author: MtjRdocic

text:
    Connellsville Central Coke Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 21798, 24226.
    Promulgated February 20, 1933.

      Thomas Watson, Esq., and D. O. Sisterson, O. P. A., for the petitioner.

      James L. BacJcstrom, Esq., and P. A. Sebastian, Esq., for the respondent.
   OPINION.

MtjRdocic

: The first question is to determine how the profits taxes due for the years 1917, 1918 and 1920 should be computed. Section 210 of the Revenue Act of 1917 provides that if the Secretary of the Treasury is unable in any case to determine satisfactorily the invested capital, a deduction shall be computed by a certain comparison with other representative taxpayers engaged in a like or similar trade or business. Section 327 (a) of the Revenue Act of 1918 provides that the tax shall be determined as provided in section 328 where the Commissioner is unable to determine the invested capital as provided in section 326. These particular provisions of the two acts need not be discussed separately. Cf. United States v. Factors & Finance Co., 288 U. S. 89. The Commissioner has determined an amount to represent the petitioner’s invested capital for each year. The petitioner claims, however, that its invested capital can not be .determined satisfactorily. If this contention is correct we need not ■consider whether there are any abnormal conditions within the meaning of section 327 (d).

It is fair to assume, from the record before us, that the petitioner ■has some earned surplus. If the amount of that surplus can be satisfactorily determined, it must be included in invested capital. The (theory of the petitioner’s case must be that it has capital assets not ■shown on its books as such; the cost of these can not be determined ;at this time; and, as a consequence, its invested capital can not be determined since a part of the cost of these assets should be reflected in :a correspondingly larger surplus than its books now show. The ¡alleged assets are entries or tunnels in the Herbert mine which were intended and equipped for further use in extracting other coal. Coal was produced in driving these entries, but another important purpose in driving them was to provide the mine with a system for the future. They were constructed and equipped in the early years of the mine, yet the system, once developed, had an effect on all of the remaining coal in the mine. Certain of these entries existed at the beginning of the fiscal year 1917 and were actually used during the three years 1917,1918 and 1920 in earning the income now being taxed. The petitioner claims that the cost of the part of this system which remained in use was substantial. No amount of diligence would disclose the actual cost. Cf. Edwin M. Knowles China Co., 9 B. T. A. 1292. It attempted to show the approximate cost. The respondent strenuously attacks the testimony of a witness on this subject, but the case does not stand or fall on his testimony. There is other evidence of the approximate cost and we are satisfied from the whole record that the cost was substantial.

The respondent concedes that the driving and equipping of these entries was development work. In most cases he requires, in accordance with good accounting practices, that the cost of assets having a useful life beyond the year in which acquired be capitalized so that income may be clearly reflected. Yet he has refused to permit the capitalization of any part of the cost of these entries and the equipment in them. As a reason in the case of mines for an exception to a general rule, he points to the fact that the entries ■were dug through solid coal and contends that the coal thus produced more than compensated the petitioner for the cost of digging it. He would apply a portion of article 222 (a) of Regulations 45, as amended on January 28, 1921, to the effect that, while a mine is in the development stage, there shall be charged to capital account only those expenditures for development in excess of receipts from minerals sold. The article in its original form and as amended is set forth in the margin. Regulations 45 relate to the Revenue Act of 1918. The year 1917, here involved, is not affected by the Revenue Act of 1918. But the amended regulation probably relates back to the years 1918 and 1920, even though it was not promulgated until afterward.

The respondent contends that the Herbert mine was in the “ development stage ” until 1915 and that a profit was made during this period by the petitioner from the sale of minerals. On his theory there were no expenditures for development in excess of receipts from minerals sold in the case of the Herbert mine, and, consequently, nothing to be charged to capital account recoverable through depletion. The regulation introduces the phrase “ receipts from minerals sold ”. The petitioner sold only a negligible amount of coal, and if the regulation were to be construed strictly, practically all of the development costs would be capitalized. Even under a liberal construction and assuming the validity of the regulation since the petitioner manufactured its coal into coke the cost and receipts allocable to the manufacturing process should be eliminated in order to determine how much should be charged to capital account.

The entries in question, when once they had been developed and equipped, added value to the mineral deposit beyond the current year. The regulation itself provides, where such development takes place after the “ development stage ” is over, that the cost shall be carried as a “ deferred charge ” and deducted over later years. The quoted words do not occur in the statute. We do not know what significance the respondent attaches to the words “ deferred charges ”. Perhaps he would allow such expenditures to be capitalized. Cf. Regulations 65, article 224 (a). He recognizes that the “development stage ” need not continue until all development work is done. For various definitions of “ development stage ” see the corresponding articles of later regulations and also Marsh Fork Coal Co. v. Lucas, 42 Fed. (2d) 83, 86; Little Cahaba Coal Co. v. United States, 15 Fed. (2d) 863. The latter case was reversed in Blockton Cahaba Coal Co. v. United States, 24 Fed. (2d) 180. It is obvious from the testimony in this case that the Herbert mine did not continue in the “ development stage ”, as we would interpret the words, until 1915. The petitioner maintains that it passed out of the “ development stage ” on or about November 1, 1909, and that the net result of the entire operation of the Herbert plant up to that date was a loss. We need determine no exact date in this connection. The mine was designed to supply the ovens with coke. It was fulfilling this purpose long before 1915, and at an early date it had sufficient entries developed for this purpose.

However, the question at once arises as to whether or not the portion Of article 222 relied upon by the Commissioner is a reasonable regulation or a proper one to apply in this case. The respondent has neither cited authority nor advanced any sound argument in support of this provision of his regulations. None occurs to us. Although there may be a practical difficulty in dividing the cost of producing coal from the cost of development, yet this difficulty need not deter us, since other portions of the regulation require such a division. The Circuit Court of Appeals for the Fifth Circuit has held, in Blockton Cahaba Coal Co., supra, that the cost of development in a coal mine should be capitalized regardless of whether or not a profit is made during the development period. In that case the development in question was the driving of a main entry into the coal from an outcrop. The case is not distinguishable from the present case. It sets at naught the very provision of the regulation which the Commissioner now relies upon.

The Revenue Act of 1913 permits as a deduction from income “ a reasonable allowance for the exhaustion, wear and tear of property arising out of its use or employment in the business, not to exceed, in the case of mines, 5 per centum of the gross value at the mine of the output for the year for which the computation is made * * * provided, that no deduction shall be allowed for any amount paid out for new buildings, permanent improvements or betterments made to increase the value of any property or estate.” The Revenue Acts of 1916 and 1918 contain similar provisions but omit the 5 per centum limitation. The latter act contains also section 234 (a) (9), which allows as a deduction:

In the case of mines * * * a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case, based upon cost including cost of development not otherwise deducted.

Through the expenditures incurred in driving and equipping these entries, the petitioner acquired facilities, including haulage ways, ventilation and drainage, which were necessary for and were actually used in the mining of the remaining coal. They not only decreased the cost of producing the remaining coal in the mine, but the evidence also indicates that they actually added value to the mine after due allowance is made for the coal extracted. The driving of an entry is a more expensive proposition than the mining of an equivalent quantity of coal from portions of the mine which are not to be used as entries. The petitioner actually found this to be true. Therefore, it seems only proper that not all of the cost of driving and equipping these entries should be charged as an ordinary and necessary expense in producing only that coal recovered from these entries. So that the remaining coal may bear its proper share of this cost, some part of the cost should be capitalized. Here we need not determine what part, for we are convinced that a substantial amount should be capitalized and that a substantial part of this cost remained during the taxable years in question after proper allowances for exhaustion. The statutes require that the cost of development be recovered upon a reasonable basis so that income may be clearly reflected. Good accounting requires that part of the cost be capitalized if income is to be clearly reflected. Under the statutes the petitioner was entitled to have a substantially larger amount of invested capital than the respondent has allowed or it is able to establish. Its invested capital can not be determined.

We have held that the petitioner should have capitalized certain amounts which it deducted as expenses. Anticipating the possibility of such a holding, the respondent contends that under that view of the case he erred in allowing deductions of $1,250 and $16,125 in computing the petitioner’s net income for 1917 and 1920, respectively. These amounts he contends represent the cost of entries constructed in those years. However, the record does not show in regard to these years what deductions the Commissioner has allowed representing cost of driving entries, the amount expended by the petitioner in driving entries, nor the nature or character of the entries actually driven. Consequently, we hold for the petitioner on this point.

The remaining issue is raised by the petitioner’s assignment of error to the effect that the Commissioner failed to allow a deduction of $65,560.53 which amount was authorized during the year 1920 “ and either paid or credited during the year 1920 as compensation to officers for services rendered in prior years”. Section 234 (a) (1) of the Revenue Act of 1918 allows as a deduction “ all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for services actually rendered ”. Additional compensation authorized to be paid for services rendered in prior years may be deducted under this provision in the year in which paid or incurred, provided that it is a reasonable allowance for the services rendered. Ox Fibre Brush Co., 8 B. T. A. 422; affd., 281 U. S. 115. Distributions of profits made to stockholders in the guise of salaries are not deductible. New York Theatre Program Corp., 4 B. T. A. 431; Twin City Tile & Marble Co., 6 B. T. A. 1238; affd., 32 Fed. (2d) 229; Am-Plus Storage Battery Co., 11 B. T. A. 733; affd., 35 Fed. (2d) 167; Marble & Shattuck Chair Co., 13 B. T. A. 657; affd., 39 Fed. (2d) 393; General Water Heater Co., 14 B. T. A. 4; affd., 42 Fed. (2d) 419; Mendelson Brothers Paper Stock Co., 17 B. T. A. 53; affd., 44 Fed. (2d) 372.

