amount originally included in gross income from $563,319.25 to $217,355.33 and reduces the asserted deficiency of $67,535.47 to approximately $23,000.

It was admitted at the hearing that the respondent had examined •the petitioner’s boohs of account beginning with the fiscal year ended May 31, 1922, through the year 1926, but had not included in the gross income, of those years, upon the audit, the amounts of advance royalties received in those years. It was stipulated at the hearing:

* * * the statute of limitations on assessments and/or collection of Federal Income and Profits Tax for all taxable years or periods prior to the fiscal year ending May 31, 1927 had run at the time the amended answer for 1927 was filed on July 8, 1931.

In such amended answer the respondent alleges:

(6) That in its returns of annual net income filed with the Collector of Internal Revenue for all years prior to the taxable year, petitioner did not report as income any portion of the advanced royalties in question; and that by reason of such action and representations thereby made, petitioner is precluded and estopped from claiming that the amount of advanced royalties is not taxable in the taxable year involved in this appeal.

We think it clear, as contended by the petitioner, that the advance royalties constituted taxable income of the years of receipt by the petitioner. Bankers Pocahontas Coal Co., 18 B.T.A. 901; New York, Chicago & St. Louis R.R. Co., 23 B.T.A. 177.

The only defense of the respondent to the claim of the petitioner that no part of the $563,319.25 advance royalties should be taken into the petitioner’s income account in the fiscal year ended May 31,1931, is that the petitioner is now estopped to deny that $217,355.33 of such amount constituted taxable income of that year; that the petitioner was obligated by the revenue acts in force from March 1, 1913, to December 31,1926, to return the royalties received; that the respondent relied upon the correctness of the returns to his detriment; and that when the petitioner took into income in the fiscal year ended May 31, 1931, the royalties which had been received in prior income tax years, the amount constituted taxable income of that year. It is apparent that if the petitioner is not estopped to deny the taxability of the income in the fiscal year ended May 31, 1931, income in the amount of $217,355.33 escapes income tax.

We are of opinion that the respondent’s contention is well founded. In Edward G. Swartz, Inc. v. Commissioner, (C.C.A., 5th Cir.) 69 Fed. (2d) 633, the court observed as follows:

This view makes it unnecessary for us to consider in detail respondent’s position advanced as its sole defense before the Board and in the alternative here, that petitioner and Swartz, its sole owners, have by returning the income as petitioner’s and not Swartz’s, estopped themselves from now claiming the contrary. We think, however, that this position is sound and that limitation having now run against taxing it to Swartz, it is too late for him now to assert that he, and not his creature, whom for years he has induced the Government to accept as the owner, is the real owner of the income. Planters’. Cotton Oil Co. v. Hopkins, 53 Fed. (2) 825; Walker v. Commr., 63 Fed. (2) 346; Commissioner v. Garber, 48 Fed. (2) 526; Lucas v. Hunt, 45 Fed. (2) 781; Hartwell Mills v. Rose, - Fed. (2) -.

In Crane v. Commissioner (C.C.A., 1st Cir.), 68 Fed. (2d) 640; affirming 27 B.T.A. 360, the taxpayer failed to report improvements made upon land owned by him as taxable income. Upon a subsequent sale of the land he claimed the right to add to his cost basis the depreciated value of the improvements. The court denied his contention, declaring:

In the instant ease, the petitioner failed to include in his return for the year 1921, or in any subsequent return, the fact that the improvements had been made. There can be no doubt that when the petitioner made his return in 1921 for 1920 income, he was under an obligation to return and pay a tax on the depreciated value of such improvements, as a part of his income for that taxable year. Article 48 of Regulation 45 (1920 Edition) as amended (T. D. 3062). Miller v. Gearin, 258 Fed. 225; United States v. Boston & Providence R. R. Corp., 37 Fed. (2d) 670. While modified by later regulations giving the taxpayer the option of spreading over the life of the lease the depreciated value of such improvements, the petitioner’s obligation to report such income continued to exist.
This obligation to report and pay a tax was never performed, and cannot now be enforced against the petitioner, because it is barred by the Statute of Limitations. The petitioner urges that he is entitled to the benefit of he Statute of Limitations, and so he is. The obligation can no longer be enforced. But the failure, however innocent, to report this income, constituted in effeet a statement that no such income was received, and the Government, in reliance thereon, failed to receive the amount of any such tarn as might have resulted if the petitioner’s returns had been accurate. The statutes and regulation should not be construed to entitle a taxpayer to the benefit of an expenditure made by his lessee, when the taxpayer has failed to report or to pay a tax in the appropriate year or years upon the income received by virtue of the lessee’s expenditure. [Italics ours.]