In its original return for 1920 the petitioner claimed a deduction of $18,963.26 as compensation of officers. The respondent has allowed this deduction. The petitioner has not shown what items go to make up this total nor who received the compensation. Fifty-seven thousand dollars was shown on the original return as an un-allowable deduction representing special bonuses to officers. But on the amended return $84,523.79 was claimed as a deduction representing compensation of officers. Thus the petitioner increased its claim by $65,560.53. The Commissioner has allowed no part of this increase. The $65,560.53 represents $57,000 paid in the early part of December 1920, and $8,560.53 paid a little more than six months later. Apparently the additional amounts were paid in 1921 because the resolution of November 28, 1920, provided that the bonus be “ free from all taxes ”. We are unable to say, however, that the $8,560.53 was either paid or incurred in 1920 and for this reason, if for no other, this amount should not be allowed as a deduction for 1920.

The petitioner claims the right to deduct the additional amount in controversy as compensation of officers, yet the record does not show that either Brennan or Hillman ever held any office in the corporation. They were directors but, so far as we know, they were not officers. However, the four individuals in some capacity or another rendered some valuable services to the corporation. But prior to 1920 each one of these individuals had been amply compensated for all services which he had rendered the corporation up to that time. They had received a total of $455,000 in prior years as directors’ salaries. Neff had received, in addition, his regular salary. The directors’ salaries were in direct proportion to stock-holdings. Counsel for the petitioner did not learn until after the hearing that these directors’ salaries had been paid. They now contend in a reply brief that these amounts were really a distribution of profits and not compensation for personal services rendered. But the extra compensation authorized in 1920 was also in direct proportion to stockholdings rather than in proportion to the value of services rendered by the four and it came nine years after Hill-man’s death. There is more reason to hold that the four individuals were compensated in full for their services by the amounts paid them in the earlier years than there is to hold that the authorization in 1920 was a belated recognition of services rendered in years long past. The petitioner was well able to pay any amount which it owed to its officers and directors prior to 1920 and the amounts paid over that period to these individuals amply compensated them for all services rendered up to 1920. In our opinion the amount authorized in 1920; was not a reasonable allowance for salaries or other compensation for services actually rendered. Bather, it was a distribution of profits in the guise of compensation.

DuPuy was paid a salary of $3,000 in 1920, but the record is not clear as to the total compensation received by Neff for that year. We have no reason to believe that the Commissioner has not already allowed as a deduction the $3,000 paid to DuPuy, and whatever amount was paid to Neff- Both Brennan and Neff died in 1920. Hillman had been dead for nine years. There is some evidence to indicate that Neff had been ill and unable to perform any services for the petitioner for a year or more prior to his death. We are unable to say that the amount allowed by the Commissioner was any less than a reasonable allowance for all salaries and other compensation for services rendered. Certain returns of other companies which were offered in evidence indicate that the allowance made by the Commissioner was adequate.

Decision will be entered under Buie 6% (o).

       [Article 222, Regulations 45, as originally promulgated.] In the case of mining operations all expenditures for plant equipment, development, rent, and royalty prior to production, and thereafter all major items of plant and equipment, shall he charged to capital account for purposes of depletion and depreciation. After a mine has heen developed and equipped to its normal and regular output capacity, however, the cost of additional minor items of equipment and plant, including mules, motors, mine cars, trackage, cables, trolley wire, fans, small tools, etc., necessary to maintain the normal output because of increased length of haul or depth of working consequent on the extraction of mineral, and the cost of replacements of these and similar minor items of worn-out and discarded plant and equipment, may be charged to current expense of operations.
      [Article 222, Regulations 45, as amended January 28, 1921.] (a) All expenditures for development, rent, and royalty in excess of receipts from minez'als sold, shall be charged to capital account recoverable through depletion, while the mine is in the development stage. Thereafter any development which adds value to the mineral deposit beyond the current year shall be carried as a deferred charge and apportioned and deducted as operating expense in the years to which it is applicable.
      (b) All expenditures for plant and equipment shall be charged to capital account recoverable through depreciation, while the mine is in the development stage. Thereafter the cost of major items of plant and equipment shall be capitalized but the cost of minor items of equipment and plant, necessary to maintain the normal output, and the cost of replacement may be charged to current expense of operation.


source: Caselaw Access Project

author: Aeundell :

license: Public Domain

text:
    Frank D. Yuengling, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 54730.
    Promulgated February 20, 1933.

      R. H. Crook, C. P. A., for the petitioner.

      Dean P. KmibaM, Esq., and E. C. Adams, Esq., for the respondent,
   OPINION.

Aeundell :

The respondent has determined a deficiency in income tax for the year 1928 in the amount of $8,068.72. The error alleged by petitioner is the inclusion in his income of an amount of trust income which the trustee, under trusts created by petitioner, used to pay premiums on policies of insurance on the life of petitioner. In his answer, counsel for respondent alleged error in failing to include fn petitioner’s income certain specified amounts alleged to have been received from three corporations in 1928, and asked that the deficiency be increased accordingly.

A stipulation of facts was filed, with accompanying exhibits, which we adopt as our findings of fact.

The facts, in brief, are that in 1921 the petitioner assigned to the Safe Deposit Bank of Pottsville, Pennsylvania, as trustee, a group of policies of insurance on his life, and also caused one policy to be issued directly to said bank as trustee. The policies, except the one issued directly to the bank, were originally payable to petitioner’s administrators, executors, or assigns, but with respect to each of them petitioner executed an assignment in due form to the Safe Deposit Bank. On August 12, 1921, the bank executed a declaration of trust describing the policies and reciting their assignment, to it, and declaring that it held the policies in trust for the purpose of collecting the proceeds, which it was to invest and upon the death of petitioner to pay one-third of the income to petitioner’s wife for life or until she should remarry, the other two-thirds to be divided among petitioner’s children. Other provisions made respecting the manner of distribution of income to the children in the event petitioner’s wife predeceased him, and upon the event of her death or remarriage before the children reached specified ages, are not material here.

On the same date, August 12,1921, the Safe Deposit Bank executed another declaration of trust reciting that petitioner had assigned to it certain investment securities and declaring that it held such securities in trust for purposes of collecting the income therefrom and out of such income paying premiums on insurance on the life of the petitioner, the balance of the income to be held in trust during the life of petitioner and upon his death one-third to be paid to his wife for life or until she should remarry, and the other two-thirds to be paid to petitioner’s children. Other provisions were made respecting the distribution of income to be made in the event the wife predeceased petitioner and upon her death or remarriage, and also for the ultimate distribution of the corpus among the children. These provisions are not material here, except perhaps from the negative point of view, that is, that there were no provisions under which any of the income was to be paid to petitioner nor was any part of the corpus to revert to him.

On August 22,1923, petitioner and his wife by written instruments requested the trustee bank to cancel and annul the declarations of trust above described and to execute new declarations respecting the insurance policies and securities theretofore assigned to it. On August 28, 1923, the trustee bank did execute new declarations of trust, in which minor changes were made with respect to the manner of distribution of income and corpus.

During the year 1923 some of the policies assigned to the trustee matured as endowments and others became paid-up policies and the trustee collected and invested the proceeds and/or dividends thereon.

During the year 1928 the trustee received net income from the trusts in the amount of $23,117.12, of which $22,572.99 was taxable, and paid premiums of $14,594.34 on the policies of insurance held in trust. The trustee has filed income tax returns, as trustee, since the creation of the trusts and has reported therein the income received as trustee without claiming any deduction for premiums paid on the insurance policies held in trust.

The respondent included as taxable income to the petitioner for 1928 the amount of $14,250.82 which represents that portion of the taxable income of the trusts which was used to pay life insurance premiums.

In several cases we have held that where the income of trusts created by a taxpayer is to be used to pay premiums on insurance on his life, the income of such trusts should be included in his income. Frederick B. Wells, 19 B. T. A. 1213; Alfred F. Pillsbury, 19 B. T. A. 1229; Irenee du Pont, 20 B. T. A. 482; affd., 63 Fed. (2d) 44. Those cases arose under the Revenue Acts of 1924 and 1926, while the present case is governed by the Revenue Act of 1928, but the applicable provisions of all three statutes are identical. Cf. section 219(h) of the Revenue Acts of 1924 and 1926; section 167 of the Revenue Act of 1928. Accordingly, on authority of the above cases we sustain the respondent on the first issue.

From 1921 to 1925 petitioner owned all the stock and was president of D. G. Yuengling and Son, Inc., and Yuengling Realty Co., Inc. In April 1925, petitioner acquired all of the stock of the Yuengling Securities Corporation, which in turn acquired all the stock of the other two corporations. Between 1921 and 1927 these three corporations procured several policies of insurance on the life of petitioner. In some of the policies the corporation procuring them was named beneficiary, but prior to 1928 such policies were assigned to the Safe Deposit Bank of Pottsville as trustee. In the other policies the Safe Deposit Bank was named as beneficiary. The several policies were received by the bank, as trustee, in trust for purposes similar to those declared in the trusts described under the first issue, that is, to collect the proceeds and pay the income therefrom to petitioner’s wife and children.

Premiums on the several policies were paid in 1928 to the insurance companies by the corporations that procured them, as follows:

D. G. Yuengling and Son, Inc-$7,623. 35
Yuengling Realty Company, Inc- 2,789.30
Yuengling Securities Corporation- 4,711.00

The premiums so paid were not included in income by petitioner in his 1928 return, nor were they included by the respondent in the notice of deficiency.

The premiums paid by the above companies on the insurance on petitioner’s life are the amounts which respondent in his answer alleges that he erred in failing to include in petitioner’s income for 1928.

This issue must be decided in favor of the respondent on the authority of prior decisions holding that premiums paid by corporations on insurance on the lives of officers or employees, where the corporation is not a beneficiary, constitute income to the insured. George Matthew Adams, 18 B. T. A. 381; N. Loring Danforth, 18 B. T. A. 1221.

Decision will he entered wider Bide 50.


author:
Black:
      Murdock, Tkammell,

text:
    Bertha G. Bamberger, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 62578-62595.
    Promulgated February 23, 1933.

      Charles M. Morris, Esq., and Edward E. Ccdlister, Esq., for the petitioners.

      R. W. Wilson, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: Bertha G. Bam-berger ; Eleanor E. Bamberger, Trustee for John E. Bamberger; Gloria Bamberger; Clarence Bamberger, Trustee for Joan Marie Bamberger; Clarence Bamberger and Richard W. Dooly, Trustees for John E. Bamberger; Joan Marie Bamberger; Clarence Bamberger, Trustee for John E. Bamberger; Clarence Bamberger, Trustee for Gloria Bamberger; Clarence Bamberger, Trustee for Clarence Bamberger, Jr.; Ernest Bam-berger ; Maria Odell Bamberger; Clarence Bamberger, Trustee for Eleanor F. Bam-berger ; Bertha G. Bamberger, Trustee for Dorothy B. Allen; Clarence Bamberger; Bertha G. Bamberger, Ernest Bamberger and Clarence Bamberger, Executors of the Last Will and Testament (Estate) of J. E. Bamberger, Deceased; Ernest Bamberger, Trustee for J. J. Bamberger; Ernest Bamberger, Trustee for Dorothy B. Allen; Ernest Bamberger.

   OPINION.

Black:

It is conceded by both parties that the transactions occurring in June 1929, by which three subsidiary corporations were organized and to which Bamberger Investment and Exploration Company transferred much of its valuable stocks and securities, receiving in consideration therefor all the capital stock of the subsidiary corporations and in turn distributing said shares of stock to its own stockholders as a part of the plans of reorganization, were nontaxable transactions under the provisions of the Revenue Act of 1928.

The stock of these three subsidiary corporations which was distributed to the stockholders of Bamberger Investment and Exploration Company without their having to surrender any of their stock in the parent corporation, comes within the description of section 112 (g) of the Revenue Act of 1928, which reads as follows:

(g) Distribution of stock on reorganization. If there is distributed, in pursuance of a plan of reorganization, to a shareholder in a corporation a party to the reorganization, stock or securities in such corporation or in another corporation a party to the reorganization, without the surrender by such shareholder of stock or securities in such a corporation, no gain to the distributee from the receipt of such stock or securities shall be recognized.

It is likewise conceded by both parties that when, on July 16, 1929, two of the three subsidiary corporations completely liquidated and distributed their assets and surplus to the stockholders, which consisted entirely of stocks and securities of other corporations, this was a taxable transaction and the basis for gain or loss is to be determined under section 113 (a) (9) of the Revenue Act of 1928, which reads as follows:

(9) Tax-free distribution. If the property consists of stock or securities distributed after December 31, 1923, to a taxpayer in connection with a transaction described in section 112 (g), the basis in the case of the stock in respect of which the distribution was made shall be apportioned, under rules and regulations prescribed by the Commissioner with the approval of the Secretary, between such stock and the stock or securities distributed. [Italics supplied.]

In pursuance of the foregoing statute, the Commissioner promulgated article 600 of Regulations 74, providing for the apportionment of the costs of stock, which regulations, as first promulgated, read in part as follows:

(1) Where the stock distributed in reorganization is all of substantially the same character or preference as the stock in respect of which the distribution is made, the basis of each share will be the quotient of the cost or other basis of the old shares of stock divided by the total number of the old and new shares.
(2) Where the stock distributed in reorganization is in whole or in part of a character or preference materially different from the stock in respect of which the distribution is made, the cost or other basis of the old shares of stock shall be divided between such old stock and the nerw stock in proportion, as nearly as may be, to the respective values of each class of stock, old and new, at the time the new shares are distributed, and the basis of each share of stock will be the quotient of the cost or other basis of the class with which such share belongs, divided by the number of shares in the class. * * *

This regulation was in full force and effect at the time the petitioners received their distribution of shares in the three subsidiary corporations from the parent corporation in June 1929, and at the time in July 1929, when two of the subsidiary corporations were completely liquidated and their assets distributed to petitioners.

This regulation was subsequently amended, to wit, on November 13,1929, in important respects, by the Commissioner with the approval of the Secretary. This amended regulation is contained in T. D. 4274, C. B. YIII-2, p. 240, and reads in part as follows:

(1) Where the stock distributed in reorganization consists solely of stock in the distributing corporation and is all of substantially the same character and preference as the stock in respect of which the distribution is made, the basis of each share will be the quotient of the cost or other basis of the old shares of stock divided by the total number of the..old and new shares.
(2) Where the stock distributed in reorganization is in whole or in part stock in a corporation a party to the reorganization other than the distributing corporation, or where the stock distributed in reorganization is in whole or in part stock of a character or preference materially different from the stock in respect of which the distribution is made, or where the distribution consists wholly or partly of securities other than stock, the cost or other basis of the stock in respect of which the distribution is made shall be apportioned between such stock and the stock or securities distributed in proportion, as nearly as may be, to the respective values of each class of stock or security, old and new, at the time of such distribution, and the basis of each share of stock or unit of security will be the quotient of the cost or other basis of the class of stock or security with which such share or unit belongs, divided by the number of shares or units in the class. Within the meaning of the foregoing provision, securities are different in class from stocks, stocks or securities in one corporation are different in class from stocks or securities in another corporation, and, in general, any material difference in character or preference or terms sufficient to distinguish one stock or security from another stock or security so that different values may properly be assigned thereto, will constitute a difference in class. [Italics supplied.]

This same treasury decision also sets forth similar amended articles 1599 of Regulations 65 and 69. Regulations 65 and 69 were applicable to the years 1924 to 1927, inclusive, and all reorganizations to which these articles apply were necessarily consummated during the years mentioned and prior to the date of amendment. That the amended articles mentioned above were all to be applied retroactively, to the years covered by Regulations 65, 69 and 74, is clearly set forth in General Counsel’s Memorandum 8751, which may be found in C. B. X-l, pp. 219 to 221. The principal changes made by the amended regulations are shown by the language set forth above in italics.

From an examination of paragraph (1) of article 600 as amended, quoted above, it will be seen that the method of apportioning on the basis of the quotient which is obtained by dividing the total cost of the original shares by the total number of the old and new shares, is restricted solely to stock of the distributing corporation. Paragraph (2) of the above quoted amended regulations provides that the method of apportioning as to all other distributions of stock shall be on the basis, as nearly as may be, of the respective values of each class of stock or security, old and new, at the time of such distribution. This is entirely different from article 600 as originally promulgated. Paragraph (1) thereof was not restricted solely to stock of the distributing corporation, but included all stock received in distribution which was of substantially the same character and, preference as the stock in respect of which the distribution was made. Paragraph (2) of article 600, as originally promulgated, was limited in its application to stock which had been received in distribution which was in whole or in-part of a character or preference materially different from the stock in respect of which the distribution is made.

In the instant case the stock in the three subsidiaries which petitioners received as a part of the plan of reorganization was all common stock, just as all the stock which they owned in the parent corporation was common stock. The authorized capital stock of each of the three subsidiaries was the same as that of the parent corporation, to wit, $300,000. The common stock of two of the subsidiary corporations, viz., the National Exploration Company and Continental Exploration Company, was of the same par value ($10 per share) as that of the parent corporation and each of these two corporations was capitalized for the same number of shares as the parent corporation, viz., 30,000 shares of common stock.