In Moran v. Commissioner (also C.C.A., 1st Cir.), 67 Fed. (2d) 601; affirming 26 B.T.A. 1164, tbe facts were tbat tbe decedent during bis lifetime held certificates of deposit representing funds deposited with a bank. Interest was not credited to tbe bolder on tbe books of tbe bank butwas computed and paid when tbe certificates were presented for redemption. In 1928 tbe decedent presented tbe certificates, receiving a substantial amount of interest for that and prior years. He reported only interest earned in 1928, claiming that tbe remainder was income constructively received in prior years though he did not report it in such years. It was held tbat, since the decedent took the position that the income was not actually received in prior years, he could not thereafter contend that it was not income to be reported in 1928 when it was received. The court held that it was unnecessary to decide whether the interest was not received by Moran until he collected it and upheld the Government’s first contention, saying:

* * * Assuming, — as we are bound to assume on the record before us, — that Moran acted honestly, his conduct, in not including the interest as it accrued in his early returns, evidenced an election on his part to treat it as not received until actually collected. Having made that election and acted on it in his dealings with the government, and having had the benefit of that position, and rights having become fixed on that basis, we are clear that his estate ought not now to be allowed to repudiate the position so definitely taken nor to assert rights inconsistent therewith. Magee v. United States, 282 U.S. 432; Davis v. Wakelee, 156 U.S. 680; Casey v. Galli, 94 U.S. 673, 680; Hartwell Mills v. Rose, 61 Fed. (2d) 441 (C.C.A. 5). * * *.

In Askin & Marine Co. v. Commissioner (C.C.A., 2d Cir.), 66 Fed. (2d) 716; affirming 26 B.T.A. 409, the court held that where a taxpayer had charged off and claimed as deductions in prior years accounts which had not been determined worthless, it was estopped to deny that amounts recovered thereon during the taxable year should be taxed as income. In this connection, the court said:

* * * we think the petitioner is now clearly estopped from denying, to the prejudice of the government, the truth of the representations upon which it has succeeded in former years in obtaining deductions from its gross income. While the commissioner must investigate returns to satisfy himself of their correctness in fact and law, a taxpayer may not benefit at the expense of the government by misrepresenting facts under oath; by succeeding in having the commissioner accept its representations as the truth; and by claiming later that what it represented to be true might have been found false had the commissioner refused to have faith in the sworn return. Commissioner v. Liberty Bank & Trust Co. (C.C.A.) 59 F. (2d) 320.

We think it immaterial whether the doctrine applied in this case is that of estoppel or of some other analogous principle. It was stated by the Supreme Court in Stearns Co. v. United States, 2 Fed. Supp. 773; 291 U.S. 54:

* * * Sometimes the resulting disability has been characterized as an estoppel, sometimes as a waiver. The label counts for little. Enough for present purposes that the disability has its roots in a principle more nearly ultimate than either waiver or estoppel, the principle that no one shall be permitted to found any claim upon his own inequity or take advantage of his own wrong. * * *'

The respondent’s contentions are sustained.

Judgment will be entered voider Bule 50.


text:
    Robert H. Lord, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 59385.
    Promulgated April 18, 1934.

      Ralph H. (Jake, Esq., for the petitioner.

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

Arundell:

We have no question here as to whether or not the amount received by petitioner from Deere & Co. constituted income. The question presented is whether such income was the separate income of petitioner or community income divisible between petitioner and his wife, they being residents of the State of Washington at the time of receipt.

Petitioner’s view is that the contract of April 8, 1918, and all his rights under it, expired when he left the service of Deere & Co.; that there was no consideration on his part for the offer contained in the letter of November 20, 1924, hence it was a mere offer and not a contract ; and that such offer did not ripen into a contract until he performed the conditions thereof by maintaining the prescribed attitude towards Deere & Co. In other words, there was no contract until 1928, when he was a resident of Washington, and the'income under such contract was then community income.

The respondent urges that the substantial consideration furnished by petitioner for the sum he received was the services he had previously rendered; that his receipt of the proceeds of the stock relates back to his contract of employment, which, being entered into in Oregon, makes the proceeds his separate income, under the rule that in determining the property rights of spouses the property is deemed to be acquired as of the time of acquisition of the initial right of which it is the development.