The other subsidiary corporation, American Venture Corporation, had its capital stock divided into 3,000,000 shares of common stock of a par value of 10 cents per share. While the capital stock of this particular subsidiary was divided into a far larger number of shares, each of a far less par value than the capital stock of the parent corporation, still we think it was stock of substantially the same character or preference as the stock of the parent corporation and would therefore seem to fit into the definition of paragraph (1) of article 600 as first promulgated. Thus it would seem that the common stock of all three of the subsidiaries distributed in reorganization is of substantially the same character or preference as the common stock in respect of which the distribution was made (the stock of the Bamberger Investment and Exploration Company) and would apparently fit into the method of apportionment prescribed by paragraph (1) of article 600, as originally promulgated.

This method petitioners have followed in their computation of the tax as shown by their returns filed for the taxable year. Did respondent have the right to change the method of apportionment ¡used by petitioner and make applicable bis amended regulations promulgated several months after the happening of the events which are the subject of the tax, though within the same year that the events occurred?

Petitioners contend that respondent had no such right, giving as reasons for their contention the following points:

I. Reorganization and complete liquidation here involved constitute a single transaction.
II. Article 600, Regulations 74, Income Tax Revenue Act oí 1928, is not interpretative but has force and effect of law.
III. Said Article 600, said Regulations 74, as amended November 13, 1929, ■does not clarify the original Article but changes entirely the basis of cost of shares in corporations, parties to a reorganization.
IV. No intention declared in Article 600, Regulations 74, as amended November 13, 1929, that it should be applied retroactively.
V. Application of said Article 600, said Regulations 74, as amended, retroactively would be unjust, arbitrary, confiscatory and violative of Fifth Amendment to Federal Constitution.

Among other cases urged by petitioners in support of their contentions is Untermeyer v. Anderson, 276 U. S. 440. For reasons which we will now undertake to state, we do not think that Untermeyer v. Anderson, supra, is applicable to the facts of the instant case. And for the same reasons which we shall presently state, we do not think Schwab v. Doyle, 258 U. S. 529; Nichols v. Coolidge, 274 U. S. 531; and Coolidge v. Long, 282 U. S. 582 (also relied upon by petitioners) are applicable. The Untermeyer v. Anderson case held that the Revenue Act of 1924, which was approved June 2, 1924, undertook to tax all gifts inter vivos made during the calendar year 1924 and that, in so far as the act sought to tax gifts made prior to the effective date thereof, it was invalid because in conflict with the due process clause of the constitution.

We think it is sufficient to say, in answer to petitioners’ contention that Untermeyer v. Anderson, supra, rules our decision in the instant case, that we have here no attempt to make a retroactive application of a statute. The transaction upon which the Commissioner seeks to impose the deficiencies, to wit, the receipt by the petitioners of all the assets of the American Venture Corporation and National Exploration Company in liquidation and complete cancellation of their stock in said corporations, occurred on July 16, 1929, more than a year after the enactment of the Revenue Act of 1928, by which the taxes proposed to be assessed were laid. Unquestionably the transaction when it occurred was taxable under the Revenue Act of 1928. It takes no retroactive application of. the statute to hold that. The only question is the basis for gain or loss which is to be applied and.section. 11.3. (a) (9) of. that act says that, the apportionment of cost shall be determined under regulations prescribed by the Commissioner with the approval of the Secretary.

Must the regulations of the Commissioner apply only from the date of their promulgation and affect only transactions which take place thereafter, or may they apply to other transactions for the same taxable year which have already gone before? Holmes Federal Taxation, 6th ed., at page 14, has this to say about the subject now under discussion:

Retroactive Effect of Rulings. Treasury Department decisions promulgating rulings of the internal revenue bureau become effective upon the date of approval unless otherwise stated therein. Cases previously adjusted on the basis of principles of law contrary to those pronounced in such decisions, are subject to readjustment in accordance with the decisions. Generally speaking, any ruling or regulation made by the department supersedes all prior rulings and regulations and is retroactive to the time the law was enacted, since a ruling or regulation is usually merely an interpretation of the meaning of the law, and in theory the meaning has been the same from the beginning. The department recognizes, however, that in some instances it would be unjust or impracticable to reopen returns, adjustments or assessments which have been made in accordance with previous rulings, and where such rulings are superseded. an express limitation is sometimes made in the superseding ruling or regulation as to the retroactive effect thereof. The 1921 and 1924 laws expressly permit amending regulations to be applied in certain cases without retroactive effect. [Italics supplied.]

And Klein, in his work on Federal Income Taxation, at page 95, paragraph 5:17, says:

Par. 5:17 — Retroactive Regulations. Prior to the enactment of the 1926 Act doubt existed as to the effect of Treasury decision on prior conflicting rulings of the Department. Where such a change in Departmental interpretation was occasioned by a binding court decision the Treasury’s adoption of the court’s decision was more or less perfunctory and the change had necessarily to be retroactive in its effect. Where, however, a ruling was changed by the Department on its own initiative, the Treasury’s practice with respect to the application of such a later ruling to an earlier issue was by no means consistent. A question arose as to the authority of the Commissioner arbitrarily to decide whether or not later rulings were to be retroactively applied, with the result that the 1926 Act expressly provided that the Commissioner had wide discretion in the premises, subject to the Secretary’s approval: Section 1108(a) of the 1926 Act reads:
“ In ease a regulation or Treasury decision relating to the internal-revenue laws, made by the Commissioner or the Secretary, or by the Commissioner with the approval of the Secretary, is reversed by a subsequent regulation or Treasury decision, and such reversal is not immediately occasioned or required by a decision of a court of competent jurisdiction, such subsequent regulation or Treasury decision may, in the discretion of the Commissioner, with the approval of the Secretary, be applied without retroactive effect.”
The 1928 Act went a step further by giving the Treasury discretion as to the retroactive applicability of the later ruling, even if the change was occasioned by a court decision: Section 605 reads:
“ In case a regulation or Treasury decision relating to the internal-revenue laws is amended by a subsequent regulation or Treasury decision, made by the Secretary or by the Commissioner with the approval of the Secretary, such subsequent regulation or Treasury decision may, with the approval of the Secretary, be applied without retroactive effect.”

When all is said and done, it seems to us that the principal question we have to decide in this proceeding is whether amended article 600, promulgated November 13, 1929, is a fair and reasonable interpretation of the law as passed by Congress and within the power of the Commissioner to make. Cf. Edward Stephen Harkness, 21 B. T. A. 1068.

Congress did not make any law setting out the method by which the cost of stock acquired in a reorganization like the one we have before us should be apportioned. It left those details to be determined by the regulations of the Commissioner, approved by the Secretary. The upshot of article 600 as amended, in so far as it is applicable to the facts of the instant case, is to provide that, where taxpajTrs receive stocks in distribution which are not of the corporation making the distribution, the method of apportionment shall be to apportion the cost of the original stock among the several stocks now owned in proportion'to the fair market value of each at the time the distribution is made. The principle involved in this method of apportionment has received the approval of the Board and the courts. Glen H. Curtiss, 21 B. T. A. 629; affd., 57 Fed. (2d) 847; Alexander D. Falck, 26 B. T. A. 1359.

While the circumstances affecting the apportionment of costs in Glen E. Curtiss and Alexander D. Falck, supra, were not identical with the circumstances affecting the apportionment in the instant case, still the method underlying the apportionment is the same, to wit, the apportioning of the cost of the original stock among the several stocks now owned upon the basis of the fair market value of each at the time of distribution. That method, it seems to us, is fair and reasonable, and we doubt if any other method would be fair and reasonable.

We find no error in the Commissioner’s determination of the deficiencies. Cf. Evelyn F. Gregory, 27 B. T. A. 223.

The claim of some of the petitioners that there has been an overpayment of their tax for 1929 is based altogether on the assumption that their contention on the main point will be sustained. Having ruled against petitioners on the main point, it naturally follows that we hold against petitioners on their claim of overpayment.

Reviewed by the Board.

Decision will be entered for the respondent.

Van Fossan dissents.

Murdock,

concurring: I agree with the result reached by the Board in this case, but I do not agree with some of the statements and conclusions expressed in the prevailing opinion. Section 113 (a) (9) of the Revenue Act of 1928 provides that the basis shall be apportioned between the stock in respect of which the distribution was, made and the stock or securities distributed. The act itself does not go into detail in regard to the manner of apportioning the basis, but provides that it shall be under rules and regulations prescribed by the Commissioner with the approval of the Secretary. This called! for some reasonable regulation. Following the enactment of this, statute, Regulations 74 were promulgated, containing article 600-It was susceptible of the interpretation that where the stock distributed in reorganization was in part stock in a corporation other than the distributing corporation, the basis should be apportioned in proportion to the respective values of each class of stock at the time of the distribution. Stock of one corporation is materially different, from that of another, both as to its character and preference. Therefore, the Commissioner correctly applied subdivision (2) of the article. It seems to me that the interpretation which the petitioners would place upon the article would make it an unreasonable regulation. Such an interpretation should be avoided in favor of a reasonable one. Thus, I would never get to the question which is discussed and decided in the prevailing opinion.

Tkammell,

dissenting: I am unable to agree with the conclusion reached by the Board in this case. The Commissioner was given express authority by section 113 (a) (1) to promulgate regulations apportioning costs among several classes of stock. His promulgation of article 600 of Regulations 74 was pursuant to the statutory authority. The statute provides as follows:

(9) Tax-free distributions. If the property consists- of stock or securities distributed after December 31, 1923, to a taxpayer in connection with a transaction described in section 112 (g), the basis in the case of the stock in respect of which the distribution was made shall be apportioned, under rules and regulations prescribed by the Commissioner with the approval of the Secretary, between .such stock and the stock or securities distributed.

The statute left certain details to be filled in by regulations of the Commissioner; when those details are filled in by the regulations they become a part of the statute, unless contrary to law or unless purely arbitrary and without reason.

This means that section 113 (a) (1) is to be read in connection, with article 600 of Regulations 74, promulgated pursuant thereto-.. To some extent at least this was a delegation of legislative authority to the Commissioner and the regulation becomes a part of the legislation. It is in no sense a regulation of the Commissioner interpreting the statute, but completes and fills out details left vacant. If the Commissioner interprets the statute by his regulations, it may be conceded that he may change his interpretation by a subsequent regulation, but in my opinion a different rule should be followed when the regulation is in effect to be read as a part of the statute specifically authorized and considered by Congress to be a material part thereof. It is not shown that article 600 of Regulations 74 as originally promulgated was invalid, contrary to the statute, or in any sense illegal. On the other hand, the prevailing opinion assumes the validity of the original regulation. At least it does not question it. This being true, the question here is whether the regulation, after once having been incorporated by the statute as a part of the law, can be changed retroactively to affect transactions which took place before the change. While Congress itself may impose an income tax retroactively, the question is, Can the Commissioner in effect change the law, by changing his regulation after it had become a part of the law? If so, it means that the Commissioner can change the law after a transaction occurred, which was not taxable at the time entered into. In my opinion Congress has not given such power to the Commissioner. When the Commissioner filled in the details of the law by his regulations as provided by the statute, he exercised his full power. Congress has not given authority to the Commissioner in effect to change or impose tax liability retroactively when Congress itself expressed no intention with respect to a retroactive application. When the Commissioner promulgated the original regulation, if valid, the details of the law had been completely filled in and the law was then complete. If the Commissioner, by regulation, changes the effect of such a law, it is new legislation, in my opinion not contemplated. It is conceded, however, that the Commissioner has the right to change the regulation prospectively. Even in legislation enacted by Congress, it must clearly appear that it was the intention to give it a retroactive effect. To give a retroactive effect to a regulation which is incorporated into the statute it seems to me would be similar to the principle announced by the Supreme Court in the cases of Untermyer v. Anderson, 276 U. S. 440; Blodgett v. Holden, 275 U. S. 142; and Arizona Grocery Co. v. Atchison T. & S. F. Ry. Co., 284 U. S. 370. If the original regulation had been contrary to law or so unreasonable or arbitrary that it should not be recognized as a valid regulation, a different situation would arise.

I do not agree with the concurring opinion that the Commissioner correctly applied subdivision (2) of article 600 and that the original regulation is capable of the interpretation expressed in the amended regulation. In my opinion stock of the same character or preference refers to the kind or character of stock and not whether it is in one corporation or another. It is true that stock of one corporation is materially different from that of another, but it is not necessarily materially different in character or preference. Section 112 (g) and article 576 refer to the surrender of stock or securities in a corporation a party to a reorganization and the receipt of stock or securities in such corporation or another corporation, a party to the reorganization. The statute clearly contemplated an exchange of stock in one corporation for stock in another.

ARUNdell agrees with this dissent.

Morris did not participate in the consideration of or decision in this proceeding.


author: Love :

text:
    Helen N. Winchester, Formerly Helen N. Holdaway, Administratrix of the Estate of H. H. Holdaway, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 55561.
    Promulgated February 27, 1933.

      Martin T. Nachtmann, Esq., for the petitioner.

      John D. Kiley, Esq., for the respondent.
   OPINION.

Love :

The evidence fails to prove that the respondent committed any error in determining that the profit from the sale of the three patents amounted to $53,491.94 instead of $28,491.94, as reported by petitioner. This leaves only the question of whether the decedent is taxable on the entire profit of $53,491.94, or on only one-half of that amount.

Prior to July 29, 1927, the husband in California was taxable on the entire community income subject to the Federal income tax. United States v. Robbins, 269 U. S. 315. On July 29, 1927, the Civil Code of California was amended as set out in our findings. In speaking of this amendment the Supreme Court of California, in Stewart v. Stewart, 269 Pac. 439, said:

This section of the Code, whatever effect it may have upon community property acquired subsequent to its effective date, cmmot in any manner relate to or govern the ownership of property acquired prior thereto. [Italics supplied.]

In United States v. Malcolm, 282 U. S. 792, the Ninth Circuit, under section 239 of the Judicial Code, certified to the United States Supreme Court two questions of law, as follows:

(1) Under the applicable provisions of the Revenue Act of 1928, must the entire community income of a husband and wife domiciled in California be returned and the income tax thereon be paid by the husband?
(2) Has the wife, under section 161a of the Civil Code of California, such an interest in the community income that she should separately report and pay tax on one-half of such income?

In answering the questions, the Supreme Court, in a per curiam opinion, said:

The first question certified is answered: No. The second question is answered: Yes. Poe v. Seaborn, ante, p. 101; Goodell v. Koch, ante, p. 118; Hopkins v. Bacon, ante, p. 122.

The facts in the Malcolm case involved only a salary of $3,600 earned by the husband during the year 1928, and did not involve any income from community property acquired prior to July 29, 1927. In commenting upon the Malcolm case, the respondent, in Mim. 3859 (X-1 C. B. 140), said in part:

This decision is applicable to income from community property acquired on and after July 29, 1927, and to salaries, wages, and fees earned on and after that date which constitute community property. The dedsipn is not applicable to income from property acquired prior to duly 29,1927, nor to salaries, wages, fees, and other compensation earned prior to that date. (See I. T. 2457, C. B. VIII-1, 89). [Italics supplied.)

The respondent’s holdings in I. T. 2457, supra, and Mim. 3859, supra, were based upon the holding of the Supreme Court of California in Stewart v. Stewart, supra. These holdings, in effect, have recently been upheld by the Ninth Circuit in a test case entitled Hirsch v. United States, 62 Fed. (2d) 128. The Hirsch case held that dividends received in 1928 on stock was community property under California law but which had been purchased with funds of the marital community acquired prior to the amendment of the California Civil Code on July 29, 1927, were wholly taxable to the husband. In so deciding, the court said in part:

Tfie Interest of tie liusband in the community property is such that the legislature can not vest any part thereof in the wife by legislation enacted subsequent to the acquisition of the community property. * * *
It seems too clear for discussion that if the legislature of California was powerless to shift the title to a portion of the community property from the husband to the wife, it is equally powerless to change their relationship to income derived from the community property vested in the husband.

In the instant case two of the patents (Nos. 1664883 and 1665457) resulted from applications filed by the decedent prior to July 29, 1927. It is now well settled that patent applications are property. Commissioner v. Stephens-Adamson Mfg. Co., 51 Fed. (2d) 681; Joseph H. Adams, 23 B. T. A. 71. Although the patents were not granted until after July 29, 1927, the interest of decedent therein remained the same as was his interest in the patent applications themselves. See quotations from McKay, a recognized authority on community property, in John M. King, 26 B. T. A. 1158, 1163. See also Stewart v. Stewart, supra. It follows that the entire profit from the sale of these two patents was wholly taxable to decedent. Hirsch v. United States, supra.

With respect to Letters Patent No. 1569280, which decedent acquired from his father on January 16, 1928, respondent contends that the assignment was a gift from the father to the son; that under section 168 of the Civil Code of California “ All property owned by the husband before marriage and that acquired afterwards by gift, bequest, devise, or descent, with the rents, issues, and profits thereof, is his separate property ”; and that, being his separate property, the decedent was taxable on the entire profit from the sale. In Granniss' Estate, 142 Cal. 1; 75 Pac. 324, the Supreme Court of California held that under section 163 (just quoted) the profits derived from the sale by the husband of his separate property remained his separate property. On the other hand, petitioner contends that the Superior Court of the State of California, in and for the County of Los Angeles, having determined in its order set out in our findings that decedent’s estate was “ community property,” it follows that since Patent No. 1569280 was acquired after July 29, 1927, to wit, January 16, 1928, the profit therefrom was taxable, under United States v. Malcolm, supra, one-half to decedent and one-half to decedent’s widow.

In support of his contention that the assignment was a gift, respondent offered an affidavit by decedent’s father, who testified in part as follows:

That the consideration for the assignment aforesaid was his natural love and affection for his said son, the fact that deponent was of advancing years and unable to develop the said patent, that his said son had for some time contributed and was then contributing to deponent’s maintenance and support; that his said son by reason of his large experience in inventions and his ability in that direction, was able to make experiments in connection therewith; and also that his said son was the owner of other patents for disk drills or drill bits, which made the disk bit aforesaid more available in his hands.