We are unable to accept petitioner’s theory that the contract of April 8, 1918, and all his rights under it completely expired when he left the service of his employer, and that a new contract — completed by performance in 1928 — was substituted for it. We recognize the rule that where there are two contracts complete in themselves relating to the same subject matter, but of different dates, the later one supersedes the earlier. But that is not the situation here. The later one does not say what constituted “ the common stock contract ” therein mentioned, from which it is obvious that any attempt on the part of petitioner to enforce any rights under the later one would have necessitated his establishment of the prior agreement. Clearly it was not intended that the offer in the letter was to stand as complete in itself. The language used demonstrates the intent not to be a complete abrogation of the prior contract, but a modification. Note the wording: “ * *' * it is our idea to continue-jour common stock contract in force * * But even if the letter be considered a new contract superseding the old, there was no lack of consideration, as contended by petitioner, which would make it ineffective until performance. Where there is a modification of a contract “ the original consideration attaches to and supports the modified contract.” Long v. Pierce County, 22 Wash. 330; 61 Pac. 142. The substitution of a new contract for an old one in itself constitutes a sufficient consideration.” Stofferan, v. Depew, 79 Wash. 170; 139 Pac. 1084.

Moreover, looking at the matter from a practical point of view, it is inconceivable that a negative or passive attitude on the part of petitioner, simply refraining from doing or saying anything that might be inimical to the welfare of Deere & Co., constituted the entire consideration for the substantial sum he received in 1928. It is a far more reasonable view that petitioner’s receipt of the proceeds of the stock had its inception or source principally in the services rendered prior to the discontinuance of service with the company. This, as we read it, was the intent of the company in its letter of November 20, 1924, expressed in the words: “ In view of the fact that you have been with this organization many years * * * it is our idea to continue your common stock contract in force.” Thus the services rendered in the past were regarded by the company as at least a part of the consideration for the sum paid petitioner after he left the employ of the company. Cf. Arthur L. Lougee, 26 B.T.A. 23; aff'd., 68 Fed. (2d) 112.

Thus the income received by petitioner in 1928 had its source in Oregon, a noncommunity state, while he and his wife were domiciled there. Separate property of the husband acquired in a foreign jurisdiction and taken into the State of Washington remains his separate property in that state. Brookman v. Durkee, 46 Wash. 578; 90 Pac. 914. And, under the doctrine of relation, the time and place of the initiation of the right to acquire property is determinative of its character when reduced to possession. McKay, in his work on Community Property (§517), states the rule as follows:

The controlling principle stalled. — As between husband and wife, when a right, legal or equitable, is acquired whether before or during marriage, all things of value into which the initial right develops by the performance of conditions, the running of time or the like, or into which it is converted by an assignment, or, if the initial right rests in obligation, all that which is obtained through the performance, discharge, satisfaction, enforcement or assignment of the obligation, are deemed in law to have been acquired as of the date of the acquisition of the initial right, and take the character, as separate or common, of that right.

An inchoate title is regarded as a right within the scope of the above rule and “its development from an inchoate to the absolute or complete form does not shift it from one fund to another; * * * it may pass from a conditional to an unconditional form, without change or [of] legal character * * McKay §520. Under these rules the character of the proceeds from the sale of stock, as separate or community, is determined by and is the same as that of the initial right, even if that was but an inchoate right, of which the proceeds are the fruit.

Under these rules, applied to a case where a resident of a community property state marries between the time of inception of a right and its fruition, the property acquired is regarded as separate property. In Davidson v. Woodward, 156 Fed. 915, a case arising in Washington, it is said:

If one marries after initiating a title, it is his separate property in all cases wherein, by the doctrine of relation, the title takes effect as of the time of the first act initiating it, as in the case of a settlement under the homestead or preemption laws of the United States. Harris v. Harris, 71 Cal. 314, 12 Pac. 274; Forker v. Henry, 21 Wash. 235, 57 Pac. 811; Gardner v. Burkhart, 4 Tex. Civ. App. 590, 23 S.W. 709. Property purchased by a contract before marriage but not paid for until after marriage, is also separate property. Lawson v. Ripley, 17 La. 238; Medlenka v. Downing, 50 Tex. 32; Wage’s Succession, 21 La. Ann. 343.