On the basis of the record made in this proceeding, we are of the opinion and so find that the assignment of Letters Patent No. 1569280 was a gift of the patent to decedent from his father. The findings of the county court that “said estate is community property,” is not res adjudioata in the instant proceeding. Guaranty State Bank of Greenville, Texas, 12 B. T. A. 543.

It follows that under section 163 of the Civil Code of California, supra, the last mentioned patent was decedent’s separate property, and that the entire profit from the sale thereof was taxable to the decedent.

The determination of the respondent is approved.

Reviewed by the Board.

Judgment will he entered for the respondent.


author: Murdock :

text:
    John J. Bliss, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 61270.
    Promulgated February 27, 1933.

      Robert Ash, Esq., for the petitioner.

      W. Frank Gibbs, Esq., for the respondent.
   OPINION.

Murdock :

Interest on an award made as just compensation for property taken through an exercise of the power of requisition or condemnation by the city of New York is not interest upon the obligations of a state, territory, or any political subdivision thereof within the meaning of section 22 (b) (4) of the Revenue Act of 1928. Leo M. Klein, 26 B. T. A. 745; Mary Lincoln Ishami, 26 B. T. A. 1040; United States Trust Co., Executor, v. Anderson, 60 Fed. (2d) 291. Cf. American Viscose Corp., 19 B. T. A. 937; affd., 56 Fed. (2d) 1033; Kansas City Southern Ry. Co., 16 B. T. A. 665; affd., 52 Fed. (2d) 372; certiorari denied, 284 U. S. 676. The Commissioner did not err in holding that this amount was income subject to tax.

The petitioner next contends that the award merely granted just compensation for the property taken and no taxable gain resulted. In his brief the petitioner merely states his contention and cities in support of it Evans v. Gore, 253 U. S. 245 and Myles v. Graham, 268 U. S. 501. Thus, the petitioner advances no argument that has not been answered satisfactorily by the Circuit Court of Appeals for the Eighth Circuit in Kansas City Southern Ry. Co., supra. It is true that that case differs from the present case. There the Federal Government had exercised its power of eminent domain to take the property for a temporary use only, the compensation was for this use and was based on earnings, and the same power which exercised its right of eminent domain also imposed taxes. Here the city of New York took the property, not temporarily, but permanently, the compensation was based upon the value of the property, and a different government has determined the tax, based upon the gain derived from the disposition of the property. There is less analogy between the present case and the two cases cited by the petitioner than there was between those two cases and the case decided by Judge Kenyon, for here the Federal Government is certainly not diminishing any obligation of its own. Cf. Washington Market Co., 25 B. T. A. 576. The proceeds of the condemnation, in so far as they constitute gain, are a part of the petitioner’s gross income for Federal tax purposes. Eastern Steamship Lines, Inc., 17 B. T. A. 787; section 112 (f) of the Revenue Act of 1928.

The petitioner now claims that the money received from the involuntary conversion of his property was expended in the acquisition of other property similar or related in service or use to the property converted, within the meaning of section 112 (f) of the Revenue Act of 1928. This claim was made for the first time at the hearing through an amendment to the petition. The excess of the amount of the award over the basis which the property had in the hands of the petitioner, after an adjustment for depreciation, was included by the petitioner in his return as a capital net gain. The respondent made a slight change in this item which the petitioner does not complain of, but the latter now seeks to show that the item never should have been taxed as income and, therefore, his taxes have been overpaid in a substantial amount. The property was involuntarily converted into money through the exercise of the power of requisition or condemnation by the city of New York and after it was taken the petitioner and his wife acquired an equity in other property which was similar or related in service or use to the property taken from them. But despite these facts the petitioner has failed to show how much of the money received through the award was “ forthwith in good faith, under regulations prescribed by the Commissioner with the approval of the Secretary expended in the acquisition of other property similar or related in service or use to the property converted ” as required by the section in question.

Clearly, a substantial part was not so expended, since some was used for other purposes. Encumbrances on the property condemned, tradesmen’s bills, and income taxes took a substantial portion. Nor have we been told exactly how much was expended in acquiring an interest in the new properties. Furthermore, we can not make even a reasonable approximation of the amount expended in acquiring the interest in the new property.

The petitioner did not attempt to be exact in the dates and figures which he gave. Each was only an approximate figure. He gave neither the date of acquisition nor the cost of any of the properties. Part of the cost was represented in mortgages, but, how much, he never said. He was the only witness. He testified entirely from memory. The cross examination brought out the fact that he was mistaken about the date when he and his wife had acquired the property later condemned. He testified that the property was condemned in May 1925. The final decree shows that if it was taken later than 1923 it was taken in 1928.

Obviously we can not hold that no gain shall be recognized in 1929. Neither can we reduce the amount of the gain to be recognized in 1929 from the figure determined by the Commissioner to any other definite amount. The scheme of section 112 (f) is to delay the recognition of gain or loss until the property substituted is disposed of: The substituted property, under other provisions of the statute, takes the basis of the old for gain or loss and for depreciation purposes. If any part of the gain is not to be recognized in 1929, the proof ought to be sufficiently accurate to disclose the data necessary to an intelligent administration of these other provisions of the statute, i. e., what particular property was acquired, the date acquired, and the cost to the taxpayer paid by funds from the award. The present petitioner has failed to show any of these facts with reasonable certainty. Chickasha Cotton Oil Co., 18 B. T. A. 1144.

Judgment will be entered for the respondent.


author: Smith:

text:
    Howard C. Hickman, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 37369.
    Promulgated February 27, 1933.

      Lynden Bowring, Esq., for the petitioner.

      J. M. Leinenhugel, Esq., for the respondent.
   opinion-.

Smith:

We have heretofore had occasion to discuss and apply the decisions of the Supreme Court (United States v. Robbins, 269 U. S. 315; Lucas v. Earl, 281 U. S. 112; United States v. Malcolm, 282 U. S. 792), regarding the taxability of income of spouses domiciled in California, and in proceedings presenting facts sufficient to sustain the existence of a prior agreement between the spouses that the earnings of either were to remain the separate property of the one whose labor produced the earnings, the Board has held that such earnings were not to be taxed to the husband as community property. The facts of record show that the petitioner and his wife had, for many years, abided by their agreement respecting the earnings of each, and the compensation here in controversy was clearly the income of the wife. Following those decisions, we hold that the respondent erred in taxing to the petitioner the separate earnings of his wife. Andrew B. C. Dohrmann, 19 B. T. A. 466; C. R. Davis, 20 B. T. A. 931; W. A. Both, 22 B. T. A. 587. See also F. J. Garman, 25 B. T. A. 162.

Judgment will be entered for the petitioner.


author: Sea well:

text:
    Robert A. Taft, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 51084, 66118.
    Promulgated February 27, 1933.

      Robert A. Taft, Esq., pro se.

      L. W. Greas on, Esq., for the respondent.
   OPINION.

Sea well:

We seek here to know and correctly to determine the true character and meaning of the transaction between the petitioner and Joseph R. Peebles’ Sons Company in reference to the lot in Cincinnati mentioned in the papers and other evidence olfered at the trial. It seems well settled that calling it a “ lease ” does not make it such, if, in fact, it is something else. Heryford v. Davis, 102 U. S. 235. “ Leases ” of personalty with the privilege of purchase are held conditional sales. Corbett v. Riddle, 209 Fed. 811; Burroughs Adding Machine Co. v. Bogdon, 9 Fed. (2d) 54; Hervey v. Rhode Island Locomotive Works, 93 U. S. 664. “Leases ” in reference to realty receive a like construction and upon the facts may be held to be sales. Alexander W. Smith, Jr., Executor, 20 B. T. A. 27; Jefferson Gas Coal Co. v. Commissioner, 52 Fed. (2d) 120; Herold v. Commissioner, 42 Fed. (2d) 942.

Taking the instrument (of July 9, 1927) by its “ four corners ”, and considering it in the light of the attending facts, we discover that its execution was preceded by an unequivocal offer of the petitioner to “ purchase ” the property at the price of $185,000. In the case of E. G. Robertson, 19 B. T. A. 534, the negotiations preceding the contract in the form of a lease included an oral agreement to purchase the land on the part of the lessee. This was considered by the Board as important and in the opinion it is said: “The intent of the parties to these transactions being to accomplish sales, we think the law must give such effect to them regardless of the forms employed.”

In the instant case the “ lease ” complied with the terms of the written “ offer to purchase ” in that the purchase price named therein, $135,000, added to the initial amount of $50,000 paid, makes exactly the $185,000 mentioned in the offer. The rental provided for in the lease after the payment of the $50,000 amounts to just 5 per cent per annum on the deferred payment of $135,000, a fair rate of interest on a loan with safe collateral. The provision of the contract of lease calling for an abatement of the “ rent ” in the sum of $50 per annum for every $1,000 paid on account of the privilege to purchase discloses the plan to continue a 5 per cent interest charge on the balance remaining due on the contract throughout. The rental value of the property, considered as a mere leasing proposition, was not rendered less by reason of the payments made; but considered as a contract of purchase of the property, of course, the interest should not be charged on deferred payments after they have been met and paid. It is further provided in the lease that if the building should be damaged by fire, tornado or windstorm, the recovery thereon shall be applied to restoring the same, or, at the option of the lessee, paid to the lessor as a partial payment on the privilege to purchase; and the rents thereafter shall be ratably reduced. It accordingly appears that for every payment on the balance owing on the contract there shall be a reduction of “ rent ”; while, although the building on the property might be totally destroyed with insufficient insurance funds to restore it to a condition of productivity, there is no provision of abatement of rent.

Another significant indication of the intention of the parties is the binding obligation of the petitioner, in any event, to pay, in addition to the initial payment of $50,000, the sum of $25,000 on July 10, 1932 (which was paid), and also $25,000 on July 10, 1937, a total of $100,000. Moreover, the petitioner is further obligated under the lease, to continue to pay the 5 per cent per annum on whatever amount of the original $185,000 remains unpaid until 1942, whether he decides to exercise, or not to exercise, his privilege to purchase in the meantime.

Considering all these facts and circumstances, it is not strange that the president and the representative of The Company, at the time, considered the transaction a sale, as he testified; nor that the petitioner himself should have testified, as he did in substance, that when the agreement was executed in 1927, he supposed that in 1942, with the stipulated payments having been made, the payment of the further sum of $85,000 would appear so advantageous to him that, of course, he would make it and take over the fee simple title to the property. It would appear difficult, in fact, to reach any other conclusion than that at the time of the execution of the paper dated July 9, 1927, and by it, considered in connection with the written offer of the petitioner to purchase, the parties intended a sale. Petitioner says, however, that while in Ohio leases with privilege to purchase, and perpetual leases are frequently referred to as sales, and while heavy initial payments and other fixed payments make more probable the exercise of the privilege to purchase, they do not compel such exercise, and that he has not yet elected to be a purchaser in this case and is consequently a lessee. In support of his position he cites article 130 of Regulations 74, and Weiss v. Wiener, 279 U. S. 333; Alameda, Park Co., 10 B. T. A. 1115; and Baton Coal Co., 19 B. T. A. 169.

The regulation referred to has no application, if the transaction we have under review was in fact a sale. In Weiss v. Wiener, supra, there was no contention that the lessee of the long term leases was really the owner of the buildings which he held under the leases. The Circuit Court of Appeals, however, said: “ For every practical purpose they are his buildings, and in our opinion they are his capital so far as they are consumed in his business.” With this conclusion the Supreme Court did not agree and it reversed the Circuit Court of Appeals, saying: He [Weiner, holder of the lease] must show an interest in the property and a present loss to him to make the statute apply.” Wiener sought not to spread the cost of his leases over their terms, in aliquot part deductions, as the petitioner in the instant case does, but to obtain obsolescence on buildings he held under lease contracts. Likewise, in Alameda Park Co., supra, there was no contention as to the nature of the transaction called a lease, but the lessee sought to deduct as operating expenses in 1917 all its income for that year which it had paid over under its contract of lease to the creditors of its lessor incurred by the lessor for certain capital expenditures. What would have been the result in the Board and in the District Court of Appeals, if the contention had been made that the transaction was, in fact, a sale, we need not here speculate. In Baton Coal Co., supra, there was no option or privilege to purchase in the contract of lease which had reference to the mining of coal and by its terms remained in force until the exhaustion of the coal vein estimated to be within 10 or 12 years. These authorities and contentions of the petitioner do not convince us of error in the action of the Commissioner and he is sustained on this point.

Somewhat as an alternative contention the petitioner alleges error on the part of the Commissioner for his failure to allow depreciation an the building “ in the event no amortization of leasehold is allowed.” It appears the Commissioner has established the rate and value for depreciation purposes on the building referred to, and as there was no evidence offered or reason shown at the hearing for disturbing that determination of the Commissioner, we must sustain it.

Judgment will be entered for the respondent.


author: Lansdon:

text:
    F. C. Hubbell, Petitioner, v. Commissioner of Internal Revenue, Respondent. Beulah C. Wachtmeister, Petitioner, v. Commissioner of Internal Revenue, Respondent. Grover C. Hubbell, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 51941-51943, 52758-52760, 54374, 55272, 55273.
    Promulgated February 27, 1933.

      J. Cr. Gamble, Esq., for the petitioners.

      W. E. Davis, Esq., for the respondent.
   OPINION.

Lansdon:

The respondent has asserted deficiencies in income taxes as follows:

Although the petition contains numerous allegations of error, there is really only one question presented for determination in these proceedings, namely, whether amounts retained by the trustees out of gross receipts of the trust to maintain a reserve for depreciation of trust assets, and to offset the undepreciated cost of obsolete buildings abandoned, constitute income distributable to the beneficiaries and taxable to them, as the respondent has determined. The material facts are presented in a written stipulation, which is hereby incorporated as a part of this report.

In F. C. Hubbell, 14 B. T. A. 1040; affd., 46 Fed. (2d) 446, certiorari denied, 283 U. S. 840, where the similar question as to prior years was presented, it was held that the trust instrument did not authorize the trustees to establish and maintain a reserve for depreciation by deductions from income and that the amounts so retained were distributable and taxable to the beneficiaries. Thereafter one of the beneficiaries brought suit in the District Court of Iowa for an accounting and to enjoin the trustees from making such deductions, alleging that the trust instrument did not authorize deductions for depreciation in computing the income distributable to the beneficiaries. On July 10,1931, the court rendered its decree for the defendant, holding that the trustees were authorized to set up a reserve for depreciation of trust property. The petitioners now urge that we are bound by the decree of the local Iowa court and that our previous opinion, which was aifirmed by the Circuit Court of Appeals, must be overruled.

A situation almost identical to that presented here was before the Circuit Court of Appeals for the Ninth Circuit in Commissioner v. Freuler, 62 Fed. (2d) 133. The court there held that in the circumstances the construction of the trust instrument by a state court is not binding on the Federal courts in determining income tax liability. In the instant case the petitioners seek to overrule a construction of the trust instrument by the Federal courts upon presentation of a local state court decree which was rendered subsequently. A similar contention was rejected by the District Court for the Western District of Kentucky in Fidelity & Columbia Trust Co. v. Lucas, 52 Fed. (2d) 298.

Upon authority of the Freuler case, sufra, which we think is controlling here, the respondent’s determination is approved.

Cf. Estate of Thomas Burke, 22 B. T. A. 337; affd., 62 Fed. (2d) 7.

Decision will be entered for the respondent.


author: ÁRUndell:

text:
    Harry C. Kayser, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 36652.
    Promulgated February 27, 1933.

      Edward Michling, Esq., for the petitioner.

      G. A. Bay, Esq., for the respondent.
   OPINION.

ÁRUndell:

The Lexington Avenue real estate was sold by petitioner in 1924 for $99,136.50. The respondent has taken as a basis for computing gain on this sale the March 1,1913, value of the property on the theory that petitioner acquired it in 1912 under his father’s will. Petitioner’s contention is that he acquired the property in 1922 upon the death of Fischer, and the then value is the proper basis for computation of gain.

The rule established by the decided cases, under the revenue acts prior to that of 1928, is that if a remainder interest vests upon the death of the ancestor, the date of death is the date of acquisition by the remainderman and the basic date for determining gain or loss. Rodman E. Griscom, 22 B. T. A. 979; William Huggett, 24 B. T. A. 669; Marian B. Pringle, 26 B. T. A. 362; Chandler v. Field, 58 Fed. (2d) 370; affd., 63 Fed. (2d) 13; Isabel R. Molter, 27 B. T. A. 442.

The statutes of the State of New York (§40, ch. 52, L. 1909, McKinney’s Consolidated Laws) declare that:

A future estate is either vested or contingent. It is vested, when there is a person in being, who would have an immediate right to the possession of the property, on the determination of all the intermediate or precedent estates. It is contingent while the person to whom or the event on which it is limited to take effect remains uncertain.

We think that under the above statute there can be little doubt that petitioner acquired a vested interest in the property upon the death of his father in 1912. The test as to vesting is stated in Moore v. Littel, 41 N. Y. 66, as follows:

If you can point to a man, woman, or child, who, if the life estate should now cease, would, eo instanti et ipso facto, have an immediate right of possession, then the remainder is vested.

This seems to be the settled rule of construction adopted by the courts of Yew York. See Knapp v. Clark, 84 Misc. Rep. 205; 146 N. Y. S. 926; In re Steinwender's Estate, 176 App. Div. 517; 163 N. Y. S. 309.

The law of Yew York as construed by its courts, and in most other jurisdictions, favors the vesting of estates, and unless a contrary intention is unequivocally expressed it will not be imputed. In Connelly v. O'Brien, 166 N. Y. 406; 60 N. E. 20, the court expressed the rule in this way:

A remainder is not to be construed as contingent in any case where it may fairly he construed to be vested, since the law favors the vesting of estates.

Under the above cases we hold that petitioner acquired a vested interest in 1912, and that accordingly March 1, 1913, is the basic date for determining the value. See also Isabel R. Molter, supra.