In Guye v. Guye, 68 Wash. 340; 115 Pac. 731, the husband had contracted to purchase land when he was single, but did not receive a deed until after his marriage. The property was held to be his separate property. Similarly, in Teynor v. Heible, 74 Wash. 222; 133 Pac. 1, homestead property upon which entry was made by a single man who received a patent to the land after his marriage was held to be separate property.

The above authorities were cited and applied in William Semar, 27 B.T.A. 994. In that case the taxpayer, who was a single man on January 1, 1924, and a resident of the State of Washington, had on that date a right to purchase stock of his corporate employer, the contract containing a provision for crediting dividends to the purchase price. He was married on March 1, 1924. On November 8, 1924, a dividend was declared by the corporation, a proportionate part was credited to the taxpayer’s account, and a stock certificate delivered to him. We held that the stock so acquired was his separate property by reason of the initiation of his right to it prior to his marriage, and the dividends therefrom were his income.

In this case petitioner’s services, which constituted at least a part of the consideration for the stock, were performed while he was domiciled in Oregon, pursuant to an agreement executed while he was in that jurisdiction; the continuation of services as a condition precedent to delivery of the stock was waived while he was domiciled in that state. Accordingly, under the authorities above set out, his right to the stock, or its proceeds, originated while he was domiciled in Oregon, under the laws of which it was his separate property, and the proceeds of the stock when received retained that character, notwithstanding his then residence in a community property state.

Decision will be entered for the respondent.


author: Morris :

text:
    Alexander M. Bing, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 59590.
    Promulgated April 19, 1934.

      Lewis M. Isaacs, Esq., for the petitioner.

      Ralph E. Smith, Esq., for the respondent.
   OPINION.

Morris :

This proceeding is for the redetermination of a deficiency in income tax of $7,624.80 for the calendar year 1929, presenting for consideration the respondent’s allegedly erroneous disallowance of a claimed deduction of $35,000, representing an amount paid by this petitioner in connection with the organization and financing of the A. M. Bing & Son Realty Corporation, as an ordinary and necessary business expense.

The petitioner, appearing here individually, is a resident of New York City.

In or about the month of December 1928, the Leonard S. Gans Co., engaged in the real estate brokerage business in the city of New York, .duly licensed to conduct such business in the State of New York, through Leonard S. Gans of that company, brought the petitioner into contact with the Goldman Sachs Trading Co., for the purpose of negotiating a deal whereby funds of the Trading Co. should be employed in real estate operations.

Following upon such introduction, the petitioner negotiated an agreement with the Goldman Sachs Trading Co. providing for the formation of a corporation to enter into certain real estate operations. The Leonard S. Gans Co. participated in the preliminary conversations and negotiations. The agreement between the petitioner and the Trading Co. was consummated on or about February 4, 1929, and a corporation known as the A. M. Bing & Son Realty Corporation was organized with a paid-in capital of $10,000, against which 1,000 shares of no par value stock were issued, 500 thereof being subscribed for by the petitioner, and 500 by the Trading Co., each paying $5,000 therefor. The Trading Co. advanced to the Corporation $5,000,000, and the corporation executed a series of notes for the face amount thereof, repayable with interest over a period ranging from five to ten years from the date of advance. Simultaneously the petitioner agreed to devote time and attention to the operations of the company, and individually guaranteed the Trading Co. against any loss on the notes up to an aggregate of 25 percent of the face thereof.

After the consummation of the agreement, the petitioner paid to the Leonard S. Gans Co. the sum of $35,000 (one payment of $15,000 being made on February 19, 1929, and the balance of $20,000 being paid on March 26, 1929), in full satisfaction for the services rendered in the above described transaction.

The payment to the Leonard S. Gans Co. by the petitioner was not shared in by the Trading Co., nor charged against the A. M. Bing & Son Realty Corporation. This payment was made by the petitioner, and neither directly nor indirectly was he reimbursed by the A. M. Bing & Son Realty Corporation, the Trading Co., or anyone else, for such payment.

At the time of the negotiations with the Goldman Sachs Trading Co., the petitioner was, and had been for upwards of 25 years, actively and extensively engaged in the real estate business in the city of New York. He paid the commission personally, charging the item in his books as an expense in the ordinary course of his business, and not as part of the cost of the stock of A. M. Bing & Son Realty Corporation.

The petitioner accepted the services of the Leonard S. Gans Cb. with the understanding that they were to be paid for if successful; but there was no agreement between the petitioner and Leonard S. Gans prior to the consummation of his agreement with the Trading Co. as to the compensation to be received by the Leonard S. Gans Co. should the transaction be closed. The amount paid to the Leonard S. Gans Co. was fixed by the petitioner with Leonard S. Gans after the consummation of the agreement with the Goldman Sachs Trading Co.