Petitioner points to the phrase “ I then give, etc.,” in the ninth clause of the will as operating to postpone vesting until after the termination of the life estates of the widow and Fischer. The same question was involved in Connelly v. O'Brien, supra, in which the will provided as follows:

I give all my estate, real and personal, after the payment of my debts, to my wife, Rose, during her life, and then to such of my children as may then be living, share and share alike.

In that case, after stating, as set forth above, that the law favors the vesting of estates, the court held that:

The adverbs of time,, tnerefore, such as “ when ”, “ then ”, “ after ”, “ from and after ”, etc. in a devise of a remainder limited upon a life estate, are construed to relate merely to the time of the enjoyment of the estate, and not to the time of its vesting in interest.

Similarly in Hersee v. Simpson, 154 N. Y. 495; 48 N. E. 890, the court held that words or phrases denoting time in a devise of a remainder limited upon a particular estate “ are construed to relate merely to the time of the enjoyment of the estate, and not to the time of its vesting”. This case collects a number of New York decisions to the same effect on this point.

The parties seem to be agreed that the subject of valuation here is the physical property as distinguished from the remainder interest. Cf. William Huggett, supra. In the absence, of a controversy on this point and an entire lack of evidence concerning it we feel bound to accept the value of the property as the basis upon which to calculate gain or loss. Cf. Isabel R. Molter, supra. The value of the remainder was probably less than that of property and if the respondent wished to claim an increased deficiency the burden was on him to establish the lower value.

The evidence fully sustains the respondent’s valuation of the property. Four qualified witnesses for the respondent testified, and their valuations as of March 1, 1913, ranged from $50,000 to $55,000. Moreover, on December 3, 1913, petitioner in connection with New York transfer tax on the estate filed with the Surrogate of New York County a schedule setting forth that the “estimated market value ” of the property was $48,000. Opposed to this was testimony of but one witness for the petitioner, who gave it as his opinion that the March 1, 1913, value was $10,600, without explanation as to how he arrived at that figure. We are satisfied that the fair market value of the property at the basic date was not in excess of $53,000.

Petitioner contends that there should be deducted from the sales price of the property the amount of $10,200, this being the aggregate of the yearly payments of $600 that he made to decedent’s widow. We know) of no provision of the statute which would permit the deduction from income of the amount so paid. If it is to enter into the computation of the income at all it would be as an addition to the basis rather than as a deduction from sales price. The basis used by the respondent in computing gain on the sale is the value of the entire property, that is, the fee, undiminished by the value of the life estates of the widow and Fischer. Undoubtedly in computing the cost of property the costs of extinguishing outstanding interests are properly included. But where the basis is value — as distinguished from cost — such costs can not possibly add to the value of the fee; their effect would be rather to decrease the value. It appears in this case that at the date of testator’s death there was a mortgage on the property in the amount of $28,000. Certainly it would not be proper to add that amount to the value of a fee interest, yet it would be necessary to discharge that encumbrance as well as the life estates,, before clear title to the property could be given. If the cost of discharging encumbrances is to be considered in determining the value of property, the extent to which they decrease value must first be shown. In this case no evidence was offered by either party to show the effect of the life interests on the value of the property. And where, as here, the value of the entire property without diminution for encumbrances is used by respondent as a basis, the petitioner is not entitled to add thereto the cost of discharging one of the liens.

In disposing of the issue concerning the gain realized by petitioner iñ 1924 on the sale of the Lexington Avenue property, we have not overlooked what appears to be a variance between the recitals of the quitclaim deed, on the one hand, and the facts as agreed and testified to, on the other hand. The only deed in evidence is one dated June 26,1912, by which the widow quitclaimed her interest in the property to Harry 0. Kayser, as executor , and trustee. It is alleged in the petition and admitted in the respondent’s answer that in June, 1912, petitioner procured a quitclaim deed from the widow. Petitioner on the witness stand testified that prior to March 1, 1913, he bought out the interest of the widow. In petitioner’s brief it is stated that he “ personally and not as trustee ” purchased the widow’s rights in the. property. There is nothing in the record to show that the quitclaim deed in evidence is the only conveyance to petitioner of the widow’s interest. In view of the agreement in the pleadings, the petitioner’s testimony, and his representation in his brief, we have proceeded on the theory that he personally acquired the interest of the widow.

The remaining question is whether petitioner is entitled to a loss deduction on account of the sale in 1924 of 60 shares of Stewart Dental Manufacturing Company stock. The stock had cost him $6,000 in 1914, and he transferred it to the president of the company in 1924 for the sum of $5. We can not doubt from the evidence that the stock was worthless in 1924.

But the evidence goes further than this and establishes with equal clarity that the stock became worthless some years prior to the taxable year. In fact Stewart, in an affidavit filed with the respondent and admitted in evidence in this proceeding, stated that in 1918 the company became insolvent and had no assets. While a sale is often convincing proof of a loss sustained, it must be a bona fide transaction. A stockholder may not select the year in which he will take a loss deduction by holding stock until long after it has become worthless and then disposing of it in a transaction like the one before us. See De Loss v. Commissioner, 28 Fed. (2d) 803. Stewart wanted the stock for a particular purpose and his offer of $5 does not establish that the stock continued to have a value during the years from 1918 to 1924. The statute allows deductions for loss in the years, sustained and in this case the loss clearly was sustained prior to 1924.

Decision will be entered wader Bule 50,.


author: Lansdon :

text:
    Wichita State Bank and Trust Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 47954, 60202.
    Promulgated February 27, 1933.

      Harry 0. Weehs, Esq., for the petitioner.

      J. M. Leinenhugel, Esq., for the respondent.
   OPINION.

Lansdon :

The respondent has determined deficiencies in income tax for the years 1926 and 1929 in the respective amounts of $4,661.23 and $475.52. The only issue is whether payments received by the petitioner in the taxable years as its pro rata share of proceeds from the liquidation of Texas state banks that had been members .of the depositors’ guaranty fund should be reported as income. The two proceedings were consolidated for hearing.

Petitioner is a banking corporation, operating under the laws of Texas, and was operating under the depositors’ guaranty fund system of Texas until it withdrew from the system some time in 1925. Pursuant to the statutory provisions governing that fund, petitioner, during 1924 and 1925, made both regular and special contributions to the fund system, totaling $26,819.14 and $31,226.48, respectively, which amounts were allowed as expense deductions in computing the net losses for those years allowable as deductions in computing 1926 income.

During the years 1924, 1925, 1926 and 1929 petitioner also received dividends from the fund system as credits of the liquidating banks with respect to which it had made special contributions pursuant to an assessment under the fund system. The total dividends received for each of the above years in their respective order were $7,850.29, $8,284.93, $8,542.11, and $4,322.90, which dividends were included in income in the year received in computing the deficiencies in question, those in 1924 and 1925 being so treated for purposes of computing net losses deductible from 1926 income.

The regular contributions, referred to above, were measured by a percentage of average daily deposits, and were paid in to create the fund. These contributions were made one-quarter in cash and three-quarters by establishing demand deposits. The contributions referred to above as special contributions or assessments were paid in cash pursuant to assessments made by the state treasurer, who was bailee of the fund, to replenish the fund after the banking commission had drawn on it to make good the loss of a member bank.

It was the special assessments that resulted in dividends being repaid to the petitioner and other member banks assessed, upon the liquidation of the failed banks. The period of liquidation was uncertain and the amount that would probably be repaid as dividends was difficult to estimate prior to complete liquidation. The dividend checks were drawn on the liquidating bank and were made out by the departmental liquidating agent. The administrative officers made no attempt to dictate how the contributing banks should treat these items.

Petitioner carried both contributions as assets on its books. Petitioner charged off its books on account of such assets, $44,931.52 in 1922, $24,000 in 1925, and $56,000 in 1926, leaving a total asset of $3,917 on petitioner’s books. Upon receipt of dividends from liquidating banks, petitioner credited the amount thereof to the capital asset account set up by reason of the contributions made to the fund.

The petitioner contends that in the liquidation of each bank that failed while it was a member of the depositors’ guaranty fund, it sustained a loss measured by the difference between the special assessment it paid on account thereof and the amount received from the liquidation. Apparently it does not question that annual or regular' contributions are properly deductible from its income as and when made as ordinary and necessary operating expenses, but contends that for tax purposes there is a distinguishable difference between the so-called regular contributions and the special assessments. In prior proceedings the Board has made no such differentiation and is still unable to do so. As we see it, there is no essential difference between a contribution to create such a fund and assessment to replenish and maintain it.

The Board has held that all contributions to the Texas depositors’ guaranty fund are ordinary and necessary expenses, deductible from income as and when made, and that recoupments from failed banks should be reported as income. First State Bank of Brackettville, 9 B. T. A. 975; First State Bank of Weimar, 10 B. T. A. 396. These decisions are consistent with the practice of the Commissioner as indicated by S. M. 3897, C. B. IV, p. 279, and by the dismissals of appeals therefrom. Upon the authorities above cited the' determination of the respondent is affirmed.

Decision will be entered for the respondent.