The certificate of incorporation of the A. M. Bing & Son Realty Corporation was filed on February 5, 1929. The organization meeting of the corporation was held on February 8, 1929. The stock was issued and paid for on February 11, 1929. The first advance on account of the $5,000,000 by the Trading Co. to the A. M. Bing & Son Realty Corporation was made on February 19, and amounted to $500,000. The aggregate payments by the Trading Co., making-up the total of $5,000,000, were made from time to time during the year, the last payment, completing the aggregate of $5,000,000, being $335,000, paid on February 27, 1930.

The petitioner filed an individual income tax return for the calendar year 1929, and in that return he deducted $35,000 as “ commissions.” This deduction the respondent disallowed for the reason, as stated in his deficiency notice, that it was “ a capital expenditure to be added to cost of stock of the C. M. [A. M.] Bing and Son [Realty] Corporation and recovered upon final liquidation of the corporation.”

In addition to the foregoing facts taken from stipulations entered into between the parties and other documentary evidence, the petitioner offered oral testimony, practically all of which duplicates matters already stipulated. One fact stipulated between the parties — the fact that the petitioner had, for a great many years, been actively and extensively engaged in the real estate business — should be supplemented by facts developed from such oral testimony showing that although he was so engaged it was through the medium of corporate enterprises and not in any individual or proprietary capacity. For instance, it is shown that his business embraced the purchase and sale of real estate, the construction of buildings, the management of realty properties, etc., and that a separate corporation was organized for each of these separate enterprises and, furthermore, that whenever it became necessary to employ outside capital this was accomplished through some profit or loss sharing arrangement and that separate corporations were formed for participation in each of such transactions.

The petitioner testified that he was not engaged in the business of a promoter — nor was he engaged in the business of forming new corporations except where such became necessary in order to carry out the purposes of his other corporate interests.

Our sole question is whether or not the $35,000 payment by the petitioner to Gans, under the circumstances hereinbefore related, constituted an “ ordinary and necessary ” expense “ paid or incurred during the taxable year in carrying on any trade or business ” within the purview of section 23 of the Revenue Act of 1928.

-Two factors stand out boldly in this proceeding in opposition to the petitioner’s cause. We know nothing of the private considerations that passed between the petitioner and Gans respecting the bringing together of the two factions, one seeking to borrow and the other seeking to lend; consequently we do not know why the petitioner, rather than the corporation, assumed the payment of this so-called commission. After all the corporation was the first to directly benefit by reason of the loan and, normally, would have been expected to bear any expenses necessitated thereby. Since, however, the petitioner, a stockholder of the corporation, bore the payment himself, such payment cannot be logically associated with the procurement of the loan itself, the loan having been made to the corporation, not to him, but must be classified consistently with the interests of the petitioner in the matter entirely apart from the corporate entity: Hence, it is reasonable to' conclude from the circumstances, in view of the fact that the arrangements for the loan, the organization of the corporation, and the issuance of the capital stock were all bound up in a single plan, that the payment of the $35,000 was in furtherance of his ultimate plan to become a stockholder of the corporation and, therefore, that such payment was a part of the cost of so doing. It is also reasonable to assume that in making this large payment personally, without direct reimbursement from the corporation, he was confident that by becoming a stockholder the amount would be returned to him in dividends or through enhancement in the value of his stock. In other words we feel, as the respondent did, that the $35,000 payment was in no sense an expense, but was a part of the cost of his capital stock, for if such payment had not been made the chances are that the corporation would never have come into being and he would never have become a stockholder therein.

The other factor to which we have referred is that, while the petitioner was engaged in the real estate business, the record shows not a single instance where he, on his own account, ever consummated or attempted to consummate a realty transaction. On the contrary the record shows that such realty transactions as were carried out were through the medium of corporate enterprises of which he no doubt was an officer and stockholder. But this cannot be said to be his, but the corporation’s trade or business. Burnet v. Clark, 287 U.S. 410. So that, even if we were to classify this item as an expense rather than as a capital expenditure, we would be unable, on the record before us, to hold that it was incurred in a “trade or business” in which the petitioner was individually engaged. For the above and foregoing reasons we are of the opinion that the respondent’s determination should be approved.

Judgment will be entered for the respondent.